SEBI (Depositories and Participants) Regulations, 2018

What this chapter covers

This chapter carries 3 per cent of the III-A examination.

LEARNING OBJECTIVES: After studying this chapter, you should know about: Requirements for getting registered as a Depository Participant with SEBI · Rights and obligation of a depository participant · Manner of creation of Pledge or Hypothecation · Cases which are considered as a default by a depository participant · Code of conduct for depository participants

Where the relationship comes from. The relationship between the Depository Participants (DPs) and the depository is governed by an agreement made between the two under the Depositories Act, 1996, SEBI [Depositories and Participants] Regulations, 2018 and the Bye-laws of the Depository.

Three sources at once — the Act, these Regulations, and the depository's own bye-laws.

And registration comes first: before commencing business as a depository participant, it has to get registered with the SEBI as a Depository Participant.

16.1 Registration

Depository Participants are required to be registered with SEBI. The application for registration should be routed through the Depository concerned. The certificate of registration granted shall be valid unless it is suspended or cancelled by SEBI.

Routed through the depository — the depository is the first filter, which follows from the fact that the participant will act as its agent.

And the certificate does not expire on its own — it runs unless it is suspended or cancelled by SEBI.

The stockbroker route. A SEBI registered stockbroker can become a depository participant provided stock broker shall have a net worth of rupees three crores {within one year of the date of notification of the Securities and Exchange Board of India (Depositories and Participants) (Amendment) Regulations, 2022}, which shall be increased to rupees five crores {within two years of the date of notification of the... (Amendment) Regulations, 2022}.

Three crore within one year, five crore within two.

And a further route: a self-clearing member fulfilling the net worth requirements as provided under the Securities and Exchange Board of India (Stock Brokers) Regulations, 1992 shall also be eligible to register as a depository participant.

Two continuing conditions and a character test. Depository participant has to fulfil the criteria of fit and proper person for SEBI to grant registration · Depository participants shall always comply with the conditions of registration · Depository participants shall always comply with the Code of Conduct.

Note the word "always" — these are not entry tests but standing obligations, which is why the first review question is True: registration with SEBI is mandatory before functioning as a participant.

16.2 Rights and obligations

Basic Services Demat Account. The Depository Participants shall provide 'Basic Services Demat Account (BSDA)' facility in the manner prescribed by SEBI.

The agreement with the investor. A Depository Participant should enter into an agreement in the prescribed format (as specified in the Depository's Bye-laws) with a beneficial owner before acting as a depository participant on his behalf.

Before acting — the agreement precedes the service, and its format comes from the depository's bye-laws.

Segregation. A separate account should be maintained for each Beneficial Owner (BO) and the securities of each beneficial owner should be segregated.

Instructions. Transfer to and from the accounts of the BO should be made only on receipt of instructions from the beneficial owner and thereafter confirm the same to the beneficial owner.

Only on instructions, and with confirmation afterwards — the rule the Reliance Capital case turned on.

And the trail must exist: every entry in the BO's account shall be supported by electronic instructions or any other mode of instruction received from the beneficial owner.

Statements. Every depository participant shall provide statements of account to the beneficial owner in such form and in such manner and at such time as provided in the agreement with the beneficial owner.

Withdrawal. BO should be allowed to withdraw or transfer securities from its account in a manner as specified in the agreement with the BO.

Connectivity. Depository Participant should maintain continuous electronic means of communication with each depository for which it is a participant.

Internal controls. Adequate mechanism for the purposes of reviewing, monitoring and evaluating the internal accounting controls should be in place.

Three verbs — reviewing, monitoring and evaluating — which is the second review question: all of these.

Returns. Depository Participants should submit periodic returns to SEBI and Depository in the specified format specified by SEBI or bye-laws of the depository, as the case may be.

No delegation. Depository Participant should not delegate its functions to any other person without prior approval of the Depository.

The rule breached in Reliance Capital.

Dematerialisation timeline. In case of a request for dematerialization, Depository Participant should, within 7 days of receipt of security certificate, furnish the same to the Issuer, who then within 15 days shall cancel the security certificate and substitute in its records the name of the Depository as the registered owner and shall send the details of the same to the Depository and to every stock exchange where the security is listed.

Seven days for the participant, fifteen for the issuer.

Pledge requests. A Depository Participant, on receiving the request for pledge or hypothecation from a beneficial owner/client, shall after satisfaction that the securities are available for pledge or hypothecation, forward the application to the Depository after necessary notings.

And a standing obligation: the depository participant shall ensure compliance with the Investor Charter specified by the Board from time to time.

16.2.1 Records of services

Depository participants should maintain the following records:

Records of all transactions entered into with the Depository and with clients (beneficial owners).

Details of securities dematerialized and rematerialized on behalf of clients with whom it has entered into an agreement.

Records of instructions received from clients and statements of account provided to clients.

Records of approval, notice, entry and cancellation of pledge or hypothecation, as the case may be.

Four heads — transactions, demat and remat, instructions and statements, and the pledge cycle.

How they must be kept.

Preserved by the Depository Participant for a minimum of 8 years. However, if any enforcement agency has taken a copy of any documents and records, then the originals of such records (whether electronic or physical) should be maintained for such a period till the trial or investigation proceedings are over.

Eight years ordinarily; longer where an investigation is running.

Maintained separately for each Depository, if a Depository Participant enters into an agreement with more than one Depository.

Reconciled by the Depository Participant with the Depository on a daily basis.

Daily — the third review question.

And two more: the location of the records and documents should be intimated to SEBI, and where records are kept electronically, the depository participant should ensure that the integrity of the data processing systems is maintained and take adequate precautions against the records being lost, destroyed or tampered with and in the event of loss or destruction, ensure the availability of sufficient back up of records at all times at a different place.

Backup at a different place — geography matters in a disaster.

Finally: a depository participant should make available all records to the depository for inspection matters relating to the transfer of securities, maintenance of records of holders, handling of physical securities.

16.2.2 to 16.2.5 Grievances, advice, compliance officer and inspection

Grievances. Depository Participant should redress the grievances of the investors promptly but not later than 21 calendar days from the receipt of grievance in such manner as may be specified by SEBI.

Twenty-one calendar days — as for stockbrokers, portfolio managers, merchant bankers and bankers to an issue.

Investment advice. A depository participant or any of its employees shall not render directly or indirectly, any investment advice about any security in the publicly accessible media, whether real-time or non-real-time, unless disclosure of his interest including a long or short position in the said security has been made while rendering such advice.

And where the firm advises: he shall also disclose the interest of his dependent family members and the employer including their long or short position in the said security while rendering such advice.

Compliance officer. A depository participant shall appoint a compliance officer, who shall be responsible for monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions etc. issued by SEBI or the central government and for redress of investor grievances. The Compliance Officer should immediately and independently report to SEBI any non-compliance observed by him.

Plus a periodic report: the compliance officer shall submit a report of any non-compliance of the Act, the Depositories Act, 1996, rules, regulations, circulars or directions issued thereunder and for the redressal of investors' grievances, to the Board on a quarterly basis in the manner as may be specified by the Board.

Immediate reporting for a breach, quarterly reporting as a matter of course.

Inspection. It shall be the duty of the depository participant whose affairs are being inspected or investigated to produce to the inspecting authority such books, accounts, securities, records and other documents in its custody or control and furnish him with such statements and information relating to his activities within a specified time period as the inspecting officer may specify.

16.3 Action in case of default

A depository or a depository participant who –

contravenes any of the provisions of the SEBI Act, the Depositories Act, the bye-laws, agreements or SEBI (Depositories and Participants) Regulations;

fails to furnish any information relating to its activity as a depository or participant as required under these regulations;

does not furnish the information called for by SEBI under the Depositories Act or furnishes false or misleading information;

does not co-operate in any inspection or investigation or enquiry conducted by SEBI;

fails to comply with any direction of SEBI issued under regulation 18 of the Depositories Act;

fails to pay the annual fee;

shall be dealt with in the manner provided under Chapter V of the SEBI (Intermediaries) Regulations, 2008.

Six grounds, one procedure — and note the third: furnishing false or misleading information is as much a default as furnishing none.

16.3.1 Creating a pledge or hypothecation

The Depository within 15 days from receipt of the application, shall after concurrence of the pledgee through its participant, create and record the pledge and send intimation of the same to the participants of the pledgor and the pledgee.

If the Depository does not create the pledge, it shall send along the with the reasons an intimation to the participants of the pledger and the pledgee.

Fifteen days, and reasons if refused.

Invocation. Basis the provision of pledge document, the pledgee may invoke the pledge and, on such invocation, the depository shall register the pledgee as the beneficial owner of such securities, amend its record and send intimation to participants, who in turn would intimate the pledgor and pledgee.

On invocation the pledgee becomes the beneficial owner — the entry is not merely noted, it is transferred.

**And: the above applies mutatis mutandis in case of hypothecation.

The participant's own step comes earlier. On receiving a request, it shall after satisfaction that the securities are available for pledge or hypothecation, forward the application to the Depository after necessary notings — it verifies availability, it does not create the pledge itself.

16.4 Code of conduct

The third schedule of the SEBI (Depositories and Participants) Regulations 2018 prescribes the Code of Conduct for Participants.

The core duties. A Participant shall make all efforts to protect the interests of investors, and shall always endeavour to – render the best possible advice to the clients having regard to the clients' needs and the environments and his own professional skills; ensure that all professional dealings are affected in a prompt, effective and efficient manner; inquiries from investors are adequately dealt with; grievances of investors are redressed without any delay.

Integrity: a Participant shall maintain high standards of integrity in all its dealings with its clients and other intermediaries, in the conduct of its business.

Promptness in the operational core: a Participant shall be prompt and diligent in the opening of a beneficial owner account, dispatch of the Dematerialization Request Form (DRF), Rematerialisation Request Form (RRF) and execution of Debit Instruction Slip and in all the other activities undertaken by him on behalf of the beneficial owners.

Complaints: a Participant shall endeavour to resolve all the complaints against it or in respect of the activities carried out by it as quickly as possible and not later than one month of receipt.

Charges: a Participant shall not increase charges / fees for the services rendered without proper advance notice to the Beneficial Owners.

Which is the fourth review question — True.

Market conduct: no unfair competition, which is likely to harm the interests of other Participants or investors or is likely to place such other Participants in a disadvantageous position · no exaggerated statement whether oral or written to the clients either about its qualifications or capability to render certain services or about its achievements in regard to services rendered to other clients · and no divulging to other clients, press or any other person any information about its clients which has come to its knowledge except with the approval / authorization of the clients or when it is required to disclose the information under the requirements of any Act, Rules or Regulations.

Towards the regulator: co-operate with SEBI as and when required · maintain the required level of knowledge and competency and comply with the award of the Ombudsman passed under SEBI (Ombudsman) Regulations, 2003 · make no untrue statement or suppress any material fact in any documents, reports, papers or information furnished to SEBI · not neglect or fail or refuse to submit to SEBI or other agencies with which it is registered, such books, documents, correspondence, and papers · and ensure SEBI is promptly informed about any action, legal proceedings etc., initiated against it in respect of material breach or non-compliance.

Operational discipline — three clauses that are peculiar to this intermediary.

A Participant shall maintain a proper inward system for all types of mail received in all forms.

A Participant shall follow the maker-checker concept in all of its activities to ensure the accuracy of the data and as a mechanism to check unauthorized transactions.

A Participant shall take adequate and necessary steps to ensure that continuity in data and record-keeping is maintained and that the data or records are not lost or destroyed. It shall also ensure that for electronic records and data, up-to-date backup is always available with it.

Maker-checker is the heart of it — one person enters, another verifies, so that no single individual can move securities alone.

Governance: provide adequate freedom and powers to its compliance officer for the effective discharge of his duties · ensure satisfactory internal control procedures... as well as adequate financial and operational capabilities which can be reasonably expected to take care of any losses arising due to theft, fraud and other dishonest acts, professional misconduct or omissions · be responsible for the acts or omissions of its employees and agents in respect of the conduct of its business · ensure that the senior management, particularly decision-makers have access to all relevant information about the business on a timely basis · and ensure that good corporate policies and corporate governance are in place.

Case 16.1 — SEBI v Reliance Capital Ltd

The facts. Inspection was conducted of RCL for period April 2010 - March 2012 wherein majority period pertained to DP activities carried out by RCL before DP functions were transferred to Reliance Securities Ltd (RSL).

From the records it was established that RCL delegated its DP functions to RSL (prior to approval from depositories for transfer of DP operations).

And the rule: in terms of regulation 52 of the DP Regulations, the DPs are restricted from delegating their functions as a participant to any other person, without the prior approval of the depository. RCL have violated the provisions of regulation 52 of DP Regulations and clause 2 of the Code of the Conduct.

The second charge concerned powers of attorney. The complaints were received at the DP's end on or after December 2010. Further... the PoA had to be modified as mandated vide SEBI circulars dated April 23, 2010 and August 31, 2010 to be implemented by September 01, 2010. It is alleged that the authority/powers granted under PoA were utilized to debit shares from the client's Demat account to cover debit in a trading ledger which would not have been the case had the PoA been suitably amended as per indicated timeline of the circulars.

Shares taken from a demat account to cover a trading-ledger debit — a use of the power of attorney the circulars were designed to stop.

The findings. An administrating warning was issued by SEBI vide letter dated March 21, 2014, to the RCL for the conduct which were rectifiable in nature and mainly on (a) No email id was specifically marked for DP related complaints, (b) Mismatch in a number of complaints submitted to SEBI vide pre-inspection questionnaire and CDSL vide Investor grievance reports and (c) the Wrong classification of complaints. The adjudication proceedings are in addition to and not in duplication of the charges for which Administrative Warning was issued.

On the transfers: as per regulation 42(2) and 42(3) RCL was obligated to transfer securities to or from beneficial owners account only on receipt of instruction from the beneficial owner... RCL failed to provide any receipt of instruction (electronic or otherwise). Therefore, RCL has violated the provisions of regulation 42(2) and 42(3) of DP Regulations and clauses 2 and 4 of the Code of the Conduct.

No instruction on record means no authority — the burden is on the participant to produce it.

And on the power of attorney: complaints would not have occurred in the first place if the RCL had revoked the PoA and implemented the circular. The circulars relate to the execution of PoA by the client in favour of stockbroker & DP, and same were issued in the interest of the investors and to protect them from any misuse of the clauses under PoA. Any non-adherence of the same cannot be considered as mere technical omission.

Not a mere technical omission — the sentence to remember.

**Order: consolidated monetary penalty of Rs 1 lakh on RCL.

The chapter's review questions confirm that it is True that an entity must be registered with SEBI as a depository participant before functioning as one; that the internal accounting controls mechanism must provide for reviewing, monitoring and evaluating — all of these; that records must be reconciled with the depository on a daily basis; and that it is True that a participant may not increase charges or fees without proper advance notice to beneficial owners.