The Depositories Act, 1996

What this chapter covers

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

LEARNING OBJECTIVES: After studying this chapter, you should know about: Rights and Obligations of depositories · Enquiry and Inspection of depositories, DPs by SEBI · Penalties applicable in case of infringement of the conditions laid down in the depositories act or related regulations.

13.1 What the Act does

The Depositories Act, 1996 provides for the establishment of depositories in securities to ensure free transferability of securities with speed, accuracy and security by (a) making securities freely transferable subject to certain exceptions; (b) dematerialization of the securities in the depository mode; and (c) providing for the maintenance of ownership records in a book-entry form.

Three mechanisms, one object — free transferability of securities with speed, accuracy and security.

That is the first review question — the Act providing for the establishment of depositories is the Depositories Act.

In order to streamline the settlement process, the Act envisages the transfer of ownership of securities electronically by book entry. The Act has made the securities of all companies freely transferable in the depository mode, restricting the company's right to use discretion in effecting the transfer of securities. The other procedural and the transfer deed requirements stated in the Companies Act have also been dispensed with.

Two things were taken away from the company — its discretion to refuse a transfer, and the paperwork of transfer deeds.

The IFSC carve-out. International Finance Securities Centre Authority Act, 2019 (IFSCA Act) read with Section 23G of Depositories Act clarifies that the powers exercisable by SEBI under Depositories Act, 1996 shall not extend to International Finance Service Centres set up under 18(1) of Special Economic Zones Act, 2005. Powers under this Act, shall be exercisable by the International Finance Services Centres Authority established under section 4(1) of IFSCA Act in so far as regulation of financial products, financial services and financial institutions are permitted in International Finance Services Centre are concerned.

Inside an IFSC, the IFSCA exercises these powers, not SEBI.

13.2 Rights and obligations of depositories

An entity intending to act as a depository participant should enter into an agreement with the Depository in the prescribed format.

That is the third review question — with the Depository, not the bank, the issuer or a broker.

Every depository shall on receipt of intimation from a participant, register the transfer of security in the name of the transferee. If the beneficial owner or a transferee of any security seeks to have custody of such security the depository shall inform the issuer accordingly.

Every person subscribing to securities shall have the option either to receive or hold securities certificates with a depository and if the person opts to hold with a depository, the issuer shall intimate depository the details of allotment and on receipt of such information, the depository shall enter the name of allottee as the beneficial owner of the security.

The investor chooses — certificate or depository.

All securities held by a depository shall be dematerialized and shall be in fungible form.

"Fungible" is the key word. In a depository one share of a company is indistinguishable from another; there are no distinguishing certificate numbers to track.

The register and index of beneficial owners maintained by a depository under Section 11 of the Depositories Act, 1996 shall be deemed to be the corresponding register and index under the Companies Act.

Depository shall inform the issuer about the transfer of securities in the name of beneficial owners at such intervals and as prescribed by bye-laws.

Registered owner and beneficial owner. Depository shall be deemed to be the registered owner for the purpose of effecting transfer of ownership of security on behalf of a beneficial owner. However, Depository as a registered owner shall not have any voting rights or any other rights in respect of securities held by it.

And correspondingly: the beneficial owner shall be entitled to all rights and benefits and be subjected to all the liabilities in respect of his securities held by a depository.

The name is with the depository; the ownership is with the investor. That separation is what makes electronic transfer possible without the company having to re-register every trade.

Opting out. If a beneficial owner seeks to opt-out of a depository in case of any security, he shall inform the depository accordingly. Thereafter, the depository shall make appropriate entries in its records and inform the issuer accordingly. The issuer on fulfilment of all conditions as per the regulations by the depository shall issue new certificates to the beneficial owner within thirty days of the receipt of information from the depository.

Thirty days to issue new certificates.

Indemnity. When any loss is caused to the beneficial owner due to negligence of the depository or the participant, the depository shall indemnify the beneficial owner. Where such loss is indemnified by the depository, it can recover the same from the participant where such loss is due to the negligence of the participant.

The investor looks to the depository; the depository looks to the participant. The investor is not made to chase the party who was actually careless.

13.3 Enquiry and inspection

SEBI may call upon any issuer, depository, depository participant or beneficial owner to furnish information in writing relating to the securities held in a depository. SEBI may also require or it may authorize any person to make an enquiry or inspection in relation to the affairs of the issuer, beneficial owner, depository participant who shall submit a report of such enquiry or inspection to it within the period specified by SEBI.

Note that the beneficial owner is included — the investor himself may be asked for information.

Every director, partner, manager, officer, employee or secretary of the depository or beneficial owner or issuer or participant shall produce all information and documents as per the requirement of the person conducting the enquiry or inspection.

After making or causing to be made an enquiry, SEBI can issue appropriate directions to the depository or participant or any person associated with securities market or to any issuer as may be appropriate in the interest of investors or the securities market.

And the disgorgement power is spelt out: it is hereby declared that the power to issue directions under this section shall include and always be deemed to have been included the power to direct any person, who made a profit or averted loss by indulging in any transaction or activity in contravention of the provisions of this Act or regulations made thereunder, to disgorge an amount equivalent to the wrongful gain made or loss averted by such contravention.

"And always be deemed to have been included" — the declaration is retrospective, putting past disgorgement orders beyond challenge.

And note both limbs — the wrongful gain made or loss averted. Avoiding a loss is treated the same as making a profit.

13.3.1 Penalties

Section 19A — failure to furnish information, return etc. applies to any person who is required under this Act or any rules or regulation or bye-laws made thereunder, and covers two defaults:

1. Failure in furnishing any information, document, books, returns or report to SEBI or filing any return within the time specified thereof, or filing of false, incorrect or incomplete information, return, report, books or other documents, shall make him liable to a penalty which shall not be less than one lakh rupees but which may extend to one lakh rupees for each day during which such failure continues subject to a maximum of one crore rupees.

2. For failure to maintain books of account or records – a penalty which shall not be less than one lakh rupees but which may extend to one lakh rupees for each day during which such failure continues subject to a maximum of one crore rupees.

The one crore maximum in the first limb is the fourth review question.

Four more sections carry exactly the same formula — not be less than one lakh rupees but which may extend to one lakh rupees for each day during which such failure continues subject to a maximum of one crore rupees:

Section 19B — for failure to enter into an agreement either by an intermediary or any issuer.

Section 19C — where an entity, being depository or participant or issuer or its agents or intermediary, fails to address investors' grievances after being asked by SEBI within the given time.

Section 19D — for delay in dematerialization or issue of a certificate of securities.

Section 19F — where any person fails to comply by the SEBI directions issued under section 19 of the Depositories Act within a specified time.

Five sections, one formula. A floor of one lakh, a daily accrual of one lakh, and a ceiling of one crore.

Section 19FA is different, and far heavier. A penalty for failure to conduct business in a fair manner can be imposed. If a depository fails to conduct its business with its participants or any issuer or its agent or any person associated with the securities markets in a fair manner in accordance with the made rules, regulations or the directions issued by SEBI under this Act, then it shall be liable to a penalty which shall not be less than five crore rupees but which may extend to twenty-five crore rupees or three times the amount of gains made out of such failure, whichever is higher.

Five crore to twenty-five crore, or three times the gains. The section applies to a depository — a market infrastructure institution — and the amounts reflect that.

Section 20 is criminal. Without prejudice to any award of penalty by adjudicating officer or SEBI, if any person contravenes or attempts to contravene or abets the contravention of the Depositories Act or rules or regulations or bye-laws made thereunder or fails to pay the penalty imposed by the adjudicating officer or to comply with any of his directions or orders, then such person shall be punishable with imprisonment for a term which may extend up to 10 years, or with fine up to Rs. 25 crores, or with both.

Note the breadth — contravention, attempts to contravene, abetment, failure to pay a penalty, and failure to comply with directions or orders.

13.4 Composition, immunity and appeals

Composition of offences

Notwithstanding anything contained in the Code of Criminal Procedures, any offence punishable under this Act, not being an offence punishable with imprisonment only, or with imprisonment and also with fine, may either before or after the institution of any proceeding, be compounded by the Securities Appellate Tribunal (SAT) or a court before which such proceedings are pending.

What can be compounded is defined negatively — anything except an offence punishable with imprisonment only or with imprisonment and also with fine.

**And it may be done either before or after the institution of any proceeding.

Immunity

The Central Government may, on recommendation by SEBI and if satisfied, grant immunity from prosecution or penalty to a person, who is alleged to have violated Depositories Act or the rules or regulations made thereunder, if such person has made full and true disclosure of such alleged violation.

Full and true disclosure is the price of immunity — which is the second review question, answered True.

One limit: no such immunity may be granted where the prosecution proceedings have already been initiated before the receipt of an application for grant of immunity.

And SEBI's view is advisory only: the recommendation of SEBI under this sub-section is not binding upon the Central Government.

Immunity can also be lost: the government may also withdraw immunity given to a person if it is satisfied that such person had given false evidence and hence may be tried for the offence.

Appeals

Any person aggrieved by an order of the SEBI made under this Act or the regulations made thereunder may prefer an appeal to the Central Government within such time as may be prescribed.

Appeal to the Securities Appellate Tribunal.

Any person aggrieved by an order of the SEBI or Adjudicating Officer (AO) may prefer an appeal to the SAT.

Every appeal shall be filed within a period of 45 days from the date on which a copy of the order made by SEBI or AO is received by the aggrieved party in such format and accompanied by such fees as prescribed.

Provided that the SAT may entertain an appeal after the expiry of the said period of 45 days if it is satisfied that there was sufficient cause for not filing it within that period.

Forty-five days, extendable for sufficient cause.

On receipt of an appeal, the SAT may, after giving the parties to the appeal an opportunity of being heard, pass such orders thereon as it thinks fit, confirming, modifying or setting aside the order appealed against.

The SAT shall send a copy of every order made by it to the SEBI, the parties to the appeal and the concerned AO.

And on representation: the appellant may either appear in person or authorize one or more chartered accountants or company secretaries or cost accountants or legal practitioners or any of its officers to present his or its case before the SAT.

Four professions and one's own officers — a wider right of audience than an ordinary court allows.

Appeal to the Supreme Court. Any person aggrieved by any decision or order of the SAT may file an appeal to the Supreme Court within 60 days from the date of communication of the SAT order to him on any question of law arising out of such order. Provided that the Supreme Court may, if it is satisfied, allow the appeal to be filed within a further period not exceeding 60 days.

Sixty days, on a question of law, with a further sixty days possible.

The chapter's review questions confirm that the Depositories Act provides for the establishment of depositories; that immunity requires full disclosure of the violation — True; that a depository participant enters into an agreement with the Depository; and that the maximum penalty for failure to furnish information is Rs. One Crore.