Securities Contracts (Regulation) Act, 1956 and Rules, 1957

What this chapter covers

This chapter carries about 4 per cent of the III-C examination.

LEARNING OBJECTIVES: After studying this chapter, you should know about: Key features of SCRA, 1956 and provisions such as call for periodical returns and contracts and options in securities · Key features of Securities Contracts (Regulation) Rules, 1957 and provisions such as eligibility criteria for membership, contract between members, audit of members and book of accounts.

5.1 The Securities Contracts (Regulation) Act, 1956

The Securities Contracts (Regulation) Act, 1956 provides for direct and indirect control of virtually all aspects of securities trading and the running of stock exchanges. This Act aims to prevent undesirable transactions in securities.

It gives the Central Government the regulatory jurisdiction over (a) stock exchanges through a process of recognition and continued supervision, (b) contracts in securities, and (c) listing of securities on stock exchanges.

Three heads of jurisdiction — exchanges, contracts, listing.

The objective of SC(R)A is to prevent undesirable speculation and to regulate contracts and transactions in securities.

And the reason it exists at all: a transaction in securities between two persons is essentially a contract. The law that specifically applies in the case of a securities contract is the SC(R)A.

That single sentence answers the fourth review question. The manner in which the derivatives contracts and other contracts should be dealt in the securities market is prescribed by the SCRA, 1956 — not the Public Debt Act, not the Depositories Act, not the Companies Act.

5.1.1 Call for periodical returns

Section 6(2) of SCRA requires every member of a recognized stock exchange to maintain and preserve for such periods not exceeding 5 years such books of accounts and other documents as the Central Government may prescribe after consultation with the concerned stock exchange, and such books of accounts and other documents shall be subject to inspection by SEBI.

Note two things. The outer limit is not exceeding 5 years; and the records are subject to inspection by SEBI.

This is the second review question. Members of stock exchanges are required, under the SCRA, to preserve books and accounts and other documents for a specific period of time — not a net worth certificate, not a registration certificate.

Section 6(3) of SCRA provides that SEBI, in the interest of trade or the public interest, may by order in writing –

Call upon a recognised stock exchange or any member thereof to furnish in writing such information or explanation relating to the affairs of the stock exchange or of the member in relation to the stock exchange as SEBI may require; or

Appoint person(s) to make inquiry into the affairs of the governing body of a stock exchange or the affairs of any of the members of the stock exchange in relation to the stock exchange and submit a report of the same to SEBI within such time as may be specified in the order or it may direct the governing body of the stock exchange to make the inquiry and submit its report to SEBI in the case of an inquiry in relation to the affairs of any of the members of a stock exchange.

So SEBI may inquire itself, or direct the exchange's governing body to inquire into its own members.

Section 6(4) tells us who must cooperate. Where an inquiry has been undertaken, every director, manager, secretary or other officer of such stock exchange; every member of the concerned stock exchange; every partner, manager, secretary or other officer of the firm (if the member of the stock exchange is a firm); and every other person or body of persons who has had dealings in the course of business (directly or indirectly) with any of the persons mentioned earlier, shall be bound to produce before the inquiring authority all such books of accounts and other documents in its custody or power, which relates to or have bearing on the subject matter of such inquiry and shall also furnish such statement or information relating to the inquiry as the inquiring authority may require.

The last limb is the widest — anyone who has had dealings in the course of business (directly or indirectly) with those persons is bound too.

And refusing has consequences. Under section 23, failing without reasonable excuse (the burden of proving which shall be on him) to comply with a requisition under sub-section (4) of section 6 is an offence.

5.1.2 Contract as principal

Section 15 of SCRA provides that no member of a recognised stock exchange shall in respect of any securities enter into any contract as a principal with any person other than a member of a recognised stock exchange, unless he has secured the consent or authority of such person and discloses in the note, memorandum or agreement of sale or purchase that he is acting as a principal.

Two requirements — consent or authority, and disclos[ure] in the note, memorandum or agreement of sale or purchase that he is acting as a principal.

And a timing rule: a stockbroker may enter into a contract, as a principal with any other person only if written consent is received from such person within 3 days from the date of the contract and disclosure to this effect is made on the contract note.

Three days for the written consent.

Section 18 excludes Spot contracts from the above requirement.

Why the section exists. A broker normally acts as an agent, matching a client with the market. When he takes the other side himself, he becomes a principal and his interest is opposed to his client's. The Act does not forbid it — it demands consent and disclosure.

Note the exclusion in the section itself: the consent requirement bites where the counterparty is any person other than a member of a recognised stock exchange. Between two members of a recognised exchange, the section's consent condition is not engaged in the same way — which is the background to the third review question, framed in the paper as True.

And the written consent is itself a record to be preserved — under Rule 15(2), written consent of clients in respect of contracts entered into as principals must be kept for 2 years.

5.1.3 Penalties and procedures

Sections 23 to 26 provide for the different penalties and procedures to be imposed upon any person /intermediary on non-compliance with any of the provisions given under the various rules and regulations governing the securities market in India.

Section 23 — the criminal provision

Any person who,

(a) Without reasonable excuse (the burden of proving which shall be on him) fails to comply with any requisition made under sub-section (4) of section 6, or

(b) Enters into any contract in derivative in contravention of section 18A or the rules made under section 30; or

(c) Not being a member of a recognised stock exchange or his agent authorised as such under the rules or bye-laws of such stock exchange or not being a dealer in securities licensed under section 17 wilfully represents to or induces any person to believe that contracts can be entered into or performed under this Act through him;

shall without prejudice to any award of penalty by the adjudicating officer or the SEBI under the Act on conviction, be punishable with imprisonment for a term which may extend to ten years or with a fine which may extend to Rs. 25 crore or with both.

Ten years, twenty-five crore, or both — and without prejudice to any award of penalty, so a monetary penalty may run alongside.

Section 18A, referred to in limb (b), is worth quoting: notwithstanding anything contained in any other law for the time being in force, contracts in derivatives shall be legal and valid if such contracts are (a) traded on a recognized stock exchange, and (b) settled on the clearing house of the recognised stock exchange, in accordance with the rules and bye-laws of such stock exchange.

Two conditions, both required — traded on a recognised exchange and settled on its clearing house.

The monetary penalties

Notice that 23D has no daily accrual — it is a straight one lakh to one crore. And 23E is the heaviest, with a five lakh floor and a twenty-five crore ceiling, because listing and delisting conditions protect the whole body of public shareholders.

Settlement, recovery, death and appeal

Section 23JA of SCRA provides for application in writing to the SEBI proposing for settlement of proceedings initiated or to be initiated for the alleged defaults. The SEBI after taking into consideration the nature, gravity and impact of defaults, may agree to the proposal for settlement, on payment of such sum by the defaulter or on such other terms as may be determined by SEBI.

Two consequences follow. No appeal lies against any order passed under this section. And all settlement amounts excluding the disgorgement amount and legal costs realised are credited to the Consolidated Fund of India.

Section 23JB sets out the procedure to be followed by the Recovery Officer of SEBI in case of non-payment of the penalty imposed under this Act by the adjudicating officer for refund of monies or compliance of disgorgement order issued under Section 12A. Recovery may be made in one or more of five modes:

i. attachment and sale of persons movable property

ii. attachment of person's bank accounts

iii. attachment and sale of person's immovable property

iv. arrest of the person and his detention in prison

v. appointing a receiver for the management of the person's movable and immovable properties

Section 23JC states that where a person dies, his legal representative shall be liable to pay any sum which the deceased would have been liable to pay, if he had not died, in the like manner and to the same extent as the deceased. However, the legal representative is liable only in case the penalty is imposed before the death of the deceased person.

The proviso is the point — a penalty not yet imposed does not pass to the estate.

Section 23L states that any person aggrieved by the order or decision of recognised stock exchange or adjudicating officer or any order made by SEBI may prefer an appeal before Securities Appellate Tribunal within forty-five days from decision of order is received by the appellant.

Forty-five days, the same period as under section 15T of the SEBI Act — and note that an order of a recognised stock exchange is appealable too.

Sections 26A to 26E have been introduced in the SCRA with respect to the establishment of Special Courts. The provisions state that the Central Government may establish or designate as many Special Courts as may be necessary. It also prescribes the rules for the constitution of the Court as well as the offences triable by the Special Courts, Appeal and Revision, Application of Code to proceedings before Special Court etc.

Three decided matters

Case 5.1: SEBI vs Vedika Securities. SEBI conducted an inspection of books of accounts of Vedika Securities Ltd (member of BSE and NSE) to verify segregation of client's funds and securities. A show cause notice alleged that Vedika was transferring funds from client account to settlement account routed through its own self-account.

The findings: clients funds were mixed with own/borrowed funds by Vedika. As said practise was continuous, it could not be ascertained whether, on a particular day, funds of the client having credit balance were being used to meet the obligation of another client(s) having a debit balance. Vedika has not maintained proper segregation of client funds and own funds and violated the SEBI circular no. SMD/SEBI/CIR/93/23321 dated November 18, 1993.

The adjudicating officer opined this to be a fit case to levy monetary penalty under section 15HB of SEBI Act and Section 23D of SCRA read with Regulation 26 (xiii), (xv) and (xvi) of SEBI Stock Broker Regulations.

The order: after considering factors mentioned in Section 23J of SCRA and in terms of power conferred under section 15-I of SEBI Act and Section 23-I of SCRA, a penalty of Rs 1 lakh was levied on Vedika Securities.

Case 5.2: SEBI vs. Ashok Shivlal Rupani, Naresh Shivlal Rupani and Utam Ravji Gada in the matter of Saianand Commercial Limited (formerly known as Oregon Commercial Limited). The Board... in its meeting held in July 2010 recommended for change in management and the proposal was moved through postal ballot. However, no corporate announcement was made by the company to the stock exchange regarding the board meeting and recommendation of change of management — a violation of regulation of 30(4) of SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 read with clause 36 of listing agreement read with section 21 and section 24 of SCRA, 1956.

SEBI's findings: it was the responsibility of all directors to ensure all the legal and procedural compliances are done by the company. Two directors failed to submit any documentary evidence regarding public announcement to the Exchanges, and the third's submission that he relied on other director's assurance that all necessary compliances have been carried out and hence not liable was not accepted by SEBI.

And the reasoning: the recommendation of the Board of Directors in regard to change in management of the company is very vital information. Not only the shareholders but the entire market needs to be made aware of such change. It is essential that corporate announcement is made, which the company did not make, all directors at the relevant time are liable for non-compliance.

The order: SEBI in 2018 levied a monetary penalty under section 23A(a) of SCRA of Rs 2 lakhs each on all three.

Reliance on a co-director is not a defence — that is the lesson to carry away.

5.2 The Securities Contracts (Regulation) Rules, 1957

In exercise of the powers conferred by section 30 of the SCRA, the Central Government has made the Securities Contracts (Regulation) Rules, 1957.

5.2.1 Eligibility for membership — Rule 8

Rule 8 of SCRR specifies the rules relating to the admission of members of the stock exchange. No person is eligible to become a member if she/he –

a. is less than 21 years of age;

b. is not a citizen of India provided that the governing body may in suitable cases relax this condition with the prior approval of SEBI;

c. has been adjudged bankrupt or receiving the order in bankruptcy has been made against her/him or has been proved to be insolvent even though she/he has obtained her/his final discharge;

d. has compounded with her/his creditors unless she/he has paid sixteen annas in the rupee;

e. has been convicted of an offence involving fraud or dishonesty;

f. is engaged as principal or employee in any business other than that of securities or commodity derivatives except as a broker or agent not involving any personal financial liability unless she/he undertakes on admission to sever her/his connection with such business;

g. has been at any time expelled or declared a defaulter by any other stock exchange;

h. has been previously refused admission to membership unless a period of one year has elapsed since the date of such rejection.

Eight disqualifications. Twenty-one is the age; sixteen annas in the rupee is the old expression for repaying creditors in full; and a previous rejection bars admission for one year.

Note limb (c) carefully — insolvency disqualifies even though she/he has obtained her/his final discharge.

Eligibility is not enough; experience is also required. No person eligible for admission as a member under the above-mentioned rule shall be admitted as a member unless she/he:

(a) has worked for not less than two years as a partner with, or an authorised assistant or authorised clerk or remisier or apprentice to, a member; or

(b) agrees to work for a minimum period of two years as a partner or representative member with another member and to enter into bargains on the floor of the stock exchange and not in her/his name but the name of such other member; or

(c) succeeds to the established business of a deceased or retiring member who is her/his father, uncle, brother or any other person who is, in the opinion of the governing body, a close relative.

Two years, before or after admission, or succession to a close relative's business.

And a waiver exists: the rules of the stock exchange may authorise the governing body to waive compliance with any of the foregoing conditions if the person seeking admission is in respect of means, position, integrity, knowledge and experience of business in securities, considered by the governing body to be otherwise qualified for membership.

5.2.2 Contracts between members — Rule 9

Rule 9 of the SCRR requires all contracts entered into between members of a recognized stock exchange to be confirmed in writing and to be enforced in accordance with the rules and bye-laws of the stock exchange of which they are members.

Confirmed in writing, and enforced under the exchange's own rules and bye-laws.

5.2.3 Audit — Rule 12

As per Rule 12, every member shall get her/his accounts audited by a chartered accountant whenever such audit is required by SEBI.

By a chartered accountant, whenever SEBI requires it.

5.2.4 Books of account — Rule 15

Under Rule 15(1) every member of a recognized stock exchange is required to maintain and preserve the following books of account and documents for 5 years:

Register of transactions (Sauda book) · Clients' ledger · General ledger · Journals · Cashbook · Bank pass-book · Documents register showing full particulars of shares and securities received and delivered.

Rule 15(2) requires every member of a recognized stock exchange to maintain and preserve the following documents for a period of 2 years:

Member's contract books showing details of all contracts entered into by the member with other members of the same exchange or counterfoils or duplicates of memos of confirmation issued to such other members · Counterfoils or duplicates of contract notes issued to clients · Written consent of clients in respect of contracts entered into as principals.

Seven items for five years, three items for two years.

The first review question falls out of Rule 15(2) — counterfoils or duplicates of contract notes issued to clients are kept for 2 years.

A useful way to hold the split. The five-year list is the books of the business — its ledgers, journals, cash book, bank book and the sauda book. The two-year list is the paperwork of individual dealings — contract books, contract note counterfoils and clients' written consents.

And note the outer limit in the Act. Section 6(2) speaks of such periods not exceeding 5 years, which is why no item in Rule 15 exceeds five.

Case 5.3: SEBI Settlement order in respect of Polson Limited. SEBI passed an interim order in June 2013 with respect to 105 listed companies who did not comply with minimum public shareholding (MPS) stipulated under Rule 19(2)(b) and 19A of SCRR, 1957. Polson Ltd was one of 105 companies. In June 2016 SEBI confirmed the interim directions, noting that the company continued to be non-compliant with MPS requirements and thereby continued to breach Rule 19A of SCRR. In November 2017 Polson informed SEBI that they have fulfilled MPS by selling 11,200 equity shares owned by the promoters of the company, using the "Offer for sale" mechanism.

BSE confirmed to SEBI in January 2018 that the company is in compliance with the public shareholding requirement of 25% mandated in Rule 19A of SCRR as a continuous listing requirement for listed companies.

SEBI revoke[d] the directions issued in the interim order, but noted that mandate of MPS was applicable since 2010. Company has delayed the compliance with MPS for 4 years and has not provided any justification for delayed compliance.

The settlement: a show cause notice (SCN) was issued in May 2018 why an enquiry should not be held against it and penalty not imposed under section 23E of SCRA. The company filed a settlement application in June 2018 proposing to settle the proceedings without admitting or denying the finding of the fact, and SEBI Whole-time member agreed on the recommendation of High-powered Committee for a settlement amount of Rs 6.80 lakhs which was duly remitted by the company.

Twenty-five per cent minimum public shareholding is a continuous listing requirement — not a one-time condition at listing.

The chapter's review questions confirm that contract note counterfoils are kept for 2 years; that members must preserve books and accounts and other documents for a specific period of time; that the statement about a stockbroker contracting with another stockbroker after obtaining consent is marked True; and that the manner of dealing in derivatives and other contracts is prescribed by the SCRA, 1956.