The Depositories Act, 1996

What this chapter covers

This chapter carries 2 per cent of the III-A 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.

15.1 Introduction

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 — and the object is stated as free transferability of securities with speed, accuracy and security. That is the sentence the first review question rests on: it is the Depositories Act that provides for the establishment of depositories.

How settlement changed. In order to streamline the settlement process, the Act envisages the transfer of ownership of securities electronically by book entry.

And what the company lost. 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.

No transfer deed, and no company discretion — a share held in demat form moves by book entry, not by the issuer's permission.

The IFSC carve-out

International Finance Securities Centre Authority Act, 2019 (IFSCA Act) read with Section 23 G 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.

**Instead, 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.

One Act, two regulators, divided by geography.

15.2 Rights and obligations of depositories

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

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

Transfers. 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.

The investor's choice. 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.

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

Fungible means one share is indistinguishable from another of the same class — there are no distinguishing certificate numbers to track, which is what makes book-entry transfer possible at all.

Statutory registers. 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.

Reporting to the issuer. 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 on the other side: 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.

A clean split. The depository's name is on the register so that transfers can be effected; every economic and governance right — dividends, bonus, voting — stays with the beneficial owner, as does every liability.

Which is why the depository holds nothing of its own. It is a registered owner for the purpose of effecting transfer and no other purpose.

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 for new certificates — the mirror of dematerialisation, and the reason the demat system is optional rather than compulsory for the holder.

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 one party. The depository pays first, whoever was negligent, and then recovers from the participant if the fault was the participant's. The investor is not made to litigate about which link in the chain failed.

15.3 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 on the list — SEBI may require information from the investor as well as from the institutions.

And the duty of production is personal. 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.

Then directions. 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.

Including disgorgement. 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.

Profit made or loss averted — both are recoverable, and the declaration is retrospective in effect, since the power is always be deemed to have been included.

15.3.1 Penalties

Five penalty sections share one formula, and one does not.

The common formula — a minimum of one lakh, one lakh per day of continuance, capped at one crore — is what the fourth review question asks about: the maximum is Rs. one crore.

Section 19FA is the outlier, and deliberately so. Where 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, the penalty starts at five crore rupees and runs to twenty-five crore rupees or three times the amount of gains made out of such failure, whichever is higher.

A depository is market infrastructure. Unfair conduct by it is not a filing lapse; it distorts the market for everyone who must use it.

Section 20 — the criminal offence

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.

Three things are punishable alike — contravention, an attempt to contravene, and abetment. And non-payment of a penalty is itself an offence.

Ten years, Rs. 25 crores, or both — and without prejudice to the monetary penalty already imposed.

15.4 Miscellaneous

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 may not be compounded — an offence punishable with imprisonment only, or with imprisonment and also with fine. Compounding is available where a fine alone is possible.

And who may compound — the Securities Appellate Tribunal (SAT) or a court before which such proceedings are pending, 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 condition — which is what the second review question confirms as True.

Two limits. 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 the recommendation of SEBI under this sub-section is not binding upon the Central Government.

And immunity can 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 — though 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.

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

Representation is wide: 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.

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, extendable by a further sixty — and only on a question of law. Findings of fact stop at the Tribunal.

The chapter's review questions confirm that it is the Depositories Act that provides for the establishment of depositories in the securities market; that it is True that immunity may be granted by the Central Government on SEBI's recommendation only where the person has made full disclosure of the violation; that a depository participant enters into an agreement with the Depository in the prescribed format; and that the penalty for failure to furnish information, books, documents or reports is capped at Rs. one crore.