Securities Contracts (Regulation) Act and Rules

What this chapter covers

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

LEARNING OBJECTIVES: After studying this chapter, you should know about: Key features of SCRA, 2018 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 Act

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.

Three areas of jurisdiction: (a) stock exchanges through a process of recognition and continued supervision, (b) contracts in securities, and (c) listing of securities on stock exchanges.

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 is stated simply: 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.

Which answers the fourth review question — the manner of dealing in derivatives and other contracts is prescribed in the SCRA, not the Public Debt Act, the Depositories Act or the Companies Act.

5.1.1 Periodical returns and inquiries

Section 6(2) of SCRA requires every member of a recognized stock exchange to maintain and preserve for such periods not exceeding 8 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.

Eight years is the outer limit under the Act — the Rules then fix shorter actual periods of five and two years.

The second review question follows from this — members must preserve books and accounts and other documents for a specific period of time.

Section 6(3) — 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.

Two routes — SEBI's own inquiry, or a direction to the exchange to inquire into its own member.

Section 6(4) — who must cooperate:

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.

Note the last category — anyone who has dealt directly or indirectly with those named. The duty reaches beyond the exchange and its members.

5.1.2 Contracting 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.

Read the words "other than a member of a recognised stock exchange" carefully. The consent-and-disclosure requirement applies where the counterparty is not a member — that is, a client. Member-to-member dealing is outside the requirement.

Which is why the third review question is False.

The timing and form: 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.

Written consent within three days, and disclosure on the contract note.

And an exclusion: Section 18 excludes Spot contracts from the above requirement.

Section 18A deals with derivatives: 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 — traded on the exchange, settled on its clearing house.

5.1.3 Penalties and procedures

Sections 23 to 26 provide for the different penalties and procedures.

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, Rs. 25 crore, or both — and note the burden of proving which shall be on him in limb (a). The excuse must be established by the defaulter.

Note 23D has no daily accrual — a flat band of one lakh to one crore.

And 23E is the only section here with a five lakh minimum and a twenty-five crore ceiling.

Settlement, recovery and appeals

Section 23JA — 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. No appeal lies against any order passed under this section. Further, all settlement amounts excluding the disgorgement amount and legal costs realised are credited to the Consolidated Fund of India.

Three points: settlement may precede proceedings (initiated or to be initiated); no appeal lies; and the money goes to the Consolidated Fund of India — not, as with SEBI Act disgorgement, to the Investor Protection and Education Fund.

Section 23JB — the Recovery Officer's 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 — 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... 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 — liability passes only if the penalty was already imposed.

Section 23L — 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, matching Section 15T of the SEBI Act. Note that an order of a recognised stock exchange is itself appealable.

Sections 26A to 26E — the Central Government may establish or designate as many Special Courts as may be necessary, with rules on 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.

The cases

Case 5.1: SEBI vs Vedika Securities. An inspection to verify segregation of client's funds and securities found that Vedika was transferring funds from client account to settlement account routed through its own self-account. SEBI noted that 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. Penalty was levied under section 15HB of SEBI Act and Section 23D of SCRA — a penalty of Rs 1 lakh.

Case 5.2: SEBI vs Ashok Shivlal Rupani and others. A board recommended a change in management but no corporate announcement was made by the company to the stock exchange. SEBI held that it was the responsibility of all directors to ensure all the legal and procedural compliances are done by the company, and rejected a director's plea that he relied on other director's assurance. 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. Penalty under section 23A(a) — Rs 2 lakhs each on all three.

Case 5.3: Polson Limited. SEBI's 2013 interim order covered 105 listed companies who did not comply with minimum public shareholding (MPS) stipulated under Rule 19(2)(b) and 19A of SCRR, 1957. Polson later achieved compliance by selling 11,200 equity shares owned by the promoters... using the "Offer for sale" mechanism, and BSE confirmed compliance with the public shareholding requirement of 25% mandated in Rule 19A of SCRR as a continuous listing requirement. A show cause notice under section 23E followed the four-year delay, and the matter settled for Rs 6.80 lakhs.

Note that MPS is 25 per cent, and it is a continuous requirement — not a one-time listing condition.

5.2 The Rules

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

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. Note 21 years, not 18; that citizenship may be relaxed with the prior approval of SEBI; that sixteen annas in the rupee means full payment; that expulsion by any other stock exchange disqualifies; and the one year cooling period after a refusal.

And even an eligible person must satisfy an experience condition. He must:

(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, past or future, or succession to a close relative's business.

With a waiver: 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.

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.

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.

Seven records, five years.

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.

Three documents, two years — and the first review question asks about the second of them: counterfoils or duplicates of contract notes issued to clients must be kept for 2 years.

Note the third item — it is the written consent required by Section 15 of the Act, which must be received within 3 days from the date of the contract.

The chapter's review questions confirm that counterfoils or duplicates of contract notes issued to clients are preserved for 2 years; that members must preserve books and accounts and other documents for a specific period of time under the SCRA; that it is False that a stockbroker needs consent to contract with another stockbroker, since Section 15's consent requirement applies to persons other than a member of a recognised stock exchange; and that the manner of dealing in derivatives and other contracts is prescribed in the SCRA.