Depositories Act

Susanta Kumar Das

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 Presentation Summary
 Need for Depositories
 Depository Act- Highlights
 Establishment of Depositories
 Governance of Depositories
 Beneficial Ownership- Difference between US
and India
 IPO Irregularities
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 Issues with Physical Shares
 Bad delivery
 Fake certificates
 Delays
 Thefts
 Mutilation
 Transfer of shares took a lot of time
 “Odd lot” Problem

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 Need for Depository
 Maintenance of Demat accounts.
 Dematerialization.
 Trade settlement.
 Liquidity to markets.
 Share transfers.
 On-market and off-market transfers.
 Eliminates the risk of holding a physical asset.
 Provide safekeeping.
 Nomination/transmission.
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 Depository Terminologies

 Account Opening
 Dematerialisation & Rematerialisation
 Delivery & Settlement of Securities
 Benpos to Companies & Corporate Action
 Lock In, Freeze and Unfreeze, pledge, hypothecate, future
dated transactions
 Inter-depository transfers
 Registered Owner Vs Beneficial Owner.
 Off market, market transactions
 House and Non-house account
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 Depository- Legal Framework

 Depositories Act 1996

 SEBI (Depositories & Participants) Regulations, 2018
 Bye Laws and Business Rules of Depositories

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 Depositories Act- Preamble
An Act to provide for regulation of
depositories in securities and for matters
connected therewith or incidental thereto. 

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 Depositories Act- Major Provisions
Section Particulars
4 Agreement between depository and participant.
5 Services of depository – Agreement with Depository through depository
Participant.

6 Surrender of certificate of security.

7 Registration of transfer of securities with depository.
8 Options to receive security certificate or hold securities with depository.
9 Securities in depositories to be fungible form.
10 Rights of depositories and beneficial owner.
11 Register of beneficial owner.
12 Pledge or hypothecation of securities held in a depository.
13 Furnishing of information and records by depository and issuer.
14 Option to opt out in respect of any security. 8
 Depositories Act – Major Provisions
SECTION BRIEF EXTRACT

18 Power of Board to call for information and enquiry

19 Power of Board to give directions in certain cases
19A Penalty for failure to furnish information, return, etc.
19B Penalty for failure to enter into an agreement
19C Penalty for failure to redress investors' grievances
19D Penalty for delay in dematerialisation or issue of certificate of securities.
19E Penalty for failure to reconcile records
19F Penalty for failure to comply with directions issued by Board under section 19 of
the Act.

19G Penalty for contravention where no separate penalty has been provided.
20 Offences
21 Offences by Companies 9
 HDFC Bank vs. SEBI- Facts

 Loan granted by HDFC Bank to BRH. The loans

were secured by pledge of shares given by BRH.
 Pledge was in accordance with the Depositories
Act and SEBI (Depositories and Participants)
Regulations, 1996.
 BRH defaulted on the obligations, HDFC Bank
invoked the pledge and sold the pledged
securities.
 SEBI’s examination found that BRH had
misappropriated client’s securities
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 HDFC Bank vs. SEBI- Allegations
 SEBI had directed that the assets of the BRH shall be utilized
only for the purpose of payment of money and/or delivery of
securities, as the case may be, to the clients/investors under
the supervision of the concerned exchanges/depositories.

 HDFC Bank illegally invoked the pledge of securities in spite of

a direction that the assets of BRH shall not be utilised for
purpose of payment.

 No due diligence was carried out by HDFC Bank to verify the

securities pledged
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 HDFC Bank vs. SEBI- Provisions
 Sec 2(1)(a) “beneficial owner” means a person whose name is recorded as such
with a depository.
 Sec 9(1) All securities held by a depository shall be dematerialized and shall be
in a fungible form.
 Sec 10(1) Notwithstanding anything contained in any other law for the time
being in force, a depository shall be deemed to be the registered owner for the
purposes of effecting transfer of ownership of security on behalf of a beneficial
owner.
 Sec 12(3) Any entry in the records of a depository shall be evidence of a pledge
or hypothecation.
 Regulation 79 (8) of D & P Regulations states that the pledgee may invoke the
pledge and on such invocation the depository shall register the pledgee as
beneficial owner of such securities in its record accordingly.
 Sec. 152A of Companies Act, 1956: The register and index of beneficial owners
maintained by a depository under Section 11 of the Depositories Act, 1996 (22
of 1996), shall be deemed to be an index of members and register and index of
debenture holders, as the case may be, for the purposes of this Act.
 Depositories Act and the regulations framed thereunder contains a whole and
self-contained procedure for creation of pledges.
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 HDFC Bank vs. SEBI- Decision
Once the shares are dematerialised and are kept in fungible form as per Section
9(1) of the Depositories Act, such shares could only be pledged in accordance
with the provisions of the Depositories Act read with the regulations and
cannot be pledged in accordance with the provisions of the Indian Contract Act.
Section 10 begins with a non obstante clause and, therefore, excludes the
provisions of the Contract Act or of the Transfer of Property Act.
Thus, ownership and transfer of dematerialised shares would be squarely
covered in accordance with the provisions of Section 12 of the Depositories Act
which provides that a beneficial owner may with the previous approval of the
Depository create a pledge in respect of a security owned by him.
It is enough for HDFC Bank to be informed by the depository that the securities
are in the name of the beneficial owner which in the instant case was the
broker BRH.
HDFC Bank was justified in invoking the pledge made by the broker BRH.

http://sat.gov.in/english/pdf/E2022_JO202183_9.PDF dated 18.02.2022 13

 Establishment of Depository

 Minimum net worth: Rs. 100 crores (Total assets minus total
outside liabilities )
 Applicant needs to belong to the category of shareholders
eligible to hold upto 15% of shares
 Depository not to carry out any activity whether involvement
of deployment of funds or otherwise without prior approval of
SEBI
 Activities not incidental to the activity of a depository assigned
to it by central government or a financial regulator to be
carried out only with the prior approval of the Board only
through strategic business units.
 Shareholding of the applicant to be locked-in for 5 years
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 Shareholding in a Depository
No person to acquire or hold more than 5% of the equity share capital;
SE, Depository, Banking Company, Insurance Company and PFI can hold
15%
Combined shareholding of all persons resident outside India not to
exceed 49%
No person to acquire or hold shares unless he is fit and proper person-
Not applicable in case of a listed depository for a person holding less
than 2%.
Persons acquiring shares between two percent and five percent, shall
seek approval of the Board within fifteen days of such acquisition
Eligible persons to acquire shares beyond 5% only with the prior
approval of the Board
Declaration regarding fit & proper person by any person holding 2% or
more
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 Fit & Proper Person- Definition
 General reputation and record of fairness and integrity
 Not to be subjected to the following disqualifications:
• Conviction for any offence
• Order for winding up
• Declared insolvent
• Restrained from dealing in securities
• Recovery proceedings by SEBI
• Unsound mind
• Financially not sound and has been categorised as wilful
defaulter

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 Governance of Depository
 Governing Board to include Shareholder director, PID and Managing
Director
 Chairperson to be elected from the PIDs
 No. of PIDs not to be less than shareholder directors
 PIDs not to be less than shareholder directors to constitute quorum
 Voting on a resolution to be valid only when the votes cast by PIDs
are more than the votes cast by shareholder directors
 Managing director to be included in the category of shareholder
director
 No DP to be allowed on the governing board of the Depository
 No FPI to have any representation on the Board of a Depository

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 Conditions of Appointment of Directors
 Appointment and re-appointment of shareholder
directors to be with the prior approval of the SEBI
 PIDs to be nominated by the SEBI
 PIDs to be appointed for a period of 3 years and
extendable upto a period of another 3 years
 PID can be appointed on another depository after
a cooling off period of 1 year
 PIDs to be remunerated only by payment of sitting
fees applicable to Independent Directors
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Appointment of Managing Director
 Appointment, reappointment and termination
with the prior approval of SEBI
 Appointment for a term not exceeding 5 years
 Maximum two terms of tenure not exceeding
5 years subject to maximum age limit of 65
years

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 Margin by way of Pledge/ Re-pledge
 Acceptance of collateral only by way of margin pledge.
 Transfer of securities to the demat account of the TM / CM for margin purposes is
prohibited
 POA not to be considered as equivalent to the collection of margin
 Depositories to provide separate pledge type i.e. margin pledge
 TM/CM to open separate demat account called for accepting margin pledge, which
to be tagged as ‘Client Securities Margin Pledge Account’
 Client to pledge securities to TM, TM in turn to repledge to CM, CM to repledge to
CC
 CM to re-pledge to CC only out of ‘Client Securities Margin Pledge Account’
Benefits
• No misuse of securities
• Corporate actions

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Beneficial Ownership- Difference between US
and India
 All shares in India are held by depositories, and investors have
beneficial ownership of the shares that they purchase. 
 In the US, dematerialized shares are held in the investor’s
name or in the broker-dealer’s name or street name.
 The street name concept allows the broker-dealers to own
stocks in their own name
 Brokers pass a “book-entry” for which the client is the
beneficiary as per its records.
 Brokers generate revenue by lending these securities to short-
sellers and offering seamless margin funding—these
revenues, in turn, subsidise 0 brokerage. 
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 Fractional Investing
 Offering fractional investing isn’t possible.
 In India, brokers act as agents who send orders to exchanges for
execution
 Once an order is executed, the shares are held in the name of the
clients.
 Directing indexing is one use case for fractionals. It allows to use
broad indices like Nifty 100 as a starting point and customize
them.
 Owning shares of an index directly allows tax-loss harvesting
 Customization for specific use cases like If someone wants to own
Nifty 100 minus HDFC
 https://zerodha.com/z-connect/rainmatter/is-fractional-share-
investing-possible-in-india

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 IPO Irregularities- Players
Financiers
 Provided finance to IPO subscription
 Ultimate beneficiaries in the scheme of cornering retail
allotment
 Made big gains by selling the shares immediately after listing
Key Operators
 Allowed their demat accounts for temporary parking of shares
received by way of credit from afferent accounts
Afferent Accounts
 Benami or Fictitious Accounts which sent the shares to Key
Operators
IPO Irregularities- Modus Operandi
 IPO Irregularities- Tools Used
 Photographs
 Bank Introduction Letters
 Depository Introduction Letters
 Multiple Bank Accounts
 Multiple Demat Accounts
 Multiple Applications

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IPO Irregularities- Modus Operandi
Key Operators opened bank accounts in their own names with Banks. Using
these bank accounts, bank introduction letters for thousands of fictitious names
were manufactured and based on such introduction letters as proof of identity
and address, they opened thousands of afferent demat accounts.
Based on only one bank account number, one Key Operator generated 15,000
bank introduction letters and using these letters as proof of identity and
address, it opened 15,000 afferent accounts with a DP, each with the same
address as that of the key operators.
Separately, Key Operators prepared several lists each with 50 fictitious persons
with same surname in the same order as were in the lists used for opening
afferent accounts.
Many such lists of 50 persons were purportedly certified by a DP. They opened
several bank accounts, each jointly with 50 fictitious persons in a list.
These bank accounts enabled the Key Operators to avail finance for IPOs from
banks. Obtained finances from many other financiers
 IPO Irregularities- Modus Operandi
 Key Operators engineered thousands of applications in the retail category over
18 IPOs
 Before listing, the Key Operators got the entire allotted shares transferred
from the afferent accounts to their own demat accounts in off-market and, in
turn, disposed of the shares directly or through the financiers.
 After the allotment, they also received the consolidated refunds from issuers
through bank and, in turn, returned the same to financiers.
 The afferent accounts were used only for receiving allotment of shares in
these IPOs and transferring those shares to demat accounts of the noticees.
 In those days, a photograph was needed to open a savings account, pre-
requisite for a demat account. The Ahmedabad-based operator, who ran a
photo studio and advertised in newspapers that it would give 2 photos free of
cost. Copies of these photographs were used for opening fictitious bank and
demat accounts.
 Another mode of sourcing photographs was from a matrimonial site.
 Applications up to Rs 50,000 did not require a PAN. Beyond Rs 50,000, a PAN
was required. Duplicate application forms could not be eliminated. 27
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 IPO Irregularities- Action Initiated
 Disgorgement order was issued

 A committee arrived at a formula for compensating investors who were

deprived in the IPOs

 First-ever disgorgement effort, SEBI reallocated unlawful gains of about

Rs 41.34 crore, as against the total payable amount of Rs.92 crore.

 1.27 million investors benefitted in the said IPO refund exercise

 RBI passed orders against errant banks levying penalty

 IPO Irregularities- Measures
 ISINs to be activated only on the date of commencement of trading

 PAN was made the sole identification number for all participants transacting in the
securities market, irrespective of the amount of transaction.

 KYC system was put in place

 In person verification was made mandatory

 Compulsory ASBA for all bidders

References
 https://www.youtube.com/watch?v=wxOXsm9oCPU
 https://www.business-standard.com/article/markets/the-scam-that-changed-india-s-
primary-market-116080101718_1.html

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Thank You

Questions??

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