Depositories to get penal powers for demat discrepancies

Markets regulator Sebi has decided to empower depositories to take penal action against companies that do not properly reconcile demat and physical shares and thus expose the equity market and investors to possible frauds.

The depositories have the mandate to help the companies convert their physical shares into de-materialised or demat form, and thereafter maintain those shares, while the companies are required to reconcile their total share capital, including physical and demat shares, in a proper manner.

However, discrepancies have come to light in share capital reconciliation of hundreds of the companies, a senior official said.

While depositories and stock exchanges have already been asked to take necessary actions against defaulting companies, Sebi is of the view that certain regulations need to be amended to empower the depositories to take penal actions in such cases.

Sebi board has approved a proposal to this effect and the necessary amendments would be made soon to Sebi (Depositories and Participants) Regulations, the official said.

The proposed amendment would allow depositories to take action if a company or its agent contravenes any provision of the relevant regulations and/or fails to furnish any information relating to its activity as an issuer of shares.

Besides, Sebi can take action against an issuer that contravenes any of the relevant regulations, fails to provide the information sought from it, does not co-operate in any inspection, investigation or enquiry conducted by any person authorised by Sebi and fails to comply with the regulators' directions.

For the purpose of enabling issue of demat shares, the issuers enter agreements with the depositories and their agents and these agreements lay down obligations to comply with the provisions of the relevant Sebi regulations.

However, it has been observed that there is no provision for action that can be taken by depositories in the event of non-compliance by issuers or their agents.

One of the obligations requires proper reconciliation of share capital by the issuer company.

"The non-reconciliation of share capital undermines the integrity of the market," Sebi has said in a memorandum presented before its board.

"In order to ensure protection of investors and market integrity, there is need to have measures in place to prevent issuer companies/promoters and issuer's agents from introducing fraudulent shares in the market or borrowing against such shares or accessing banking system for loans etc," Sebi said.

Under the existing regulations, a company needs to reconcile its share capital on daily basis and send a quarterly audit report to the stock exchanges on reconciliation of the total issued capital, listed capital and capital held by depositories in demat form.

In case of discrepancies, the issuer is obligated to bring it to the notice of the exchanges and depositories.

One of the challenges observed in the present depositories framework is that in case of some issuers, issued capital or listed capital does not reconcile with the actual capital (demat and physical shares), thereby indicating non-compliance with D&P Regulations.

As per reports submitted by the stock exchanges to Sebi, some companies have failed to submit quarterly audit report or have reported discrepancies in share capital reconciliation.

Further, in some cases, the discrepancy is explainable whereas in some cases, the issuer is unable to provide justification for the discrepancy.

NSE and BSE have reported discrepancies in share capital reconciliation of 329 and 695 companies respectively for the quarter ending March 2012.

To curtail the transfer of additional issue of shares by listed companies, Sebi has asked the depositories to devise a mechanism so that such newly created securities are frozen until final listing/trading permission by the exchange.

Depositories have also been asked to create a database of distinctive numbers, to be implemented in phases - first phase by October 31, 2012 and the second by December 31, 2012.

In second phase, the issuers and their agents would provide information on listed capital, number of shares in demat and physical form and number of shares pending final approval.

The interface of database would be common across both the depositories, exchanges and the companies and would enable all the stakeholders to view the status of shares issued, listed, and dematerialised on a common interface.

The database would enable all issued shares to be accounted for through their distinctive numbers and would require periodic updating and monitoring by the depositories.