DEPOSITORY PARTICIPANTS AUDIT BY SAMRISH BHANJA(FCS, LLB) PROPRITOR, B SAMRISH & CO

Introduction & Historical Background In the past when there was just a handful of investors the system of settlement based on physical delivery of paper certificates was probably adequate But with the increase in number of listed entities the clearing and settlement mechanisms had been encumbered by the huge volumes of paperwork related to processing of share certificates. Need for the introduction of scripless was felt for the settlement to improve the efficiency of the markets and eliminate various problems brought about by dealing in physical certificates. Thus The Depositories Act was passed by both the Houses of Parliament in August, 1996.

Concept of Depository System According to section 2(e) of the Depositories Act, 1996, “Depository means a company formed and registered under the Companies Act, 1956 and which has been granted a certificate of registration under section 12(1A) of the Securities and Exchange Board of India Act, 1992”. A Depository Participant (DP) is an agent appointed by the Depository i.e. —National Securities Depository Ltd (NSDL) and/or Central Depository Services Ltd (CDSL) and is authorized to offer depository services to all investors. An investor has to open his account through a DP only. Thus, the DP is basically the interface between the investor and the Depository. PNB is a DP of both Depositories (NSDL as well as CDSL.).

The Depositories Act, 1996 The depositories legislation as per the Statement of Objects and Reasons appended to the Depositories Act, 1996 aims at providing for: A legal basis for establishment of depositories to conduct the task of maintenance of ownership records of securities and effect changes in ownership records through book entry; Dematerilisation of securities in the depositories mode as well as giving option to an investor to choose between holding securities in physical mode and holding securities in a dematerialized form in a depository; Making the securities fungible; Making the shares, debentures and any interest thereon of a public limited company freely transferable; and Exempting all transfers of shares within a depository from stamp duty.

Constituents of depository system There are basically four participant: The Depository The Depository Participant The Issuing Company The Investor

Who is depository? Depository facilitates holding of securities in the electronic form and enables securities transactions to be processed by book entry by a Depository Participant (DP), who as an agent of the depository, offers depository services to investors

Features of depository system in India In the depository system, the apex body is the Depository.. A depository can be compared with a bank Depository services through depository participants. Fungibility Registered Owner/ Beneficial Owner (two types of owner)

NATIONAL SECURITIES DEPOSITORIES LIMITED NSDL is the first and largest depository in India, and established in August 1996 It has 267 depository Participants (as on 13.12.08) Address: Trade World, a Wing, 4th &5th Floors Kamala Mills Compound Lower Parel Mumbai 400013 website: nsdl.co.in

PROMOTERS OF NSDL Industrial Development Bank of India Limited Unit Trust of India National Stock Exchange of India Limited

SHAREHOLDERS OF NSDL State Bank of India Oriental Bank of Commerce Citibank Standard Chartered Bank HDFC Bank Limited The Hongkong and Shanghai Banking Corporation Limited Deutsche Bank Dena Bank Canara Bank Union Bank of India

CENTRAL DEPOSITORY SERVICES (INDIA) LIMITED This is the second depository in India. This was formed and registered in 1999. It has 455 DPs as on 4.08.08 Address: Phiroz Jeejeebhoy Towers 16th Floor, Dalal Street Mumbai website: www.cdslindia.com

A Bank-Depository Analogy

Who Is Depository Participant: A Depository Participant (DP) is an agent of the depository through which it interfaces with an investor. A DP can offer depository services only after it gets proper registration from SEBI. A DP is just like a Branch of a Bank.

Who can be Depository Participant? In terms of the Depositories Act, 1996, SEBI (Depositories & Participants) Regulations,1996, only the following entities are eligible to become a Depository Participant: Financial Institutions, Banks, including approved foreign bank Custodians, Stockbrokers, A clearing corporation or a clearing house of a stock exchange A non-banking finance company, A registrar to an issue or share transfer agent

Types of ownership In the depository system, the ownership of securities dematerialized is bifurcated in to: REGISTERED OWNER BENEFICIAL OWNER

Benefits of depository system/holding securities in dematerialized form Depository system provides benefits to: The investors, and The issuers.

Scope of Internal Audit Evaluating the adequacy of internal controls Suggesting ways to reduce the costs and promote efficiency Assessing the compliance with the applicable laws and regulations Assist management in decision making Backbone of a sound corporate governance system CA Rajkumar S. Adukia

Need for Internal Audit Increased complexity of businesses Enhanced compliance requirements Focus on risk management and internal controls to manage them Unconventional business models Intensive use of information technology Stringent norms mandated by regulators to protect investors An increasingly competitive environment CA Rajkumar S. Adukia

What is an opportunity? Every event has two exhaustive classification namely Opportunity Risk CA Rajkumar S. Adukia

Listing of Broad Opportunities in Internal Audit Internal Controls Auditing Internal Audit Functions/Requirements Under Various Laws Enterprise Risk Management – The ERM Role Audit of Compliance of Standards on Internal Audit Monitoring XBRL Implementation and Reporting Results Audit of IFRS Convergence Forensic Audit CA Rajkumar S. Adukia

Listing of Broad Opportunities in Internal Audit Fraud Detection Internal Audit and Corporate Governance Internal Audit Of Management Functions Stock Audit/Credit Audit Internal Audit of Compliance with Commercial Laws Due Diligence Social Audit CA Rajkumar S. Adukia

Listing of Broad Opportunities in Internal Audit Environmental Audit Corporate Social Responsibility (CSR) Audit ISO 9000 Audit Cyber Audit Industry Specific Internal Audit Programs Assurance Services Internal Audit of Tendering Process Audit of Sustainability Initiatives and Integrated Reports CA Rajkumar S. Adukia

Account Opening Agreement to be executed under stamp & signature of DP Agreement to be executed before opening an account Agreement to be executed under stamp & signature of DP Printed agreement with printed name of DP and signed Agreement not signed by DP or BO No agreement Agreement not produced for verification at the time of inspection Account to be opened based on Account Opening Form Single form for multiple accounts of same exchange for a CM Stamp duty document by sharmila

Account Opening Proof of Identity & Proof of Address Observations: No POI PANCARD given does not match. Any other POI obtained if PANCARD is not there or it mismatches. Comment whether the account is freezed for debit, if no PANCARD or it mismatches Non-compliance pointed should be as per SEBI guidelines only Bank statement obtained as proof of address(comm.807,967) Stamp duty document by sharmila

Account Opening ‘In Person verification’(comm.978 ) Applicable for accounts opened after October 22,2007 DPs to do In Person verification of the applicants at the time of opening of demat accounts Authorized official of DP should personally verify the photograph(s) affixed on the AOF and proof of identity document

Account Opening DP to affix a stamp “In Person verified “on proof of identity document having verified ‘in person’ Also required to verify valid original proof of identity documents with the copies and affix “verified with originals” stamp Authorized official doing in person verification and verification of documents with original should sign under the DP stamp

Account Opening Methodology Type of documents Validity of documents Signature of DP official and stamp Stamp of In Person verified and verified with original affixed on a valid POI document (SEBI specified) and signed by the authorized official of the DP under DP stamp Verify with the documents that only authorized official of DP has signed,check the authority of the person doing the same

Account Opening Proof of permanent address for joint holders(comm.888) Additional Documents to be collected from different type of BOs(comm.887,932) Body Corporate & Corporate CM : certificate of Incorporation POA- Document registered with registering authority or bank statement or agreement for sale or leave license agreement or acknowledged copy of income tax return OCB: Declaration from the OCB that it meets with the guidelines issued by RBI/Ministry of finance

Account Opening Additional Documents to be collected from different type of BOs(contd…) OCB(contd): Certificate from overseas auditors in form OAC-1 Statement of A/c from the bank Registered Society: POA –Document registered with registering authority or bank statement or agreement for sale or leave license agreement or acknowledged copy of income tax return

Account Opening Additional Documents to be collected from different type of BOs Banks Certificate of Incorporation or copy of RBI registration certificate in case of scheduled/co-operative banks POA -Proof of address – document registered with registering authority / agreement for sale/ leave and license agreement / acknowledged copy of income tax return Mutual funds SEBI Registration Certificate clearly indicating the address of the mutual fund

Account Opening Additional Documents to be collected from different type of BOs Public Trust /Charitable Trust and trust capable of holding property in its name (Registered Trust /Public trust) Certificate of Registration of Trust under the Public Trust Act 1950/Public trust Act of relevant state or Societies Registration Act,1860 PANCARD of trust Proof of address Proof of registered office address evidenced by document registered with registering authority or bank statement or agreement for sale or leave license agreement or acknowledgement copy of income tax return

Account Opening Private Trust Additional Documents to be collected from different type of Bos Private Trust PAN card of the trust Recognized Funds/trusts /other Similar entities Categories :Employees PF, recognized by PF commissioner under PF Act, 1952,employees Gratuity fund under payment of gratuity act,1972,superannuation fund formed under guidelines issued by income tax dept.,venture capital funds registered with SEBI,ESOP trust formed pursuant to SEBI guidelines

Account Opening Certificate of registration Additional Documents to be collected from different type of Bos Recognized Funds/trusts /other Similar entities(contd..) Accounts of the above Funds/trusts /other Similar entities should be opened as they are recognized either with Income tax Act or SEBI Documents : Certificate of registration Trust deed and rules and/or charter defining their constitution and providing for management thereof List of members on the Board of trustees/Governing body Certified true copy of resolution passed by Board of trustees/Governing body

Account Opening Names of the authorized signatories,designation and their specimen signatures duly verified by the managing trustee One passport-size photograph of all authorized signatories with signature across photograph PAN card of Fund/Trust/Entity POA of registered office address evidenced by document registered with registering authority or bank statement or agreement for sale or leave license agreement or acknowledgement copy of Income Tax return

Account Opening cannot have joint holders cannot appoint nominee HUF account cannot have joint holders cannot appoint nominee Observations : -comments given in the report/against checklist point ‘No’ ‘There is no account’ Disproportionately large no. of a/cs Same name, Same address,Same bank account details,Same Pan card details Observations: -comments given in the report N.A. ,No such accounts Nomination Nomination form signed by all joint holders Only individuals to appoint nominees and be appointed as nominee A minor, represented by guardian, can be appointed as nominee Two witness to sign the nomination form Nomination register to be maintained Nomination registration number ( as per register) to be noted on the nomination form Details to be captured in CDAS

Account Modification On Account opening & Modification in bank details ,Obtaining of bank details and proof made mandatory(comm.887) Proof of bank account details : Photocopy of cancelled cheque having name of the account holder Photocopy of bank statement having name and address of the BO and not more than 4 months old Photocopy of bank passbook having name and address of the BO Letter from bank

Account Modification Individuals Corporates Change in address Proof of address - verified with original by DP official Corporates Certified true copy of Form 23 Latest transaction statement received from the DP Verified with original Confirmation letter to be sent to BO at old as well as new address

Account Modification Individuals Change in signature of the BO Reason for change of signature BO to visit personally with valid proof of identity BO to affix new signature in the presence of a DP official If BO cannot come personally Modification form / letter to contain old and new signature New signature – attested by the BO’s banker

A/c Modification Change in signature of the BO Corporates Certified true copy of Board Resolution Fresh list of authorized signatories Bank – a letter on the letter head of the bank Request for simultaneous change in address and signature Normally should not be accepted Abundant caution to be exercised

The sample selection all categories of BOs DPA5 report The sample should cover : all categories of BOs BOs with pin codes other than Main DP address BOs with nominees Minor BOs ( on the basis of date of birth)

The methodology POI and POA Type of documents Validity of documents Signature of DP official and stamp Necessary documents as prescribed by CDSL Documents as per Operating Instructions Ensure completeness and accuracy PAN verification Flag verification(comm.789) Verified with original

What is new? Communiqué no. 796 – New Demat rejection code New Checklist point added –2.1(b) Whether DP has a system of inward of Demat request (DRF) received which clearly gives information about date of receipt of DRF from BO

Discrepancies observed in Inspection Reports Whether Demat request received from Bos are sent to the issuer/RTA within seven days- As informed by the DP. In case of demat rejection –whether there is a system in place to analyze the demat rejection –NA Details of dispatch maintained by the DP – Date of dispatch is not mentioned.

Common Violations Observed in Inspections The procedure to affix a stamp "surrendered for dematerialization along with DP name, DP ID and BO ID" on the certificates submitted for demat is not followed while processing some demat requests. The time limits prescribed for processing of demat requests received from BOs are not adhered to in all cases.

Account Closure Closure initiated by BO Closure initiated by DP

Initiated by BO Duly filled ACF/Letter from BO Signatures of all BOs In case of transfer of holdings – Duly filled in instruction slip Transaction statement for the quarter Account closed / to be closed Proof of despatch Final statement of account showing zero balance

Initiated by BO Power of Attorney holder cannot close Procedure for transfer to be initiated within 2 days from date of receipt

Initiated by BO Non responding issuers / RTAs BO to submit Closure with pending demat Non responding issuers / RTAs BO to submit A letter in prescribed format requesting rejection A letter giving details of DRN details duly signed and stamped by the DP DP to follow up with Issuer?RTA for rejection

Withdrawal of DP Option to BOs Transfer to another DP Rematerialise

Shifting of account New account in the same order of names Documents to be submitted ACF Instruction slip – duly filled Unused debit instruction slips Client master report – stamped and signed by new DP Verification of names and order of names

Initiated by DP Non payment of dues Violation of agreement with the DP Reasons such as :- Non payment of dues Violation of agreement with the DP Transfer to another DP/ Main DP due to closure of branch / Main DP Notice of 30 days specifying the reasons Proof of despatch and copy of the notcie to be maintained No response – DP can initiate Transaction statement – as per ‘closure initiated by BOs’

Delivery Instruction Slips

New Arrivals Communiqué no. 846- Safeguards regarding issuance/ use/ execution of DIS and booklets Issue only one booklet containing not more than 20 slips for individual account holder and not more than 100 slips for non-individual account holder, at a time. In case of the booklet reported lost/ stolen/ not traceable by the BO, the unused DIS of the said booklet must be cancelled. Subsequent issue of DIS booklet to the BO should be only after BO has used not less than 75% of the slips contained in the previous DIS booklet

New Arrivals Not to issue more than 10 loose DIS to one BO in a financial year (April to March). The loose DIS should be signed in the presence of an authorised DP official. DP should mandatorily verify with the BO before acting upon the DIS , in case of dormant account whenever all the ISIN are transferred at a time. To record the details of the process, date & time of verification (on DIS under his sign) of the transaction where BO has 5 or more ISINs and all such ISINs are transferred at a time.

New Arrivals Communiqué no. 847- Future-dated transactions DPs were instructed to exercise care while entering future-dated transactions so as to prevent error, especially in the future date of the transaction as transaction with execution date greater than 10 days from the date of entry/ upload on the CDSL system will fail.

New Arrivals Communiqué no. 884 dated 27.04.2007 – Cautionary note in delivery instruction slip: “Blank & Signed DIS should not be left with your DP/ Broker”- Rider should be added to DIS. As and when new stock are ordered.

Common violations in DP operations 1.  The inventory control mechanism for instruction slip booklets is not proper. 2. Physical inventory of instruction slip booklets is not tallied with the inventory records at prescribed intervals. 3. Some of the DIS issued to BOs do not have pre-stamped BO ID and/or pre-printed serial number.                           

Common violations in DP operations  4.      Some delivery instruction booklets are issued to the BOs without keeping requisition slip (which forms part of the earlier issued instruction slip booklet and has pre-printed instruction slip serial number range of the booklet), on record. 5. The instruction slip numbers are not verified, at the time of receipt from BO, against the issue details.  6.      In some cases, instructions are executed by the DP on the basis of instruction slips which are not signed by all joint holders or which are not signed as per the ‘mode of operation’. In some cases, the instructions are executed in spite of prima-facie mismatch of signatures.

Discrepancies in the inspection report As explained/ informed by DP in case of: Inventory control Issue of first DIS Procedure to be followed in case of issue of DIS without requisition slip Dormant account Fax indemnity Blocking of DIS

New Arrivals Communiqué No. 956 dated 14.09.2007- Supervision of branches of Depository Participants: To keep record of identification documents (including photo-identification) of all persons engaged in DP operations (1) at their main office (2) at all live-connected branches, and (3) at back office connected branches

New Arrivals To maintain documentation at the main office regarding the scope of activity of each branch (live or back office). This document should include the following aspects: (1) Services being provided by each branch (2) Authorization levels of each type of transaction i.e. - maker/ checker - limits based on value of transaction. (3) Record-keeping policy, including exception reporting mechanism, maintenance of registers, agreements, inventory of instruction slip booklets, reconciliation procedures (if any documents are forwarded to the main DP)

New Arrivals To ensure that all live connected branches as well as back office connected branches display the types of services provided by each of them. The display board/ chart should be prominently visible to the clients. The DO’S and DONT’S should also be displayed similarly.

Back office software Mandatory from 1st April 2007 for DPs with more than 500 accounts Minimum features Maker-checker Approval of verifier required for slips with value of transactions more than Rs.5 lakhs Capture of BO signature and retrieval for verification

Back office software Minimum features ( contd…) Proper records of instruction slips Inventory control Details of serial numbers issued to a BO Verification of issue details with instruction slip serial no. submitted for execution Blocking of serial numbers already used Facility to block serial numbers – reported as lost/ misplaced

Back office software Sample selected – bigger clients Matching of statement of transaction from CDAS with backoffice Sample selected – bigger clients Generate statement of transaction from CDAS and Backoffice for the same period and compare Back office (including web site) is updated regularly Check update procedure and frequency Back up of data residing in back office

Back office software Back office network connected to Internet Try accessing portals – preferably government sites If connected to internet Check from system personnel for installation of firewalls Check system policy for access rights Back office network connected to CDSL Check upload procedure Mechanism to ensure integrity of files Check system controls Check access controls

OTHER TRANSACTIONS

Transmission Notarized copy of Death Certificate Transmittee BO with CDSL DP Receipt of intimation of death Notarized copy of Death Certificate No execution of any instruction other than transmission request

Transmission Joint holders Sole holder Nominee Holding > 100000

Transmission Death of one of the Joint Holders Transmission in favour of surviving joint holders Duly filled in TRF Notarized copy of death certificate Client master –DPA5 of the surviving joint holders if a/c is with other CDSL DP Transposition form - If a/c in different order of names

Transmission Death of Sole Holder – Nominee Duly filled in Transmission request form(TRF) Notarized copy of death certificate Client master-DPA5 report of the nominee’s a/c if a/c with other CDSL DP

Transmission Death of sole holder - No nomination – value of holding > 100,000 Duly filled in TRF complete all respect Notarized copy of death certificate Any of the following : Succession Certificate Letter of Administration Probate of the will In case of multiple successors- Each successor should submit separate TRF

Transmission Death of sole holder - No nomination – value of holding < 100,000 Duly filled in TRF complete all respect Notarized copy of death certificate Letter of surety Letter of indemnity Affidavit from applicant No objection letter from legal heirs who are not applicants

Transmission Statement of transaction to the transmittee after transmission

Pledge/ Unpledge PLEDGE : Pledgor & Pledgee must have active accounts in CDSL DP PRF should be complete in all respects PSN should be recorded on the PRF Pledgor DP to send PRF and system generated letter to pledgor Copy of PRF to be kept on record Acceptance of pledge – on the basis of PRF signed by pledgor DP

Pledge/ Unpledge Initiated by pledgee – auto unpledge Initiated by pledgor - acceptance by pledgee DP URF should be complete in all respects Invocation IRF should be complete in all respects

Rematerialization RRF in duplicate signed by all the holders RRN to be generated on CDAS on the same day or the next working day from the date of receipt RRN noted RRF to be sent to Issuer/RTA within two days of receipt of RRF Follow up with RTA if not honoured within 30 days from the date of receipt of RRF by the RTA Corrective action for rejected RRF

Freeze /Unfreeze BO as safekeeping measure Initiation of Freeze BO as safekeeping measure DP based on instructions received from CDSL or statutory / regulatory authority CDSL based on instructions received from statutory authority Verification of signature – BO initiated freeze Acknowledgment letter to be sent to the BO

Freeze /Unfreeze Freeze/ unfreeze requests received from BOs Records to be maintained Freeze/ unfreeze requests received from BOs Orders from statutory authorities copies of acknowledgement sent to BOs Record of despatch of acknowledgement copy

Power of Attorney (POA) Verify signatures of the BO If POA is granted by all joint holders to one person , POA should be signed by all such holders Copy of POA – certified as “true copy” by BO Notarization at the discretion of the DP If expiry date is mentioned on POA, the same should be captured in CDAS DP to have internal controls for expiry date

Power of Attorney (POA) DP to have internal controls for expiry date POA to single entity should not have any clause which is detrimental to the interest of the BO Delivery Instruction slips to be issued only to POA holder and not to the BO Instructions to be routed only through the POA holder Merger of balances kept under various accounts to nullify the debit in any other account of the client without taking any further instructions from the constituent Lien on the securities of the clients towards realization of the dues including broking related operations.

BO Grievance BO Grievance Register to be maintained BO grievance report on monthly basis to CDSL Resolve the grievance within 30 days Email id for grievances(comm.816)

Transaction statements Main DP to send transaction statements to all BOs including branch BOs Transaction statements to be sent at least once at the end of every month, if there has been any transaction. In any event, such statement has to be sent once at the end of each quarter to all BOs Maker checker concept in all other transaction to check unauthorized transaction

Records & Documents Proper filing system and maintenance of details of files for easy retrieval If records are shifted to a different place – a log of such files Proper records of retrieval

Records & Documents Separate record for each depository. Maintain records for a minimum period of 10 years Verify arrangements made for storage of documents Maintenance of proper details May check on sample basis Compliance officer Employee of the DP Intimation of change to the depository

Records & Documents Concurrent audit of risk prone areas Report on monthly basis Action taken by the DP Concurrent auditor to inform the serious non-compliances to depository

Thank You!! CA Rajkumar S Adukia