Bombay HC fixes liability on depositories for DP frauds, major relief for investors

Bombay HC fixes liability on depositories for DP frauds, major relief for investors

Bombay High Court in a recent judgement had given hopes to investors who lost their shares in broker-depository participant related frauds. Bombay High Court has ruled that depository participants (DPs) act as an agent of depositories, and hence depositories are liable for the acts of DPs. High Court affirmed the order passed by arbitration tribunal in favour of investor and directed the depository CDSL to compensate for the loss with interest.

The matter pertains to one investor Daksha Narendra Bhavsar, who and husband, had given a power of attorney (POA) to BRH Wealth Kreators in June 2018 while opening their demat account. BRH, who was DP with CDSL, allegedly misused this POA to transfer her securities, along with those of about 9,493 other clients, from their demat accounts into its own TM/CM (trading–clearing member) accounts and then pledge these pooled shares to HDFC Bank to secure a large loan. After BRH defaulted, HDFC Bank invoked the pledge and sold the shares. Matter went into arbitration, which ruled in favour of investor, CDSL challenged this arbitration award in HC which affirmed the arbitral award.

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Justice Sandeep V Marne dismissed CDSL’s petition. The court held that BRH’s misconduct was not only as a stockbroker but also in its capacity as CDSL’s depository participant and agent, triggering CDSL’s statutory liability under Section 16 of the Depositories Act to indemnify the beneficial owner for negligence of a DP. Arbitration tribunal had ordered CDSL to pay an investor Rs 86.02 lakh plus 9 percent post‑award interest, representing the value of shares misappropriated from her demat account and eventually sold after being pledged to HDFC Bank by BRH.

The court accepted that the key legal question was the capacity in which BRH acted and whether its conduct could be attributed to it as a DP. Relying on CDSL’s own bye‑laws, which expressly state that a participant acts as CDSL’s “agent” when dealing with beneficial owners. The court found that BRH’s use of the demat infrastructure and POA for off‑market transfers and pledge creation necessarily involved its DP role and the depository’s systems, not just its broker function. Once BRH’s negligence as DP was established, the court held, its CDSL’s duty to indemnify the investor.  HC order stated, “There is ample material on record to indicate that BRH has not acted in its capacity solely as broker. It has not effected any trades on the Stock Exchange. As DP, it acted as agent of the Petitioner, with whom the shares were entrusted for safe keeping in dematerialised form”.

Before turning to CDSL, the investor had approached the National Stock Exchange, whose Defaulters Committee repeatedly refused compensation from its Investor Protection Fund (IPF) on the ground that she had not executed trades on the exchange platform. CDSL argued that a later SEBI circular dated 25 July 2023 on IPF utilisation in POA‑misuse cases shifted responsibility to exchanges, but the court held that this framework only allocates which IPF pays and does not dilute a depository’s independent statutory liability to investors under the law. The court noted that, the narrow complaint‑timing conditions in circular meant the investor risked being left remediless if both NSE and CDSL disclaimed responsibility, a result the court refused to endorse.

In June 2018, investor opened a demat account with BRH Wealth Kreators Limited after compulsory closure of Karvy Stock Broking and executed a POA. After her husband’s death in June 2019, BRH transferred her shares to its TM/CM account and later consolidated client shares. In September 2019, BRH pledged these shares with HDFC Bank Limited and was suspended by National Stock Exchange of India Limited. HDFC invoked the pledge; Securities Appellate Tribunal upheld its validity in February 2022. SEBI debarred BRH in January 2023. Arbitration followed, and in January 2024, Central Depository Services Ltd. was directed to indemnify the investor.

The HC judgment sends a strong signal that depositories cannot shield themselves behind technical distinctions between broker and DP roles when their own participants misuse demat accounts and POAs to strip investors of securities. For investors, this expands the practical avenues of recovery in demat fraud situations: even if an exchange’s IPF route fails, they can press claims against the depository itself, arguing vicarious liability for the DP’s negligent or fraudulent operations and seeking arbitration under depository by‑laws, as was done here.

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Sumit Agrawal, Founder, Regstreet Law Advisors says, “The Bombay High Court has clarified that depositories cannot distance themselves once investor harm is traced to negligence or misconduct of their Depository Participants. For investors stuck in a regulatory grey zone, where exchanges disclaim liability due to absence of trades, this ruling provides a clear and credible accountability pathway”.

However, it’s expected that due to very wide impact of the HC order, CDSL is likely to challenge the single-judge ruling before division bench of the HC.

Post Karvy Stock broking incident, SEBI has strengthened safeguards by enforcing depositories’ statutory indemnity liability, banning brokers from pledging client securities or transferring them to TM/CM accounts, mandating segregation of client assets, and making powers of attorney optional to prevent misuse and protect investors.