A depository such as NSDL or CDSL never meets the ordinary investor. It reaches the market through a chain of intermediaries, and the first and most important link in that chain is forged by Section 4 of the Depositories Act, 1996 — the provision under which a depository “shall enter into an agreement with one or more participants as its agent.” That single sentence carries an enormous structural load: it defines the depository participant (DP) as an agent rather than a principal, it pushes the operative terms of the relationship into the bye-laws, and it sets up the cascade of agency, indemnity and segregation duties that protect the millions of beneficial owners whose securities sit in electronic form. This article unpacks Section 4 clause by clause, situates it against Sections 5, 6, 7, 10 and 16 of the Act, and tests it against the regulatory fabric of the SEBI (Depositories and Participants) Regulations, 2018, the depository bye-laws, and the cautionary record of cases such as the Karvy episode. For the foundational architecture, read it alongside the introduction, object and scheme of the Act and the controlling definitions of depository, participant and beneficial owner.
The Bare Text and Statutory Placement of Section 4
Section 4 of the Depositories Act, 1996 is deceptively short. Sub-section (1) provides that “a depository shall enter into an agreement with one or more participants as its agent.” Sub-section (2) adds that “every agreement under sub-section (1) shall be in such form as may be specified by the bye-laws.” Two ideas are compressed here. First, the participant is engaged as agent of the depository — the statute itself fixes the legal character of the relationship, rather than leaving it to the parties’ labelling. Second, the depository does not have a free hand to write whatever contract it pleases; the form of the agreement is dictated by the bye-laws, which under the scheme of the Act are themselves subject to the prior approval and oversight of the Securities and Exchange Board of India.
Placement matters. Section 4 sits immediately after the registration provisions (Sections 3 and 3A) that bring a depository and its participants into existence, and immediately before Section 5, under which an investor — routed compulsorily through a participant — enters into an agreement with the depository to avail its services. The legislative sequence is therefore deliberate: the depository must first knit itself to its participants under Section 4, and only then can the investor-facing relationship of Section 5 take effect. The two agreements are distinct contracts serving different ends, a distinction examined in the dedicated note on the services of the depository.
Who Are the Contracting Parties?
The contracting parties are precisely defined. Under Section 2(1)(e), a “depository” means a company formed and registered under the Companies Act and which has been granted a certificate of registration under Section 12(1A) of the SEBI Act, 1992. Under Section 2(1)(g), a “participant” means a person registered as such under Section 12(1A) of the SEBI Act in accordance with the regulations. The participant is thus a separately registered intermediary — typically a bank, a non-banking financial company, a custodian or a stock broker — that holds its own SEBI registration in addition to being admitted by the depository under Section 4.
This dual gatekeeping is structurally important. A participant cannot operate merely because a depository is willing to contract with it; it must independently satisfy SEBI’s fit-and-proper and net-worth criteria. Conversely, SEBI registration alone is insufficient — without the Section 4 agreement the participant has no operational link to any depository. The full taxonomy of these actors, including the beneficial owner who stands at the end of the chain, is developed in the note on definitions of depository, participant and beneficial owner. For exam purposes, the crisp point is that Section 4 presupposes two already-registered entities and supplies the private-law instrument that binds them.
"As Its Agent": The Agency Character of the Participant
The three words “as its agent” in Section 4(1) are the doctrinal heart of the provision. By statute, the participant acts as the agent of the depository. The settled market understanding, reflected in the depositories’ own literature and in SEBI’s framework, is that depository participants are agents of the depository through whom the depository interfaces with investors. The agency relationship engages the ordinary principles of Chapter X of the Indian Contract Act, 1872 — the participant must act within the scope of its authority, must not make secret profits, and binds the depository (as principal) when acting within that authority.
The agency runs to the depository, not to the investor, and this is frequently tested. The participant is not, by force of Section 4, the agent of the beneficial owner. The investor’s relationship is separately constituted — historically by a beneficial-owner agreement and, after the 2013–14 reforms, by the standardised “Rights and Obligations of Beneficial Owner and Depository Participant” document. Yet the participant does owe direct duties to the investor under the regulatory regime, so the agency label cannot be pressed too far. The cleaner formulation is that the participant is the depository’s agent for the purpose of providing depository services, while simultaneously being a SEBI-regulated intermediary bound by independent statutory and quasi-contractual duties to the beneficial owner. The consequences of this dual position surface most sharply in the indemnity scheme of Section 16, discussed below.
Form Specified by the Bye-Laws
Section 4(2) does not leave the content of the agreement to negotiation. It commands that the agreement be “in such form as may be specified by the bye-laws.” Under Section 26 of the Act, every depository must make bye-laws, with the previous approval of SEBI, governing among other things the form and manner of agreements with participants, the conditions of admission and the rights and obligations of participants. SEBI also retains power under the Act to direct a depository to amend its bye-laws. The result is a layered hierarchy: the Act supplies the skeleton (Section 4), the bye-laws supply the prescribed form, and SEBI’s approval ensures that the form serves the statutory object of investor protection.
Two practical consequences follow. First, because the form is bye-law-driven and bye-laws bind under the Act, a participant cannot contract out of obligations that the bye-laws impose — any private term inconsistent with the bye-laws or the Act is liable to be treated as ineffective. Second, uniformity is achieved across all participants of a given depository, which is essential for a fungible, interoperable electronic settlement system. The bye-law-mandated form is what allows thousands of participants to plug into a single depository on materially identical terms. The mechanics of how the depository then renders services under these uniform terms are taken up in the companion note on the services of a depository.
Rights and Obligations Flowing from the Agreement
Section 4 supplies the vessel; the rights and obligations that fill it come from several sources at once. Section 17 of the Act — in its sub-section dealing with the consequences of the agreement — makes clear that depositories, participants, issuers and beneficial owners are bound not only by the Act, the regulations and the bye-laws but also by “the agreements entered into by them.” The standard documentation issued by the depositories spells this out: the participant and the beneficial owner are bound by the provisions of the Depositories Act, 1996, the SEBI (Depositories and Participants) Regulations, 2018, the rules, regulations, circulars and guidelines of SEBI, and the bye-laws and business rules of the depository, as in force from time to time.
Among the core participant obligations that the agreement and the surrounding framework impose are: opening or activating a beneficial owner’s demat account only after receipt of a complete account-opening form and KYC documents specified by SEBI; effecting debits and credits to a beneficial owner’s account only on the basis of an order, instruction, direction or mandate duly authorised by that beneficial owner, with the original authorisations and audit trail preserved; furnishing periodic statements of account; and maintaining strict confidentiality. These duties are not optional add-ons — they are the substance that the Section 4 form is designed to carry, and a participant’s failure to observe them is the trigger for the indemnity and enforcement consequences examined later.
Segregation of Securities: A Cardinal Term
A defining obligation embedded in the participant relationship is the segregation of holdings. Under the regulatory framework, a participant must maintain separate accounts in respect of the securities owned by it and the securities held by it on behalf of each of its clients, and must keep the latter distinct from its proprietary holdings. The depository’s records likewise distinguish, for every participant, between the participant’s own securities and those of its beneficial owners. This segregation is the practical guarantee that a participant’s insolvency or default does not engulf the securities of its clients.
The principle has powerful protective consequences for beneficial owners. Because Section 10 of the Act deems the depository to be the registered owner only for the limited purpose of effecting transfer, while expressly providing that the depository shall not have any voting rights or other rights in respect of the securities and that the beneficial owner shall be entitled to all such rights, the securities never become the participant’s property. Segregation operationalises that statutory ring-fence. The doctrinal reasoning that government and ordinary creditors do not gain precedence over property that does not belong to the defaulting intermediary was articulated by the Supreme Court in Stock Exchange, Bombay v. V. S. Kandalgaonkar (2014), in the analogous context of a defaulting member’s assets; the same logic underpins why a participant’s creditors cannot reach segregated client securities.
Section 4 Versus Section 5: Two Different Agreements
A perennial source of confusion — and a favourite of examiners — is the difference between the Section 4 agreement and the Section 5 agreement. Section 4 governs the depository–participant relationship: it is the wholesale link by which the depository appoints its agents. Section 5 governs the investor–depository relationship: “any person, through a participant, may enter into an agreement, in such form as may be specified by the bye-laws, with any depository for availing its services.” Note the words “through a participant” — the investor cannot approach the depository directly; the participant is the mandatory conduit, which is precisely why the Section 4 agency must be in place first.
The distinction is not merely formal. The Section 4 agreement creates an agency; the Section 5 arrangement creates a service relationship between the investor and the depository, intermediated by the participant. A breach by a participant of its Section 4 obligations is, in the first instance, a matter between the depository and the participant; but because the depository is statutorily liable to the beneficial owner under Section 16 for the participant’s negligence, the two strands ultimately converge. The detailed anatomy of the Section 5 service relationship, including the surrender of physical certificates that follows dematerialisation, is set out in the notes on the services of a depository and on the surrender of certificate of security.
Section 16: How the Agency Drives the Indemnity Scheme
The agency character fixed by Section 4 has its most consequential pay-off in Section 16, which deals with indemnity for loss. Section 16(1) provides that, without prejudice to the provisions of any other law for the time being in force, where any loss is caused to the beneficial owner due to the negligence of the depository or the participant, the depository shall indemnify such beneficial owner. Section 16(2) then provides that where the loss due to the negligence of the participant is indemnified by the depository, the depository shall have the right to recover the same from such participant.
This is the agency logic made explicit. Because the participant acts as the depository’s agent under Section 4, the depository — as principal — bears front-line liability to the beneficial owner even for the participant’s negligence, and is then left to its right of recovery against the agent. The investor is thus shielded from having to litigate against a possibly insolvent or recalcitrant participant: the deep-pocketed depository must pay first. For aspirants, the precise mechanics matter — primary liability on the depository, a statutory right of recovery against the participant, and the “without prejudice” clause that preserves the beneficial owner’s other remedies. The interaction of Section 16 with the participant’s independent duties is what makes the Section 4 agency more than a label.
The SEBI (Depositories and Participants) Regulations, 2018
The statutory form of Section 4 is fleshed out by the SEBI (Depositories and Participants) Regulations, 2018, notified on 3 October 2018 in supersession of the 1996 Regulations. The Regulations govern registration of depositories and participants, their net-worth and fit-and-proper requirements, the code of conduct, and the obligation of every participant to enter into an agreement with a beneficial owner before acting on his behalf, in the manner specified by the depository in its bye-laws. They also require, where the issuer has appointed a registrar to an issue and share transfer agent, that the depository enter into a tripartite agreement with the issuer and that registrar — a separate species of agreement from the Section 4 participant agreement.
SEBI’s supervisory powers over the relationship are real and have teeth. The Regulations empower SEBI to suspend or cancel the registration of a depository or participant for breach of regulatory requirements, and SEBI has periodically enforced the code of conduct against depositories themselves — for instance, the settlement by NSDL of proceedings concerning, among other things, the redressal of investor and participant grievances within the prescribed period. The Section 4 agreement therefore operates within a live regulatory perimeter, not as a purely private contract. The broader object that this regulatory architecture serves is traced in the note on the introduction, object and scheme of the Act.
From Bilateral Agreement to Standardised Rights and Obligations
An important evolution sits at the investor end of the chain and illuminates the function of Section 4 by contrast. Until 2013–14, the participant and the beneficial owner executed a separate bilateral beneficial-owner agreement. Pursuant to SEBI guidance issued in December 2013 and carried into the depositories’ master circulars, the existing beneficial-owner agreements were replaced by a single standardised document titled “Rights and Obligations of Beneficial Owner and Depository Participant.” The participant must furnish a copy of this document to the beneficial owner and obtain an acknowledgement; the document is mandatory and binding on all existing and new clients and participants.
This reform did not touch Section 4 itself — the depository–participant agency agreement remains a bye-law-form contract — but it standardised and simplified the downstream documentation, reducing friction and the scope for one-sided terms imposed on investors. For the examinee, the takeaway is to keep three instruments distinct: the Section 4 depository–participant agreement (wholesale agency); the Section 5 / standardised Rights-and-Obligations arrangement at the investor interface; and the tripartite issuer–depository–registrar agreement that supports dematerialisation of a particular issuer’s securities, on which the note on registration of transfer elaborates.
When the Agency Is Abused: The Karvy Episode
The protective architecture built on Section 4 is best understood through a failure. Karvy Stock Broking Limited (KSBL) was both a SEBI-registered stock broker and a depository participant. Following an inspection by the exchange and SEBI, it emerged that securities lying in clients’ demat accounts had been transferred into and out of accounts by misusing the power of attorney granted by clients, with securities pledged to raise funds diverted to group entities. By its ex-parte ad-interim order of 22 November 2019, SEBI prohibited KSBL from taking new clients and directed the depositories, NSDL and CDSL, not to act upon instructions given by KSBL under the powers of attorney, permitting transfers only to the respective beneficial owners who had paid in full, under the supervision of the exchange. In Karvy Stock Broking Limited v. SEBI (2019), the Securities Appellate Tribunal substantially declined to interfere with the interim measures designed to protect investors.
The episode is instructive on the limits of the agency. The participant’s authority under Section 4 and the surrounding framework is to act on duly authorised instructions of beneficial owners; a participant that exploits a power of attorney to move clients’ segregated securities for its own ends acts outside that authority and in breach of the code of conduct. It also vindicated the depository’s gatekeeping role — SEBI could halt the abuse by directing the depositories, sitting above the participant in the chain, to freeze the offending instructions. The Karvy fallout accelerated reforms such as restrictions on the use of demat powers of attorney and the segregation and disclosure of client securities.
Termination, Default and Continuity of the Relationship
The Section 4 agreement, being a bye-law-form agency contract, is not perpetual. The bye-laws and the regulations provide for suspension and termination of a participant’s admission — on the participant’s own request, on its ceasing to meet eligibility norms, or as a disciplinary measure. SEBI’s power to suspend or cancel a participant’s registration runs in parallel. Because thousands of beneficial owners may have their accounts with a single participant, termination cannot be allowed to strand investors. The framework therefore contemplates orderly transfer: on a participant’s exit, the depository facilitates shifting of beneficial owners’ accounts to other participants, and the segregation of holdings ensures that the underlying securities, never being the participant’s property, follow the beneficial owner.
This continuity principle is a direct corollary of the agency in Section 4 and the deemed-registered-owner rule in Section 10. The depository remains the constant fulcrum of the system; participants are interchangeable agents plugged into it on uniform bye-law terms. The death or default of an agent does not destroy the principal’s relationship with the ultimate owner of the securities. For the way the underlying ownership is recorded and transferred independently of any particular participant, see the note on registration of transfer.
Exam Synthesis and Common Traps
Pulling the threads together, Section 4 should be remembered as a four-part proposition: (i) a depository may have one or more participants; (ii) the participant is engaged as the depository’s agent; (iii) the agreement must be in the form specified by the bye-laws; and (iv) the bye-laws are themselves subject to SEBI approval. The most common trap is to assert that the participant is the agent of the beneficial owner — it is the agent of the depository, although it owes independent statutory duties to the investor. A second trap is to conflate the Section 4 agreement with the Section 5 investor arrangement or with the tripartite issuer agreement; keep all three distinct.
A third frequently-missed point is the indemnity inversion in Section 16: the depository, not the participant, bears primary liability to the beneficial owner for the participant’s negligence, with a statutory right of recovery against the participant — a direct consequence of the Section 4 agency. Finally, candidates should be ready to connect the dry contractual provision to its protective purpose, illustrated by the Karvy proceedings and the segregation principle echoed in Stock Exchange, Bombay v. V. S. Kandalgaonkar. To revise the wider scheme into which Section 4 fits, return to the hub on Depositories Act notes and the foundational note on the introduction, object and scheme of the Act.
Frequently asked questions
Is a depository participant the agent of the depository or of the investor?
Section 4(1) expressly engages the participant as the agent of the depository. The participant is therefore the depository's agent for providing depository services. It is not, by force of Section 4, the agent of the beneficial owner, although it owes independent statutory and regulatory duties directly to the investor under the SEBI (Depositories and Participants) Regulations, 2018 and the depository bye-laws.
In what form must the depository-participant agreement be?
Section 4(2) requires the agreement to be in such form as may be specified by the bye-laws. The depository's bye-laws, made under Section 26 with the prior approval of SEBI, prescribe the form and the rights and obligations of participants. This ensures a uniform, SEBI-supervised template across all participants of a depository, rather than freely negotiated terms.
How does Section 4 differ from Section 5 of the Act?
Section 4 governs the wholesale depository-participant relationship and creates an agency. Section 5 governs the investor-facing relationship: any person, through a participant, may agree with a depository to avail its services. The investor cannot approach the depository directly, which is why the Section 4 agency must be established first. They are two distinct contracts.
Who is liable if a participant's negligence causes loss to a beneficial owner?
Under Section 16(1), the depository must indemnify the beneficial owner for loss caused by the negligence of the depository or the participant. Under Section 16(2), where the loss is due to the participant's negligence, the depository, having indemnified the investor, has a statutory right to recover the amount from the participant. Primary liability thus rests on the depository as principal.
What does the Karvy episode illustrate about the agency under Section 4?
In the matter of Karvy Stock Broking Limited (SEBI's interim order of 22 November 2019, substantially upheld by the SAT), the participant misused clients' powers of attorney to move segregated demat securities for its own purposes — conduct outside the authority an agent enjoys. SEBI halted it by directing NSDL and CDSL, which sit above the participant, to freeze the offending instructions, vindicating the depository's gatekeeping role.
Did the standardised 'Rights and Obligations' document replace the Section 4 agreement?
No. Following SEBI's December 2013 guidance, the standardised “Rights and Obligations of Beneficial Owner and Depository Participant” document replaced the earlier bilateral beneficial-owner agreement at the investor interface. The Section 4 depository-participant agency agreement, a bye-law-form contract, was untouched. Three instruments remain distinct: the Section 4 agreement, the investor Rights-and-Obligations document, and the tripartite issuer-depository-registrar agreement.