In a rare instance, the Bombay High Court imposed a penalty of Rs 80 lakh on the Securities and Exchange Board of India (Sebi), the National Stock Exchange (NSE), and the BSE for unlawfully freezing a demat account. This case is a reminder of the importance of due process in regulatory actions and the potential for individuals to challenge unjust decisions. It is also instructive of what investors can do if their demat account is frozen or when they should go for legal recourse.

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Case Background: Pradeep and Neil Mehta’s Ordeal

In 2017, the demat accounts of Pradeep Mehta, a Mumbai resident, and his non-resident son, Neil Mehta, were frozen following a Sebi order against Shrenuj & Company for alleged regulatory violations. Pradeep Mehta and his son were mistakenly classified as promoters due to their familial connection with the company’s chief promoter, Neil’s father-in-law. However, they were neither involved in the company’s management nor connected with its operations.

Despite their attempts to rectify the situation through Sebi and the depositories, they were not granted an opportunity to be heard. Their plea to the Bombay High Court resulted in a landmark judgment declaring Sebi’s action illegal and ordering compensation for the father-son duo.

Understand Why Your Account Is Frozen

There are various reasons as to why a demat account could be frozen.

For instance, an investor themselves may choose to freeze their demat account if they suspect any unauthorised access to their account or if they want to prevent any unauthorised transactions due to security concerns. Moreover, freezing the account can also be a cautionary step in a financially uncertain situation or if the account holder is undergoing legal proceedings.

To ensure the security and integrity of the securities market, Sebi (including other regulatory authorities) may freeze a demat account for failing to meet some key requirements, such as Know Your Customer (KYC) details.

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The following are some reasons why your demat account is frozen for reasons other than personal preferences:

Regulatory Actions: If the account holder is classified as a promoter of a company that has violated regulatory norms.

KYC Non-Compliance: If your Know-Your-Customer (KYC) details are incomplete or outdated.

Inactive Accounts: Accounts that haven’t seen any activity for a long time might be frozen for security reasons.

Court Orders: In some cases, a legal dispute could lead to the freezing of your account. Contact your depository participant (DP), which could be your bank or broker, to understand the specific reason for the freeze.

What should you do if your demat account is frozen?

Immediate Steps To Take: Investors can raise a complaint on the depositories’ investor grievance portal. Says Sidharth S. Kumar, senior associate, BTG Advaya, “If the depository staff does not satisfactorily resolve their grievance, the investors can escalate the issue to the respective depository’s Investor Grievance Committees. If the grievance persists, investors can raise a complaint on the SCORES portal of Sebi or choose arbitration depending on the by-laws of the depositories.”

When to take the legal route?

In Pradeep Mehta’s case, Sebi did not directly initiate a regulatory action against the company or its promoters. The market regulator issued circulars (which include prudential norms for intermediaries) that allow stock exchanges and depositories to freeze the demat accounts of the promoters of companies that default on specific regulatory requirements. Mehta was classified as a promoter of an errant company without his knowledge or consent. The Stock Exchanges and the Depositories froze his demat accounts without further inquiring about his promoter status.

“Even though he approached Sebi and the Depositories, they did not give him an opportunity of hearing to ascertain his role in the company. The court has held Sebi and the stock exchanges responsible for imposing financial sanctions on the investor without affording an opportunity for hearing as per the principles of natural justice,” Kumar states.

He further adds that Sebi should have ideally directed the stock exchanges or depositories to hear him out and review their decisions. “This is one instance where Sebi should have examined the impact of its regulations on the ordinary investor.”

How does the distinction between a formal order and an internal communication (as in the Mehta case) affect the legal recourse available to investors?

In the case of a formal order passed by Sebi, it can be challenged before the Securities Appellate Tribunal (SAT). “However, if any punitive action is taken behind the back of the investor, they can directly approach the High Court under Article 226 of the Constitution for violation of the principles of natural justice,” Kumar informs.

What are the specific legal grounds on which an investor can challenge freezing their Demat account in court?

According to Kumar, the grounds for the challenge would depend entirely on the nature of the reasons provided by the intermediaries to freeze the demat accounts and how the authorised personnel made such decisions. In the case of Dr Mehta, the Bombay High Court set aside the decision to freeze the demat accounts because depositories exceeded their authority to freeze the accounts, and he was not given a proper hearing.

Proactive Steps for Investors

Stay Informed: Regularly monitor your investments and be aware of any regulatory actions against companies you are associated with.

Document Everything: Keep detailed records of all communications with Sebi, stock exchanges, and depositories.

Seek Legal Advice: If your demat account is frozen, you can also consult with a legal expert to understand your options and the best course of action.

Consider Court Action: If administrative avenues fail, the High Court may offer a viable path to justice.

“Investors should promptly respond to any notice or intimation from the intermediaries and follow the process detailed above at Sl. No.1. This would enable investors to build a strong case if the intermediaries or Sebi do not adequately address their grievances,” Kumar advices.