Stockbroker default is a cause for concern. The main reason for such default is misuse of investors’ securities and funds. The sudden jump in the reported number of broker defaults may have been a result of the increased supervisory role of regulators.
The default of the broker due to misuse of securities is mainly due to the Power of Attorney (PoA) given by the investors to the brokers. The objective of POA is to facilitate easy receipt and payment mechanism for trading, i.e. the broker can issue the shares sold on behalf of the investor without submitting the physical Delivery Instruction Slip (DIS). However, some brokers abuse this POA to transfer investors’ shares to their pool account and then pledge them to raise funds for their own purposes or to meet the margin requirements of other investors. To address this abuse, the regulator has stipulated that the shares being offered as collateral should remain in the demat account of an individual and be marked as ‘pledge’ in the depository system. The regulator has strictly prohibited brokers from using investor’s securities as collateral.
In addition, the regulator has now put in place a system of electronic DIS that allows investors to sell shares without a POA with the broker. Investors should understand that POA is not a mandatory requirement as per the regulator and the exchanges.
Misuse of investors’ idle funds has been another reason for broker defaults. To avoid this, the regulator implemented a current account authorization mechanism whereby idle money is returned to investors at a pre-determined frequency. Thus, if investors have opted for a current account, they should consciously monitor that the broker settles the account as per the agreed frequency (settlement of 30 or 90 days). Also, investors should not keep dormant funds with the stock broker as the claims of these funds in case of misuse are not accepted by the stock exchange in case of broker default. Brokers are now required to report individual client-level funds allocations so that funds from one client cannot be used for margin requirements of another.
Our analysis of some broker default cases shows that investors are attracted by fixed/guaranteed/regular returns or capital protection schemes which are not within the scope of the services offered by the broker. Investors should avoid entering into loan agreements in which brokers pay interest on funds offered by the investor. Any such settlement that gets rejected does not qualify as a claim by the exchanges against broker defaults.
SEBI has issued several operational guidelines for the management of clients’ funds and securities. The regulator has also put in place systems for advanced supervision and early warning to detect any misuse and diversion of funds. These early warning signals are given in case the stockbroker/depository participant’s financial position deteriorates; pledge transactions; The number of complaints has increased due to unauthorized trading, unauthorized delivery instructions and non-receipt of funds and securities. In addition, internal audit is mandatory for brokers on a half-yearly basis, wherein they have to certify compliance/non-compliance on areas such as execution of POA; Maintaining a Register – Customer wise – Scrip wise; Separation of funds/securities of clients from funds/securities of brokers.
Nevertheless, as broker defaults continue in the face of strong regulatory measures, the supervisory role of exchanges needs to be increased and they need to be held accountable, along with internal auditors. Part of the solution lies with investors being more cautious. Investors can do this by following certain checks such as ensuring that their KYC details are up to date, email/SMS confirmation of their trades by exchanges with contract notes received from the broker, and funds and securities balance remitted immediately. Check statement. on a weekly basis by the exchanges. In addition, investors should verify and reconcile their Consolidated Accounting Statement (CAS) with their holdings of securities and should also not give a blanket POA to their brokers.
Thus, it is important that investors follow the principle of ‘caveat emptor’ – let them be aware and be more responsible for their money.
Kuldeep Thareja, Mitu Bharadwaj and Rasmeet Kohli are working with the National Institute of Securities Markets. Thoughts are personal.
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