Home / Opinion / Fixing the weak link in stock broking

First it was Unicon Securities Pvt. Ltd which misappropriated its clients’ funds and securities. Then, last month, Securities and Exchange Board of India (Sebi) passed an order against Kassa Finvest Pvt. Ltd for misusing client funds. On Sunday, Press Trust of India reported that the regulator is investigating at least five stock brokers for siphoning off funds from client accounts.

The broking community will argue that such infractions are few and far between among the thousands of brokers spread across the country. But considering that the stock markets and the stock broking industry already suffer from trust deficit, even a few bad examples can result in considerable damage.

Besides, these episodes raise questions about the rules and processes that are in place to curb fraud by brokers. While India’s secondary market infrastructure is considered to be top-notch, with robust risk management and settlement systems at the stock exchange and clearing corporation level, clearly, the same can’t be said for the safety of clients’ funds and securities with brokers. Is the broking industry, then, a weak link in the country’s otherwise healthy secondary market infrastructure story?

To be fair to the market regulator and the stock exchanges, as far as rules are concerned, they have regularly issued circulars to ensure the safety of clients’ funds and securities with brokers. As long back as 1993, Sebi ruled that brokers must operate separate accounts for their own trading and for client funds, with the latter’s bank account even having a name that included the word “client". Fund transfers from and to these accounts aren’t permitted, except in some rare cases. In addition, to curb the misuse of running accounts where clients don’t insist on daily payments of their settlement funds into their own bank accounts, Sebi said in 2009 that in such cases brokers must settle clients’ accounts at least once in a month or every quarter. Since 2011, clients can also get SMS and email alerts directly from stock exchanges on their transactions, so that any unauthorized transactions come to light.

Of course, as the experience with Unicon et al shows, in some cases these rules look good only on paper. An order passed by an adjudicating officer at Sebi last month showed how Mumbai-based Focus Shares and Securities Pvt. Ltd hadn’t bothered using the word “client" in the name of a bank account attached to its clients’ funds. The broker also transferred funds from this account to its own account. All of this came out during an inspection by Sebi, unlike in the case of Unicon and Kassa, where the regulator had got a number of investor complaints.

According to a former exchange official, necessary rules for the protection of clients’ funds are already in place. The weak link, according to him, lies in the inspection done by exchanges. As frontline regulators, they should have their ears to the ground and should clamp down on errant brokers before things go out of hand. Apart from complaints by a broker’s clients, exchanges and the regulator often get complaints from other sources as well, such as competitors. It makes sense to dig deeper when such complaints come to the table. Incidentally, most of the infractions have happened in the National Capital Region, which perhaps makes a case for sprucing up inspections in that region.

Another area for improvement is speedy and exemplary justice. Sebi first passed an interim order against Unicon last May, barring its directors from the securities market. It confirmed the order last month, adding that the securities lying in Unicon’s accounts can be disposed to meet claims made by its clients. But the regulator also said that its investigations aren’t complete. Sebi should not only move quickly, but also ensure that the punishment is exemplary. If the broker gets away with a paltry fine, it’s hardly a deterrent.

Considering that this has ramifications for the credibility of the entire stock market, both Sebi and the exchanges should treat the issue with the seriousness it deserves. When the National Spot Exchange Ltd scam came to the fore in 2013, it was argued that nothing of the kind will occur in the well-regulated stock markets. While the funds lost by Unicon’s investors collectively are of a far lower magnitude, the problem is the same—funds set aside for trading have disappeared because of faulty processes.

For a long time now, this column has argued that regulatory aspects of a stock exchange, such as broker supervision, should be moved to an independent organization. For an exchange that’s largely focused on the profit motive, it makes hardly any sense to act tough against a broker who is a source of trading volume and revenues. While this is not to contend that the National Stock Exchange of India Ltd and BSE Ltd are overly profit focused, it’s best for the markets that exchanges are not tested on this account.

Sebi’s policy response, then, to the spate of frauds by brokers should be to deliver exemplary justice and spruce up its own inspection efforts and that of exchanges; or, better still, shift this regulatory role out of exchanges.

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