Of stock markets, brokerages and the trade in trust
2 min read.Updated: 26 Nov 2019, 12:03 AM ISTNeil Borate
The market regulator is considering the possibility of barring brokers from settling and clearing trades
Money that sits in a brokerage account does not have a formal guarantee
India’s financial sector seems to be hurtling from crisis to crisis. The latest one involves Karvy Stock Broking, which allegedly diverted clients’ money. This could snowball into a bigger crisis as several banks and NBFCs have exposure to Karvy. Mint takes a look.
What happened with Karvy Stock Broking?
On 22 November, the Securities and Exchange Board of India (Sebi) passed an interim order against Karvy based on an NSE report that found the firm had transferred client securities to itself, besides pledging them to borrow money. The report found that Karvy had transferred ₹1,096 crore to a group company, Karvy Realty. The regulator directed Karvy to refrain from taking on new clients. It also asked the depositories (NSDL and CDSL) to not honour instructions from Karvy Stock Broking acting on the basis of power of attorney given by its clients in order to prevent further misuse of clients’ securities.
So how safe is a brokerage account?
Money that sits in a brokerage account does not have a formal guarantee. An investor can, however, recover the money from the broker by filing a complaint with the stock exchange. If the broker is declared a defaulter, the investor can file claims with the Investor Protection Fund of the exchange. In India, shares purchased through a broker are held in the name of the investor in a dematerialized (demat) account, which is meant to hold securities. Stock brokers, however, routinely take power of attorney for such demat accounts to execute trades. This power can sometimes be misused.
What action is Sebi taking to fix the problem?
The market regulator is considering the possibility of barring brokers from settling and clearing trades. Custody of client collateral, settlement, and clearing of trades may be managed by well-capitalized bank custodians. Transfers of client shares to a pool account or broker proprietary account may also be restricted.
What action can an investor take?
Investors can file complaints with the broker. If not satisfied, they can approach the investor services cell of the exchange in question. For instance, an online complaint can be filed with NSE. The exchange will try to recover the money from the broker and repay the investor. However, if the exchange declares the broker as a defaulter, it will invite claims from the public against its Investor Protection Fund. Investors can also file complaints directly with Sebi online on its SCORES platform.
What are the criteria for choosing a broker?
Brokers can be full service or discount. Full service brokers offer research and recommendations but tend to charge more. Discount brokers offer only execution but charge much less. Investors should also look at the broker’s parentage. Brokers owned by banks let you to keep funds in your own bank account rather than in a brokerage account. This lets investors earn interest even as they have control over the money. If the discount broker has a strong financial background, default may be less of a worry.