Sebi may reduce brokers’ power over clients’ accounts, but more needs to be done
It’s also the responsibility of the exchanges to bring such cases to light as they conduct exhaustive audits
These days, Jharkhand-based businessperson Mukul Modi, 28, spends most of his day following developments in the Karvy Stock Broking Ltd (KSBL) case. His shares worth ₹8 lakh and cash to the tune of ₹4.9 lakh are stuck with Karvy. “A few clients have been able to transfer their stocks to other stockbrokers but I have not been able to. No one answers when I call Karvy’s helpline number or the relationship managers. There’s an auto-generated reply to the emails," he said.
Karvy’s case seems to be going the way other financial crises and scams have developed in the past. New skeletons are tumbling out of the closet every day. According to recent reports, the worth of client securities misused by the broker is far higher than what the capital markets regulator Securities and Exchange Board of India (Sebi) had estimated initially. Earlier, estimates pegged it at ₹2,000 crore, but it’s expected to reach ₹2,800 crore. The exact extent of the mess would only become clear when EY India, which is conducting a forensic audit on behalf of the National Stock Exchange of India Ltd (NSE), submits its findings.
The trend of stockbrokers misusing clients’ money and securities is not new. In the past few years, Sebi banned Kassa Finvest Pvt. Ltd, Guiness Securities Ltd, Ficus Securities, BRH Wealth Kreators, and Fairwealth Securities for similar violations. However, in Karvy’s case, the magnitude of the misappropriation is far higher. Of the 244,000 Karvy clients, around 95,000 are staring at uncertainty as they wait to regain access to their shares and receive payouts.
Despite precedents of misappropriation of funds by other broking firms, the regulator has been slow to act. It was only in June this year that Sebi came up with tighter norms for the usage of clients’ funds by brokers. Sebi mandated brokers to transfer the securities to their client accounts within a day of payment. Only in the case where a client defaults, the broker can hold the securities for up to five days before liquidating them to recover the dues, Sebi said.
But brokers have continued to misuse client’s funds despite stricter regulations. “When a regulator makes rules, it does think of multiple scenarios. But it’s not possible to think of every loophole. That’s why most regulations follow violations," said J.N. Gupta, former executive director at Sebi and managing director of proxy advisory firm Stakeholders Empowerment Services.
Arun Kejriwal, director at investment advisory firm KRIS, said Sebi relies on exchanges for implementation of its rules. Exchanges such as BSE Ltd and NSE are self-regulatory organizations, which exercise some degree of regulatory authority over intermediaries. It’s also their responsibility to bring such cases to light as they conduct exhaustive audits of brokers.
reducing brokers’ role
Brokers have been misusing the power of attorney (PoA), which gives them access to clients’ securities, for years now. There have been cases where relationship managers or sub-brokers bought and sold stocks from the client’s account without her knowledge to generate brokerage.
Looking at all this, Sebi could propose a process that takes away broker’s control of clients’ accounts. “After all these instances, Sebi could propose a mechanism where depositories work jointly with the Clearing Corporation of India (CCI), not involving the brokers in the settlement of securities," said Venu Madhav, chief operating officer, Zerodha, an online broking platform.
Today, if a client sells, the broker debits the stock from the customer’s demat account as it has a PoA. Going forward, when a customer sells the stock, there will be no role of the broker. CCI, through the depository, will directly debit the stock from customers’ accounts. For this, Sebi has recently issued a circular asking all demat accounts to be mapped with a trading ID, which could be seen as a step towards this direction.
Reforms still needed
Currently, brokers are required to disclose their proprietary trading status to the exchanges and Sebi. But transactions with related parties are not captured in the scheme of things, except at the level of the ministry of corporate affairs. Regulators, clients, customers and investors have no access to actual related-party and counter-party transactions carried out by the broker. Also, there is no framework for approval or processing of related-party transactions the way it is required in the Companies Act, 2013.
“Had these brokers disclosed that they had dealings with related parties and exchanges, auditors would have taken note of such dealings to investigate further and could have identified defaults earlier," said Jimeet Modi, founder and CEO, Samco Securities. This issue needs to be addressed as such cases of intentional fraud go unnoticed by clients and, to some extent, even by regulators and exchanges, he added.
Meanwhile, Mukul Modi, who had chosen KSBL for its brand and reputation, never expecting that it would default or misuse clients’ funds, is now rethinking his options. I am signing up on NSDL’s SPEED-e service, which allows clients to transfer securities online without interference from the stockbroker," he said. But the money he has lost is gone and with it the trust in the market.
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