In the last three years, market regulator SEBI has pulled up several brokerages for misusing client's funds and securities.
The headline case was of Karvy Stock Broking Ltd., which was barred from taking on new clients via an interim order in 2019. Just last month, after a four-year investigation, Karvy, its managing director, and independent directors were barred from the securities market.
Another case is of Pentagon Stock Brokers Pvt., which faced a penalty of Rs 20 lakh in June last year for deliberately misusing client's funds. And this week, the regulator barred IIFL Securities from onboarding new clients for two years, for failing to implement rules on segregation of funds and securities of clients.
While the final regulatory orders in these cases came much later, SEBI tightened the framework for brokers even as its investigations were under way.
A 1993 circular, an Enhanced Supervision Framework of 2016, and several amendments to it govern the relationship between brokerages and their clients today.
Client's Funds To Be Separated From Brokers
According to the1993 circular, stockbrokers are required to separate their funds from those of their clients. They need to keep clients' money in a separate account and tag it as such. The funds in these accounts can be used only for settling the obligations of the respective client. This includes money owed towards the settlement of trade and other charges, such as brokerages, statutory dues, etc.
To tighten the framework, SEBI introduced enhanced supervision for stockbrokers in 2016. The new circular required stockbrokers to follow a uniform nomenclature for “naming/tagging of bank and demat accounts”.
It also required any transfer from a client’s account to a proprietary account to be clearly recorded in a daily reconciliation statement. It further mandated that unused funds be returned to each client after the end of each quarter.
The regulator took another step towards investor protection last month by introducing a facility similar to ASBA, or Application Supported by Blocked Amount, for the secondary market. Under the system, the funds for trading would be blocked in the bank accounts of investors through UPI. The settlement would be undertaken directly with the clearing corporation, without having to move through the accounts of brokers. The facility is, however, optional for brokers as well as clients.
Can A Broker Pledge Clients' Securities?
A stockbroker is allowed to pledge clients' securities as long as there is a debit balance in the latter's account. This occurs when the funds available with the stockbroker, with respect to the client, are less than the securities purchased by him.
However, this is only allowed with the explicit authorisation of the client and should be reflected in the client's account. The client is also eligible to receive a statement of the same.
The rules were further tightened in 2021 when SEBI mandated the segregation of collateral at the client level. This means that stockbrokers have to identify the collateral provided by each client and use the funds only for that client's purposes.
And most recently, in April this year, SEBI barred brokers and clearing members from using clients' funds as a pledge for bank guarantees.
What If The Broker Defaults?
If a stockbroker defaults in meeting either of these obligations, a client is free to file his claims with the respective stock exchange within three years of the default. Any claim after three years shall be dealt with as a civil dispute. If the default is proven, the investor is eligible for compensation from the Investor Protection Fund set up by SEBI. The legitimacy of a claim is determined through an arbitration mechanism.
The SEBI Complaints Redress System, or SCORES platform, is another place where investors can file complaints. After determining its suitability, the complaint is first referred to the broker, who has to respond within 30 days, failing which the regulator takes up the complaint for investigation.
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