Sebi frowns on prepaid brokerages

With clients feeling they were taken for a ride, regulator instructs firms to backpedal on the product

Saket L, a small-time stock investor, was coaxed into buying a prepaid brokerage package, which requires investors to make a one-time upfront payment to the broking firm for subsequent trades. Despite not being an active trader, he was given the impression by the sales person that the upfront money would be deducted against the purchases made.

However, as he began trading under this account, Saket realised the money paid in advance would only be used to set off the brokerage costs incurred during buying of shares. And, that he would have to generate trading volumes equal to 75 times his current holdings to use up his deposit.

Saket, who posted his complaint in an online forum, is among the many investors who have raised concerns over the way this product was pitched to them, prompting the capital markets regulator to act. The Securities and Exchange Board of India (Sebi) has now asked firms offering prepaid brokerage schemes to restrict the sales of this product, in the wake of several cases of mis-selling, according to senior officials at four brokerages.  

A senior official with one of the largest retail brokers said brokers were now not offering this product in the same manner following a reprimand from the regulator. Sebi had observed, he said, that these were often sold even to clients with low trading volumes.

“Sebi has been talking about the fact that when customers don’t trade, the effective brokerage becomes very high. Such plans might have been the flavour of the month but not any longer,” said the person.

Under the prepaid brokerage system, clients were offered lower rates of brokerage if they paid a certain sum upfront. This sum was sometimes not refunded or was carried over to the next year if not used during the period. While savvy high net worth individuals would use the product to minimise trading costs, unwary retail investors who did not trade the same high volumes would forfeit their upfront payments.Thus, they would end up paying more money for a product that was ostensibly designed to cut costs.     Turn to TSI, Page 6 >

The charging of money in advance has also not gone down well with the regulator, said the chief executive officer of another brokerage.

“Sebi has asked why customers should pay for a service they haven’t received yet,” said the person. An email sent to Sebi on the matter did not elicit a response.

Many brokers don’t offer the product to clients now, unless large high net worth clients request for it. Even then, at least one large broker has an audit process in place to ensure there is no mis-selling.

“There was a lot of mis-selling. People were led to believe the prepaid amount would also contribute to margins or was refundable. This was not the case. We have largely discontinued the product, though it was not a big part of our business,” said the head of broking at a leading domestic brokerage. Market conditions with limited retail participation also leave little scope for such products, said another broker.