Handing over shares to a broker for fixed return may land you in trouble

An ex-parte order issued recently by the Securities and Exchange Board of India (Sebi) against New Delhi-based Modex International Securities has once again brought to the fore the risk clients run when they hand over their shares to their stockbroker against the promise of a fixed return. The broker pledged his clients’ shares as margin and traded in the futures and options (F&O) segment. He sustained losses, as happens often in such cases. And now it is his clients who have to bear the brunt.      

Brokers are supposed to report, on a weekly and monthly basis, the shares of clients that they hold. Once this report is received, the exchange compares the security balances with those reported by clearing members to the Clearing Corporation and the depository participant’s records. In this case, a discrepancy was observed. The National Stock Exchange (NSE) then initiated a forensic audit, which threw up several irregularities. 

Some clients had handed over their shares to the broker on the promise that the latter would give them periodic returns. The securities were pledged as margin. The broker suffered losses on his trades. To keep paying the promised return, he sold the securities belonging to some of his clients, and then fudged his books to hide this fact. NSE’s forensic audit brought all these facts to the fore. All in all, there is a shortfall of Rs 95.29 crore worth of securities.

The foremost lesson from this episode is that brokers are not equipped to act as money managers. “Never hand over your shares to a broker in lieu of a promise of periodic returns,” says Shrey Jain, founder, SAS Online, a Delhi-based discount broking firm. Numerous such incidents have happened in the past also where brokers promised fixed returns, then suffered losses while trading on clients’ behalf. If you have money or securities that you want to earn returns on, then give that money to mutual funds, portfolio management services or Sebi-registered investment advisors who offer stock related advice. “Another option is to go for a small case, which allows investors to put their money in a wide range of investment portfolios catering to varied risk appetites,” says Ankur Kapur, managing partner, Plutus Capital. This is a low-cost alternative that is nowadays offered by many leading stock brokers. All these options have much lower probability of fraud.

Key mistakes to avoid

• If you must trade, do so yourself. If someone else trades on your behalf, he could take very high risks and cause losses  
• If you wish to make money from the shares in your demat account, use exchange-based platforms like the Security Lending and Borrowing Mechanism (SLBM) offered by brokers 
• Avoid brokers involved in proprietary trading 
• Examine the contract notes sent by your broker and the consolidated account statement (CAS) sent each month by your depository to keep a tab on your securities
• Avoid brokers who try to lure you with the promise of leverage. Leveraged bets in F&O segment can lead to massive losses

Normally, when a customer’s shares are lying in a demat account, he receives monthly statements from National Securities Depository Limited (NSDL) or Central Depository Services Limited (CDSL) stating his holdings. CDSL even provides a facility called Easi (electronic access to securities information) wherein customers can login and check the holdings in their accounts. “So, even if the broker's statement is wrong, you will get an exact picture of your holdings from the depository,” says Vikas Singhania, executive director, Trade Smart Online. 

However, when a customer hands over his shares to a broker to do margin trading in the F&O segment, it becomes harder to keep track of them. The shares are moved from the client's demat account to the broker's margin account and from there to the clearing member or the exchange. “The customer can at best ask the broker to show his ledger. But if the broker fudges his ledger books, the customer has no way of knowing that his shares have already been sold,” says Jain. Hence, this route of earning returns on shares is best avoided.

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