How to protect your interests when your stockbroker is headed for trouble

Delays in transferring securities from pool account to your demat account, or in paying out money to you are signs of potential trouble

Over the past couple of years, there have been a number of cases of brokers defaulting, or being investigated and fined by the market regulator. Allied Financials, Amrapali Aadya Trading & Investment, Kassa Finvest, Unicon, and F6 Finserve are some that have got into trouble, and landed their customers into difficulties as well. The latest case is that of a Kolkata-based broker named BMA Wealth Creators.

Misappropriation of clients’ securities likely: When a client buys shares, the broker has to transfer them to the former’s demat account. But sometimes the broker keeps the shares in his own pool account. This usually happens when the client has not paid the full amount for those shares. Brokers need to send periodic reports to the exchanges, informing them about the clients’ securities lying with them.

In an email dated September 26, the National Stock Exchange (NSE) informed the Securities and Exchange Board of India (Sebi) that it had compared the monthly client funds and securities balances as reported by BMA with the statement of depository account. NSE observed that as on August 30, there was a shortfall in the value of client securities held by BMA with depositories amounting to Rs 93.31 crore.  

NSE further observed that of the securities that were short, securities worth more than Rs 60 crore were used to meet the pay-in obligations of certain clients. The address of these clients was the same as that of the broker, indicating that they were related parties.  

What happens next? Customers of the broker should file a complaint with Sebi and NSE, stating how much of their money is lying with the broker. Complaints to Sebi can be filed at the SCORES (Sebi Complaints Redress System) web site. NSE too has an investor grievance portal called NICE Plus.  

Brokers say that customers’ shares lying in their demat account at the depository – Central Depository Services Ltd (CDSL) in this case – are safe.

Vikas Singhania, executive director, Trade Smart Online, explains that three possible scenarios can play out hereafter. One, customers can apply to the broker and get their shares transferred from the BMA demat account to a new account they have opened. This is assuming that the demat account is still active. (When such events occur, operations are usually shut down for a period of time, until a forensic audit is completed.) Two, sometimes in such cases, another broker takes over the depository participant (DP) membership. In that case, customers will have to start dealing with the new broker. And three, investors can send their delivery instruction slips directly to CDSL. The latter could then transfer the shares to another demat account.

Clients are likely to face some delays and issues in getting back the shares lying in the broker’s pool account.  “Clients with securities of up to Rs 25 lakh are secured by the exchange. Those who have funds and securities in excess of Rs 25 lakh may have to undergo arbitration proceedings presided over by a former judge. This process could take three to six months,” says Shrey Jain, founder, SAS Online, a Delhi-based discount broking firm. He adds that when a number of customers are affected, all their cases are bundled into one and decided in a time-bound manner.

Sebi has already tightened regulations: On June 20 this year, Sebi had issued a circular aimed at curbing precisely this kind of malpractice by brokers. The circular contains three key provisions. One, it says that brokers must segregate the securities and funds belonging to clients from their own. Two, shares received from the exchange must be transferred from the broker’s pool account to the client’s demat account within one working day. If a client has not paid for the shares he has purchased, the broker may retain them in a separate account (to be opened by each broker) called “client unpaid securities account”. A broker will only be able to retain such shares for five days after receiving them from the exchange. If the client does not pay by then, he must liquidate them. Three, the regulator has said that clients’ securities lying with the broker cannot be pledged with banks or non-banking financial companies (NBFCs) to raise funds.

The provisions of this circular came into force from October 1. The first two points will curb misappropriation of clients’ securities by brokers. The third provision, about not pledging clients’ securities, will also have widespread consequences. Many traditional brokers, who have pledged clients’ securities to raise money, will have to un-pledge them to become compliant. Many brokers who do not have the money to do so could default.  

Pay heed to warning signs: Given the frequency with which brokers get into trouble, clients must select their broker carefully for the sake of preserving their wealth. Stay away from those whose primary pitch to clients is that they will provide leverage. “Leverage is like a WMD (weapon of mass destruction). It can destroy everyone in the ecosystem—both the broker and the customer,” says Nithin Kamath, founder and chief executive officer (CEO), Zerodha.

Customers should also keep track of how their broker operates. When you request for money lying in your trading account, observe whether it is transferred immediately or there is a delay. Similarly, when you purchase a stock, does it come directly into your demat account directly, as it ideally should, or does it first lie in the broker’s pooled account? Once the shares you have purchased come into your demat account, you will get a message from CDSL/NSDL stating that your demat account has been credited with x number of securities. Ideally, this should happen within two days of purchasing a stock. If it does not happen, it indicates that the broker is holding back your securities. Any delay in these two things is a sign that your broker could potentially be in trouble. “As soon as you observe such signs, shift your account to a safer broker,” advises Kamath.