Deal With The Dud

The exchange has been trying to introduce an element of culpability for the member broker to recoup its losses. But a personal indemnity scheme, on the lines proposed by the exchange, serves no purpose. For one, calling upon directors on boards of corporate broker-members to furnish unlimited personal guarantees flies in the face of the concept of corporatisation of brokerages. The law recognises that the liability of a shareholder (and therefore of shareholding directors) in a limited company is limited to the extent of his shareholding. Nevertheless, NSE has insisted on unlimited guarantees not only from the directors but also from dominant shareholders in the broking companies. In the circumstances, there can be no difference between corporate brokerages and sole proprietorship/partnership concerns, where the liability of the proprietor/partner is unlimited. Brokers who have paid a premium for corporate tickets are, therefore, in no mood to play along.

The broader question, however, is: indemnity for what purpose? If it is only a cover for the downside risk of the broker introducing stolen, fake or forged shares, the NSE management must realise that no trading system can be totally rid of settlement and counter-party risk. There is nothing to stop a wayward broker from introducing dud shares to the maximum exposure limit available. Surely, NSE cannot expect its brokers to put up guarantees covering their total exposure. Moreover, getting directors' and shareholder's indemnity does not help because most of the time they may not have the requisite net worth in their individual capacities. Indeed, there is the real chance of adverse selection in that brokers with fraud on their mind would be most willing to offer indemnities, knowing fully well that their indemnity is not worth the paper it is typed on.

Risk cannot be entirely covered, but can only be contained through prudent trading practices and tough supervision. Pre-verification of shares, as mooted in some quarters, is a Utopian solution because there can be no guarantee of the worth of the shares until they are lodged with the company concerned for transfer. The bad shares issue needs to be sorted out with other exchanges, which simply return doubtful shares as bad delivery. Most often these shares land up at the NSE. The solution would be for all exchanges to confiscate all doubtful shares so that they do not go back into circulation. Perhaps when all exchanges go into trade guarantee schemes of their own, they will realise the point is stamping out