What Are Some Stock Broker Defaults That Investors Can Avoid? by Nancy Ahuja (2024)

by Nancy Ahuja Blogger

The Securities Exchange Board of India (SEBI) has issued several operational guidelines for stockbrokers to handle clients' funds and financial assets. The regulator has also enhanced supervision to detect any misuse of securities and unethical diversion of funds. It includes a check on the financial health of the stock broker, transactions made using pledged securities, number of complaints from clients, delivery instructions, receipt of funds and securities, etc. With the enhanced supervisory role, the SEBI has mandated the internal audit for stockbrokers on a half-yearly basis for the execution of PoA, maintaining scrip-wise records, and segregating clients' funds/securities from broker's funds /securities.

Common Malpractice and Stockbroker Defaults

1. Misuse of Idle Funds: A prominent reason for broker defaults is the misuse of funds by their clients. Investors should keep track of all the funds in their trading account and funds with their broker.

To resolve this reason for stock broker default, the regulator has introduced a running account authorization mechanism. It makes it necessary for stockbrokers to return the idle funds to the investors at an agreed frequency (30 or 90 days settlement). Investors considering upcoming IPOs should know that the SEBI has reduced the timeline to refund to applicants in case of partial or non-allotment of shares.

Brokers are bound to report the client-level allocation of funds. It will ensure that a client's funds are not used to meet another client's margin requirements.

2. Misuse of PoA: Stockbroker defaults on account of misuse of securities using the investor’s PoA. With a grant of PoA, brokers can release the sold securities without a delivery instruction slip (DIS) on behalf of the investor. Also, a broker can misuse a PoA to transfer the stocks of their clients into the firm's pool account. They can pledge these stocks to raise funds for their benefits or to meet the margin requirements.

To address the issue of misusing the PoA, the SEBI has stated that collateralized stocks must remain in the investor's demat account marked as 'pledged' in the depository system. Brokers have been strictly prohibited from using the investor's securities. Make sure you read all clauses before signing the agreement with the broker for demat account opening online.

Also, the regulator has introduced an online DIS mechanism to sell stocks without granting a PoA to the broker.

3. Misuse of Loan Agreements: A broker defaults on schemes that do not come within the scope of its services. Fixed/regular returns or capital protection schemes attract most investors. The broker may offer these schemes even if they are out of their scope. It can be a loan agreement where the broker pays interest on the funds provided by the investor. Such loan agreements will be dishonored by exchanges that lead to broker defaults.

Essential Safety Guidelines to Avoid Stockbroker Defaults

Here are the key safety guidelines for investors:

• Power of Attorney: Investors should know that a PoA is not a mandatory grant to trade financial assets. It facilitates investors with easier receipt and payment mechanisms for trade, but investors are not bound to issue a PoA in favor of the broker.

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• Fund Settlement: The investors should monitor the time a broker takes to settle the account as per the agreed frequency (30 or 90 days settlement).

• Debit Instruction Slip (DIS): Avoid providing pre-signed slips to the stockbroker, and keep your DIS in a safe place.

• Keep login credentials with yourself: No one can have access to your demat account until you share your login credentials with someone. Keep it to yourself only to ensure safety.

• Avoid falling for high return promises: Stock trading cannot provide you with a corpus within a short duration. Stock market investments also require time to offer legitimate money. A promise of quick money is a scam. Avoid lending money to brokers to access such wrongful doings.

• Avoid any trading account surplus. You should not leave a large corpus in the trading account. The broker can misuse it.

• Use Demat freeze/de-freeze facility: Investors should use the demat freezing facility if they need to take a break from trading. It will help to secure their securities.

Thus, to avoid such broker defaults, investors should choose a reputed stock broker in the industry to open a demat and trading account. It will ensure the safety of your accounts under the surveillance of the SEBI. You can check the reviews of the existing clients of the broker before approaching a broker. You should check the updates and messages sent by depositories and brokers regarding your trading transactions. Therefore, it is necessary that your contact details are updated with them.

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Created on Sep 21st 2022 23:59. Viewed 363 times.

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