Jimeet Modi, Founder & CEO, Samco Securities explains the root causes of brokerage firms defaulting is their genuine fraudulent intent in an interview with Himali Patel.

With an increasing number of stock brokerages defaulting, could you explain the root cause?

The root causes of broker defaults are broadly to meet a broker’s own financial obligations or for genuine fraudulent intent. Currently, there is no framework for approval or processing of related party transactions by a broker. If brokers had disclosed they had dealings with related parties, exchanges and auditors would have taken note of such dealings to investigate further and could have identified defaults much earlier. Additionally, when a broker is involved in proprietary trading or unrelated businesses and if it ends up losing a large sum of money then the financial obligation mounts, which causes the misuse of securities.

How such defaults could be prevented and what is the role of Sebi in it?

Various government and financial reforms are required to be addressed in order to prevent further defaults by brokers. From a government reforms’ perspective, there should be at least one mandatory independent director on the board of a broker entity. This will bring about transparency and will prevent the company from taking any law defying steps. As far as the financial reforms are concerned, it should be mandatory to maintain a dynamic capital adequacy ratio with regards to the size of the business of a broking company. Moreover, there has been no change in the networth requirement of brokers since the past 20 years.

What are the disclosures that brokerage houses are required to reveal to investors?

Currently there are none. Hence, investors and clients of several brokerage houses must be informed about various activities in the form of disclosures in order to empower them about their broker and enable them to make informed decisions. Disclosures should be on any related party transactions done by brokers with any associates or subsidies or others, proprietary turnover and proprietary gains or losses at regular intervals. These details will make investors aware of the way their broker is functioning and any red flag can give them an insight to re-evaluate the current relationship with their broker. Brokers can disclose annual statements at least on their company website for clients to know about their financial position.

What are the rights of the investors that protects them during such events?

During such events, an investor must approach the exchange first, wherein he has to file an Investment Grievance Redressal Forum or IGRP, immediately lodging his claim of unauthorised transactions in his account without consent. No fees are to be paid for this remedy. Thereafter, the second stage is to go for arbitration under the supervision of the Exchange. This is a judicial proceeding wherein competent or retired judges decide the matter on merits. Thereafter, appeal can also be filed before a three-judge arbitrary bench. But nonetheless, it is expected that Sebi will take a holistic view and decide all matters pertaining to investors during such events.