Defaulting brokers and vanishing share portfolios have prompted the capital market regulator to consider ways to protect the interests of retail investors who are often at the mercy of unscrupulous brokers misusing clients’ shares without consent. 

The Securities and Exchange Board of India (SEBI) plans to tighten rules for trading settlement and introduce custodians for retail investors, said two people familiar with the matter. 

These proposals were discussed in the Sebi’s Secondary Market Advisory Committee meeting recently. 

The details could not be ascertained because the plan is still on the drawing board. Sebi’s plan is to ensure brokers do not misuse clients’ accounts and sell their shares without nod unless the client has defaulted. 

The market regulator is considering the introduction of custodians for retail investors — akin to intermediaries for foreign portfolio investors — that will manage the back-end operations of investors after a trade is done. 

Sebi may also put the onus on depositories — Central Depository Services Ltd and National Securities Depository Ltd — to validate trades by investors. Depositories hold securities like shares and debentures in electronic form. 

“In the past, there have been instances when brokers go bust and clients’ shares also vanish. There are a few proposals: one is, can we have a system where clients’ shares are not with the broker?” said a senior regulatory official. 

Brokers are also depository participants and act as the intermediary between the investor and the depository. They facilitate the settlement of trades done on stock exchanges. 

But instances of brokers defaulting on payments to clients have prompted the regulator to take a relook at brokers’ powers in handling clients’ share accounts. 

In the past one year, at least 12 stock brokers have shut shop. 

These brokers have been accused of selling clients’ shares without permission and not repaying client money. In most of these instances, Sebi noticed that brokers misused the power of attorney, which can only be used if clients default. 

Asenior official, familiar with Sebi’s plan, said defaulting brokers have taken away investor money worth almost Rs 1,000 crore. 

“The thinking now is that the security will not move to the broker but will be marked as a pledge to the broker’s account. Here, the broker cannot sell the shares unless there is a default by the client,” said the regulatory official quoted above. 

A custodian for retail investors could ensure that brokers do not misuse client accounts. Custodial services for FPIs ensure safekeeping of securities and maintenance of client accounts. 

“In the event of default, securities should be with a neutral or third party so that shares don’t vanish. Securities are the property of clients,” the regulatory official said. The debate is whether the custodian services for retail investors should be mandatory or optional. 

Critics said the introduction of such custodians could lead to an increase in costs for small investors. Such an arrangement would mostly be feasible for the more affluent. 

Some brokers fear such rules would restrict their roles. “Brokers will end up being just trade executors unless the established ones can become custodians,” said the head of a large broking company.  #casansaar (Source - ET, SEBI)