March 10, 2008

life in financial markets: suggestions for new sebi chairman

The Indian securities market regulator, Securities and Exchange Board of India (Sebi), has a new chairman since the last three weeks.

Here are some areas which I think Sebi needs to look at on a priority basis:

1) The clauses governing the client-broker agreement and the client-DP agreement are heavily tilted in favour of the broker and the DP. A major chunk of all obligations are passed on to the investor while the broker and the DP retain very little and that too are stated in no unambiguous terms.

The power of attorney clause needs to be controlled with restrictions.

A revist of the agreement by Sebi is long overdue. Not just that, there should be a direct random sample investigation of BSE-NSE brokers and CDSL-NSDL DPs every year to detect violations. Sebi should not just rely on what the stock exchanges and the depositories tell it.

2) If Sebi wants to rely on the exchanges and the depositories then a thorough investigation of them needs to be carried out by Sebi every year. The details of the findings from these investigations must be shared with the public.

There are a lot of problems being faced by investors in their dealings with brokers and depositories. The stock exchanges and depositories are doing extremely little in taking action against the errant brokers and DPs. Cases of fictituous contract notes that includes more than contract note being issued by a brokers with the same number are not taken seriously by NSE and BSE when it is brought to their notice. Heavy manipulation by the brokers of their ability to change client codes is also a anti-investor activity that the exchanges have not taken adequate action on against the brokers.

Presently, the investing public is expected to blindly trust Sebi and Sebi too arrogantly expects the investing public to trust it blindly. To make financial markets healthy this attitude needs to change.

3) In a T+2 settlement system, brokers are demanding payment of monies and delivery of shares earlier from investors. This has forced brokers to ask for it before the trades even happen to or to force investors to give them a power of attorney. An investor might be comfortable with the former (delivering shares or making payment before transacting) and not with the latter (giving PoA to broker).

But he wants a legal protection under the exchange rules and regulations. Today, the exchanges regulations activate investor rights only AFTER a trade takes place and NOT BEFORE. Sebi should make the exchanges modify their rules/byelaws/regulations to bring the pre-trade transfers made by the investor to the broker.

If there is a fear that brokers can mis-use this provision too then innovative clauses can be considered – for instance, a pre-trade transfer may be valid only for 2 days or 5 days, and brokers would be mandated to transfer back shares/money if the investor has not traded. (The broker should not be allowed to get investor undertaking to maintain a running account. Even the running account system should be bought under the protection of the broker having to transfer back shares/money if no trades are executed by the investor for 2 or 5 days.)

There could be a pre-trade contract note-like system too, where unique numbers are given for each pre-trade transfer. Exchanges should then grant the same rights (grievance redressal, arbitration etc) on these pre-trade contract notes as it does after the trades are executed and contract notes generated.

4) The entire arbitration system of exchanges and depositories appears to be to make it easier for exchanges and depositories to not take on legal responsibility for disputes between investors and brokes/DPs. The quality of arbitrators is extremely poor as is seen from the track record so far.

Sebi needs to do something about this urgently. If the financial compensation aspect is extremely difficult to bring under exchanges/depositories purview, at least the exchanges/depositories should be made liable to conduct investigation of broker/DP for the purpose of levying penalty or suspending it or whatever and the findings of this investigation would have to be mandatorily disclosed to the complaining investor.

5) In the DIP norms pertaining to primary market issues, there is no enforcement of any kind whatsoever on the liabilities laid down on the lead managers (investment banking companies). For instance, the lead managers are supposed to "weed out" multiple application bids.

In the 2005-06 benami application scam in more than 20 IPOs, the lead managers could have nipped the scam at the application stage itself if a simple software would have been run on the addresses of the applicants. Even if in near future the DP system is integrated with the IPO system the lead managers should still be required to run a software check on the addresses of the applicants.

6) The mid-October Sebi press releases on the FII-Pnotes issue has not be converted into any amendment in the FII regulations. This has opened the doors for corruption among Sebi officers.

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