October 28, 2009

life in financial markets: wild west among india's equity brokers!

In the last one month or so, the National Stock Exchange has been publishing ads in newspapers alerting readers (who would be investors in the stock market) about the role of Power of Attorney (PoA) that they hand over to brokers.

I am amused. The NSE is spending a lot of money in these ads. Instead, it can spend one-tenth of it by just auditing the records of 5% clients of its top 20 brokers (by number of clients) and checking the PoA documents signed by the investors and handed over to brokers. These lie with with the broker and NSE has regulatory powers to inpsect any broker's records.

But as I said in a post earlier this month, the stock exchanges are amazingly loathe to take any tough action against its brokers.

Anyway, the NSE ad reminded me of a story I had written last year and submitted, in December 2008, to the magazine I work for, for a potential new, but undecided, specialised and frequent section in the magazine.

That story talked of the dangers of the documents that investors were being forced to sign by brokers and DPs. Here is that story:

One-sided agreements

Its a wild west out there among brokers and DPs. Put on your Client Eastwood hat to take them on.

The underlying principle behind legal agreements is that they protect the rights—and spell out the obligations—of ALL the parties to the contract or agreement. The stock market has its share of legal agreements but they are getting increasingly opposed to the rights of you—the investor.

To carry out your investment activities in equity shares you have a trading account with a NSE (National Stock Exchange) or BSE (Bombay Stock Exchange) broker and a demat account with a NSDL (National Securities Depository) or CDSL (Central Depository Services) depository participant (DP). The legal umbrella is the client-broker and client-DP agreement. Willy-nilly you sign them.

Well, this umbrella is leaking. What's worse is that brokers are making you sign various authority letters and powers of attorney. We take a look at these legal agreements to see whether they offer you protection or potential hazards.

Client-broker agreement. In the last seven years, brokers have almost resorted to incorporating all kinds of clauses that are heavy on your obligations but feather-light on the broker's. More than 95 per cent of them dwell on your do's and don'ts and the remaining tiny portion is on jurisdictional and dispute issues. This wasn't the case two years ago. Then, these agreements contained specific clauses on broker's obligations to deliver shares and pay funds within 24 hours of settlement pay-out to the client and dispatch of contract notes within 24 hours of the trade. Such clauses have performed the Houdini act. In their place have come new ones that are nothing but a sleight of the hand for investors.

The NSE and BSE have been mute witnesses to the mutation of this crucial legal document. Pick up any agreement of any big broking firm and one sees this new trend. Although exchanges' rules and regulations also define the rights and obligations of broker vis-a-vie their interactions with investor-clients, not-so-savvy investors are not likely to know the existence of these and therefore vulnerable to being taken for a ride by some unscrupulous brokers. Their brokers will point to the agreement and say "See! Your complaints are not covered here. So chill!" The chill should have been going down the spines of the officials of the inspection department on uncovering such agreements during their yearly sojourn of brokers' offices. But so far the two exchanges have chosen to ignore this investor-related area in their regulation of the markets.

Irrevocable power of Attorney. The rolling settlement cycle got shortened to T+2 from April 2003, and since then there has been pressure on you to pay funds or deliver shares to your brokers on time. Taking advantage of this situation many brokers today coerce you to give them your irrevocable power of attorney (PoA) to manage your demat account (and with some brokers whose associates are banks even your bank account) so that you are saved from the effort of handing debit instruction slips to your DP against your sales on time. These PoAs also go further to include your investments in mutual funds, government securities and other securities through the broker who could be an authorised mutual fund agent and investment agent to government agencies.

But the problem arises when you are given no other option but to give your broker or DP such a PoA. Says the NSE official: "As far as any authorisation is concerned the investor has got complete freedom not to give it and the broker can't refuse service on that ground. Brokers' internal arrangements can not override our or Sebi rules."

This would be reassuring if the reality reflects it. But walk in to any office or branch of a large- or medium-sized brokerage firm and enquire about opening a new trading account and demat account with either of them and you will find their representatives clearly telling you that if you do not sign on the POA, they will not process your application form at all. A majority of brokers do this and NSE and BSE do nothing about it. This is despite alternative solutions made available by NSDL and CDSL enabling investors to move shares through the internet. Brokers and DPs are stingy in informing their investors of such an alternative solution.

What makes matters worse is that the PoA does not specify that it will be used only for settlement for trades done through the broker. They give unhindered and all-pervasive rights to the broker to do what it wants to with your demat account including making off-market transfers. Where the PoA confers rights to your broker to operate your money account with certain specified banks then your entire savings account balances are at risk if there is malfeasance committed by any official of the broker. The chances of this are not exactly remote because in most PoAs the brokers are also conferring upon themselves the right to choose one or more substitutes, that is external persons, to execute the rights under the PoA. Potentially it could really become a wild west out there.

In the past even DPs used to take PoAs. In November 2005 NSDL detected anomalies in the account-opening process of one of its DP, Indiabulls Securities, wherein not only the PoA was made mandatory but it took away all rights of the investors to operate their demat account and only the DP retained that the right. Taking a cue from its inspection of Indiabulls NSDL ended up issuing a circular to all DPs to discontinue with the PoA compulsion and desist from doing four things through the PoA – (i) restraining the investor from operating his demat account, (ii) denying delivery instruction slip books, (iii) merging shares kept under various client accounts and (iv) having a lien on the clients' shares.

Other authorisations. Many brokers additionally take an authority letter to maintain a running account wherein the broker keeps the shares you bought or the funds received against your sales unless you ask for it in writing to be returned to you. This too is being forced upon investors.

On 3 December, posing as an investor, this BW reporter walked in to the Annie Besant Road (Worli, Bombay) branch of LKP Shares & Stock Brokers, and enquired with an official, Jolly Shah, about wanting to open a trading account and a demat account. On asking, she showed the documentation docket that included the client-broker agreement but also included a set of documents termed as 'Voluntary documents'. The first document in the 'Voluntary documents' was that of a running account authorisation. This reporter asked her whether it was a must for him to sign that document she said 'Yes'. On questioning how LKP is making it compulsory for investors to sign on a 'Voluntary document' she took offence and did not answer.

Both the exchanges are not taking action against the scores of brokers who are subtly but surely forcing the signing of documents that according to NSE's rules and regulations they can't force any one to sign. The running account authorisation is pernicious because under it the broker gets to retain the shares or funds for almost any reason or even without a reason when the investor buys or sells shares. As per NSE's and BSE's rules the broker has to transfer the shares/fundswithin 24 hours of the pay-out. The forced running account authorisations are violating this important exchange rule. BW queried both the exchanges but did not receive any response.

As an investor you can complain to the stock exchange if you have similar experiences. If it's with a NSE broker write to cc_nse@nse.co. if it's a BSE one write to corporate.affairs@bseindia.com. Safe investing!

No comments: