SEBI wants brokers and investors to give an undertaking that they have no connection with the company in which the investor wants to invest his hard earned money

Just two days ago, regulators including Securities and Exchange Board of India (SEBI), released the draft “National Strategy for Financial Education” to convert savers into investors. This is needed because India's investor population is fast dwindling. However, while making an effort to increase number of investors, SEBI, is making survival difficult for those who are actively participating in the markets.
 
SEBI, especially its surveillance department appears to compelling brokers through exchanges to obtain certain undertaking from clients (investors) who have traded in shares being investigated. The forms being circulated to brokers are, in a way an attempt by the regulator to ‘trap’ or make a ‘scapegoat’ of broker/s in case something goes wrong in share trading. We sent mails to SEBI, BSE and NSE on 17 July at 4pm.

In an email reply, received on 19 July at 6.52pm, SEBI said, "The requirement of obtaining undertakings from clients have been formulated by Stock Exchanges (Bombay Stock Exchange and National Stock Exchange) in consultation with SEBI. These undertakings are sought by stock exchanges in respect of those cases where the stock exchanges have initiated examination and from those clients whose transactions have been observed to be suspicious or prima facie inconsistent with the behaviour of a rationale investor."

"We are taking the undertaking from clients, it is a SEBI requirement," said NSE in an email reply.

BSE, on the other hand, declined to comment.
 
One important factor is that brokers share only a commercial relation with clients (investors) and have no statutory or regulatory jurisdiction either on clients or any third parties or listed companies. Even exchanges do not have any jurisdiction to question trading clients about their relationships with any third persons.

Yet, the undertaking by SEBI asks brokers to ratify that their client is not connected with any promoter, director, officer or an employee of the brokerage. Is also asks the brokerage to confirm that the dealings in securities undertaken by their client/s has been funded by the client himself through his own account! The brokerage even has to affirm that there is no connection among its clients who have dealt in securities of a particular company through the broker.

According to the clarification given by SEBI, objective for an undertaking from a broker is to make him exercise due care and diligence on the activities of clients. "Such a practice is in line with most developed jurisdictions where brokers are sought to be involved in better surveillance of markets as the first line of reporting suspicious transactions," it said.
 
“Most of the information contained in this undertaking would not be in the personal knowledge of the broker and his client. For example, it beats us totally as to how a trading client would know his relationship, “directly or indirectly” with any of the thousands of employees of a listed company. For that matter, how would he even know who are the officers and employees of the listed company? said one broker who does not want to be identified.
 
The brokers are not the only ones who have to give the undertaking. Even the investor has to give an undertaking that he is not directly or indirectly connected with any promoter, director, officer or employee of the company (whose shares he wants to buy or has already bought). Not just this, the investor also has to give in writing that he is neither related with the company nor he has any business or professional relationship with it, directly or indirectly.

SEBI, in its email reply, said, "Objective behind obtaining an undertaking from a client is to ascertain his/her linkages with the management of a company that is under examination, which in turn would pave the way for wider and more effective monitoring and surveillance that is in the interest of the market. Such undertaking also requires a client to update his KYC with broker. It also seeks an affirmation whether clients' own funds are being used for investment, which is already a pre-requisite under the code of conduct and circulars governing conduct of a broker."
 
This is really weird. How can anybody certify that he does not have any direct or indirect business relationship or connection with a listed company? Does this mean that someone would be at fault for buying shares in ‘X’ company just because his friend’s wife’s third or fourth cousin happens to be a raw material supplier or consultant or employee of ‘X’?
 
“To us, it is an attempt by the lazy and ineffective surveillance department of SEBI to shift its work and accountability to exchanges and brokers. The hapless brokers are getting threats from exchanges to somehow comply with the SEBI directive. In turn the brokers are threatening the clients to close the account with them if they do not give this undertaking,” said another broker.
 
After all the pressure-chain created by SEBI, exchanges and brokers, the client, who does not know the relevant facts, has only two choices—either to give a false undertaking without even fully knowing what he is signing or to suffer financial losses because of a possible closing of his trading account by the broker. “How can the exchange and SEBI punish an investor for not knowing facts which are outside his personal knowledge?” asked one investor preferring anonymity.
 
No doubt, whether it is SEBI or any other investigating agency, they need to carry out certain procedures to safeguard the interest of common investors. But this latest undertaking is an attempt by the regulator to make the broker and investor, a readymade ‘scapegoat’ in case something goes wrong or it finds something wrong in share trading of that particular company. If these kinds of things do not end, we would see further diminishing of interest in our capital markets.