Fresh broker defaults continue and the industry is now seeing a record 28 defaults or expulsions since November 2019, just a little before the pandemic. In our article in December 2020
, we reported that this was the highest number of broker defaults in the past 20 years. Until then, there were 18 broker defaults on the National Stock Exchange (NSE). If the brokers have a membership of the Bombay Stock Exchange (BSE), they are suspended by that Exchange too. In March 2021, when more broker defaults were reported, we pointed to regulatory lapses by the Exchange and called for action by the finance ministry (Read: 20 Broker Defaults: It’s Time the Finance Minister Demanded These Specific Actions
Ten more brokers have defaulted and/ or been expelled
by the NSE between December 2020 and July 2021. Of these, five have been expelled by the BSE too. Most defaults have inflicted crippling losses on investors, although the settlement guarantee ensures that there is no impact on the market itself. In many cases, brokers used investors’ shares to obtain leverage and take speculative positions on the derivatives market leading to losses.
Sometimes, they passed back a small interest for the pledged shares but, in many cases, investors were unaware of their shares being pledged.
For instance, in 2019 Karvy Stock Broking was banned by the Securities and Exchange Board of India (SEBI) for defaulting clients for around Rs2,000 crore making it one of the biggest such cases in India.
List of defaulting brokers on NSE
This list does not include the two firms, which abruptly closed their capital market business of their own accord (voluntarily). One is IndiaNivesh, whose voluntary closure has led to litigation between HDFC Bank and Edelweiss Custodial Services and exposed the shady practice of 'funded fixed deposits' being accepted by the clearing corporation as collateral. In this case, the dispute is over a Rs100 crore funded FD, which HDFC Bank refused to honour. The other was Action Financial, which initially claimed to have done a voluntary closure but was later expelled by the exchange since it had failed to refund investors money. (Read: IndiaNivesh, Edelweiss & HDFC Bank: The Curious Case of Rs100 Crore Fixed Deposit Receipts
In October 2020, market regulator - SEBI announced that NSE increase its investor protection fund (IPF) to Rs1,500 crore. However, even this increased corpus might not be enough to fully reimburse all clients as the default by brokers in the derivative segment is higher. Exchanges too have an obligatory cap on how much money each investor can claim. SEBI had also directed exchanges to conduct an annual review to ascertain the adequacy of the IPF; disclose IPF corpus on a monthly basis and implement a standard operating procedure for processing investor claims. (Read: SEBI Asks NSE To Increase its IPF Corpus to Rs1,500 Crore from Rs594 Crore at Present
More importantly, clients can go to exchanges with their claim only after a broker is declared a defaulter. Often, the delay in declaring brokers as defaulters leaves client claims in limbo and the investor clients end up waiting for a long time to get their funds back.
In many cases, the claims are rejected citing some little-known rules and procedures. Hapless clients then approach the High Court but even there it is a long-drawn legal battle.
While earlier broker defaults were often due to the broker’s failure to honour settlement obligations with clearing corporations, broker defaults in recent years come by when they are unable to repay client assets—shares or money—as and when required.
Broker default in refunding client assets is primarily due to diversion of client funds or securities towards businesses other than those of securities – most of the time real estate or financing for speculative trades.
Last month, SEBI issued a framework to minimise the risk of misuse of investor funds by stock brokers. The new measures are part of the market regulator’s effort to prevent misappropriation and misuse of client funds by brokers and also to protect the clients in the event of a default by the brokers. (Read: SEBI Develops System to Detect Misuse of Client Securities by Brokers
This follows several instances of brokers misusing clients’ securities for trades that were not authorised by them and submitting false information to stock exchanges.
Unfortunately, nothing seems to stem the spate of broker defaults and voluntary closures of business by brokerage firms—especially among commodity brokers.
This list has not looked at the commodity markets, which are now allowed to trade in equities and are also under SEBI regulation and supervision.