[Memo] Penny-wise & pound-foolish – how brokers dupe investors?


Following is a copy of recent memo shared with Stalwart’s clients –

It is unfortunate that despite such strict regulations and risk management by SEBI and Exchanges, in a recent case a Delhi-based broker could pledge his clients’ securities worth Rs 55 Cr., borrow money, divert funds for trading/personal use and eventually default. The investors are now at risk of losing a part or all of their portfolio.

A broker can do that because sometimes clients agree to transfer their securities to broker’s pool account, whereas in many cases it could also be done fraudulently without letting clients know about it.

Why do investors allow the broker to transfer their DP holding to broker’s pool account? Brokers lure clients by offering interest on securities as high as 7-10% if they agree to keep their securities in his pool account. In turn, the broker is able to get a higher margin from the exchange which allows him to have bigger positions in Futures & Options.

Other reasons for investors agreeing to keep securities in broker’s pool account could be the trust they have in him; the broker could be a neighbor, a friend or someone we have known for long. He may be ethical but by nature markets are so volatile that his one wrong decision in F&O can take him down and if your portfolio is pledged for his trading, you stand to lose too. If not him, it could be his employee who could get everyone in trouble. Something similar happened at Emkay during Oct’12 when a trader by mistake placed a sell order on Nifty for Rs 650 Cr. instead for Rs 65 Cr., Nifty crashed from 5,800 to 4,800 in two minutes and Emkay suffered losses to the tune of Rs 70 Cr., eroding its net-worth by 50%. When one of India’s biggest institutional broker could have such a lapse in systems and processes, what kind of risk-management should we expect at these single location neighborhood brokers?

What are some of the best practices while managing your broking account?

  1. Don’t risk your entire portfolio just to save some tiny brokerage. Operate only with well known national brokers who are financially strong and have robust systems & processes in place. Doesn’t matter if that means you have to pay 5 or 10 basis points extra brokerage.
  2. Never allow the broker to transfer your DP holding to the pool account. Don’t fall prey to any scheme of making money on your DP holding.
  3. Never share your online trading password with anyone and keep updating it at regular intervals.
  4. Reconcile the financial and demat ledger at regular intervals, at least every month, just the way we do with our bank accounts.
  5. A demat account is like your bank account, it can be easily cashable. To avoid that you can even lock/freeze the shares. You can even have two DP accounts, one as the core for long-term holding and other as the satellite for trading/IPO etc.
  6. To be extra careful, some investors even open and manage the demat account through their bank and have only trading through a broker.
  7. Make sure your email address and phone number registered with NSDL/CDSL are up to date and you are receiving notifications the same day of trade. If there is any discrepancy, immediately file a complaint with broker’s compliance officer and also register one with SEBI at SCORES
  8. Avoid keeping too much cash in your trading account. Though it reflects as credit in your trading account, that money is actually lying in broker’s bank account. It is best to park surplus cash in a liquid mutual fund or keep it in the bank account.

Disclaimer: We are an independent equity research outfit with absolutely no interest in broking. Investors can choose to execute trades at any broker of their choice. The sole purpose of this note is to remind that despite technological advancements and stricter regulations, there continues to be a risk of such unfortunate incidents which could put one’s entire life savings at risk.

PS: If we have missed any point, please do add in the comments, especially those running a broking house or working for one are encouraged to share what are the other loopholes/pitfalls which investors should be aware of while managing their broking accounts.

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