SEBI tightens rules for usage of client funds by brokerages

In April 2008, SEBI informed brokers through a circular that a client's unpaid securities and collateral in the form of securities shall NOT be used for purposes other than meeting his pay-in obligation or margin requirement. Last week, SEBI released an updated circular tightening the rules for usage of client funds by brokerages effective from Sept 1.

Following are the key points from the new circular:

1. SEBI has ordered brokers and clearing members to open a new type of demat account termed as 'client unpaid securities account' and close earlier demat accounts used for managing clients' securities. 

2. Brokers and clearing members are required to transfer a client's securities received in pay-out to his demat account within 1 working day

3. In the event of the client defaulting on payment for the securities, the broker and clearing member can retain the securities for a maximum of five days, after which the securities need to be compulsorily sold under the client's account. 

4. SEBI has reiterated that the broker cannot use unpaid securities for purposes other than meeting pay-in obligations and collateral against these securities can only be used for meeting margin requirements.

5. Brokerages have also been asked to wind-up any client accounts that don’t fall under category of pool account, client margin trading securities account and client collateral account by August 2019. 

There have been cases of misappropriating the unpaid securities and securities-based collateral of clients, particularly those who operate running accounts or margin trading accounts. Many brokers have transferred these securities to their own account and then placed them as collateral with banks and NBFCs to borrow funds to meet margin requirement of other clients or their own proprietary obligations. These securities have also been fraudulently utilized by brokers to fulfill securities shortages of other clients or proprietary trades. 

Most of these points were already implemented by brokers as part of the margin and risk management. However, given the rising number of misuse of certain norms within the 2008 circular, SEBI has decided to provide further clarification and remove all weakness & misinterpretations in the system currently. It's a welcome move!

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