Considering the instances where the Stockbrokers have diverted client securities, observed that these diversions were coming to light on failure of these stockbrokers to meet margin and/ or settlement obligations to Stock Exchange/ Clearing Corporation. In this regard, the Securities Exchange Board of India (SEBI), noted the thrust of these diversions towards raising loan against shares on their own account and/ or for meeting securities shortages in settlement obligations and decided on establishing an Early Warning Mechanism as well as facilitating the sharing of information between Stock Exchanges, Depositories and Clearing Corporations.
Aiming at ensuring the effective detection through the insertion of these systems which connect different platforms, SEBI left the threshold for the early warning signals to the discretion of the Stock Exchanges, Depositories and Clearing Corporations, who had to decide this threhold with mutual consultation.
SEBI suggested an indicative criteria of what these early warning signals for the prevention of such diversions could include. The early warning signals were divided into 5 categories:
1.Deterioration in financial health of the stock broker/ depository participant
The parameters for the deterioration were laid out from 3.1 a) to j) and included aspects such as a significant reduction in the net worth, losses including significant mark-to-market loss, delays in reporting requirements, both regarding its financial health and regarding related party dealings, significant activity in dormant accounts, resignation of key personnel (statutory auditors or directors).
2. Securities pledge transactions by the stock broker that are to be identified by the Depositories and shared with Stock Exchanges
Such early warning signals may include alerts for stockbrokers maintaining multiple proprietary accounts, transfer/movement/depletion of large magnitude of shares as well as invocation of pledges of securities.
3. Increase in the number of complaints on grounds of unauthorized trading/ unauthorized delivery instructions being processed and non-receipt of funds and securities.
4.Alerts through the Risk Based Supervision (RBS) or Enhanced Supervision to the Stock Exchanges
Failure to upload required weekly data or misreporting/wrong reporting on such uploads, significant increase in RBS score, recovery and non-recovery of the significant dues to the credit and debit balance respectively.
5.The disabling of stock broker’s terminal for certain number of days in any segment / Stock Exchange in previous quarter
Framing an internal policy: SEBI requires the Stock Exchanges and Depositories to frame internal policies/ guidelines regarding non- cooperation by stock brokers and depository participants during inspections. These policies must lay down the time period, the type of documents critical for closing the inspections. Non-submission of these can be treated as non-cooperation.
- Mechanism to detect diversion of clients’ securities and effective sharing of information: The information shared amongst stock exchanges includes information regarding- unauthorised/fraudulent transfers, information and clarifications regarding mis-matches, diversion of pay-out securities to non-client account.
- Alerts triggered at place shared to all other participants.
- A non-exhaustive list of actions that can be initiated by stock exchanges includes: imposition of limits, cross-checking of details, conducting meetings, undertaking uniform action of deactivation of trading terminals, blocking certain percentage of available collateral.
- Actions that can be taken by depositories include and are not limited to, restriction of further pledges, impositions of concurrent audits and restrictions (to the point of cessation) on uses of Power of Attorney.
The mechanism suggested in this circular is to be implemented with effect from 1 February 2019 and all Stock Exchanges, Clearing Corporations and Depositories must adopt the suggested mechanism along with preventive actions.