Custodians costly balm for broker pain

Custodians costly balm for broker pain

Markets regulator Sebi reportedly plans to introduce custodians for retail investors to prevent brokers from misusing their clients’ accounts. Fraudulent brokers deserve exemplary punishment: criminal prosecution, apart from termination of membership and fines. A broker is allowed to sell securities of a client only if the latter fails to pay the settlement dues in time (read defaults). Allegations over the misuse of client funds must be investigated swiftly as retail investors should not be short-changed. Brokers should maintain margins that are intelligently and dynamically set. Audits on brokers must be rigorous to prevent frauds. But a new layer to validate trades will raise the costs for retail investors who are charged a fee by brokers for executing their trades. There is no guarantee that frauds will not occur.

Reportedly, one option is to put the onus on the depositories—Central Depository Services Ltd and National Securities Depository Ltd—to validate trades by investors. Ideally, brokers should have a self-regulatory organisation, just as mutual funds, to conduct their activities in a way that prevents such kind of practices. In the US, for example, brokers and dealers register with the SEC, and also a self-regulatory organisation (SRO). Compliance requirements to anti-fraud measures are stringent. It includes the duty of fair dealing, best execution and customer confirmation rules.

Smaller brokers should begin as sub-brokers and become independent brokers only after winning trust and growing financial muscle. Retail investors also have the option to make use of mutual funds, unit-linked insurance plans and other pooled savings instruments to invest in stocks, including Tier II of the National Pension System. Custodians who eat into earnings are not the solution.