MC Exclusive: Brokerages evade regulatory scrutiny of illegal prop-renting with an easy hack

Renting out prop accounts has became so lucrative for brokerages that the brokerages have set up pyramid-like schemes for their distribution. (Photo by Scott Webb: Pexels)

Brokerages are finding new ways to continue their lucrative but illegal business of renting out their proprietary account to traders. They are using an easily available and affordable technology to hoodwink the regulator's monitoring mechanism, according to market insiders.

The Securities and Exchange Board of India (SEBI) has been concerned about the various illegal practices using brokerages' proprietary accounts, including brokerages 'renting out' their proprietary accounts for a fee. Therefore, market insiders told Moneycontrol, the regulator has started looking more closely at the location from where the prop trades are being placed.

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Brokerages are allowed to place proprietary orders only from specific locations. But brokerages renting out their prop accounts were allowing their tenant-traders to access the account from wherever they were located.

“People have been placing trades for prop books from different parts of the country, some people even take trades from their homes. But the regulator had never looked at that too closely… until now,” said an industry insider.

Another said that the scrutiny has increased particularly since October. In the press conference after the last board meeting, SEBI chairperson Madhabi Puri Buch had commented on such practices saying that these are worth investigating and that the regulator is examining them.

In a bid to evade the heightened scrutiny, errant brokerages are using remote desktop protocol (RDP) to give access to traders who are not working from the specified or registered location. As insiders told Moneycontrol, brokerages are letting people trade from various locations across the country by giving them remote access to systems placed in the registered location/locations.

Why is this a concern? 

This allows brokerages to continue to rent out their prop account to traders who are looking for excess leverage, particular after the upfront-margin collection norm. SEBI on May 10, 2022, issued a circular that mandated upfront collection of margin, which ended the possibility of brokerages providing excess leverage to traders.

This renting out of prop accounts is an illegal arrangement and brokerages are known to charge anywhere between 6 percent and 12 percent on the leverage provided.

This business did so well that brokerages set up elaborate pyramid-like structures to distribute this service. That is, a trader who is registered as a sub-broker would first rent access to the prop book. Then this trader would ‘sublet’ their credit limit to other traders for a fee. Anecdotal evidence gathered from insiders suggest that these intermediary traders can even hope to make a few crores a month through such arrangements.

While people have been taking such trades from various locations without too much scrutiny, there were other ways of evading the regulator’s eye as well.

“You can do this with a simple app,” the brokerage executive explained. The trader feeds the trades he/she wants to place into the app and they are forwarded to the brokerage, which then places these trades from their systems. In this case, the app acts somewhat like a simple messaging solution.

“The lag would be only around 35 microseconds to 40 microseconds for trades taken like this,” said an industry insider, adding that these lags don’t really matter much to such traders because their strategies aren’t as price or time sensitive.

Dropping a pin

One way to check if the prop accounts are not being misused was to track the locations from which their trades are placed, using the static ID.

That is, whenever a person logs into the internet from a location, a static ID is generated. This ID carries the information of the location from which the person is logging in. If the regulator tracks this and sees that trades are being taken from locations that don’t have clearance, that would be a red flag.

This would also flag other illegal practices such as traders who act as fund managers for various brokerages. That is, traders who manage the prop accounts for the brokerages for a fee.

This practice too can be traced using the IP address, if trades for various prop books are seen to be taken from the same location. Again, static ID can help here.

Therefore, the easiest way to get around this IP-driven locating of trades is the RDP protocol. As an insider told Moneycontrol, these systems can be set up in the brokerage office for anywhere between Rs 50,000 to Rs 70,000 per system.

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“You need only a regular system to access the remotely located computer,” said the trader, adding that the brokerages have added that to the fee too.

Then a trader who is renting out the prop book can place his/her orders from the remote system placed in the broker’s office. Therefore, the static ID from where the trades have been sent will only reflect the broker’s office location and not the trader’s location.