MC EXCLUSIVE Prop trading scam uncovered: No KYC, no paper trail; misuse of leverage runs on victim’s trust

Moneycontrol Exclusive: No agreement, No KYC, No paper trail, But trust is the only currency in the Prop-trading misuse scam. Prop Trading Scam (Part 2)

Following Moneycontrol’s report showcasing how a prop trading blow-up is turning out to be a Rs 150 crore scam, many investors and traders have come forward to share their ordeals of similar dealings with other stockbrokers in Mumbai, Delhi-NCR and Rajasthan.

Though the amounts involved are of lesser scale, the rampant misuse of prop-trading is worrisome. There is no agreement, no KYC, no paper trail, yet trades happen in full swing, and things are considered fine as long as profits accrue, but worsen the moment there is default or a big loss.

Market regulator Sebi’s regulations say that proprietary trading, commonly called prop-trading, is for brokers to do trades with their own funds for themselves, the realty is sometimes surprising.

The misuse of prop-account 

The model is basically built around extremely lucrative leverage. Market sources told Moneycontrol that there are agents who arrange leverage and limit arrangements with brokers, based on deposited margins. These agents are neither authorised by brokers nor registered with the regulator, yet they bring business for brokers and are a key resource for them, while staying invisible on paper and compliances. They are nowhere in the picture in the formal structure, yet they push up the prop book. The funds are taken in some other bank account not directly related to broking business or in cash, some times both, depending on the amount involved.

Is it a win-win for everyone?

The brokers get good returns if the trader has trading skills, as many time arrangements can include profit sharing. Brokers also earn brokerage on transactions, besides interest on leverage limit provided to the individual traders. Agents get a commission from brokers and an arbitrage from individual traders for arranging the limits from brokers.

For example, if agent makes an informal arrangement with broker to arrange a limit of say 4 percent, then it may pass the same to individual trader at 6 percent and make earning on the 2 percent interest. The individual trader using this route saves money, as he is not required to give full margin but a fraction, and bet on large trades.

In simple language for example, a trader depositing Rs 1 crore could get exposure to trade up to Rs 7 crore, paying just 4 percent interest on annul calculation basis. No retail trader in India can get anything close to this kind of leverage legally through any exchange-regulated mechanism. The broker earns 4 percent interest on his margin money parked with exchange and clearing house. As per industry insiders, brokers charge interest for such limits which varies between 2-6 percent for intraday trades and 10-15 percent for overnight trades. Sometimes, the arrangement also includes profit or loss sharing.

Where lies the problem?

“Everyone is friend in profits but become enemies if there is loss or default,” said one industry insider. If one person defaults, the whole chain is broken and the entire risk can fall on broker, if unreasonable limits were extended. As many such brokers get credit through bank guarantees, the risk can spill on lenders too. Though Sebi’s efforts in recent years like direct payout of securities and upstreaming of funds ensure that risk is minimised if any broker defaults, it still creates problem for investors in resuming their trading activities due to the long and complex process of regaining their funds and securities. And it certainly damages the investor sentiment.

How did individuals get trapped?

Most individuals get approached through social media platforms, popular chatting apps, referrals, social circles and the paid P&L screenshot hype machinery. The lure is always same - high leverage, high returns, insider like positioning, smart money-making tag - to win investor’s confidence.

Prop-trading and Sebi rules

Sebi rules clearly say that proprietary trading accounts are meant for broker’s own capital and own positions, and not for public pooling. Yet, instances show that this has been misused as the broker’s prop account extends massive margin benefit that retail accounts cannot get. “This prop model is most prevalent in cities across Gujarat, Rajasthan and Delhi-NCR region, Mumbai Metropolitan Region, small towns near Jodhpur and Bengaluru,” one industry insider said.

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Earlier, the practice was in close groups, but it is now more widespread. “This pattern has grown up in the last two years, especially after derivatives contract sizes increased across index contracts,” one individual trader said. After contract size expansion, many began pooling investor money, claiming lucrative margin at low cost and huge returns.