MC EXCLUSIVE Sebi orders exchanges to investigate prop-trading account misuse after Moneycontrol expose

MC Impact-SEBI orders exchanges to investigate the prop-account misuse post Moneycontrol Expose

Market regulator Securities and Exchange Board of India (Sebi) has ordered exchanges to investigate the wrongdoings involving the rampant misuse of prop-trading accounts, following Moneycontrol’s expose last week.

In a three-part series, Moneycontrol has reported that some broking firms were facilitating individual traders in multiple cities to trade in brokers’ own trading accounts in lieu of commission or profit sharing, in violation of Sebi and exchange rules.

One Sebi official has confirmed the development while requesting not to be named. “Sebi has directed exchanges to investigate the violations and submit a report,” the source said, adding, “…allegations have been taken seriously as the activities seem to be violative of regulations.”

Sebi, in consultation with exchanges, is also likely to expedite proposed tweaks in regulations to tighten the misuse of prop-trading accounts, including mandatory mapping of Media Access Control (MAC) and IP address of such trading terminals. During inspections or investigations, exchanges and Sebi officials can exactly find out the terminal from which trades were executed and extract to find out the persons executing them.

In one of the prop trading scams, Moneycontrol found out that the access of trading terminals in Surat was allowed to individual traders in Delhi-NCR, Jodhpur, Kolhapur and Ranchi. Similarly, a Delhi-NCR based broker’s prop-trading terminal’s access was allowed to individuals in Jodhpur and Mumbai.

A tighter monitoring of access to such terminals may have prevented unlawful actions.

To remove ambiguity in regulation, Sebi in its recent consultation paper on review of Stock Broker Regulation has proposed to define Proprietary Trading. Presently, the term ‘Proprietary Trading Member’ implies a stockbroker who trades in the debt segment of a recognised exchange, exclusively on its own account, or as permitted by the sectoral regulator. The current definition of the proprietary trading member covers only the debt segment.

Sebi’s consultation paper said that in line with proprietary trading, and to bring clarity in demarcation of own trading and trading on behalf of clients by brokers, it has proposed to define ‘Proprietary Trading’ in its regulations. The consultation paper has proposed to define proprietary trading as ‘trading in any segment of a recognised stock exchange in its own account by a stock broker’. Sebi is likely to take this proposal to the December board meeting for approval, it is learnt.

Moneycontrol’s three-part exclusive has reported on how brokers were not only violating the exchange and Sebi regulations, but also posing a risk to the market as well as individual traders. The Surat prop-trading scam, initially expected to be a Rs 5 crore has emerged to be more than Rs 150 crore scam.

On digging deeper, it emerged that some brokers were allowing individual traders to take positions in the market without any agreement, KYC, or any kind of formal arrangement. Due to lack of any formal arrangement, the individuals’ deposit to access prop-trading accounts got stuck with no grievance mechanism available to resolve the matter.

It was also uncovered that a section of brokers had shown traders as salaried employees, to avoid inspections. In fact, thousands of fake NISM certifications were used to get access IDs to individual traders who were shown on record as employees.

Moneycontrol has reported in April this year that the Income Tax department is investigating the issue of prop-trading account misuse from a tax evasion angle. Many income tax notices had mentioned unusually large, unsecured loan entries in the books of prop-trading brokers, running into hundreds of crores in some cases.

Tax officials had suspected that these entries were used to conceal commission income earned from unauthorized traders using brokers’ proprietary accounts. Income tax department grew suspicious as the people who had unsecured loans had not even filed their income tax return and were unable to explain the source of income.

The misuse of Authorised Persons (APs) terminal is also an issue that exchanges and Sebi are grappling with, as mentioned in the regulator’s recent orders.