Market regulator Securities and Exchange Board of India (SEBI) has published a consultation paper on institutional mechanisms for stockbrokers, including identification and surveillance of fraudulent practices like front running, price manipulation, insider trading, and spoofing. The paper also proposes that brokers formulate a whistle-blower policy that provides whistle-blowing channels, the process for raising concerns about suspected fraudulent, unfair, or unethical practices, violations of regulatory or legal requirements, and governance weaknesses.
Stockbrokers play a pivotal role in protecting investors' interests and developing securities markets. The broker regulations 1992 place broad responsibility on brokers to exercise due diligence by prescribing a code of conduct and cast an obligation on their compliance officer to monitor regulatory compliance.
SEBI says that its consultation paper solicits comments from market participants on a proposal that requires broking firms and their senior management to be accountable for detecting and preventing fraud or marker abuse by setting up robust surveillance and control systems and ensuring appropriate escalation and reporting mechanisms.
The floated consultation paper proposes a regulatory framework on four important aspects.
Firstly, the chief executive officer (CEO), managing director (MD), compliance officer, principal officer, key managerial persons (KMP), directors, or analogous persons of the broking firms will be responsible for ensuring independent trade surveillance systems and internal control systems to ensure compliance with the regulatory requirements prescribed by SEBI and stock exchanges. These persons will be held accountable for non-compliance in implementing appropriate surveillance and internal control systems.
Secondly, SEBI says brokers should establish trade surveillance systems and internal control procedures that correspond with the nature of the business and the size of its operations and are capable enough to detect potential fraud or market abuse by its clients, promoters, and employees.
A standard operating procedure (SOP) that documents the processes, roles and responsibilities and guidelines on the corrective actions to be taken should also be placed with this. The surveillance systems should be customised for the complexity of the cases. The thresholds for alerts for various scenarios should be set at a reasonable level and should be documented with a clear rationale.
Thirdly, SEBI says a reporting mechanism with well-defined processes that detect fraud or suspicious trading activities that need to be escalated. The processes should be properly documented and appropriately implemented to keep independent senior management informed of any instances.
"Any unusual trading practices should be reported by the broker to the concerned stock exchanges through the specified channels. A summary analysis and the action taken against the suspected fraud or market abuse should be submitted to exchanges on a half-yearly basis. Any changes that will be made to the proposed corrective measures, and risk management policies should also be submitted to the exchange after being placed and approved by the board. This should be done at regular intervals. In case of limited information on trading practices or a need for guidance in surveillance, the broker can engage in communications with the stock exchanges," the market regulator says.
Lastly, the broker should establish a whistle-blower policy with adequate channels for raising concerns about suspected fraud, unfair practices, violations of regulatory or legal requirements, and governance weaknesses.
SEBI says, "The whistle-blower policy should be for not only the stakeholders but also the employees. The whistle-blowing complaints in the case of listed entities should be addressed by the auditing committee of the broking firm. In case of complaints against directors, CEO, KMPs, or board of directors, it should be addressed by analogous bodies. Any other types of complaints will be handled by the compliance officer."
The market regulator also prescribed a guidance note for the detection and prevention of fraud and market abuse. This includes an indicative list of the comment market abuses, the factors that should be considered in accessing them, a list of entities that should be surveilled, controls for monitoring, and a model of accountability matrix.
It says, "Stock brokers should observe and assess factors like connections between the client based on KYC, unusual price movements, timings of trade, time proximity of front running order, big client's order, changes in trade behaviours, the relation of clients with the listed companies, frequent cancellation of bulk orders. This is to identify the market abuses like circular trading, price manipulation, front running, insider trading, and spoofing."
In the case of price manipulation, unauthorised trading, spoofing, and circular trading, SEBI says, the brokers are obliged to have surveillance over the clients. "Issuance of fraud alerts and pre-trading measures like blocking of scrips should be executed. If employees are suspected of engaging in market abuses, the broker should restrict their access to trading floors, implement voice and email surveillance, and execute IP analysis."
"If the authorised persons (APs) are suspected of engaging in fraudulent activities, brokers can make surprise visits to the AP's office posing as clients. Through social media monitoring and scrip level analysis, it can be checked whether the AP is misusing logos, giving assured returns, and concentrating on a particular scrip, respectively. If CEOs, MDs, KMPs, and promoters are suspected of internal wrongdoings then monitoring emails should be sent to senior employees outside the organisation. The broker should abide by the whistle-blower policy and report fraudulent activities," it added.
SEBI has proposed a model of accountability matrix for different types of suspicious behaviour.
It says, "CEOs, KMPs, promoters, and directors will be under the surveillance of the board of directors or the audit committee in the case of listed entities. While clients and APs will be under the surveillance of officials responsible for trade surveillance under the supervision of senior management, the employees of broking firms will be surveilled by CEOs, KMPs, and directors."
SEBI has asked for comments on the proposals to be sent by 21 February 2023.
