India's broking industry is shaken after the recent order by the Securities Exchange Board of India (SEBI) against IIFL Securities banning the company from onboarding new clients for two years.
Though, Securities Appellate Tribunal (SAT) has suspended the order, the harsh order by SEBI has created panic among industry players, who fear that orders of this magnitude is coming for them that will destroy the industry.
A promoter of a large broking firm said: “The SEBI order against IIFL seems to be a clear cut instance of punishment grossly exceeding the violation and retrospective in nature.”
The SEBI order is based on their inspection of IIFL Securities for a period from 2011 to 2014 when they found IIFL Securities didn’t assign its accounts appropriate nomenclature wherein it was keeping clients’ money so as to clearly label them as ‘client accounts’.
Additionally, it was mixing clients’ funds with its own fund before using those mixed funds for its own proprietary usage.
The SEBI order of banning IIFL Securities from onboarding new clients for two years came even after the regulator had slapped Rs 2 crore fine on the broking firm for the same observations and allegations.
Three CEOs of large broking firms agreed that this a harsh order and are worried in case SEBI issues further orders against them as well for which they have already been fined.
One of the CEOs said: “The industry will collapse with the regulator goes for such black and white judgements. There are no instances of default of malpractice by brokers including IIFL Securities. This kind of banning business will be deadly for every broker.”
Data shows, for similar violations like IIFL Securities or even graver violations, the market regulator had let off half a dozen brokers with fine ranging from Rs 1 lakh to Rs 35.32 lakhs.
SEBI had imposed a penalty of Rs 1 lakh on Anand Rathi Share and Stock Brokers Ltd in November 2018; a fine of Rs 15 lakhs on Systematix Shares & Stocks (I) Ltd in December 2017; a fine of Rs 17 lakhd on Motilal Oswal Financial Services in February 2020; a fine of Rs 30 lakhs on Nirmal Bang Securities in February 2020; and a fine of Rs 35 lakhs on Edelweiss Securities in settlement order.
In a more severe case in 2020, SEBI had imposed just a fine of Rs 12 lakh on Ganganagar Commodities. In that case, SEBI had observed usage of funds of credit balance clients for settling some of the trades of debit balance clients.
Three CEOs at large broking firms said, this practice was prevalent in those days.
“It was not done with any ill intent to siphon off clients’ money but was for operational comfort and it was not violating any SEBI norms specifically at that time. All brokers rectified this practice after SEBI issued a clear enhanced circular in 2017.”
SEBI in its own IIFL Securities order said: "I find that the violation by way of assigning wrong nomenclature to the ‘clients accounts’ has been remedied by the Noticee (IIFL Securities)… further the violation committed by the way of mixing funds of clients with its own funds has not been observed in March 2017 inspection.
"Further, I find no instance of misuse of clients’ funds by the notice placed before me which has occurred subsequent to implementation of the Enhanced Supervision Circular dated September 16, 2016.” SEBI also did not find any actual misuse of funds by IIFL Securities.
One former official with the regulator said: “One of the fundamental principles of jurisprudence is that the quantum of punishment should never exceed the quantum of crime. In this case the punishment seems to be harsh and unjustified that is why SAT suspended the order so quickly.
“Also the SEBI order is retrospective in nature as it uses provisions under the 2017 circular retrospectively for observations between 2011-2014 period. While it is essential to have a hawk’s eye, unnecessarily harsh judgements will affect fairness of regulator.”
SEBI used a formula prescribed in the Enhanced Supervision Circular dated September 26, 2016, which came into effect in 2017 to instances that happened several years before the issuance of the said circular.
A senior compliance official with a broking firm said: “SEBI made retrospective application of the Enhanced Supervision Circular and the same is repugnant to basic rule of law. Neither is the circular intended to have retrospective application, nor does the SEBI Act enable any circulars to be made with retrospective effect. On the contrary, the effective date of the circular was positively prospective and was even deferred to a future prospective date.”
This retrospective application of the enhanced circular has made brokers fear further action across the industry and that too in a black and white manner making business survival and growth difficult.
One CEO of a large broking firm said: “The industry is already burdened with increased regulation, lower brokerage regime and reduced customer acquisition due to market volatility. This kind harsh actions can break the industry completely with no way to return.”
