Standard Operating Procedure for Broker Default — What Happens When a Broker Fails
SEBI has issued a Standard Operating Procedure (SoP) specifying steps to be taken by stock exchanges, clearing corporations, and depositories when a trading or clearing member is likely to default. The framework is aimed at protecting the interest of non-defaulting clients of trading members (TMs) or clearing members (CMs) in the likely event of default. This article explains the triggers, the timeline of actions, and the protection available to non-defaulting clients.
The Regulatory Framework
SEBI issued the SoP in July 2020, with subsequent modifications, to deal with possible defaults by trading or clearing members. The SoP enumerates actions that need to be taken when a stock exchange or clearing corporation is of the view that a trading or a clearing member is likely to default in repayment of funds or securities to its clients. The measures were taken on the back of increasing number of defaults by brokers being reported and especially after investors faced problems due to default by Karvy Stock Broking.
Triggers for Action
The SoP is triggered when:
- There is shortage of funds / securities payable to the clients by Rs. 10 crore (or as per exchange's criteria).
- The TM / CM has failed to meet the settlement obligations to CM / CC.
- There is sudden increase in the number of investor's complaints against the TM / CM for non-payment of funds and / or transfer of securities.
Timeline of Actions
. S. No. . Action . Timeline . . 1 . Seek documents / explanation or Meeting with designated directors of TM. . Within 3 trading days of trigger . . 2 . A limited purpose joint inspection of TM shall be initiated. . Within 3 trading days of the meeting / explanation . . 3 . The trading terminal of the TM may be directed to be disabled. A preliminary assessment of assets and liabilities of the TM shall be completed. . Within 7 trading days . . 4 . ISE shall issue a notice / circular informing the disablement of the TM in all segments. . Within 1 day of disablement . . 5 . ISE shall communicate the decision of disablement to the TM and CM(s) with an advice to CM(s) to square.off open positions. . Within 1 trading day of disablement . . 6 . ISE shall inform the Depositories about the disablement immediately and advice Depositories to freeze the demat accounts of the TM. . Within 1 trading day of disablement . . 7 . ISE shall inform other SEs about the disablement immediately and the other SEs shall disable the said TM. . Within 1 trading day of receipt of intimation . . 8 . TM may also stand suspended to act as a client with any other TM / CM. . Within 1 trading day . . 9 . In case of open positions of clients / TM, CM shall liquidate / square off the open positions. . Within 15 trading days . . 10 . All SEs shall immediately direct other TM / CM so as not to alienate the unencumbered surplus funds / securities held by them for such TM registered as a client. . Within 1 trading day . . 11 . All SEs shall inform the CM / CC regarding pay.out proceeds due to the TM. . As and when payout is made . . 12 . If the open position of clients of TM could not be liquidated / squared off, the re.pledged securities of the client of the TM lying with the CM shall be taken / encashed over by CM. . Within 15 trading days . . 13 . All the securities lying in client unpaid securities account of the TM (CUSA) shall be liquidated by CM / CC / ISE. . Within 15 trading days . . 14 . ISE, in consultation with SEs / CCs, shall appoint a forensic auditor to conduct forensic audit of books of accounts of the concerned TM. . Within 15 trading days of disablement . . 15 . ISE shall also provide a report to SEBI on the reasons for trigger, the meetings held, and the outcomes. . Within 30 trading days .
Action by Depositories
. S. No. . Action . Timeline .
. 1 . Depositories to freeze the demat accounts of the TM (including TM Pool Accounts). . Within 1 trading day . . 2 . Depositories shall not allow new account opening by the DP (Defaulting TM / CM) and shall suspend all Power of Attorney. . Within 1 trading day . . 3 . If the TM is also a Depository Participant (DP), the Depositories shall depute its officials / auditor to monitor the transactions. . Within 3 trading days . . 4 . Depositories shall initiate concurrent audit for 100% verification of debit transfers. . Within 7 trading days . . 5 . Depositories shall provide the details of pledges that were invoked by Banks/ NBFCs in the previous 30 days. . Within 15 trading days .
Action by ISE / SEs / CCs and Banks
. S. No. . Action . Timeline . . 1 . Issuance of instruction to the banks that the balance in all the bank accounts of TM / CM shall be frozen. . Within 1 trading day . . 2 . SEs to direct CCs / CM to invoke the unencumbered collateral deposits including BGs / FDRs. . Within 1 trading day . . 3 . CCs / CM shall secure the unencumbered collateral deposits, electronic balances in the depository accounts of the TM / CM. . Within 1 trading day .
What Happens to Clients
- Public Notice is issued informing declaration of a stock broker as defaulter and inviting claims within a specified period.
- Intimation to clients of defaulter stock brokers via emails and SMS for facilitating lodging of claims within the specified period.
- Norms for eligibility of claims for compensation from Investor Protection Fund (IPF) are made available on the Stock Exchange website.
- Claim form for lodging claim against defaulter stock broker is made available.
- FAQ on processing of investors' claims against Defaulter stock broker is made available.
- Standard Operating Procedure (SOP) for handling of Claims of Investors in the Cases of Default by Brokers is made available.
How We Help
At Anuj Desai & Associates, we help stock brokers understand the default management framework, implement preventive measures, and ensure compliance with the SoP. If you need assistance with default preparedness or regulatory compliance, reach out to our regulatory compliance desk.