NISM Series XIV Internal Auditors For Stock Brokers December 2018 PDF

NISM: Internal Auditors of Stock Brokers Certification Examination
Workbook for
NISM‐Series‐XIV: Internal Auditors for Stock Brokers
Certification Examination

National Institute of Securities Markets
www.nism.ac.in

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This workbook has been developed to assist candidates in preparing for the National Institute of
Securities Markets (NISM) Certification Examination for Internal Auditors for Stock Brokers.

Workbook Version: December 2018

Published by:
National Institute of Securities Markets
© National Institute of Securities Markets, 2018
Plot 82, Sector 17, Vashi
Navi Mumbai – 400 703, India

All rights reserved. Reproduction of this publication in any form without prior permission of the
publishers is strictly prohibited.

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FOREWORD
NISM is a leading provider of high end professional education, certifications, training and
research in financial markets. NISM engages in capacity building among stakeholders in
the securities markets through professional education, financial literacy, enhancing
governance standards and fostering policy research. NISM works closely with all financial
sector regulators in the area of financial education.
NISM Certification programs aim to enhance the quality and standards of professionals
employed in various segments of the financial services sector. NISM’s School for
Certification of Intermediaries (SCI) develops and conducts certification examinations and
Continuing Professional Education (CPE) programs that aim to ensure that professionals
meet the defined minimum common knowledge benchmark for various critical market
functions.
NISM certification examinations and educational programs cater to different segments of
intermediaries focusing on varied product lines and functional areas. NISM Certifications
have established knowledge benchmarks for various market products and functions such
as Equities, Mutual Funds, Derivatives, Compliance, Operations, Advisory and Research.
NISM certification examinations and training programs provide a structured learning plan
and career path to students and job aspirants who wish to make a professional career in
the Securities markets. Till March 2018, NISM has certified nearly 7 lakh individuals
through its Certification Examinations and CPE Programs.
NISM supports candidates by providing lucid and focused workbooks that assist them in
understanding the subject and preparing for NISM Examinations. This book helps
understand the regulatory framework under which the stock brokers perform their
various activities; various operations performed by the Stock brokers; and various
compliance and reporting requirements from audit perspective. This book will be
immensely useful to all those who are involved in the internal audit process of stock
brokers and want to learn about the various functions of the stock brokers and risk
management practices adopted by them.
Dr. M Thenmozhi
Director
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Disclaimer
The contents of this publication do not necessarily constitute or imply its endorsement,
recommendation, or favoring by the National Institute of Securities Markets (NISM) or the
Securities and Exchange Board of India (SEBI). This publication is meant for general reading and
educational purpose only.
The statements/explanations/concepts are of general nature and may not have taken into
account the particular objective/ move/ aim/ need/ circumstances of individual user/ reader/
organization/ institute. Thus NISM and SEBI do not assume any responsibility for any wrong move
or action taken based on the information available in this publication.
Therefore before acting on or following the steps suggested on any theme or before following any
recommendation given in this publication user/reader should consider/seek professional advice.
The publication contains information, statements, opinions, statistics and materials that have
been obtained from sources believed to be reliable and the publishers of this title have made best
efforts to avoid any errors. However, publishers of this material offer no guarantees and
warranties of any kind to the readers/users of the information contained in this publication.
Since the work and research is still going on in all these knowledge streams, NISM and SEBI do not
warrant the totality and absolute accuracy, adequacy or completeness of this information and
material and expressly disclaim any liability for errors or omissions in this information and
material herein. NISM and SEBI do not accept any legal liability what so ever based on any
information contained herein.
While the NISM Certification examination will be largely based on material in this workbook, NISM
does not guarantee that all questions in the examination will be from material covered herein.

Acknowledgement

This workbook has been developed jointly by the Certification Team of National Institute of
Securities Markets and Ms. T S Jagadharini, Resource Person engaged with NISM. NISM gratefully
acknowledges the contribution of the Examination Committee for NISM‐Series‐XIV: Internal
Auditors for Stock Brokers Certification Examination consisting of representatives from the Stock
Exchanges and the Industry.

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About NISM
National Institute of Securities Markets (NISM) was established by the Securities and Exchange
Board of India (SEBI), in pursuance of the announcement made by the Finance Minister in his
Budget Speech in February 2005.
SEBI, by establishing NISM, articulated the desire expressed by the Government of India to
promote securities market education and research.
Towards accomplishing the desire of Government of India and vision of SEBI, NISM delivers
financial and securities education at various levels and across various segments in India and
abroad. To implement its objectives, NISM has established six distinct schools to cater to the
educational needs of various constituencies such as investors, issuers, intermediaries, regulatory
staff, policy makers, academia and future professionals of securities markets.
NISM is mandated to implement Certification Examinations for professionals employed in various
segments of the Indian securities markets.
NISM also conducts numerous training programs and brings out various publications on securities
markets with a view to enhance knowledge levels of participants in the securities industry.
About NISM Certifications
The School for Certification of Intermediaries (SCI) at NISM is engaged in developing and
administering Certification Examinations and CPE Programs for professionals employed in various
segments of the Indian securities markets. These Certifications and CPE Programs are being
developed and administered by NISM as mandated under Securities and Exchange Board of India
(Certification of Associated Persons in the Securities Markets) Regulations, 2007.
The skills, expertise and ethics of professionals in the securities markets are crucial in providing
effective intermediation to investors and in increasing the investor confidence in market systems
and processes. The School for Certification of Intermediaries (SCI) seeks to ensure that market
intermediaries meet defined minimum common benchmark of required functional knowledge
through Certification Examinations and Continuing Professional Education Programmes on
Mutual Funds, Equities, Derivatives Securities Operations, Compliance, Research Analysis,
Investment Advice and many more.
Certification creates quality market professionals and catalyzes greater investor participation in
the markets. Certification also provides structured career paths to students and job aspirants in
the securities markets.

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About the Workbook

This workbook has been developed to assist candidates in preparing for the National Institute of
Securities Markets (NISM) Certification Examination for Internal Auditors for Stock Brokers. NISM‐
Series‐XIV: Internal Auditors for Stock Brokers Certification Examination seeks to create a
common minimum knowledge benchmark for Independent Chartered Accountants, Company
Secretaries and Management Accountants, who carry out Internal Audit of the Operations of
Stock Brokers/Clearing Members.

The book covers the various operations of stock brokers, regulatory framework under which the
stock brokers perform their various activities and various compliance and reporting requirements
from audit perspective.

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About the Certification Examination for Internal Auditors of Stock Brokers

NISM‐Series‐XIV: Internal Auditors for Stock Brokers Certification Examination is the requisite
standard for Auditors (who are chartered accountants, company secretaries or cost and
management accountants as mentioned in SEBI Circular no. MRD/DMS/Cir‐29/2008 dated
October 21, 2008) and/or its employees or partners signing the internal audit report.

Examination Objectives

The examination seeks to create a common minimum knowledge benchmark for Independent
Chartered Accountants, Company Secretaries and Management Accountants, who carry out
Internal Audit of the Operations of Stock Brokers/Clearing Members.

On successful completion of the examination the candidate should:
• Know regulatory framework under which the stock brokers perform their various activities.
• Understand the various operations performed by the Stock brokers
• Understand the various compliance and reporting requirements from audit perspective.

Assessment Structure

The examination consists of 100 questions of 1 mark each and should be completed in 2 hours.
The passing score on the examination is 60 percent. There shall be negative marking of 25 percent
of the marks assigned to a question.

Examination Structure

The exam covers knowledge competencies required related to audit functions of stock brokers. It
also includes the regulatory structure and the operational knowledge the risk management
practices and the clearing and settlement process for a trade executed in the secondary market.

How to register and take the examination
To find out more and register for the examination please visit www.nism.ac.in

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Table of Contents
1 Introduction to Internal Audit .............................................................................. 11
1.1 Scope ............................................................................................................................. 11
1.2 Objective ........................................................................................................................ 11
1.3 Who can conduct Internal Audit ................................................................................... 12
1.4 Audit Report .................................................................................................................. 12
2 Financial system and regulatory framework ...................................................... 145
2.1 Financial System and its role in an economy ................................................................ 14
2.2 Financial Market Intermediaries ................................................................................... 16
2.3 Financial Securities ........................................................................................................ 21
2.4 Regulatory System ......................................................................................................... 24
2.5 Financial Market Regulators .......................................................................................... 25
2.6 Role of the other Regulators in the Financial Market ................................................... 30
2.7 Appellate Authority ....................................................................................................... 34
3 SEBI Act 1992, SCRA and SCRR ............................................................................. 37
3.1 Securities and Exchange Board of India Act, 1992 ........................................................ 37
3.2 Securities Contracts (Regulation) Act, 1956 .................................................................. 43
3.3 Securities Contracts (Regulation) Rules, 1957 ............................................................... 46
4 SEBI (Prohibition of Insider Trading) Regulations, 2015 ........................................ 50
4.1 Definitions ..................................................................................................................... 50
4.2 Restriction on communication and trading by insiders ................................................ 52
4.3 Disclosure of trading by insiders ................................................................................... 54
4.4 Code of disclosure and conduct .................................................................................... 55
5 Securities and Exchange Board of India (Prohibition of Fraudulent and unfair trade
practices relating to securities Market)Regulations, 2003 ........................................... 60
5.1 Fraud and Fraudulent .................................................................................................... 60
5.2 Prohibition of Fraudulent and Unfair Trade Practices .................................................. 61
5.3 Prohibition of manipulative, fraudulent and unfair trade practices ............................. 61
5.4 Power of the Board to order investigation .................................................................... 62
5.5 Submission of report and enforcement ........................................................................ 63
5.6 Suspension or cancellation of registration .................................................................... 63
6 The Prevention of Money Laundering Act, 2002 (PMLA) ...................................... 66
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6.1 Money Laundering ......................................................................................................... 66
6.2 Prevention of Money laundering .................................................................................. 66
6.3 Offence of money‐laundering ....................................................................................... 70
6.4 Adjudicating Authorities, composition, powers, etc ..................................................... 72
6.5 Agreement with foreign countries ................................................................................ 74
6.6 SEBI Procedures ............................................................................................................. 74
7 SEBI (Stock Brokers and Sub Brokers) Regulations, 1992 ...................................... 84
7.1 Introduction to SEBI (Stock Brokers and Sub Brokers) Regulations, 1992 .................... 84
8 Introduction to Stock Broking Operations .......................................................... 105
8.1 Trade Life Cycle ............................................................................................................ 105
8.2 Front Office Operations ............................................................................................... 106
8.3 Middle Office Operations ............................................................................................ 117
8.4 Back Office Operations ................................................................................................ 119
8.5 Margin trading ............................................................................................................. 130
8.6 Securities Lending and Borrowing Program (SLB) ....................................................... 134
9 Risk Management .............................................................................................. 140
9.1 Risk Management Framework for Cash Segment ....................................................... 140
9.2 Risk Management Framework for F&O Segment ........................................................ 148
9.3 Annual Compliance Requirements .............................................................................. 156
9.4 Quarterly Compliance Requirements .......................................................................... 161
9.5 Other Compliances ...................................................................................................... 164
10 Clearing and Settlement Process .................................................................... 168
10.1 Clearing and Settlement Process for Cash Market ...................................................... 168
10.2 Clearing and Settlement Process for Futures & Options Market ................................ 175
10.3 Settlement Guarantee fund ........................................................................................ 179
10.4 Investor Protection Fund ............................................................................................. 182
10.5 SEBI Investor Protection and Education Fund ............................................................. 184
10.6 Outsourcing By Brokers ............................................................................................... 185
11 Investor Grievance Redressal ......................................................................... 190
11.1 Investor Grievance....................................................................................................... 190
11.2 Investor Protection ...................................................................................................... 190
11.3 Investor Grievance Redressal Mechanism .................................................................. 192
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11.4 Arbitration Mechanism ............................................................................................... 197

Annexure I ................................................................................................................ 203
Annexure II ............................................................................................................... 247

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Chapter 1 Introduction to Internal Audit

Learning Objectives:

After studying this chapter, you should know about:

 Scope of internal audit for stock brokers
 Purpose of internal audit of stock brokers
 Parties who can conduct internal audit

 Submission of audit report

As per the Government of India directive No: F.1/5/SE/83 dated May 31, 1984, all stock brokers
have to get their books of accounts audited by qualified Chartered Accountants. Hence, SEBI vide
its circular no: SMD/SED/0072/92 dated December 31, 1992 has made it mandatory for all
members of the stock exchanges to get their annual accounts audited by Chartered Accountants
within 6 months from the closing of books of accounts and submit a copy of the same to stock
exchanges within 30 days of the receipt of the audit report.

To augment this process and to enhance standards of compliance of stock brokers, SEBI has vide
its circular no: MIRSD/ DPSIII/ Cir‐26/ 08 dated August 22, 2008 advised the Stock Exchanges to
direct its stock brokers/clearing members to carry out complete internal audit on a half yearly
basis.
1.1 Scope
As per the SEBI circular, the scope of internal audit should cover the existence, scope and
efficiency of the internal control system, compliance with the provisions of the SEBI Act, 1992,
Securities Contracts (Regulation) Act 1956, SEBI (Stock Brokers and Sub‐Brokers) Regulations,
1992, circulars issued by SEBI, agreements, KYC requirements, Bye‐Laws of the Exchanges, data
security and insurance in respect of the operations of stock brokers/clearing members.
1.2 Objective
The purpose of the internal audit should be to:
(a) ensure that the books of account, records and documents are being maintained in the
manner required under Securities and Exchange Board of India Act, 1992, Securities
Contracts (Regulation) Act, 1956, SEBI (Stock brokers and Sub‐brokers) Regulations, 1992,
Securities Contracts (Regulation) Rules, 1957, Circulars issued by SEBI, Agreements, bye‐
laws of the Exchanges, data security and insurance in respect of operations of trading
member/clearing members.
(b) ascertain whether adequate internal control systems, procedures and safeguards have
been established and are being followed by the intermediary to fulfill its obligations under
Securities and Exchange Board of India Act, 1992, Securities Contracts (Regulation) Act,
1956, SEBI (Stock brokers and Sub‐brokers) Regulations, 1992, Securities Contracts
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(Regulation) Rules, 1957, circulars issued by SEBI, Agreements, bye‐laws of the Exchanges,
data security and insurance in respect of operations of trading member/clearing
members.
(c) ascertain whether any circumstances exist which would render the intermediary unfit or
ineligible for dealing in securities market.
(d) ascertain whether the provisions of the securities laws and the directions and/or circulars
issued there under by SEBI/Exchanges are being complied with.
(e) ascertain, whether the provision of stock exchange, bye‐laws, notices, circulars,
instructions or orders issued by stock exchanges are being complied with.
(f) inquire suo motu into such matters as may be deemed fit by the auditor in the interest of
investors or the securities market.
1.3 Who can conduct Internal Audit?
Internal audit should be carried out on a half yearly basis by Chartered Accountants, Company
Secretaries or Cost and Management Accountants who are in practice and who do not have any
conflict of interest.
1.4 Audit Report
Internal audit report should be submitted to the Proprietor/Partners/Board of respective
trading/clearing member who would place the report before its Board of
Directors/proprietor/partners and shall forward the same along with para‐wise comments to
respective stock exchange within 2 months of the end of half year period only in electronic form.1
No documents are to be submitted in physical form. The audit report may be combined across
segments and activity (trading/clearing) for respective Exchange. The format of the Audit Report
and the Certificate Formats are given in Annexure I (attached at the end of the workbook).

1
SEBI/HO/MIRSD/MIRSD2/CIR/P/2016/95 dated September 26, 2016 and SEBI/HO/MIRSD/MIRSD2/CIR/P/2016/138
dated December 20, 2016
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Review Questions

1. Internal audit should be conducted ______________.
a) Yearly
b) Half yearly
c) Every Quarter
d) Once in 2 years
Ans: (b)
2. Internal audit can be conducted by ______________.
a) Chartered Accountant only
b) Compliance officer of the Broker/Clearing Member
c) Chartered Accountant, Company Secretary, Cost and Management accountant who do
not have any conflict of interest
d) Any finance professional
Ans: (c)

3. Internal Audit report should be submitted to the Stock Exchanges _____________.
a) Within 1 month of the end of the half year period
b) Within 2 months of the end of the half year period
c) As soon as the report is completed by the Auditor
d) Within 3 months of the end of the financial year
Ans: (b)

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Chapter 2 Financial System and Regulatory framework

Learning Objective:


 Role of financial system in an economy

 Structure of the Indian financial system
 Different kinds of financial market intermediaries and their roles
 Various types of financial securities

 Financial market regulators and their role

2.1 Financial System ‐ Role in the Economy
The role of the financial system is to channelize funds from those with surplus to those who are
in need. In order to achieve this goal, there are different channels through which the funds flow.
The financial system consists of the borrowers, lenders, the intermediaries and the regulators.
The lenders can be household, firms and government, whereas the borrowers can be typically
corporate entities and Government bodies. Household borrowings also take place in the form of
personal, housing and vehicle loans.

The two routes through which funds are transferred from the lender to the borrower are:
 Direct Financing
 Indirect Financing

Direct financing is also known as market based financing. In this the borrower can issue financial
instruments either in the form of capital or debt (in the primary or money market) which is then
subscribed by the lenders.

Indirect financing takes place when an intermediary such as banks or financial institutions help
route the funds from the surplus entity to the entity which is in need of funds in the form of loans
and other instruments.

Financial System the big picture

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Direct Finance
• Household Funds
‐Capital Market Funds •Firms
• Firms ‐Money Market •Government
• Government •Household
Lenders Borrowers
Funds Funds
Financial intermediaries
‐Banks
‐Financial Institutions
‐Others
Indirect Finance

Indian financial system reforms

A balance of payment crisis in the year 1991 among other things propelled India towards
economic liberalisation. A slew of measures were taken by the country including doing away with
license raj, import liberalisation, financial reforms which included opening up the market to
foreign investments.
Post liberalisation, the Indian Financial markets saw a slew of developments. Some of the major
developments in the capital market include:
 Setting up of Securities and Exchange Board of India (SEBI)
 Abolition of Controller of Capital Issues (CCI)
 Nationwide electronic trading system
 Setting up of OTCEI, National Stock Exchange (NSE) and Demutualisation of Bombay Stock
Exchange (BSE)
 Foreign Institutional Investor (FII) regulations and Foreign Direct Investment (FDI) norms
 Depository system to remove paper based trading
 Market determined pricing of issues
 Various entities brought under the regulations of SEBI

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Indian Financial System

The figure below gives a bird‐eye view of the Indian Financial System structure

Ministry of Finance

Reserve Bank of India Pension Fund Insurance
Securities and Exchange Regulatory & Regulatory and
(RBI) Board of India
Development Development Authority
(SEBI)
Authority (PFRDA) Of India (IRDAI)

Financial Commercial Primary NBFC Mutual Venture Capital Insurance

Institutions Banks Dealers Fund Capital Markets Companies
Fund Insurance

Agents

Public Sector Banks;

Private Sector Banks;

Regional/Rural Banks; Stock Exchanges;
Foreign Banks Depositories;
Custodians;
R&T agencies;
FPI;
Retail Investors;
Merchant Bankers;
Portfolio Managers;
Stock Brokers;
Depository Participants;
Credit rating agencies;
Term Finance Sectoral Investment Advisors;

Research Analysts;
IDBI EXIM; Central Record Keeping
ICICI NABARD; Agency (CRA);
IFCI Power Finance Corporation;
Pension Fund Manager;
Tourism Finance corporation; NPS Trustee Bank;
Custodian

The core components of the financial system are the intermediaries and the financial instruments.
The details of these two components are discussed in the subsequent sections.
2.2 Financial Market Intermediaries

For the financial markets to function efficiently, there are various intermediaries who perform
different roles. The functions of some of them are discussed below:
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2.2.1 Stock Exchange
Stock Exchange is either a body corporate or an association which provides the platform for
investors to buy and sell shares through their agents who are also called as stock brokers. Stock
Exchange performs multiple roles for providing this service such as:
 Providing a platform for securities to be listed
 Providing infrastructure in terms of electronic trading system to buy and sell listed
securities
 Acting as a Self Regulatory Organisation (SRO) in terms of defining rules and regulations
and enforce compliance
2.2.2 Clearing Corporation / House (CC/CH)
"Clearing Corporation" is an entity that is established to undertake the activity of clearing and
settlement of trades in securities or other instruments or products that are traded on a recognised
stock exchange and includes a clearing house. The Clearing House / Clearing Corporation carries
the following functions:
 Clear and settle trades executed on the associated Stock Exchange
 Carry out risk management to ensure adequate risk protection for the trades executed
 Provide settlement guarantee for trades cleared and settled by it.
2.2.3 Depository
Depository is an entity which does safekeeping of securities (shares, debentures, bonds,
government securities, mutual fund units etc.) of investors in an electronic form at the request of
the investors. The securities are held in the form of electronic or dematerialised form and can be
transferred between depository accounts electronically. National Securities Depository Limited
(NSDL) and Central Depository Services (India) Limited (CDSL) are the Depositories that are
licensed to operate in India and are registered with SEBI.
2.2.4 Depository Participant
Depository Participant (DP) is an agent of the depository and makes the services of the Depository
available to the investors; the DP provides the interface between investor and the Depository.
Banks, financial institutions, custodians and stock brokers offer the service of the DP.
2.2.5 Stock Broker
A stock broker is an intermediary who arranges to buy and sell securities on the behalf of clients
(the buyer and the seller) for a fee called brokerage. According to SEBI (Stock Brokers and Sub‐
Brokers) Regulations, 1992, a stockbroker is member of a stock exchange and requires holding a
certificate of registration from SEBI in order to buy, sell or deal in securities.

SEBI grants a certificate to a stock broker subject to the conditions that the stock broker:
 holds the membership of any stock exchange;
 should abide by the rules, regulations and bye‐laws of the stock exchange or stock
exchanges of which he is a member;
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 should obtain prior permission of SEBI to continue to buy, sell or deal in securities in any
stock exchange in case of any change in the status and constitution;
 should pay the amount of fees for registration in the prescribed manner; and
 should take adequate steps to redress grievances of the investors within one month of
the date of the receipt of the complaint and keep SEBI informed about the number, nature
and other particulars of the complaints.
2.2.6 Clearing Member
Clearing member is the member of the clearing house/clearing corporation. The clearing member
should be SEBI registered before offering the services of clearing and settlement. A Clearing
Member has the responsibility to clear and settle all deals executed by Stock Broker or
institutional clients who clear and settle through them.

The clearing member performs the following functions:

 Clearing ‐ Computing obligations of all their clients
 Settlement of funds and securities
 Risk Management ‐ Setting position limits based on margins collected from their clients
and monitoring positions on a continuous basis.

Clearing members can be a Self Clearing Member (SCM), Trading cum Clearing Member (TCM) or
Professional Clearing Member (PCM). SCM is a trading member who clears and settles their own
trades. The TCM has both trading and clearing rights. He can clear his own trades as well as the
trades of others. PCM has the right only to clear trades. The PCM does not have any trading rights.
These types of members can clear trades of all members associated with him. Any member of the
equity segment of the Exchange is eligible to become trading cum clearing member of the
Derivatives Segment. More about clearing member is given in section 10.1.2.1.
2.2.7 Custodians
Custodians are entities who provide custodial services for securities, gold and gold related
instruments. Clients are typically mutual funds, financial institutions and foreign portfolio
investors (FPIs). They perform functions such as:
 Maintaining accounts of securities or gold or gold related instruments or title deeds of
real estate assets of a client;
 Undertaking activities as a Depository
 Collecting benefits or rights accruing to the client in respect of securities or gold or gold
related instruments or title deeds of real estate assets;
 Keeping client informed of the actions taken by the issuer of securities in terms of
benefits or rights accruing to the client;
 Settling trades on behalf of the clients of the trading members, when a particular trade is
assigned to them for settlement;
 Maintaining and reconciling records;
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 Facilitating registration of FPIs by Designated Depository Participants (DDPs)2 on behalf
of SEBI.
2.2.8 Registrar and Transfer Agent
The Registrar and Transfer Agent (RTA) is the entity involved in the issue management and
maintenance of shareholder records for the corporates.
As a “Registrar to an issue”, the RTA performs the following functions on behalf of a body
corporate which makes a public issue:
 Collect applications from investors in respect of an issue;
 Keep proper record of applications and monies received from investors or paid to the
seller of the securities;
 Assist in determining the basis of allotment of securities in consultation with stock
exchange;
 Finalise list of persons entitled to allotment;
 Process and dispatch allotment letters, refund orders or certificates and other related
documents
As a “share transfer agent”, the RTA maintains the records of holders of securities issued by such
body corporate and deals with all matters connected with the transfer and redemption of its
securities.
2.2.9 Merchant Banker
As per SEBI (Merchant Bankers) Regulations, a Merchant banker is “any person who is engaged in
the business of issue management either by making arrangements regarding selling, buying or
subscribing to securities as manager, consultant, advisor or rendering corporate advisory
service in relation to such issue management”

As part of this role, a Merchant Banker performs various activities including helping the client
raise finance either through private placement or public issue, project management, advisory
services, corporate restructuring including mergers and acquisitions etc. All Merchant Bankers are
required to be registered with SEBI.
2.2.10 Investment Advisor
As per SEBI (Investment Advisers) Regulations, an Investment Advisor means any person who
provides investment advice to clients for a fee. Investment advice is defined as advice provided
relating to investing in, purchasing, selling or otherwise dealing in securities or investment
products, and advice on investment portfolio containing securities or investment products and
shall include financial planning. Any investment advice given through newspaper, magazines,
2
Each FPI engages a Designated Depository Participant (DDP) before making investment in Indian securities market.
At all times the DDP and the Custodian of Securities (“Custodian”) of the FPI shall be the same entity.

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electronic or broadcasting media which is widely available to public is excluded from this
definition.
2.2.11 Research Analysts
Research Analysts are primarily responsible for preparation or publication of the content of the
research report, making 'buy/ sell/ hold' recommendations, giving price target, offering opinion
concerning public offer, with respect to securities that are listed or to be listed in a stock exchange.
SEBI’s Research Analyst Regulations have specified that ‘Research Analyst’ should obtain a
certificate of registration from SEBI before rendering any research advice. Stock Brokers also
provide research services, in such cases, such broker is also required to obtain the ‘Research
Analyst’ registration from SEBI.
2.2.12 Bankers to the Issue
As per SEBI (Banker to an Issue) Regulations, “Banker to an Issue” means a scheduled bank which
carries out all or any of the activities:
 Accept application and application monies;
 Accept allotment or call monies;
 Refund application monies;
 Payment of dividend or interest warrants;
Bankers to the Issue should obtain Certificate of Registration from SEBI. They should enter into an
agreement with the body corporate for whom it is acting as bankers to an issue. It should maintain
records with respect to:
 Number of applications received, the names of the investors, the dates on which the
applications were received and the amount so received from the investors;
 Time within which the applications received from the investors were forwarded to the
body corporate or registrar to an issue, as the case may be;
 Dates and amount of refund monies paid to the investors;
 Dates, names and amount of dividend/interest warrant paid to the investors;

2.2.13 Mutual Funds
Mutual Funds are organizations that mobilise funds from investors by issuing units and undertake
to invest the money in a manner consistent with the specified investment objective. The objective
could be to maximise capital growth or to maximise current income or have a regular source of
income. There are two types of investment schemes: open‐ended and close‐ended. In the former,
a demand for units is met by a fresh supply, so there is no limit on the number of units that can
be issued. With closed‐end funds, there is a limit on the number of units that can be issued and
following issuance, units are traded in the secondary market. Closed‐end funds have a specified
maturity unlike open‐end funds.
2.2.14 Portfolio Manager
Portfolio Managers are individuals or firms that administer the portfolios of individuals/
corporates or provide advice or direction to that effect, for a fee or a share in the profits or a
combination of the two.
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2.3 Financial Securities
As per Securities Contract Regulations Act, 1956 “Securities” include:

a. Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities
of a like nature in or of any incorporated company or other body corporate;
b. Derivative;
c. Units or any other instrument issued by any collective investment scheme to the investors
in such schemes;
d. Security receipt as defined under Securitisation and Reconstruction of Financial Assets
and Enforcement of Security Interest Act, 2002;
e. Units or any other such instrument issued to the investors under any mutual fund scheme;
f. Any certificate or instrument (by whatever name called), issued to an investor by any
issuer being a special purpose distinct entity which possesses any debt or
receivable, including mortgage debt assigned to such entity, and acknowledging
beneficial interest of such investor in such debt or receivable, including mortgage debt as
the case may be;
g. Government securities;
h. Such other instruments as may be declared by the Central Government to be securities
i. Rights or interest in securities;
Given below is a detailed description of some of the financial securities which are available in the
Indian financial system.
2.3.1 Equity Shares
Equity share represents a share in the capital. It entitles the holder ownership of the company in
proportion to the shares held. An equity shareholder has the following rights:
 Elect the Board of Directors
 Entitle to vote on substantial business matters through shareholder meetings
 Receive income in the form of dividend whenever distributed.

Companies which fulfill specific conditions can also issue equity shares with differential rights as
receiving dividend, voting or otherwise.
2.3.2 Preference Shares
Under the Companies Act, companies can issue two types of share capital i.e., equity share capital
and preference share capital. Preference shares carry a preferential right to dividend at a fixed
rate or amount and repayment of capital in case of winding‐up of the company. Share capital
which is not preference share capital is regarded as equity share capital. Preference shares can
be convertible or non‐convertible shares. If it is convertible preference shares, it can be converted
into equity shares within a specified period. Preference shares can be redeemable or non‐
redeemable preference shares. Redeemable preference shares can be redeemed on or after a
period fixed for redemption or after giving notice of redemption. Preference shareholders do not
carry any voting rights on matters not directly affecting them.
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2.3.3 Debentures
Debenture is a debt instrument issued by a corporate to borrow funds for a medium term or long
term. Debentures typically carry an interest coupon and are for a fixed maturity period.
Debentures can be either convertible or non‐convertible debentures. Convertible debentures can
be fully convertible debentures or partly convertible debentures. Convertible debentures can be
converted either into equity shares or preference shares based on the issue specification.
2.3.4 Derivatives
Derivatives are financial instruments which derive their value from an underlying asset.

The underlying asset can be:
 Equity share
 Debt instrument
 Commodity
 Currency

Derivative contracts as they are known are used for hedging or as risk management tools.
Derivatives contracts can be of two kinds i.e., futures and options.

Futures contract: Forward contract is a derivative contract entered between a buyer and a seller
to buy or sell an underlying asset at a future date. When the terms of the contract is standardised
in terms of settlement date and contract size it is called a futures contract. Futures contract are
exchange traded. Exchanges define contract specifications which include:

 Number of underlying asset for each contract
 Expiry date when the contract will be settled
 Mode of settlement.
Futures contract traded on the stock exchanges in India include:
 Index futures
 Stock futures
 Currency futures
 Interest rate futures

Options contract: Options contracts are standardised contract entered between a buyer and a
seller to buy or sell an underlying asset at a future date. The price is agreed between the parties
at the time of entering into the contract. The seller of the option has an obligation to buy or sell
the underlying asset whereas the buyer of the option exercises their right. For acquiring this right,
the buyer of the options pays a fee to the seller which is called option premium. Options contracts
are of 2 types namely call and put:

 When the buyer acquires the right to buy the underlying asset, it is called the call option.
 When the buyer acquires the right to sell the underlying asset, it is called the put option.
The price paid at the time of exercise is called the strike price or exercise price.
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 The buyer of the option pays the strike price to buy the underlying asset, if it is a call

option.
 The buyer of the option receives the strike price to sell the underlying asset, if it is a put
option.
The Stock Exchange defines the contract specifications.
2.3.5 Warrants
Warrants are instruments issued by companies which give the holder the right to buy the shares
of the company at a future rate at a specified price which is also called the exercise price. Warrants
can be traded on the Exchange and their price is based on the underlying stock price. Warrants
do not carry a voting right. Warrants can be either issued independently or as a detachable
warrant which forms part of a debenture or equity issue.
2.3.6 American Depository Receipt (ADR) / Global Depository Receipt (GDR)

American Depository Receipt (ADR) is a depository receipt issued by a U.S. bank representing a
specified number of shares in a foreign stock and traded on a U.S. exchange. ADRs are
denominated in U.S. dollars, with the underlying security held by a U.S. financial institution
overseas. When an Indian company wishes to raise capital and list in an American Stock Exchange
it can issue an ADR. ADRs issued by Indian Companies are listed either on the New York Stock
Exchange (NYSE) or NASDAQ. All other DR issues are called Global Depository Receipt (GDRs).
GDRs can be in any convertible foreign currency. GDRs can be either listed or unlisted. Typically
GDRs are listed either at London Stock Exchange or Luxembourg Stock Exchange.
2.3.7 Indian Depository Receipts (IDR)
Foreign companies are not allowed to list directly on the Indian stock exchanges. Hence foreign
companies wishing to list on the Indian securities market can issue an instrument called Indian
Depository Receipt (IDR) to the Indian investors. The IDR is raised in Indian rupees and listed on
the Indian Stock Exchanges. IDRs are issued in the form of depository receipt against underlying
equity shares of the issuing company. The underlying shares are held by a foreign custodian. The
foreign custodian in turn issues depository receipts against these shares which are held by Indian
Depository. The investors can either hold the depository receipt or request for redemption into
underlying shares. Redemption is permitted after one year from the date of listing3.
2.3.8 Masala Bonds
Masala Bonds or Rupee denominated bonds are issued overseas by corporates, Indian banks, Real
Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) (coming under the
regulatory jurisdiction of the SEBI). Other resident entities like Limited Liability Partnerships and
Partnership firms, etc. are not eligible to issue these bonds.

The masala bonds can be subscribed / invested by Multilateral and Regional Financial Institutions
where India is a member country or by an investor who is a resident of a country satisfying the
following criteria:
3
SEBI Circular Ref. No. CIR/CFD/DIL/10/2012, dated August 28, 2012.
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 that is a member of Financial Action Task Force (FATF) or a member of a FATF‐Style Regional
body; and
 whose securities market regulator is a signatory to the International Organization of
Securities Commission's (IOSCO’s) Multilateral Memorandum of Understanding (Appendix A
Signatories) or a signatory to bilateral Memorandum of Understanding with the SEBI for
information sharing arrangements; and
 should not be a country identified in the public statement of the FATF as:
However, related party within the meaning as given in Ind‐AS 24 cannot subscribe or invest in or
purchase such bonds.
2.3.9 Exchange Traded Fund (ETF)
Exchange Traded Fund (ETF) is a type of mutual fund which is traded on the Stock Exchange. ETFs
can be based on stocks, indices or commodities. Unlike traditional open ended mutual funds
whose net asset value is determined end of each day, the price of an ETF is quoted dynamically
on the Stock Exchange.
2.3.10 Currency Derivatives
Currency Derivatives contract is a contract to exchange one currency for another at a specified
date in the future at a price (exchange rate) that is fixed on the purchase date. It can be either a
future or an options contract. Currency Derivative contracts allow investors to hedge against
foreign exchange risk. It can be either a forward contract or it can be an exchange traded futures
and options contract. In India, currency derivatives contracts (both futures and options) are
available for trading. Currently currency futures are traded on four currency pairs and currency
options on US Dollars.
2.3.11 Interest rate Derivatives
Interest rate derivative is an instrument based on an underlying financial security whose value is
affected by changes in interest rates. Interest rate derivative is used for hedging by institutional
investors such as banks to protect against changes in market interest rates. It can be an OTC
contract or it can be exchange traded. In India, the underlying security for Interest Rate futures is
either Government Bond or T‐Bill. Exchange traded Interest Rate Futures are standardised
contracts based on 10‐Year Government of India Security and 91‐day Government of India
Treasury Bill. All interest rate futures contracts traded in India are cash settled.
2.4 Regulatory System

Regulation of the securities market is motivated by the need to safeguard the interests of
investors. What is paramount is to ensure that investors make informed decisions on the basis of
complete transparency and fairness in both primary and secondary market transactions. The basic
objective of SEBI is:

a. To protect the interest of investors in securities markets
b. To promote the development of securities markets
c. To regulate the securities markets
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There are many other issues which warrant regulation. For example, deliberately engineered
speculative activities in the stock market or insider trading are undesirable as they can hurt
investors at large; companies and mutual funds issuing securities and units ought to furnish
adequate disclosures on all relevant facts; and stockbrokers ought to execute transactions in the
most efficient manner and refrain from charging excessive brokerage. There can be instances of
unethical activities which can be detrimental to investors in general such as insider trading,
misusing power of attorney given by investors to brokers, suspicious transaction reporting, front
running, etc.

There are various regulatory institutions which regulate different sectors of the financial system.
For instance, the Securities and Exchange Board of India (SEBI) regulates the Securities industry
(Capital market), the Reserve Bank of India (RBI) regulates the banking sector, the Insurance
Regulatory and Development Authority of India (IRDAI) regulates the insurance companies, while
the Pension Fund Regulatory and Development Authority (PFRDA) regulates the pension fund
sector. Additionally, intermediaries representing some segment of the securities market may
form a Self‐Regulatory Organization (SRO). For recognition as an SRO by SEBI, certain conditions
have to be met as prescribed under the SEBI (Self‐Regulatory Organizations) Regulations, 2004.
Ideally, an SRO will seek to uphold investors’ interest by laying out and maintaining high ethical
and professional standards of conduct and encouraging best practices among its members.

The ruling given by a regulator may be challenged by petitioning the prescribed authority. In the
case of SEBI, for example, the appellate authority is the Securities Appellate Tribunal (SAT). Rulings
of the SAT can be challenged in the Supreme Court of India. It is important to note that, no civil
court can entertain any suit or proceeding relating to a matter which an adjudicating officer
appointed under the SEBI Act, or under a duly constituted SAT, is empowered under the said Act
to decide upon. Further, no injunction can be granted by any court or any other authority with
regard to any action taken or to be taken pursuant to any power conferred by the SEBI Act.

2.5 Financial Market Regulators

The role of a market regulator is to regulate markets to ensure integrity and protect the interests
of investors. The different regulators who regulate the activities of the different sectors in the
financial market are as given below:
 Ministry of Finance (MOF)
 Ministry of Corporate Affairs (MCA)
 Securities and Exchange Board of India (SEBI) regulates the Securities market.
 Reserve Bank of India (RBI) is the authority to regulate and monitor the Banking sector.
 Insurance Regulatory and Development Authority of India (IRDAI) regulates the Insurance
sector.
 Pension Fund Regulatory and Development Authority (PFRDA) regulates the pension fund
sector.

We will discuss in brief the role of each regulator in brief in the subsequent sections.
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2.5.1 Securities and Exchange Board of India

SEBI was established on April 12, 1992 in accordance with the provisions of the SEBI Act, 1992.
The preamble of the SEBI describes the basic functions of the Securities and Exchange Board of
India as “...to protect the interests of investors in securities and to promote the development of
and to regulate the securities market and for matters connected therewith or incidental thereto...”

As per Section 11(2) of SEBI Act, SEBI is empowered under the various regulations of the SEBI Act
to;
a) Regulate the business in stock exchanges and any other securities markets.
b) Register and regulate the working of stockbrokers, sub‐brokers, and share transfer
agents, bankers to an issue, trustees of trust deeds, registrars to an issue, merchant
bankers, underwriters, portfolio managers, investment advisers and others associated
with the securities market. SEBI’s powers also extend to registering and regulating the
working of depositories and depository participants, custodians of securities, foreign
portfolio investors, credit rating agencies, and others as may be specified by SEBI.
c) Register and regulate the working of venture capital funds and collective investment
schemes including mutual funds.
d) Promote and regulate SROs.
e) Prohibit fraudulent and unfair trade practices relating to the securities market.
f) Promote investors’ education and training of intermediaries in the securities market.
g) Prohibit insider trading in securities.
h) Regulate substantial acquisition of shares and takeover of companies.
i) Require disclosure of information, to undertake inspection, to conduct inquiries and
audits of stock exchanges, mutual funds, other persons associated with the securities
market, intermediaries and SROs in the securities market. The requirement of disclosure
of information can apply to any bank or any other authority or board or corporation.
j) Calling for information from or furnishing information to other authorities within India or
abroad having functions similar to SEBI in matters relating to prevention or detection of
violations in respect of securities laws.
k) Perform such functions and to exercise such powers under the Securities Contracts
(Regulation) Act, 1956 as may be delegated to it by the Central Government.
l) Levy fees or other charges pursuant to implementation of this regulation.
m) Conduct research for the above purposes.
n) Calling from or furnishing to such agencies specified by the SEBI, information as may be
considered necessary for discharge of its functions.
o) Performing such other functions as may be prescribed.
Further, SEBI is also empowered to enforce disclosure of information or to furnish information to
agencies as may be deemed necessary. Some of the powers of SEBI as provided in SEBI Act include:

Section 11(2A): The power to inspect any book of accounts, register or other document or record
of any listed company or a public company which intends to get its securities listed at a recognised
stock exchange if SEBI has reasonable grounds to assume that the concerned company has been
indulging in insider trading or other illegitimate practices such as fraudulent or unfair trade
practices.

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Section 11(3): SEBI shall have the same powers as are vested in a civil court under the Code of
Civil Procedure in respect of certain matters, such as the inspection of books and registers and
summoning and enforcing the attendance of persons and examining them on oath.

Section 11(4) empowers SEBI to take the following actions, if it is in the interest of investors or
the securities market:
 suspend trading in any security at a recognised stock exchange
 restrain persons from accessing the securities markets, and prohibiting any persons
associated with the securities market from buying, selling or dealing in securities
 suspend any office bearer of any stock exchange or SRO from holding the position
 impound and retain the proceeds or securities relating to any transaction which is under
investigation
 direct any intermediary or person associated with the securities market not to dispose off
or alienate an asset constituting a part of any transaction which is under investigation

Section 11(5): The amount disgorged pursuant to direction issued under section 11B of the SEBI
Act, 1992 or section 12A of the Securities Contracts (Regulation) Act, 1956 or section 19 of the
Depositories Act, 1996, shall be credited to the Investor Protection and Education Fund.

Section 11A: SEBI is vested with the power to regulate or prohibit issue of prospectus, offer
document or advertisement which solicits money for issue of securities.

Section 11A (1) empowers SEBI to specify regulations with respect to matters relating to issue of
capital, transfer of securities and other incidental matters as well as the manner in which such
matters are required to be disclosed by the Companies. Apart from this, SEBI is empowered to
issue general or special orders prohibiting any company from issuing the prospectus or offer
document or advertisement soliciting money from the public for issue of securities and specify
the conditions subject to which the prospectus or offer document or advertisement may be
issued.

Section 11A (2) empowers SEBI to specify the requirements for listing and transfer of securities
and matters incidental thereto.

Section 11B: SEBI has been vested with the powers to issue direction to any intermediary, if after
making an enquiry it is found that the investor’s interest is at stake or action of the intermediary
is obstructing the orderly development of the securities market. If need be, SEBI can also in the
interest of the market/investors secure the proper management of any such intermediary or
person against whom enquiry have been made. This also includes the power to direct any person
who made profit or averted loss by indulging in any transaction or activity in contravention of the
provisions of this Act or regulations made thereunder, to disgorge an amount equivalent to the
wrongful gain made or loss averted by such contravention.

Section 11C: In cases where SEBI has reasonable ground to believe that the transaction in
securities are being dealt with in a manner detrimental to the investors or the securities market
or that the intermediary or any person associated with the securities market have violated any of
the provisions of the SEBI Act or any other rules or regulations, by order in writing may direct any
person to investigate the affairs of such intermediary or person associated with the securities
market and also report to SEBI such investigation. In the course of investigation, if the
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Investigating Authority has reasonable ground to believe that the books, registers, other
documents and record of, or relating to, any intermediary or any person associated with securities
market in any manner, may be destroyed, mutilated, altered, falsified or secreted, the
Investigating Authority may make an application to the Magistrate or Judge of such designated
court in Mumbai, as may be notified by the Central Government for an order for the seizure of
such books, registers, other documents and record.

The commodity markets in India was regulated by the Forward Markets Commission (FMC). The
merger of FMC with SEBI dated September 28, 2015, brought the commodity markets under the
purview of SEBI.
2.5.2 Reserve Bank of India
Reserve Bank of India (RBI) is the central bank of the country vested with the responsibility of
administering the monetary policy. Therefore, its key concern is to ensure the adequate growth
of money supply in the economy so that economic growth and financial transactions are
facilitated, but not so rapidly which may precipitate inflationary trends. This is borne out in its
Preamble, in which the basic functions of the Bank are thus defined: “…to regulate the issue of
Bank Notes and keeping of reserves with a view to securing monetary stability in India and
generally to operate the currency and credit system of the country to its advantage”. In addition
to the primary responsibility of administering India’s monetary policy, RBI has other onerous
responsibilities, such as financial supervision.

The roles played by RBI are:

1. As the monetary authority: to formulate, implement and monitor the monetary policy in
a manner as to maintain price stability while ensuring an adequate flow of credit to
productive sectors of the economy.
2. As the regulator and supervisor of the financial system: To prescribe broad parameters
of banking operations within which Indian banking and financial system functions. The
objective here is to maintain public confidence in the system, protect the interest of the
people who have deposited money with the bank and facilitate cost‐effective banking
services to the public.
3. As the manager of Foreign Exchange: To administer the Foreign Exchange Management
Act 1999, in a manner as to facilitate external trade and payment and promote orderly
development and maintenance of the foreign exchange market in India.
4. As the issuer of currency: To issue currency and coins and to exchange or destroy the
same when not fit for circulation. The objective that guides RBI here is to ensure the
circulation of an adequate quantity of currency notes and coins of good quality.
5. Developmental role: To perform a wide range of promotional functions to support
national objectives.
6. Banking functions:
a) It acts as a banker to the Government and manages issuances of Central and State
Government securities.
b) It acts as a banker to the banks by maintaining the banking accounts of all scheduled
banks.

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The general superintendence and direction of RBI’s affairs are looked after by a Central Board of
Directors which is appointed by the Government of India. Further, each of the four regions in the
country is served by a Local Board which advises the Central Board on local issues and represents
territorial and economic interests of local co‐operative and indigenous banks. The Local Boards
will also perform other functions as delegated by the Central Board.

RBI performs the important function of financial supervision under the guidance of the Board for
Financial Supervision (BFS) which was constituted in 1994 as a committee of the Central Board
of Directors. The primary objective of the BFS is to carry out consolidated supervision of the
financial sector consisting of commercial banks, financial institutions and non‐banking finance
companies. The BFS oversees the functioning of the Department of Banking Supervision, the
Department of Non‐Banking Supervision and Financial Institutions Division and issues directions
on regulatory and supervisory issues. Some of the initiatives undertaken by the BFS are:
 A restructuring of the system of bank inspections
 Introduction of offsite surveillance
 Strengthening the role of statutory auditors
 Strengthening the internal defences of supervised institutions

Currently, the Board for Financial Supervision is focused on:
 Supervision of financial institutions
 Consolidated accounting
 Legal issues in bank frauds
 Divergence in assessments of non‐performing assets
 Supervisory rating model for banks

RBI’s functions are governed by the Reserve Bank of India Act 1934, whereas the financial sector
is governed by the Banking Regulation Act 1949.
2.5.3 Insurance Regulatory and Development Authority of India
Insurance Regulatory and Development Authority of India’s (IRDAI’s) mission is to regulate,
promote and ensure orderly growth of the insurance sector, including the re‐insurance business,
while ensuring protection of the interests of insurance policyholders. IRDAI was constituted by an
Act of Parliament and according to Section 4 of the IRDA Act 1999 the Authority comprises ten
members who are all government appointees.

The powers and functions of the authority include the following:

a) Issuing a certificate of registration or renewing, modifying, withdrawing, suspending or
cancelling such registration.
b) Protecting the interests of policyholders in matters relating to assignment of policy,
nomination by policyholders, insurable interest, settlement of insurance claim, surrender
value of policy and other clauses of insurance contracts.
c) Spelling out the required qualifications, code of conduct and practical training for
intermediaries including insurance intermediaries and agents.
d) Specifying the code of conduct for surveyors and loss assessors.
e) Seeking information, undertaking inspection, conducting inquiries and investigations
including audit of the insurer, intermediaries and others.
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f) To control and regulate the rates and terms and conditions that may be offered by
insurers with regard to general insurance, which are not covered by the Tariff Advisory
Committee.
g) Regulating the investment of funds by insurance companies

2.5.4 Pension Fund Regulatory and Development Authority

PFRDA was established on 18 September 2013 in accordance with the provisions of the Pension
Fund Regulatory and Development Authority Act, 2013 with the following responsibilities: (a) To
promote old age income security by establishing, developing and regulating pension funds, (b) To
protect the interests of subscribers to schemes of pension funds and related matters. The PFRDA
Act is applicable to (i) the National Pension System (NPS) and (ii) any other pension scheme not
regulated by any other enactment.

The PFRDA is empowered under the various regulations of the PFRDA Act to:
 regulate, promote and ensure orderly growth of the National Pension System and pension
schemes to which this Act applies
 protect the interests of subscribers of such System and schemes
 call for information from, undertaking inspection of, conducting inquiries and
investigations including audit of, intermediaries and other entities or organisations
connected with pension funds.
The National Pension System (NPS) is a defined contribution retirement savings scheme regulated
by PFRDA. It offers a menu of investment choices and Fund Managers to its subscribers. NPS is
made mandatory for the new recruits to the Central Government, except the armed forces. NPS
is also available for all the citizens of India on a voluntary basis. However, mandatory programmes
under the Employees Provident Fund Organization (EPFO) and other special provident funds
continue to operate according to the existing system, under the Employees Provident Fund (EPF)
and Miscellaneous Provisions Act 1952 and other special acts governing these funds.

2.6 Role of other Regulators/ Agencies in the Financial Market

There are several government departments / agencies / organisations that also help in the
regulation of the financial market such as:

Ministry of Finance (MoF) governs the entire fiscal system of the Government of India. It
centralises around all the issues in India pertaining to economy and finance. It also includes the
task of mobilization of resources in terms of execution of developmental programmes.
Department of Economic Affairs, Department of Expenditure, Department of Revenue,
Department of Financial Services etc. are the various departments which are headed by the MoF.

Department of Economic Affairs (DEA) is the nodal agency of the central government to
formulate and monitor India’s economic policies having a bearing on domestic and international
aspects of economic management. Main function of the DEA is formulation and monitoring of
macroeconomic policies relating to fiscal policy and public finance etc. as well as functioning of
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the capital market including stock exchanges. Other responsibilities include the mobilization of
external resources, foreign investments and monitoring foreign exchange resources including
balance of payments, production of bank notes and coins of various denominations etc.

Department of Financial Services administers government policies relating to:

 Public sector banks
 Term‐lending financial institutions
 Life insurance and general insurance
 Pension reforms

Department of Investment and Public Asset Management oversees, among other things, all
matters relating to the disinvestment of Central Government equity from Central Public Sector
undertakings. The department is also concerned with the financial policy relating to the utilization
of proceeds of disinvestment.

The Ministry of Corporate Affairs is mainly concerned with the administration of the Companies
Act, 1956, 2013 and other allied acts, rules and regulations pertaining to the corporate sector. The
Ministry is also responsible for administering the Competition Act 2002 which has replaced the
Monopolies and Restrictive Trade Practices Act, 1969 (MRTP). The Ministry also supervises three
professional bodies, viz., the Institute of Chartered Accountants of India (ICAI), the Institute of
Company Secretaries of India (ICSI) and the Institute of Cost and Works Accountants of India
(ICWAI).The Ministry of Corporate Affairs is also vested with the responsibility of administering
the Partnership Act, 1932, the Companies (Donations to National Funds) Act, 1951 and Societies
Registration Act, 1980.

2.6.1 Registrar of Companies

The Central Government has appointed Registrars at different places to discharge the function of
registration of companies as provided in Section 7 of the Companies Act, 2013. Registrar of
Companies (ROC) cover the various States and Union Territories and are vested with the primary
duty of registering companies created in the respective states and the Union Territories and
ensuring that such companies comply with statutory requirements under the Act. These offices
function as registry of records, relating to the companies registered with them, which are
available for inspection by members of public on payment of the prescribed fee. The Central
Government exercises administrative control over these offices through the respective Regional
Directors.

The ROC also undertakes other important duties, some of which are given below:

Under Section 81, the Registrar has to maintain a register containing particulars of all charges in
respect of each company.

Under Section 83, the Registrar on being given satisfactory evidence with respect to any registered
charge:

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a) That the debt for which the charge was created has been paid or satisfied wholly or partly,
or
b) That the part of the property or undertaking charged has been released from the charge
or has ceased to form a part of the company’s property or undertaking;

the Registrar may enter in the Register of Charges a memorandum of satisfaction in whole or in
part or about the fact that a part of the property or undertaking has been released from the
charge or no longer forms a part of the company’s property or undertaking as the case may be,
even if no intimation is received by him from the company.

Section 206 confers power on the Registrar to call for information or explanation. On perusing any
document which a company is required to submit to him under the Act, if the Registrar determines
that any information or explanation pertinent to the document is necessary, the Registrar may by
written order call for information in writing from the company. If no information or explanation
is forthcoming within the time specified, or if the information or explanation is inadequate, then
the Registrar may demand that the company produce for inspection such books and papers as he
deems necessary.

Section 209 spells out the power of the Registrar to seek the seizure of documents and therefore,
goes a step beyond Section 206, by which the Registrar may only demand the production of
documents. If the Registrar has reasonable grounds to believe that books and papers of, or
relating to, any company or body corporate or managing director or manager of such an entity
may be destroyed, mutilated, altered, falsified or secreted, then the Registrar may obtain an order
from the Special Court to search and seize the books and papers as he deems necessary.

2.6.2 Economic Offences Wing
The Economic Offences Wing (EOW) in the Central Bureau of Investigation was created in 1964 to
deal with offences under various sections of the Indian Penal Code and notified Special Acts
mainly relating to serious frauds in banks, stock exchanges, financial institutions, joint stock
companies, public limited companies, misappropriation of public funds, criminal breach of trust,
violation of Customs Act, counterfeiting of currency, narcotics, drug trafficking, arms peddling and
offences relating to adulteration, black‐marketing and others.

Following the securities and stock market scam of 1992, it was deemed desirable to strengthen
and expand the EOW and accordingly, a full‐fledged Economic Offences Division (EOD) was
formed in 1994. The EOD has four zones of which one focuses exclusively on large and
complicated security and bank frauds.

The areas currently covered by the EOD are:

1. Frauds relating to foreign trade
2. Banking frauds
3. Insurance frauds
4. Foreign exchange frauds
5. Frauds involving manipulation of share prices, insider trading and others
6. Smuggling of narcotics and psychotropic substances
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7. Forgery of travel documents, identity papers and overseas job rackets
8. Counterfeit currency and fake Government stamps and paper
9. Smuggling of antiques, arts and treasures
10. Cyber crimes
11. Violation of Intellectual Property Rights, audio and video piracy and software piracy
12. Wildlife and environmental offences

State governments have also set up their own EOWs to deal with commercial crimes, thefts of
idols, bogus lottery tickets and other offences.

2.6.3 Financial Intelligence Unit – India
FIU‐I was set up by the Government of India in 2004 as the central nodal agency responsible for
receiving, processing, analyzing and disseminating information regarding suspicious financial
transactions in order to support anti‐money laundering efforts. FIU‐I is an independent body
reporting directly to the Economic Intelligence Council headed by the Finance Minister. More
specifically, the functions of FIU‐I are:

A. To serve as the nerve centre for receiving reports on cash and other suspicious
transactions.
B. To analyse the information collected to trace patterns of transactions which could involve
money laundering and other crimes.
C. To share information on suspicious transactions with its counterparts and regulatory
bodies in other countries.
D. To establish and maintain a database on cash and suspicious transactions.
E. To co‐ordinate and strengthen collection and sharing of financial intelligence through an
effective national, regional and global network to fight money laundering and related
crimes.
F. To undertake research and analysis in order to monitor and identify strategic areas on
money laundering trends and other such developments.

Certain exclusive and concurrent powers under the Prevention of Money Laundering Act (PMLA)
are conferred on the Director, FIU‐I. For instance, under Section 13(2) of the PMLA, the Director
may impose a fine on any banking company, financial institution or intermediary for failing to
comply with obligations of maintenance of records or in furnishing information or in verifying the
identities of clients. For the purposes of Section 13, the Director shall have the same powers as
are vested in a civil court under the Court of Civil Procedure 1908, while trying a suit, such as
discovery and inspection, compelling the production of records and so on. Under Section 66 of
the PMLA, the Director or a specified authority may furnish or cause to be furnished any
information received or obtained, to any officer, authority or body, if it is deemed to be in the
public interest
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2.7 Appellate Authority
2.7.1 Securities Appellate Tribunal
The Securities Appellate Tribunal has been set up under the SEBI Act, which looks into the appeal
of any person who has been aggrieved by any order of SEBI, IRDAI or PFRDA. This section
elaborates on the different sections under the SEBI Act which discusses the establishment and the
role of SAT. Section 15K (1) of the SEBI Act, 1992, empowers the Central Government to establish
Securities Appellate Tribunal (SAT) to exercise jurisdiction, powers and authority under the said
act or any other law in force. The SAT consists of a Presiding Officer and two other members,
appointed by the Central Government. The qualification for appointment is that the person
should be a sitting or retired judge of the Supreme Court or a retired Chief Justice of a High Court.

Any person aggrieved by the following may appeal to the SAT, provided the aggrieved person had
not granted his consent to the order against which the appeal is being made. The appeal must be
filed within a period of 45 days from the date on which a copy of the order is received:

a. An order of SEBI made on or after the commencement of the Securities Laws (Second
Amendment) Act, 1999, under the SEBI Act 1992, or related rules and regulations.
OR
b. By an order made by an adjudicating officer under the Act.

As per Section 15U (1), the SAT shall not be bound by the procedure laid down by the Code of Civil
Procedure, 1908, but shall be guided by the principles of natural justice. Further, subject to other
provisions of the SEBI Act, 1992, and other rules, the SAT shall have powers to regulate its own
procedure.

As per Section 15U (2), the SAT shall have, for discharging its functions, the same powers as are
vested in a civil court under the Code of Civil Procedure, 1908, while trying a suit, in respect of the
following matters:

a) Summoning and enforcing the attendance of any person and examining him on oath
b) Requiring the discovery and production of documents
c) Receiving evidence on affidavits
d) Issuing commissions for the examination of witnesses or documents
e) Reviewing its decisions
f) Dismissing an application for default or deciding it ex‐parte
g) Setting aside any order of dismissal of any application for default or any order passed by
it ex‐parte
h) Any other matter which may be prescribed

According to Section 15U (3), every proceeding before the SAT shall be deemed to be a judicial
proceeding and SAT shall be deemed to be a civil court. Section 15V states that the appellant may
either appear in person or authorise one or more chartered accountants or company secretaries
or cost accountants or legal practitioners or any of its officers to present his or its case before the
SAT.

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Section 15W states that the provisions of the Limitation Act, 1963 shall apply to an appeal made
to a SAT.

Section 15Y specifies that no civil court shall have jurisdiction to entertain any suit or proceeding
in respect of any matter which SAT constituted under the SEBI Act is empowered to decide upon.
Further, no injunction shall be granted by any court or an authority in respect of any action taken
or to be taken in pursuance of any power conferred by or under the SEBI Act.

Section 15Z states that any person aggrieved by any decision or order of the SAT may file an appeal
to the Supreme Court within 60 days from the date of communication of the decision or order of
the SAT to him, on any question of law arising out of the order.

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Review Questions

1. Financial System intermediaries includes
(a) Banks, Custodians, Stock Exchanges, Depositories
(b) Banks, Custodians, RBI, SEBI only
(c) Investors only
(d) Corporate only
Ans: (a)

2. Debenture holder has the right to
(a) Interest
(b) Dividend
(c) Vote
(d) None of the above
Ans: (a)

3. Exchange Traded Fund (ETF) can be based on
(a) Debt instrument
(b) Treasury Bills
(c) Commercial Paper
(d) Stocks, Indices or Commodities
Ans: (d)

4. Public issue application processing is carried out by
(a) Bankers to the issue
(b) Merchant Bankers
(c) Stock Exchange
(d) Registrar and Share Transfer Agent
Ans: (d)

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Chapter 3 SEBI Act 1992, SCRA and SCRR


After studying this chapter, you should know about some key provisions relating to the:

 SEBI Act 1992

 Securities Contract (Regulation) Act, 1956
 Securities Contract (Regulation) Rules, 1957

3.1 Securities and Exchange Board of India Act, 1992

3.1.1 Salient Features of SEBI Act, 1992

The SEBI Act of 1992 was enacted upon “to provide for the establishment of a Board to protect
the interests of investors in securities and to promote the development of, and to regulate, the
securities market and for matters connected therewith or incidental thereto”.

3.1.2 Powers and Functions of the SEBI

The SEBI Act in the broader sense performs the functions as stated in the above para, however,
without any prejudice to the generality, the Act also provides for the following measures:

a. Regulating the business in stock exchanges and any other securities markets;
b. Registering and regulating the working of the stock brokers, sub‐brokers, share transfer
agents, bankers to an issue, registrars to an issue, merchant bankers, underwriters,
portfolio managers, investment advisers and such other intermediaries who may be
associated with the securities markets in any manner;
c. Registering and regulating the working of the depositories and its participants, custodian
of securities, foreign portfolio investors, credit rating agencies and such other
intermediaries as notified by the SEBI.
d. Registering and regulating the working of Venture Capital Funds and other Collective
Investment Schemes.
e. Promoting and regulating self‐regulatory organisations.
f. Prohibiting fraudulent and unfair trade practices relating to securities markets.
g. Promoting investors’ education and training of intermediaries of securities markets.
h. Prohibiting insider trading in securities.
i. Regulating substantial acquisition of shares and take‐over of companies.
j. Calling for information from, undertaking inspection, conducting inquiries and audits of
the intermediaries and other persons associated with the securities market.
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k. Performing all such functions and exercising such powers under the provisions of the
Securities Contracts (Regulation) Act, 1956 as maybe delegated to SEBI by the central
government.
l. Conducting research for the above purposes
m. Calling from or furnishing to any such agencies, as may be specified by the Board, such
information as may be considered necessary by it for the efficient discharge of its
functions.
According to sub‐section 3 of Section 11 of the SEBI Act, notwithstanding anything contained in
any other law for the time being in force while exercising the powers, SEBI shall have the same
powers as are vested in a civil court under the Code of Civil Procedure, while trying a suit in respect
of the following matters;

i. The discovery and production of books of account and other documents, at such place
and such time as may be specified by SEBI;
ii. Summoning and enforcing the attendance of persons and examining them on oath;
iii. Inspection of any books, registers and other documents of any person;
iv. Issuing commissions for the examination of witnesses or documents.

The Section 11A of the SEBI Act states that without any prejudice to the provisions of the
Companies Act, SEBI may for the protection of investors, ‐
(a) Specify, by regulations –
i. The matters relating to issue of capital, transfer of securities and other matters
incidental thereto; and
ii. The manner in which such matters shall be disclosed by the Companies;
(b) By general or special orders –
i. Prohibit any company from issuing prospectus, any offer document, or
advertisement soliciting money from the public for the issue of securities;
ii. Specify the conditions subject to which the prospectus, such offer document or
advertisement, if not prohibited, may be issued.
3.1.3 Penalties and Adjudication

SEBI Act empowers SEBI to impose penalties and initiate adjudication proceedings against
intermediaries who default on the following grounds such as failure to furnish information, return
etc. or failure by any person to enter into agreement with clients etc. In this section we discuss
the various clauses of sub‐Sections 15, failing to comply with any of these will lead to penalties
and adjudication proceedings.

Section 15A: Penalty for failure to furnish information, return etc.

Section15A prescribes penalty payable by an intermediary for failing to‐
a) Furnish any document, return or report to SEBI.
b) File any return or furnish any information, books or other documents within the time
specified as in the regulations.
c) Maintain books of account or records.
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The penalty amount shall not be less than one lakh rupees but which may extend to one lakh
rupees for each day during which such failure continues subject to a maximum of one crore
rupees.

Section 15B: Penalty for failure by any person to enter into agreements with clients

Section 15B prescribes the penalty of not be less than one lakh rupees but which may extend to
one lakh rupees for each day during which such failure continues subject to a maximum of one
crore rupees by an intermediary for failing to enter into an agreement with his/her client in
violation of such a requirement under the SEBI Act, 1992.

Section 15C: Penalty for failure to redress investors’ grievances

Section 15C prescribes the penalty applicable to a listed company or any person who is registered
as an intermediary, for failing to redress investors’ grievances after having been directed in writing
by SEBI to do so within a specified time period. The penalty amount shall not be less than one lakh
rupees but which may extend to one lakh rupees for each day during which such failure continues
subject to a maximum of one crore rupees.

Section 15D: Penalty for certain defaults in case of mutual funds

Section 15D relates to defaults by mutual funds (MFs) and prescribes penalties in the following
cases:
a) If a person sponsors or carries on any collective investment scheme, including MFs,
without obtaining the required certificate of registration.
b) If a person registered with SEBI as a collective investment scheme including mutual funds,
fails to comply with the terms and conditions of the certificate of registration.
c) A failure, by a person registered with SEBI as a collective investment scheme including
mutual funds, to submit an application for listing of the collective investment scheme(s),
in accordance with the regulations governing such listing.
d) A failure, by a person registered with SEBI as a collective investment scheme including
mutual funds, to dispatch unit certificates of any scheme in accordance with the
regulations governing such dispatch.
e) A failure, by a person registered with SEBI as a collective investment scheme including
mutual funds, to refund the application monies of investors within the period specified in
the relevant regulations.
f) A failure, by a person registered with SEBI as a collective investment scheme including
mutual funds, to invest money collected by such schemes in the manner or within the
period specified in the relevant regulations.
The penalty amount shall not be less than one lakh rupees but which may extend to one lakh
rupees for each day during which such failure continues subject to a maximum of one crore
rupees.
Section 15E: Penalty for failure to observe rules and regulations by an asset management company
(AMC)
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Section 15E prescribes the penalty payable by an AMC of a mutual fund registered under the SEBI
Act, on failing to comply with any of the regulations that place restrictions on the activities of
asset management companies.

Section 15F: Penalty for certain default in case of stock brokers

Section 15F prescribes the penalty payable by a stock broker registered under the SEBI Act, under
the following cases:
i. A failure to issue contract notes in the form and manner specified by the stock exchange
of which the broker is a member. In such cases, penalty which shall not be less than one
lakh rupees but which may extend to for which the contract note was required to be
issued by that broker.
ii. A failure to deliver any security or to make payment of the amount due to the investor in
the manner and within the period specified in the regulations. In such cases, which shall
not be less than one lakh rupees but which may extend to one lakh rupees for each day
during which he sponsors or carries on any such collective investment scheme including
mutual funds subject to a maximum of one crore rupees.
iii. Charging an amount of brokerage in excess of that specified in the regulations. In such
cases, a penalty shall not be less than one lakh rupees but may extend to five times the
amount of brokerage charged in excess of the specified brokerage, whichever is higher.

Section 15G: Penalty for insider trading

Section 15G prescribes penalties for the following:
a) When an insider acting on his/her own behalf or on behalf of another deals in securities
of a body corporate listed on any stock exchange on the basis of any unpublished price‐
sensitive information.
b) When an insider communicates any unpublished price‐sensitive information to any
person, with or without his request for such information except as required in the
ordinary course of business or under any law.
c) When an insider counsels, or procures for any other person to deal in any securities of
any corporate body on the basis of unpublished price‐sensitive information.
Any insider who indulges in any of the aforementioned activities shall be liable to a penalty which
shall not be less than ten lakh rupees but which may extend to twenty‐five crore rupees or three
times the amount of profits made out of insider trading, whichever is higher.

Section 15H: Penalty for non‐disclosure of acquisition of shares and takeovers

Section 15H prescribes the penalty for non‐disclosure of acquisition of shares and takeovers. If
any person fails to:
(i) disclose the aggregate of his shareholding in the body corporate before he acquires any shares
of that body corporate; or
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(ii) make a public announcement to acquire shares at a minimum price; or
(iii) make a public offer by sending letter of offer to the shareholders of the concerned company;
or
(iv) make payment of consideration to the shareholders who sold their shares pursuant to
letter of offer,
For any of the above non‐disclosures, a person shall be liable to a penalty which shall not be less
than ten lakh rupees but which may extend to twenty‐five crore rupees or three times the amount
of profits made out of such failure, whichever is higher.

Section 15HA: Penalty for fraudulent and unfair trade practices

Section 15HA prescribes a penalty for people indulging in fraudulent and unfair trade practices
relating to securities. Any person indulging in such activities would be liable to a penalty which
shall not be less than five lakh rupees but which may extend to twenty‐five crore rupees or three
times the amount of profits made out of such practices, whichever is higher.

Section 15HB: Penalty for Contravention where no separate penalty has been provided

Section 15HB states that whoever fails to comply with any provision of the SEBI Act, the rules or
the regulations made or directions issued by SEBI thereunder, for which no separate penalty has
been provided, shall be liable to a penalty which shall not be less than Rs. One lakh but which may
extend to Rs. One crore.

To understand the various statutes of the Securities market, it is also essential to understand the
jurisdiction, authority and procedure adopted by the Appellate Tribunal. Appeal against any ruling
of the capital market regulator is petitioned to the appellate tribunal set up for this purpose i.e.
Securities Appellate Tribunal.

3.1.4 Securities Appellate Tribunal

The Securities Appellate Tribunal (SAT) according to Section 15U is not bound by the procedure
laid down by the Code of Civil Procedure, but shall be guided by the principles of natural justice
and shall have the powers to regulate their own procedures. The tribunal for the purpose of
discharging its functions under this Act shall have the same powers as are vested in a civil court
under the code of civil procedure while trying a suit in respect of the following matters, namely:‐
 Summoning and enforcing the attendance of any person and examining him on oath;
 Requiring the discovery and production of documents;
 Receiving evidence on affidavits;
 Issuing commissions for the examination of witnesses or documents;
 Reviewing its decisions;
 Dismissing an application for default or deciding its ex‐parte;
 Setting aside any order of dismissal of any application for default or any order passed by
it ex‐parte.
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Any proceeding before the SAT shall be deemed to be a judicial proceeding within the meaning of
provisions as given under the Indian Penal Code.

Section 15T: Appeal to Securities Appellate Tribunal

Section 15T of the SEBI Act gives the right to “Appeal to the SAT”. It states that any person
aggrieved by an order –

(i) Of the SEBI Board made, on and after the commencement of the Securities Laws
(Second Amendment) Act, 1999, under the SEBI Act, or the rules and regulations
made thereunder; or
(ii) Made by an adjudicating officer appointed under this Act; or
(iii) Made by the Insurance Regulatory and Development Authority or the Pension Fund
Regulatory and Development Authority
may prefer an appeal to the SAT having jurisdiction in this matter. Every appeal should be filed
within a period of 45 days from the date on which a copy of the order made by SEBI or the
Adjudicating Officer or the Insurance Regulatory and Development Authority (IRDAI) or the
Pension Fund Regulatory and Development Authority (PFRDA) is received by him in a specified
form along with the fee as prescribed.

Section 15Z: Appeal to Supreme Court

Any person aggrieved by any decision or order of the Securities Appellate Tribunal may file an
appeal to the Supreme Court within 60 days from the date of communication of the decisions or
order of the SAT to him.

3.1.5 Registration of Intermediaries

Section 12 of SEBI Act vests SEBI with the power to issue the certificate of registration without
which no stockbroker, sub‐broker, share transfer agent, banker to an issue, trustee of trust deed,
registrar to an issue, merchant banker, underwriter, portfolio manager, investment adviser or
such other intermediary who may be associated with the securities market shall buy, sell or deal
in securities. These intermediaries also requires to comply with certain other provisions in certain
other regulations while applying for certificate of registration such as a stock broker applying to
SEBI for a certificate of registration needs to apply as per the FORM A of the SEBI (Stock Brokers
and Sub‐brokers) Regulations 1992. Similarly a sub‐broker needs to apply as per the FORM B of
the SEBI (Stock Brokers and Sub‐brokers) Regulations 1992.These regulations would be discussed
in length in the later sections of this workbook.

The Section 12 also states that no person shall sponsor or cause to be sponsored or carry on or
caused to be carried on any venture capital funds or collective investment schemes including
mutual funds if the same does not obtain a certificate of registration from the SEBI. The
application for registration and the payment of such fees shall be in accordance with the
provisions of the regulations. SEBI may however by order, suspend or cancel a certificate of
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registration as under the provisions in the regulations after giving the person concerned a
reasonable opportunity of presenting his/her case.

3.1.6 Prohibition of Manipulative and Deceptive Devices, Insider Trading etc.

Section 12A prescribes that no person shall directly or indirectly ‐

a. Use or employ, in connection with the issue, purchase or sale of any securities, which are
either listed or proposed to be listed on a recognised stock exchange, any manipulative
or deceptive device or contrivance in contravention of the provisions of this Act or any
rules made there under;
b. Employ any device, scheme or artifice to defraud in connection with issue or dealing in
securities which are listed or proposed to be listed on a recognised stock exchange;
c. Engage in any act, practice, course of business which operates or would operate as fraud
or deceit upon any person, in connection with the issue, dealing in securities which are
listed or proposed to be listed on a recognised stock exchange, in contravention of the
provisions of this act;
d. Engage in any insider trading activity;
e. Deal in securities while in possession of material or non‐public information or
communicate such material or non‐public information to any other person, in a manner
which is in contravention of the provisions of this Act or rules /regulations made
hereunder;
f. Acquire control of any company or securities more than the percentage of the equity
share capital of a company whose securities are listed or proposed to be listed on a
recognised stock exchange in contravention of the regulations made under this Act.

The designated compliance officer in each intermediary should ensure that the intermediary is
functioning in compliance with the provisions of the various regulations (as discussed in this
chapter) of the SEBI Act. Non‐compliance of the rules and regulations laid down by SEBI will attract
a penalty either monetary or suspension.

3.2 Securities Contracts (Regulation) Act, 1956

The Securities Contracts (Regulation) Act, 1956 provides for direct and indirect control of virtually
all aspects of securities trading and the running of stock exchanges. This act aims to prevent
undesirable transactions in securities. It gives the central government and SEBI the regulatory
jurisdiction over (a) stock exchanges through a process of recognition and continued supervision,
(b) contracts in securities, and (c) listing of securities on stock exchanges. The objective of SC(R)A
is to prevent undesirable speculation and to regulate contracts and transactions in securities. A
transaction in securities between two persons is essentially a contract. The law that specifically
applies in the case of a securities contract is the SC(R)A.

SC(R)A covers around 31 Sections. Sections 3 to 12 are specifically related to various aspects of
stock exchange recognition. The Central Government has the powers to prescribe admission
criteria and qualifications for members. The members are required to maintain books and records
in a prescribed manner, which are subject to inspection upon enquiry. The SCRA also specifies the
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manner in which derivative contracts and other contracts shall be dealt with in recognised stock
exchanges. Contraventions to any of the provisions of this Act are liable to attract penalty.
Sections 13 to 19 deals with the provisions for contracts and options in securities, Section 21 and
22 with listing of securities and Sections 23 to 26 on penalties and procedures imposed on non‐
compliance of the rules and regulations. Sections 27‐31 deals with issues such as the power of
SEBI to make regulations, power of Central Government to make rules etc.

3.2.1 Call for Periodical Returns

Section 6(2) of SCRA requires every member of a recognised stock exchange to maintain and
preserve for such periods not exceeding 5 years such books of accounts and other documents as
the Central Government may prescribe after consultation with the concerned stock exchange,
and such books of accounts and other documents shall be subject to inspection by SEBI.

Section 6(3) of SCRA provides that SEBI, in the interest of trade or in the public interest, may by
order in writing –
 Call upon any member of a recognised stock exchange to furnish in writing such
information or explanation relating to the affairs of the member in relation to the stock
exchange as SEBI may require; or
 Appoint person(s) to make inquiry into the affairs of any member of a stock exchange in
relation to the stock exchange and submit a report of the same to SEBI or it may direct
the governing body of the stock exchange to make the inquiry and submit its report to
SEBI.

Section 6(4) of SCRA provides that where an inquiry, as mentioned above, has been undertaken,
every member of the concerned stock exchange shall be bound to produce before the inquiring
authority all such books of accounts and other documents in its custody or power, which relates
to or have bearing on the subject matter of such inquiry and shall also furnish such statement or
information relating to the inquiry as the inquiring authority may require.
3.2.2 Contracts and Options in Securities

Section15 of SCRA provides that no member of a recognised stock exchange shall in respect of
any securities enter into any contract as a principal with any person other than a member of a
recognised stock exchange, unless he has secured the consent or authority of such person and
discloses in the note, memorandum or agreement of sale or purchase that he is acting as a
principal. However, a stock broker may enter into contract, as a principal with any other person
only if written consent is received from such person within 3 days from the date of the contract
and a disclosure to this effect is made on the contract note.
3.2.3 Penalties and Procedures

The Sections 23 to 26 provide for the different penalties and procedures to be imposed upon any
person /intermediary on non‐compliance with any of the provisions given under the various rules
and regulations governing the securities market in India.

Section 23 states that any person who,
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(a) Without reasonable excuse fails to comply with any requisition made under sub‐section
(4) of section 6 of the SCRA, or
(b) Enters into any contract in derivative in contravention of section 18A or the rules made
under section 30; or
(c) Not being a member of a recognised stock exchange or his agent authorised as such under
the rules or bye‐laws of such stock exchange or not being a dealer in securities licensed
under section 17 wilfully represents to or induces any person to believe that contracts
can be entered into or performed under this Act through him;

shall without prejudice to any award of penalty by the adjudicating officer under the Act on
conviction, be punishable with imprisonment for a term which may extend to ten years or with
fine which may extend to Rs. 25 crore or with both.

Section 23A of SCRA provides that any person, who is required under the SCRA or SCRR –
 to furnish any information, document, books, returns or report to a recognised stock
exchange, fails to furnish the same within the specified time shall be liable to a penalty
which shall not be less than Rs.1 lakh but which may extend to Rs.1 lakh for each day
during which such failure continues subject to maximum of Rs.1 crore for each such
failure.
 to maintain books of account or records as per the listing agreements, conditions or bye‐
laws of the stock exchange, fails to maintain the same, shall be liable to a penalty which
shall not be less than Rs.1 lakh but which may extend to Rs.1 lakh for each day during
which such failure continues subject to maximum of Rs.1 crore.

Section 23B of SCRA provides that if a broker fails to enter into an agreement with its client who
is required to enter as per the Act, he shall be liable to a penalty which shall not be less than Rs.1
lakh but which may extend to Rs.1 lakh for each day during which such failure continues subject
to maximum of Rs.1 crore for every such failure.

Section 23C of SCRA provides that if a broker/ sub‐broker/ company fails to redress the grievances
of any investor after having been directed by SEBI or Stock Exchange, in writing, to do so within
the stipulated time, he/ it shall be liable to a penalty which shall not be less than Rs.1 lakh but
which may extend to Rs.1 lakh for each day during which such failure continues subject to
maximum of Rs.1 crore.

Section 23D of SCRA provides that if a broker fails to segregate securities or monies of client(s)
from its own securities or funds or uses the securities or monies of client(s) for self or for any
other client(s), he shall be liable to a penalty which shall not be less than Rs.1 lakh but may extend
to Rs.1 crore.

Section 23JA of SCRA provides for application in writing to the SEBI proposing for settlement of
proceedings initiated or to be initiated for the alleged defaults. The SEBI after taking into
consideration the nature, gravity and impact of defaults, may agree to the proposal for
settlement, on payment of such sum by the defaulter or on such other terms as may be
determined by SEBI.

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Section 23JB of SCRA states the procedure to be followed by the Recovery Officer of SEBI in case
of non‐payment of the penalty imposed by the adjudicating officer for refund of monies or
compliance of disgorgement order issued under Section 12A.

Sections 26A to 26E have been introduced in the SCRA with respect to establishment of Special
Courts. The provisions state that the Central Government may establish or designate as many
Special Courts as may be necessary. It also prescribes the rules for constitution of the Court, the
offences triable by the Special Courts, Appeal and Revision, Application of Code to proceedings
before Special Court etc.

3.3 Securities Contracts (Regulation) Rules, 1957

In exercise of the powers conferred by the section 30 of the SCRA, the Central Government has
made the Securities Contracts (Regulation) Rules, 1957. In this section we discuss those rules
formed under the SCRR which are of importance from compliance point of view.
3.3.1 Eligibility criteria for membership of a recognised stock exchange

Rule 8 of SCRR specifies the rules relating to admission of members of the stock exchange. No
person is eligible to become a member if he

a. is less than 21 years of age.
b. is not a citizen of India provided that the governing body may in suitable cases relax this
condition with the prior approval of the SEBI.
c. has been adjudged bankrupt or a receiving order in bankruptcy has been made against
him or has been proved to be insolvent even though he has obtained his final discharge.
d. has compounded with his creditors unless he has paid sixteen annas in the rupee.
e. has been convicted of an offence involving fraud or dishonesty.
f. is engaged as principal or employee in any business other than that of securities or
commodity derivatives except as a broker or agent not involving any personal financial
liability unless he undertakes on admission to sever his connection with such business.
Provided that no member may conduct business in commodity derivatives, except by
setting up a separate company which shall comply with the regulatory requirements, such
as, networth, capital adequacy, margins and exposure norms as may be specified by the
market regulator, from time to time.

Provided further that nothing herein shall be applicable to any corporations, bodies
corporate, companies or institutions referred to in items (a) to (n)of the proviso to sub‐
rule (4).
g. has been at any time expelled or declared a defaulter by any other stock exchange.
h. has been previously refused admission to membership unless a period of one year has
elapsed since the date of such rejection.

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No person eligible for admission as a member under the above mentioned rules shall be admitted
as a member unless he:

a) has worked for not less than two years as a partner with, or an authorised assistant or
authorised clerk or remisier or apprentice to, a member; or
b) agrees to work for a minimum period of two years as a partner or representative member
with another member and to enter into bargains on the floor of the stock exchange and
not in his own name but in the name of such other member; or
c) succeeds to the established business of a deceased or retiring member who is his father,
uncle, brother or any other person who is, in the opinion of the governing body, a close
relative
Provided that the rules of the stock exchange may authorise the governing body to waive
compliance with any of the foregoing conditions:

 If the person seeking admission is in respect of means, position, integrity, knowledge and
experience of business in securities, considered by the governing body to be otherwise
qualified for membership.
3.3.2 Contracts between members

Rule 9 of the SCRR requires all contracts entered into between members of a recognised stock
exchange to be confirmed in writing.
3.3.3 Audit of accounts of members

Rule 12 requires all stock brokers to get their accounts audited by a chartered accountant
whenever such audit is required by SEBI.
3.3.4 Books of account

Under Rule 15(1) every member of a recognised stock exchange is required to maintain and
preserve the following books of account and documents for a period of 5 years:

 Register of transactions (Sauda book).
 Clients’ ledger.
 General ledger.
 Journals.
 Cash book.
 Bank pass‐book.
 Documents register showing full particulars of shares and securities received and
delivered.

Rule 15(2) requires every member of a recognised stock exchange to maintain and preserve the
following documents for a period of 2 years:

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 Member’s contract books showing details of all contracts entered into by the member
with other members of the same exchange or counterfoils or duplicates of memos of
confirmation issued to such other members.
 Counterfoils or duplicates of contract notes issued to clients.
 Written consent of clients in respect of contracts entered into as principals.
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Review Questions

1. All of the following are the functions of SEBI under SEBI Act, 1992, EXCEPT:
(a) Regulating the business in other securities markets but not in stock exchanges
(b) Promoting and regulating self‐regulatory organisations
(c) Regulating substantial acquisition of shares and take‐over of companies
(d) Prohibiting insider trading in securities
Ans: (a)
2. Penalty may be payable by an intermediary under SEBI Act if it fails to:
(a) File any return or furnish any information, books or other documents within the time
specified as in the regulations
(b) Maintain books of account or records
(c) Both I and II
Ans: (c)
3. As per SCRR, the trading members of the stock exchanges are required to maintain the
counterfoils or duplicates of contract notes issued to clients for how many years?
(a) 3
(b) 5
(c) 2
(d) 7
Ans: (c)
4. Members of the stock exchanges are required to preserve which of the following documents
as per the Securities Contracts (Regulation) Act.
(a) Networth certificate
(b) Books and accounts and other documents for specific period of time
(c) Registration certificate
(d) All of the above
Ans: (b)
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Chapter 4 SEBI (Prohibition of Insider Trading) Regulations, 2015


After studying this chapter, you should know the following relating to the SEBI
(Prohibition of Insider Trading) Regulations 2015:

 Key definitions of entities who come under the ambit of Insider Trading
Regulations
 Restrictions on communication and trading by Insiders

 Disclosure of trading by Insiders
 Code of disclosure and conduct for board of directors of a listed company and
market intermediaries

4.1 Definitions
Key definitions under the SEBI (Prohibition of Insider Trading) Regulations, 2015 are given blow:
4.1.1 Compliance Officer
“Compliance officer” is a senior officer who has been designated as such and is reporting to the
Board of Directors or to the head of the organisations where there is no Board of Directors. The
officer shall be financially literate, understand legal and regulatory compliance requirements and
shall be responsible for compliance of policies, procedures, maintenance of records, monitoring
adherence to the rules for preservation of unpublished price sensitive information, monitoring of
trades and the implementation of the code under these regulations under the overall supervision
of the Board of Directors or head of the organisation as the case may be.
4.1.2 Connected person
“Connected person” is defined as any person
a. who is or has during the six months prior to the concerned act been associated with
the company either in a direct or indirect manner which includes frequent
communication with the company’s officers
b. any person in any contractual, fiduciary or employment relationship, director, officer
or an employee of the company or holds any position professional or business
relationship whether temporary or permanent.
that allows such person directly or indirectly, access to unpublished price sensitive information or
is reasonably expected to allow such access.

Without limiting the generality of the above, connected person will include the following;
a) an immediate relative of connected persons; or
b) a holding company or associate company or subsidiary company; or an intermediary as
specified in section 12 of the Act or an employee or director thereof; or
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c) an investment company, trustee company, asset management company or an employee
or director thereof; or
d) an official of a stock exchange or of clearing house or corporation; or
e) a member of board of trustees of a mutual fund or a member of the board of directors of
the asset management company of a mutual fund or is an employee thereof; or
f) a member of the board of directors or an employee, of a public financial institution as
defined in section 2 (72) of the Companies Act, 2013; or
g) an official or an employee of a self‐regulatory organization recognised or authorised by
SEBI; or
h) a banker of the company; or
i) a concern, firm, trust, Hindu undivided family, company or association of persons wherein
a director of a company or his immediate relative or banker of the company, has more
than ten per cent of the holding or interest;
4.1.3 Immediate relative

“Immediate relative” of a person includes
(a) Spouse
(b) Parent
(c) Sibling
(d) Child
Of such person or of the spouse, any of whom is either dependent financially on such person, or
consults such person in taking decisions relating to trading in securities.
4.1.4 Generally available information
“Generally available information” means information that is accessible to the public on a non‐
discriminatory basis.
4.1.5 Insider
"Insider" means any person who is:
i. a connected person; or
ii. in possession of or having access to unpublished price sensitive information.

It is intended that anyone in possession of or having access to unpublished price sensitive
information should be considered an “insider”. This definition is intended to bring within its reach
any person who is in receipt of or has access to unpublished price sensitive information. The onus
of showing that a certain person was in possession of or had access to unpublished price sensitive
information at the time of trading would, therefore, be on the person leveling the charge after
which the person who has traded when in possession of or having access to unpublished price
sensitive information may demonstrate that he was not in such possession or that he has not
traded or he could not access or that his trading when in possession of such information was
squarely covered by the exonerating circumstances.

4.1.6 Trading
“Trading” means subscribing, buying, selling dealing or agreeing to subscribe, buy, sell or deal in
securities.

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Trading not only includes buying, selling or subscribing but also includes activities such as pledging
etc. thus covering through the term “dealing in securities”.
4.1.7 Unpublished price sensitive information
"Unpublished price sensitive information" means any information, relating to a company or its
securities, directly or indirectly, that is not generally available which upon becoming generally
available, is likely to materially affect the price of the securities and shall, ordinarily including but
not restricted to, information relating to the following: –
(i) financial results;
(ii) dividends;
(iii) change in capital structure;
(iv) mergers, de‐mergers, acquisitions, delistings, disposals and expansion of business and such
other transactions;
(v) changes in key managerial personnel; and
(vi) material events in accordance with the listing agreement.

It is intended that information relating to a company or securities, that is not generally available
would be unpublished price sensitive information if it is likely to materially affect the price upon
coming into the public domain.
4.2 Restriction on communication and trading by insiders
4.2.1 Communication or procurement of unpublished price sensitive information
Regulation 3 specifies the following:

1) No insider shall communicate, provide, or allow access to any unpublished price sensitive
information, relating to a company or securities listed or proposed to be listed, to any person
including other insiders except where such communication is in furtherance of legitimate
purposes, performance of duties or discharge of legal obligations.

2) No person shall procure from or cause the communication by any insider of unpublished price
sensitive information, relating to a company or securities listed or proposed to be listed,
except in furtherance of legitimate purposes, performance of duties or discharge of legal
obligations.

3) In the following circumstances, unpublished price sensitive information may be
communicated, provided, allowed access to or procured:

In case of a transaction that would:–
(i) entail an obligation to make an open offer under the takeover regulations where the board of
directors of the company is of informed opinion that the proposed transaction is in the best
interests of the company;

It is intended to acknowledge the necessity of communicating, providing, allowing access to or
procuring unpublished price sensitive information for substantial transactions such as takeovers,
mergers and acquisitions involving trading in securities and change of control to assess a potential
investment.

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(ii) not attract the obligation to make an open offer under the takeover regulations but where the
board of directors of the company is of informed opinion that the proposed transaction is in the
best interests of the company and the information that constitute unpublished price sensitive
information is made generally available at least two trading days prior to the proposed transaction
being effected in such form as the board of directors may determine.

For purposes of sub‐regulation (3), the board of directors shall require the parties to execute
agreements to contract confidentiality and non‐disclosure obligations on the part of such parties
and such parties shall keep information so received confidential, except for the purpose of sub‐
regulation (3), and shall not otherwise trade in securities of the company when in possession of
unpublished price sensitive information.
4.2.2 Trading when in possession of unpublished price sensitive information

Regulation 4 specifies the following:

(1) No insider shall trade in securities that are listed or proposed to be listed on a stock exchange
when in possession of unpublished price sensitive information:

Provided that the insider may prove his innocence by demonstrating the circumstances including
the following:
i. the transaction is an off‐market inter‐se transfer between promoters who were in possession
of the same unpublished price sensitive information without being in breach of regulation 3
and both parties had made a conscious and informed trade decision;
ii. in the case of non‐individual insiders:
the individuals who were in possession of such unpublished price sensitive information were
different from the individuals taking trading decisions and such decision‐making individuals
were not in possession of such unpublished price sensitive information when they took the
decision to trade; and appropriate and adequate arrangements were in place to ensure that
these regulations are not violated and no unpublished price sensitive information was
communicated by the individuals possessing the information to the individuals taking trading
decisions and there is no evidence of such arrangements having been breached;
iii. the trades were pursuant to a trading plan set up in accordance with regulation 5.

(2) In the case of connected persons the onus of establishing, that they were not in possession
of unpublished price sensitive information, shall be on such connected persons and in other cases,
the onus would be on the Board.

(3) SEBI may specify such standards and requirements, from time to time, as it may deem
necessary for the purpose of these regulations.

4.2.3 Trading Plans

(1) An insider is entitled to formulate a trading plan and present it to the compliance officer for
approval and public disclosure pursuant to which trades may be carried out on his behalf in
accordance with such plan.

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(2) Such trading plan shall:–
i. not entail commencement of trading on behalf of the insider earlier than six months from
the public disclosure of the plan;

ii. not entail trading for the period between the twentieth trading day prior to the last day
of any financial period for which results are required to be announced by the issuer of the
securities and the second trading day after the disclosure of such financial results;

iii. entail trading for a period of not less than twelve months;

iv. not entail overlap of any period for which another trading plan is already in existence;

v. set out either the value of trades to be effected or the number of securities to be traded
along with the nature of the trade and the intervals at, or dates on which such trades shall
be effected; and

vi. not entail trading in securities for market abuse.

(3) The compliance officer shall review the trading plan to assess whether the plan would have
any potential for violation of these regulations and shall be entitled to seek such express
undertakings as may be necessary to enable such assessment and to approve and monitor
the implementation of the plan.

(4) The trading plan once approved shall be irrevocable and the insider shall mandatorily have to
implement the plan, without being entitled to either deviate from it or to execute any trade
in the securities outside the scope of the trading plan.

Provided that the implementation of the trading plan shall not be commenced if any
unpublished price sensitive information in possession of the insider at the time of formulation
of the plan has not become generally available at the time of the commencement of
implementation and in such event the compliance officer shall confirm that the
commencement ought to be deferred until such unpublished price sensitive information
becomes generally available information.

(5) Upon approval of the trading plan, the compliance officer shall notify the plan to the stock
exchanges on which the securities are listed.

4.3 Disclosure of trading by insiders

General provisions

(1) Disclosures should be as per the form specified.
(2) Disclosures shall include those relating to trading by such person’s immediate relatives, and
by any other person for whom such person takes trading decisions.
(3) Disclosures of trading in securities shall also include trading in derivatives of securities and
the traded value of the derivatives shall be taken into account, provided that trading in
derivatives of securities is permitted by any law for the time being in force.
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(4) Disclosures made under this Regulation shall be maintained by the company, for a minimum
period of five years, in specified form.

4.3.1 Disclosure by certain persons
4.3.1.1 Initial disclosures
a. Every promoter, key managerial personnel and director of every company whose securities
are listed on any recognised stock exchange shall disclose his holding of securities of the
company as on the date of these regulations taking effect, to the company within thirty days
of these regulations taking effect;

b. Every person on appointment as a key managerial personnel or a director of the company or
upon becoming a promoter shall disclose his holding of securities of the company as on the
date of appointment or becoming a promoter, to the company within seven days of such
appointment or becoming a promoter.

4.3.1.2 Continual disclosures
a. Every promoter, employee and director of every company shall disclose to the company the
number of such securities acquired or disposed of within two trading days of such transaction
if the value of the securities traded, whether in one transaction or a series of transactions
over any calendar quarter, aggregates to a traded value in excess of ten lakh rupees or such
other value as may be specified;

b. Every company shall notify the particulars of such trading to the stock exchange on which the
securities are listed within two trading days of receipt of the disclosure or from becoming
aware of such information.

Incremental transactions after any disclosure under this sub‐regulation, shall be made when the
transactions effected after the prior disclosure cross the threshold specified in clause (a).
4.3.1.3 Disclosure by other connected persons
Any company whose securities are listed on a stock exchange may, at its discretion require any
other connected person or class of connected persons to make disclosures of holdings and trading
in securities of the company in such form and at such frequency as may be determined by the
company in order to monitor compliance with these regulations.

This is an enabling provision for listed companies to seek information from those to whom it has
to provide unpublished price sensitive information. This provision confers discretion on any
company to seek such information. For example, a listed company may ask that a management
consultant who would advise it on corporate strategy and would need to review unpublished price
sensitive information, should make disclosures of his trades to the company.

4.4 Code of disclosure and conduct

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4.4.1 Code of fair disclosure

(1) The board of directors of every company, whose securities are listed on a stock exchange,
shall formulate and publish on its official website, a code of practices and procedures for fair
disclosure of unpublished price sensitive information that it would follow in order to adhere
to each of the principles as stated in the Schedule A of the SEBI Insider Trading Regulation,
without diluting the provisions of these regulations in any manner.

(2) Every such code of practices and procedures for fair disclosure of unpublished price sensitive
information and every amendment thereto shall be promptly intimated to the stock
exchanges where the securities are listed.

Schedule A: Principles of Fair Disclosure for purposes of Code of Practices and Procedures for
Fair Disclosure of Unpublished Price Sensitive Information

1. Prompt public disclosure of unpublished price sensitive information that would impact price
discovery no sooner than credible and concrete information comes into being in order to
make such information generally available.
2. Uniform and universal dissemination of unpublished price sensitive information to avoid
selective disclosure.
3. Designation of a senior officer as a chief investor relations officer to deal with dissemination
of information and disclosure of unpublished price sensitive information.
4. Prompt dissemination of unpublished price sensitive information that gets disclosed
selectively, inadvertently or otherwise to make such information generally available.
5. Appropriate and fair response to queries on news reports and requests for verification of
market rumours by regulatory authorities.
6. Ensuring that information shared with analysts and research personnel is not unpublished
price sensitive information.
7. Developing best practices to make transcripts or records of proceedings of meetings with
analysts and other investor relations conferences on the official website to ensure official
confirmation and documentation of disclosures made.
8. Handling of all unpublished price sensitive information on a need‐to‐know basis.
4.4.2 Code of conduct

(1) The board of directors of every listed company and market intermediary shall formulate a
code of conduct to regulate, monitor and report trading by its employees and other
connected persons towards achieving compliance with these regulations, adopting the
minimum standards as specified in Schedule B of the SEBI Insider Trading Regulations, without
diluting the provisions of these regulations in any manner.

(2) Every other person who is required to handle unpublished price sensitive information in the
course of business operations shall formulate a code of conduct to regulate, monitor and
report trading by employees and other connected persons towards achieving compliance with
these regulations, adopting the minimum standards set out in Schedule B to these
regulations, without diluting the provisions of these regulations in any manner.
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(3) Every listed company, market intermediary and other persons formulating a code of conduct
shall identify and designate a compliance officer to administer the code of conduct and
other requirements under these regulations.

Schedule B: Minimum Standards for Code of Conduct to Regulate, Monitor and Report Trading
by Insiders

1. The compliance officer shall report to the board of directors and in particular, shall provide
reports to the Chairman of the Audit Committee, if any, or to the Chairman of the board of
directors at such frequency as may be stipulated by the board of directors.

2. All information shall be handled within the organisation on a need‐to‐know basis and no
unpublished price sensitive information shall be communicated to any person except in
furtherance of the insider’s legitimate purposes, performance of duties or discharge of his
legal obligations. The code of conduct shall contain norms for appropriate Chinese Walls
procedures, and processes for permitting any designated person to “cross the wall”.

3. Employees and connected persons designated on the basis of their functional role
(“designated persons”) in the organisation shall be governed by an internal code of conduct
governing dealing in securities. The board of directors shall in consultation with the
compliance officer specify the designated persons to be covered by such code on the basis of
their role and function in the organisation. Due regard shall be had to the access that such
role and function would provide to unpublished price sensitive information in addition to
seniority and professional designation.

4. Designated persons may execute trades subject to compliance with these regulations.
Towards the end, a notional trading window shall be used as an instrument of monitoring
trading by the designated persons. The trading window shall be closed when the compliance
officer determines that a designated person or class of designated persons can reasonably be
expected to have possession of unpublished price sensitive information. Such closure shall be
imposed in relation to such securities to which such unpublished price sensitive information
relates. Designated persons and their immediate relatives shall not trade in securities when
the trading window is closed.

5. The timing for re‐opening of the trading window shall be determined by the compliance
officer taking into account various factors including the unpublished price sensitive
information in question becoming generally available and being capable of assimilation by the
market, which in any event shall not be earlier than forty‐eight hours after the information
becomes generally available. The trading window shall also be applicable to any person having
contractual or fiduciary relation with the company, such as auditors, accountancy firms, law
firms, analysts, consultants etc., assisting or advising the company.

6. When the trading window is open, trading by designated persons shall be subject to
preclearance by the compliance officer, if the value of the proposed trades is above such
thresholds as the board of directors may stipulate. No designated person shall apply for pre‐
clearance of any proposed trade if such designated person is in possession of unpublished
price sensitive information even if the trading window is not closed.

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7. The compliance officer shall confidentially maintain a list of such securities as a “restricted
list” which shall be used as the basis for approving or rejecting applications for preclearance
of trades.

8. Prior to approving any trades, the compliance officer shall be entitled to seek declarations to
the effect that the applicant for pre‐clearance is not in possession of any unpublished price
sensitive information. He shall also have regard to whether any such declaration is reasonably
capable of being rendered inaccurate.

9. The code of conduct shall specify any reasonable timeframe, which in any event shall not be
more than seven trading days, within which trades that have been pre‐cleared have to be
executed by the designated person, failing which fresh pre‐clearance would be needed for
the trades to be executed.

10. The code of conduct shall specify the period, which in any event shall not be less than six
months, within which a designated person who is permitted to trade shall not execute a
contra trade. The compliance officer may be empowered to grant relaxation from strict
application of such restriction for reasons to be recorded in writing provided that such
relaxation does not violate these regulations. Should a contra trade be executed,
inadvertently or otherwise, in violation of such a restriction, the profits from such trade shall
be liable to be disgorged for remittance to the Board for credit to the Investor Protection and
Education Fund administered by the Board under the Act.

11. The code of conduct shall stipulate such formats as the board of directors deems necessary
for making applications for pre‐clearance, reporting of trades executed, reporting of decisions
not to trade after securing pre‐clearance, recording of reasons for such decisions and for
reporting level of holdings in securities at such intervals as may be determined as being
necessary to monitor compliance with these regulations.

12. Without prejudice to the power of the Board under the Act, the code of conduct shall stipulate
the sanctions and disciplinary actions, including wage freeze, suspension etc., that may be
imposed, by the persons required to formulate a code of conduct under sub‐regulation (1)
and sub‐regulation (2) of regulation 9, for the contravention of the code of conduct.

13. The code of conduct shall specify that in case it is observed by the persons required to
formulate a code of conduct under sub‐regulation (1) and sub‐regulation (2) of regulation 9,
that there has been a violation of these regulations, they shall inform the Board promptly.

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Review Questions

1. Which of the following is not considered as “Price Sensitive” information?
(a) Periodical financial results of the company;
(b) Intended declaration of dividends (both interim and final);
(c) Issue of securities or buy‐back of securities
(d) Routine product promotion material
Ans: (d)
2. Disclosures made under SEBI (Prohibition of Insider Trading) Regulations, 2015 should be
maintained by the company for a period of _____.
(a) 1 year
(b) 2 years
(c) 3 years
(d) 5 years
Ans: (d)
3. Every person on appointment as a key managerial personnel or a director of the company has
to disclose his holding of securities of the company as on the date of appointment within
_________of such appointment.

(a) 15 days
(b) 10 days
(c) 30 days
(d) 7 days
Ans: (d)
4. Under code of conduct specified within SEBI (Prohibition of Insider Trading) Regulations,
2015 pre‐cleared trades shall be executed within _______
a) 2 trading days
b) 7 trading days
c) 2 calendar days
d) 7 calendar days
Ans: (b)

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Chapter 5 SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to
Securities Market) Regulations, 2003


After studying this chapter, you should know about the following relating to SEBI (Prohibition
of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003:

 Definition of Fraud and Fraudulent

 Practices which are considered as fraudulent and unfair
 Powers of SEBI to order investigation on intermediaries or persons associated with
the securities markets.

The SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market)
Regulations, 2003 prohibit fraudulent, unfair and manipulative trade practices in securities. These
regulations have been made in exercise of the powers conferred by section 30 of the SEBI Act,
1992.

5.1 Fraud and Fraudulent

As per the Regulation, “fraud” includes any act, expression, omission or concealment committed
whether in a deceitful manner or not by a person or by any other person with his connivance or
by his agent while dealing in securities in order to induce another person or his agent to deal in
securities, whether or not there is any wrongful gain or avoidance of any loss, and shall also
include—
a) a knowing misrepresentation of the truth or concealment of material fact in order that
another person may act to his detriment;
b) a suggestion as to a fact which is not true by one who does not believe it to be true;
c) an active concealment of a fact by a person having knowledge or belief of the fact;
d) a promise made without any intention of performing it;
e) a representation made in a reckless and careless manner whether it be true or false;
f) any such act or omission as any other law specifically declares to be fraudulent;
g) deceptive behaviour by a person depriving another of informed consent or full
participation;
h) a false statement made without reasonable ground for believing it to be true;
i) the act of an issuer of securities giving out misinformation that affects the market price
of the security, resulting in investors being effectively misled even though they did not
rely on the statement itself or anything derived from it other than the market price.

And “fraudulent” shall be construed accordingly.

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This shall not apply to any general comments made in good faith with respect to the economic
policy of the government, economic situation of the country, trends in the securities market and
matters of like nature.

5.2 Prohibition of Fraudulent and Unfair Trade Practices

As per regulation 3, the following acts are prohibited with respect to securities listed or proposed
to be listed on a Stock Exchange:

 buy, sell or otherwise deal in securities in a fraudulent manner;
 use or employ manipulative or deceptive device to buy or sell securities;
 employ any device, scheme or artifice to defraud in connection with dealing in or issue
of securities;
 engage in any act, practice, course of business which operates or would operate as
fraud or deceit upon any person.

5.3 Prohibition of manipulative, fraudulent and unfair trade practices

As per regulation 4, no person shall indulge in a fraudulent or an unfair trade practice in securities.

The following will be considered as fraudulent or an unfair trade practice:

a) indulging in an act which creates false or misleading appearance of trading in the
securities market;
b) dealing in a security not intended to effect transfer of beneficial ownership but intended
to operate only to inflate, depress or cause fluctuations in the price of such security for
wrongful gain or avoidance of loss;
c) advancing or agreeing to advance any money to any person to buy any security in any
issue only with the intention of securing the minimum subscription to such issue;
d) Paying, offering or agreeing to pay or offer, directly or indirectly, to any person any money
or money’s worth for dealing in any security with the object of inflating, depressing,
maintaining or causing fluctuation in the price of such security;
e) Any act or omission amounting to manipulation of the price of a security;
f) Publishing or causing to publish or reporting or causing to report any information which
is not true or which he does not believe to be true prior to or in the course of dealing in
securities;
g) entering into a transaction in securities without intention of performing it or without
intention of change of ownership of such security;
h) selling, dealing or pledging of stolen or counterfeit security whether in physical or
dematerialised form;
i) an intermediary promising a certain price in respect of buying or selling of a security to a
client and waiting till a discrepancy arises in the price of such security and retaining the
difference in prices as profit for himself;
j) an intermediary providing his clients with such information relating to a security which
cannot be verified ;
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k) an advertisement that is misleading or that contains information in a distorted manner
and which may influence the decision of the investors;
l) an intermediary reporting trading transactions to his clients entered into on their behalf
in an inflated manner in order to increase his commission and brokerage;
m) an intermediary not disclosing to his client transactions entered into on his behalf
including taking an option position;
n) circular transactions in respect of a security entered into between intermediaries in order
to increase commission to provide a false appearance of trading in such security or to
inflate, depress or cause fluctuations in the price of such security;
o) encouraging the clients by an intermediary to deal in securities solely with the object of
enhancing his brokerage or commission;
p) an intermediary predating or otherwise falsifying records such as contract notes;
q) an intermediary buying or selling securities in advance of a substantial client order or
whereby a futures or option position is taken about an impending transaction;
r) planting false or misleading news which may induce sale or purchase of securities;
s) mis‐selling of units of a mutual fund scheme through any of the methods namely, false or
misleading statement, concealing or omitting material facts of the scheme, concealing the
risk factors of the scheme, not taking care to ensure suitability of the scheme to the buyer
or illegal mobilisation of funds through collective investment scheme.

5.4 Power of SEBI to order investigation

As per regulation 5, the SEBI Chairman, Member or Executive Director may initiate investigation
by an order in writing, on intermediary or persons associated with the securities market or any
other person, if it has reasonable grounds to believe that:

 the transactions in securities are being dealt with in a manner detrimental to the investors
or the securities market in violation of these regulations
 any intermediary or any person associated with the securities market has violated any of
the provisions of the SEBI Act or the rules or the regulations

The Investigating Authority shall have the following powers:

a) Call for information or records;
b) Undertake inspection of any book, or register, or other document or record of any listed
public company or a public company which intends to get its securities listed on any
recognised stock exchange;
c) To require any intermediary or any person associated with securities market to furnish
such information to, or produce such books, or registers, or other documents, or record
relevant or necessary for the purposes of the investigation;
d) To keep in his custody any books, registers, other documents and record produced under
this regulation for a maximum period of one month which may be extended up to a period
of six months by SEBI;
e) To examine orally and to record the statement of the person concerned or any director,
partner, member or employee of such person and to take notes of such oral examination
to be used as an evidence against such person;
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f) To examine on oath any manager, managing director, officer or other employee of any
intermediary or any person associated with securities market.

Investigating authority may exercise the following powers with prior approval from the
Chairman or member:

a) Call for information and record from any bank or any other authority or board or
corporation established or constituted by or under any Central, State or Provincial Act;
b) Make an application to the Judicial Magistrate of the first class having jurisdiction for an
order for the seizure of any books, registers, other documents and record, if it has
reasonable ground to believe it may be destroyed, mutilated, altered, falsified or
secreted;
c) Keep in his custody the books, registers, other documents and record seized under these
regulations for such period not later than the conclusion of the investigation.

5.5 Submission of report and enforcement

The Investigating Authority shall submit a report to SEBI on completion of investigation. SEBI may,
after consideration of the report, if satisfied that there is a violation of these regulations and after
giving a reasonable opportunity of hearing to the persons concerned may carry out any of the
following actions:

a) suspend the trading of the security found to be or prima facie found to be involved in
fraudulent and unfair trade practice in a recognised stock exchange;
b) restrain persons from accessing the securities market and prohibit any person associated
with securities market to buy, sell or deal in securities;
c) suspend any office‐bearer of any stock exchange or self‐regulatory organization from
holding such position;
d) impound and retain the proceeds or securities in respect of any transaction which is in
violation or prima facie in violation of these regulations;
e) direct any intermediary or any person associated with the securities market in any
manner not to dispose of or alienate an asset forming part of a fraudulent and unfair
transaction;
f) require the person concerned to call upon any of its officers, other employees or
representatives to refrain from dealing in securities in any particular manner;
g) prohibit the person concerned from disposing of any of the securities acquired in
contravention of these regulations;
h) direct the person concerned to dispose of any such securities acquired in contravention
of these regulations

SEBI shall issue a press release in respect of any final order passed in at least two newspapers of
which one shall have nationwide circulation and shall also put the order on the website of SEBI.

5.6 Suspension or cancellation of registration

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SEBI may for reasons to be recorded in writing, in the interests of investors and securities
market take the following action against an intermediary:

a) Issue a warning or censure;
b) Suspend the registration of the intermediary; or
c) Cancel of the registration of the intermediary

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Review Questions

1. Which of the following cannot be considered as “Fraud”
a) a promise made without any intention of performing it;
b) a representation made in a reckless and careless manner whether it be true or false;
c) any such act or omission as any other law specifically declares to be fraudulent,
d) General comment made in good faith
Ans: (d)

2. In cases of fraud, SEBI can ___________ the registration of an intermediary?
(a) Cancel
(b) Suspend
(c) Both a and b
Ans: (c)
3. The investigating authority has under the Regulation powers to:
a) Call for information or records
b) Undertake inspection of any book, or register, or other document
c) To examine orally and to record the statement of the person concerned
d) All of the above
Ans: (d)

4. Fraud includes an intermediary providing his clients with such information relating to a
security as cannot be verified by the clients before their dealing in such security. State
whether True or False?
(a) True
(b) False
Ans: (a)

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Chapter 6 The Prevention of Money Laundering Act, 2002 (PMLA)

LEARNING OBJECTIVES:

After studying this chapter you should know about the following relating to the
Prevention of Money Laundering Act:

 Meaning of money laundering and key definitions relating to money laundering
 Records to be maintained by a banking company, financial institutions and
intermediaries and verification of records

 Actions taken against the offence of money laundering
 Adjudicating authority for PMLA and its powers
 Policies and procedures to be followed for intermediaries for combating money
laundering

6.1 Money Laundering

As per the Prevention of Money Laundering Act, 2002 (PMLA), “Whosoever directly or indirectly
attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any
process or activity connected with the proceeds of crime including its concealment, possession,
acquisition or use and projecting or claiming it as untainted property shall be guilty of offence of
money laundering.”
In simple words, money laundering is a mechanism by which funds generated through criminal
means are transformed as if they originated from a legitimate source. This includes money
obtained through drug trafficking, terrorist activities etc.
6.2 Prevention of Money Laundering
The PMLA 2002 was enacted in 2003 and brought into force on 1st July 2005 to prevent money
laundering and to provide for attachment, seizure and confiscation of property obtained or
derived, directly or indirectly, from or involved in money laundering and for matters connected
therewith or incidental thereto.
The objective of PMLA is, “to prevent money‐laundering and to provide for confiscation of
property derived from, or involved in, money‐laundering and for matters connected therewith
or incidental thereto.”
The PMLA was enacted to implement the resolution and declaration made under the Political
Declaration and Global Programme of Action against Money Laundering adopted by the General
Assembly of the United Nations in 1998.
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PMLA imposes obligation on banking and financial institutions and intermediaries to carry out

verification and also maintain records of the identity of its clients and also the transactions carried
out by them. It casts obligation on these entities to furnish information of any suspicious
transactions to the Financial Intelligence Unit (FIU‐IND). The Director of FIU‐IND can impose
penalty on these institutions if they fail to comply with the provisions of the PMLA.

6.2.1 Obligations of Banking companies, Financial Institutions and Intermediaries

For the purpose of the Act:
“Banking Company” means a banking company or a co‐operative bank to which the Banking
Regulation Act, 1949 applies.

“Intermediary” has been defined as stock‐broker, sub‐broker, share transfer agent, banker to an
issue, trustee to a trust deed, registrar to an issue, merchant banker, underwriter, portfolio
manager, investment adviser and any other intermediary associated with securities market and
registered under section 12 of the Securities and Exchange Board of India Act, 1992. It also
includes an association recognised or registered under the Forward Contracts (Regulation) Act,
1952 (74 of 1952) or any member of such association; or intermediary registered by the Pension
Fund Regulatory and Development Authority; or a recognised stock exchange referred to in clause
(f) of section 2 of the Securities Contracts (Regulation) Act, 1956.

"Financial Institution" is defined in clause (c) of section 45‐I of the Reserve Bank of India Act, 1934
(2 of 1934) and includes a chit fund company, a housing finance institution, an authorised person,
a payment system operator, a nonbanking financial company and the Department of Posts in the
Government of India.

The Act imposes obligations on the Banking and Financial Institutions and intermediaries to
maintain records of certain type of transactions and furnish the same to the Director who is
appointed under the Act. The Act also imposes obligations as to verification of records of identity
of clients and maintenance of such records of clients.

6.2.2 Maintenance of Records

As per Section 12 of the PMLA and Rule 3 of the PMLA regarding rules relating to maintenance of
records, every banking company, financial institution or intermediary shall maintain a record of:
(A) All cash transactions of the value of more than rupees ten lakhs or its equivalent in foreign
currency;
(B) All series of cash transactions integrally connected to each other which have been
individually valued below rupees ten lakh or its equivalent in foreign currency where such
series of transactions have taken place within a month and the monthly aggregate
exceeds an amount of ten lakh rupees or its equivalent in foreign currency;
BA) All transactions involving receipts by non‐profit organisations of value more than
rupees ten lakh, or its equivalent in foreign currency;
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(C) All cash transactions where forged or counterfeit currency notes or bank notes have been
used as genuine or where any forgery of a valuable security or a document has taken
place facilitating the transactions;
(D) All suspicious transactions whether or not made in cash and by way of:
I. Deposits and credits, withdrawals into or from any accounts in whatsoever name
they are referred to in any currency;
II. Credits or debits into or from any non‐monetary accounts such as demat account,
security account in any currency maintained by the banking company, financial
institution and intermediary, as the case may be;
III. Money transfer or remittances in favour of own clients or non‐clients from India
or abroad and to third party beneficiaries in India or abroad including
transactions on its own account in any currency
IV. Loans and advances including credit or loan substitutes, investments and
contingent liability
V. Collection services in any currency by way of collection of bills, cheques,
instruments or any other mode of collection in whatsoever name it is referred to.
(E) All cross border wire transfers of the value of more than five lakh rupees or its equivalent
in foreign currency where either the origin or destination of fund is in India;
(F) All purchase and sale by any person of immovable property valued at fifty lakh rupees or
more that is registered by the reporting entity, as the case may be.
6.2.3 Procedure for maintaining and furnishing records

The records maintained should contain the following information:
 Nature of the transactions;
 Amount of the transaction and the currency in which it was denominated;
 Date on which the transaction was conducted; and
 Parties to the transaction
The records should be maintained in both hard and soft copies as per procedures specified by RBI
/ SEBI as the case may be.

The records should be maintained for a period of 5years from the date of cessation of transaction
between the client and the banking company, financial institution or intermediary.

A Principal Officer should be identified by these organisations for the purpose of this Act. The
Principal Officer should furnish information specified in clause (A), (B), (BA), (C) and (E) referred
to in the section on “records to be maintained” (section 6.2.2 of this workbook) every month by
the 15th day of the succeeding month to the Director. The Principal Officer of a reporting entity
shall furnish the information promptly in writing or by fax or by electronic mail to the Director in
respect of transactions referred to in clause (D) not later than seven working days on being
satisfied that the transaction is suspicious.
The Principal Officer of a reporting entity shall furnish, the information in respect of transactions
referred to in clause (F) every quarter to the Director by the 15th day of the month succeeding
the quarter.
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For the purpose of this rule, delay of each day in not reporting a transaction or delay of each day
in rectifying a mis‐reported transaction beyond the time limit as specified in this rule shall
constitute a separate violation.

6.2.4 Verification of the records of the identity of clients

Every banking company, financial institution and intermediary, as the case may be, shall, at the
time of opening an account or executing any transaction with it, verify and maintain the record
of identity and current address or addresses including permanent address or addresses of the
client, the nature of business of the client and his financial status;

Verification process for clients4
Client who is an individual should submit the following:
 Aadhaar Number issued by UIDAI or proof of application of enrolment for Aadhaar
(applicable for individuals who are eligible for Aadhaar number enrolment);
 Permanent Account Number (PAN) or Form No. 60 as defined in Income Tax Rules, 1962;
 Other documents including in respect of the nature of business and financial status of the
client.
Client not submitting his PAN or not eligible to be enrolled for Aadhaar should submit the
following documents:
one certified copy of an officially valid document containing details of his identity,
permanent address or addresses, current address or addresses;
 one copy of his recent photograph;
 such other documents including in respect of the nature of business and financial status
of the client.
Client who is a company should submit certified copies of the following5:
Certificate of incorporation;
Memorandum and Articles of Association;
Resolution from the Board of Directors and power of attorney granted to its managers,
officers or employees to transact on its behalf;
 (i) Aadhaar numbers and (ii) PAN or Form No. 60 as defined in Income Tax Rules, 1962,
issued to managers, officers or employees holding an attorney to transact on its behalf.
Client who is a partnership firm should submit certified copies of the following:
Registration certificate;
Partnership deed;
(i) Aadhaar numbers and (ii) PAN or Form No. 60 as defined in Income Tax Rules, 1962,
issued to the person holding an attorney to transact on its behalf;
Client who is a trust should submit certified copies of the following:
 Registration certificate;
 Trust deed;
4
Source: http://egazette.nic.in/WriteReadData/2017/176407.pdf
5
Source: http://fiuindia.gov.in/files/AML%20Legislation/notifications/rule_9.html [Rule 9 sub‐rule 6]
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 (i) Aadhaar numbers and (ii) PAN or Form No. 60 as defined in Income Tax Rules, 1962,
issued to the person holding an attorney to transact on its behalf;
Client who is an unincorporated association or a body of individuals should submit certified copies
of the following:
Resolution of the managing body of such association or body of individuals;
Power of attorney granted to him to transact on its behalf;
(i) Aadhaar numbers and (ii) PAN or Form No. 60 as defined in Income Tax Rules, 1962,
issued to the person holding an attorney to transact on its behalf; and
 Such information as may be required to collectively establish the legal existence of such
an association or body of individuals.
The organisations implementing these regulations should have a client identification program
incorporating the above requirements including any additional requirements that they find
appropriate to determine the true identity of its clients. A copy of this program should be
forwarded to the Director.
6.2.5 Maintenance of records of the identity of clients

The records of identity of clients should be maintained for a period of 5 years6 from the date of
cessation of the transaction between the client and the banking company or financial institution
or intermediary.

6.3 Offence of money‐laundering

Whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party
or is actually involved in any process or activity connected with the proceeds of crime including
its concealment, possession, acquisition or use and projecting or claiming it as untainted property
shall be guilty of offence of money laundering.

This is punishable with rigorous imprisonment for a term not less than three years but can extend
to seven years apart from being liable for a fine. If the offence comes under the Narcotic Drugs
and Psychotropic Substances Act 1985, the imprisonment may extend to ten years.

6.3.1 Procedures relating to money‐laundering

The relevant authority may take various actions including survey, attachment of property, search,
seizure and arrest with respect to scheduled offence.

As per 2(1)(y) of the Prevention of Money Laundering Act, 2002, 7“Scheduled offence” means ‐
(i) The offences specified under Part A of the Schedule, or
6
PMLA Amendment Act, 2012 brought into force on February 15, 2013, Vide S.O. 343E dated February 8, 2013.
7
Source: http://pib.nic.in/newsite/PrintRelease.aspx?relid=145129
http://lawmin.nic.in/ld/P‐ACT/2003/The%20Prevention%20of%20Money‐laudering%20Act,%202002.pdf
Page 70 of 247
(ii) The offences specified under Part B of the Schedule if the total value involved in such
offences is Rs.1 crore or more; or
(iii) The offences specified under Part C of the Schedule.
The Schedule to the Prevention of Money Laundering Act, 2002 lists all such offences.

Part A includes offences under the Indian Penal Code such as wagering or attempting to wager
war or abetting waging of war against the Government of India, offences under the Narcotic Drugs
and Psychotropic Substances Act, violations to the prohibitions on manipulative and deceptive
devices, insider trading and substantial acquisition of securities or control as prescribed in Section
12A read with Section 24 of the SEBI Act, 1992 etc;

Part B consists of offences under the Customs Act; and Part C consists of offenses having cross
border implications, offences against property under Indian Penal Code, offences of willful
attempt to evade any tax, penalty or interest referred to in section 51 of the Black Money
(Undisclosed Foreign Income and Assets) and Imposition of Tax Act.

6.3.2 Attachment of property

The Director or any officer not below the rank of Deputy Director can for reasons recorded in
writing take action to attach a property if he believes on the basis of material in his possession,
that‐
 Any person is in possession of any proceeds of crime; and
 Such proceeds of crime are likely to be concealed, transferred or dealt with in any manner
which may result in frustrating any proceedings relating to confiscation of such proceeds
of crime.
The Director may, by order in writing, provisionally attach such property for a period not
exceeding one hundred and eighty days from the date of the order. Before proceeding with the
attachment a report has to be forwarded to a Magistrate under Section 173 of the Code of
Criminal Procedure, 1973 or a Complaint has to be filed depending on the type of offence.

Immediately after the attachment, a copy of the order along with the material in possession
should be forwarded to the Adjudicating Authority in a sealed envelope.
6.3.3 Power of survey

Where an authority, on the basis of material in his possession, has reason to believe (the reasons
for such belief to be recorded in writing) that an offence has been committed under the Act, may
enter any place within the limits of the area assigned to him or has been authorised and may
require any proprietor, employee or any other person to,‐‐
 Provide him necessary facility to inspect records;
 Provide him necessary facility to check or verify the proceeds of crime or any transaction
related to proceeds of crime which may be found;
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 Furnish such information as he may require as to any matter which may be useful or
relevant.
6.3.4 Search and seizure

Where the Director or any officer not below the rank of Deputy Director, on the basis of
information in his possession, has reason to believe (the reason for such belief to be recorded in
writing) that an offence has been committed under the Act, enter and search any building, place,
vessel, vehicle or aircraft and seize any record or property found.
Immediately after completion of survey or search and seizure, the authority / Director shall
forward a copy of the reasons so recorded along with material in his possession in a sealed
envelope to the Adjudicating Authority.
Similarly, the authority has also power to search a person if he has reason to believe that the
person is in possession, ownership or control records or proceeds of crime which may be useful
or relevant or arrest any person on the basis of material in his possession, there is reason to
believe that he has been guilty of an offence punishable under this Act.
The authority can retain property seized and also retain records if they are required for the
purpose of adjudication for a period not exceeding 6 months. It can be retained for a further
period, if the Adjudicating Authority permits such retention after satisfying themselves that the
property is prima facie involved in money laundering and required for the purpose of adjudication.

6.4 Adjudicating Authorities, composition, powers, etc.

The Central Government has appointed an Adjudicating Authority to exercise jurisdiction, powers
and authority conferred by or under the said Act. The Adjudicating Authority will consist of a
Chairperson and two Members and will function within the Department of Revenue, Ministry of
Finance of the Central Government. The Chairperson and every Member shall hold office as such
for a term of five years from the date on which he enters upon his office. No Chairperson or other
Member shall hold office as such after he has attained the age of sixty‐five years.

6.4.1 Adjudication

On receipt of a complaint, if the Adjudicating Authority has reasons to believe that any person has
committed an offense under Section 3 of the Act, it will serve a notice of not less than thirty days
on such person calling upon him to indicate
 the sources of his income, earning or assets, out of which or by means of which he has
acquired the property attached or seized
 the evidence on which he relies and other relevant information and particulars and
 to show cause why all or any of such properties should not be declared to be the
properties involved in money‐laundering and confiscated by the Central Government.
The Adjudicating Authority shall after:
 Considering the reply if any received towards the notice issued,
 Hearing the aggrieved person and the Director or any other officer authorised by him in
this behalf; and
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 Taking into account all relevant materials placed on record before him.
by an order, record a finding whether all or any of the properties referred to in the notice are
involved in money‐laundering. In cases, where the Adjudicating Authority decides that any
property is involved in money‐laundering, he shall, by an order in writing, confirm the attachment
of the property and record a finding to that effect.
The property will continue to be attached or retained during the pendency of the proceedings
before a court.
Where on conclusion of a trial for any scheduled offence, the person concerned is acquitted, the
attachment of the property or the retention of the seized property will cease to have effect.
Where the attachment of property or retention of the seized property become final after the guilt
of the person is proved in the trial court, the Adjudicating Authority shall make an order
confiscating such property. All rights and title of such property will then vest absolutely in the
Central Government.
The Central Government will appoint an administrator to manage the property who will receive
and manage the property and take such measures as Central Government may direct, including
disposal of the property.
6.4.2 Power of the Adjudicating Authority

The Adjudicating Authority shall have the same powers as are vested in a civil court under the
Code of Civil Procedure, 1908 namely:
 discovery and inspection;
 enforcing the attendance of any person, including any officer of a banking company or a
financial institution or a company, and examining him on oath;
 compelling the production of records;
 receiving evidence on affidavits;
 issuing commissions for examination of witnesses and documents; and
 any other matter which may be prescribed.
6.4.3 Appellate Tribunal

The Appellate Tribunal will consist of a Chairperson and two other Members. Any person
aggrieved by an order of the Adjudicating Authority can prefer an appeal to the Appellate Tribunal
within forty‐five days from the date of receipt of such order. The Appellate Tribunal can extend
the time for appeal if it is satisfied that there is sufficient cause for such extension. The Appellate
Tribunal shall be guided by the principles of natural justice and subject to the provisions of the
SEBI Act, shall have powers to regulate its own procedure. The Tribunal after hearing the parties
making the appeal may pass such orders confirming, modifying or setting aside the order
appealed against.

6.4.4 Appeal to High Court

Any person aggrieved by the order of the Appellate Tribunal can file an appeal to the High Court
within sixty days from the date of communication of the order. If the High Court is satisfied that
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the appellant was prevented by sufficient cause to file the appeal within the said period, it can
extend the time further for a period not exceeding sixty days.
6.5 Agreement with foreign countries

The Central Government of India may enter into an agreement with the Government of any
country for enforcing the provisions of this Act, for exchange of information or investigation of
cases relating to any offence committed under this Act.
6.6 SEBI Procedures

As per the provisions of the PMLA, intermediary including a stock broker, sub‐broker and any
other intermediary associated with the securities market and registered under Section 12 of the
SEBI Act, 1992 should adhere to client account opening procedures and maintain records of such
transactions as prescribed by the PMLA and Rules notified there under.

Given below are the procedures / directive issued by SEBI in this regard covering issues relating
to Know Your Client (KYC), Anti‐Money Laundering (AML), Client Due Diligence (CDD) and
Combating Financing of Terrorism (CFT). The SEBI directives are minimum requirements and the
intermediaries may specify additional disclosures. SEBI directives in this regard are applicable to
the intermediaries and their branches and subsidiaries located abroad. Where local applicable
laws and regulations prohibit implementation of the directives, the same shall be brought to the
notice of SEBI. In case of variance between standards specified by SEBI and the regulations of the
host country, the more stringent requirements of the two will be applicable.

6.6.1 Policies and Procedures to Combat Money Laundering and Terrorist Financing

The Registered Intermediaries shall:
a) Issue a statement of policies and procedures, on a group basis where applicable, for
dealing with Money Laundering (ML) and Terrorist Financing (TF) reflecting the current
statutory and regulatory requirements;
b) Ensure that the content of these Directives are understood by all staff members;
c) Regularly review the policies and procedures on the prevention of ML and TF to ensure
their effectiveness. The person doing such a review shall be different from the one who
has framed such policies and procedures;
d) Adopt client acceptance policies and procedures which are sensitive to the risk of ML and
TF;
e) Undertake Client Due Diligence (“CDD”)measures to an extent that is sensitive to the risk
of ML and TF depending on the type of client, business relationship or transaction;
f) Have a system in place for identifying, monitoring and reporting suspected ML or TF
transactions to the law enforcement authorities;
g) Develop staff members’ awareness and vigilance to guard against ML and TF;

Policies and procedures to combat ML shall cover:
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a) Communication of group policies relating to prevention of ML and TF to all management
and relevant staff that handle account information, securities transactions, money and
client records etc. whether in branches, departments or subsidiaries;
b) Client acceptance policy and client due diligence measures, including requirements for
proper identification;
c) Maintenance of records;
d) Compliance with relevant statutory and regulatory requirements;
e) Co‐operation with the relevant law enforcement authorities, including the timely
disclosure of information;
f) Role of internal audit or compliance function to ensure compliance with the policies,
procedures, and controls relating to the prevention of ML and TF, including the testing of
the system for detecting suspected money laundering transactions, evaluating and
checking the adequacy of exception reports generated on large and/or irregular
transactions, the quality of reporting of suspicious transactions and the level of awareness
of front line staff, of their responsibilities in this regard;
g) The internal audit function shall be independent, adequately resourced and
commensurate with the size of the business and operations, organization structure,
number of clients and other such factors.

6.6.2 Written Anti Money Laundering Procedures

Each registered intermediary shall adopt written procedures to implement the anti‐money
laundering provisions. The procedures should cover the following relating to “Client Due Diligence
Process”:
I. Policy for acceptance of clients;
II. Procedure for identifying the clients;
III. Transaction monitoring and reporting especially Suspicious Transactions Reporting (STR).

6.6.2.1 Client Due Diligence (CDD)

The CDD measures comprise the following:
(a) Obtaining sufficient information in order to identify persons who beneficially own or control
securities account. Whenever it is apparent that the securities acquired or maintained
through an account are beneficially owned by a party other than the client, that party should
be identified using client identification and verification procedures. The beneficial owner is
the natural person or persons who ultimately own, control or influence a client and/or
persons on whose behalf a transaction is being conducted. It also incorporates those persons
who exercise ultimate effective control over a legal person or arrangement.
(b) Verify the customer’s identity using reliable, independent source documents, data or
information;
(c) Identify beneficial ownership and control, i.e. determine which individual(s) ultimately own(s)
or control(s) the customer and/or the person on whose behalf a transaction is being
conducted;
(d) Verify the identity of the beneficial owner of the customer and/or the person on whose behalf
a transaction is being conducted, corroborating the information provided in relation to (c);
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(e) Conduct ongoing due diligence and scrutiny, i.e. perform ongoing scrutiny of the transactions
and account throughout the course of the business relationship to ensure that the
transactions being conducted are consistent with the registered intermediary’s knowledge of
the customer, its business and risk profile, taking into account, where necessary, the
customer’s source of funds;
(f) Understand the ownership and control structure of the client;
(g) Registered intermediaries shall periodically update all documents, data or information of all
clients and beneficial owners collected under the CDD process; and
(h) Member has undertaken appropriate due diligence w.r.t fit & proper requirement of clients
dealing with listed Stock Exchanges and sent text of Regulation 19 & 20 of SECC Regulations,
2012 to such clients along with the contract notes.

All registered intermediaries should develop customer acceptance policies and procedures that
aim to identify the types of customers that are likely to pose a higher than the average risk of
money laundering or terrorist financing. By establishing such policies and procedures, the
intermediaries will be in a position to apply CDD on a risk sensitive basis depending on the type
of customer business relationship or transaction. In a nutshell, the following safeguards are to be
followed while accepting the clients:
i. No account should be opened in a fictitious / benami name or on an anonymous basis.
ii. Factors of risk perception of the client should be clearly defined having regard to clients’
location, nature of business activity, trading turnover etc. and manner of making payment
for transactions undertaken. The parameters should enable classification of clients into
low, medium and high risk.
iii. It should be ensured that an account is not opened where the intermediary is unable to
apply appropriate CDD / KYC policies. The market intermediary should not continue to do
business with such a person and file a suspicious activity report. It should also evaluate
whether there is suspicious trading in determining in whether to freeze or close the
account. The market intermediary should be cautious to ensure that it does not return
securities of money that may be from suspicious trades. However, the market
intermediary should consult the relevant authorities in determining what action it should
take when it suspects suspicious trading.
iv. The circumstances under which the client is permitted to act on behalf of another person
/ entity should be clearly laid down. It should be specified in what manner the account
should be operated, transaction limits for the operation, additional authority required for
transactions exceeding a specified quantity / value and other appropriate details. Further
the rights and responsibilities of both the persons (i.e. the agent‐ client registered with
the intermediary, as well as the person on whose behalf the agent is acting should be
clearly laid down). Adequate verification of a person’s authority to act on behalf the
customer should also be carried out.
v. Necessary checks and balances should be put into place before opening an account so as
to ensure that the identity of the client does not match with any person having known
criminal background or is not banned in any other manner, whether in terms of criminal
or civil proceedings by any enforcement agency worldwide.
vi. The CDD process shall necessarily be revisited when there are suspicions of money
laundering of financing of terrorism.
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6.6.2.2 Client Identification Procedure (CIP)

The ‘Know your Client’ (KYC) policy should clearly spell out the client identification procedure to
be carried out at different stages i.e. while establishing the intermediary – client relationship,
while carrying out transactions for the client or when the intermediary has doubts regarding the
veracity or the adequacy of previously obtained client identification data. Intermediaries should
comply with the following requirements while putting in place CIP:
(a) All registered intermediaries shall proactively put in place appropriate risk management
systems to determine whether their client or potential client or the beneficial owner of
such client is a politically exposed person.
(b) All registered intermediaries are required to obtain senior management approval for
establishing business relationships with Politically Exposed Persons (PEPs).
(c) Registered intermediaries should also take reasonable measures to verify the sources of
funds as well as wealth of clients and beneficial owners identified as PEP.
(d) The client should be identified by the intermediary by using reliable sources including
documents / information. The intermediary should obtain adequate information to
satisfactorily establish the identity of each new client and the purpose of the intended
nature of the relationship.
(e) The information should be adequate enough to satisfy competent authorities (regulatory
/ enforcement authorities) in future that due diligence was observed by the intermediary
in compliance with the Guidelines. Each original document should be seen prior to
acceptance of a copy.
(f) Failure by prospective client to provide satisfactory evidence of identity should be noted
and reported to the higher authority within the intermediary.

SEBI has prescribed the minimum requirements relating to KYC for certain class of the registered
intermediaries from time to time. Taking into account the basic principles enshrined in the KYC
norms which have already been prescribed or which may be prescribed by SEBI from time to time,
all registered intermediaries should frame their own internal guidelines based on their experience
in dealing with their clients and legal requirements as per the established practices. Further, the
intermediary should also maintain continuous familiarity and follow‐up where it notices
inconsistencies in the Information provided. The underlying principle should be to follow the
principles enshrined in the PML Act, 2002 as well as the SEBI Act, 1992 so that the intermediary is
aware of the clients on whose behalf it is dealing.

6.6.3 Record Keeping

All the intermediaries shall put in place a system of maintaining proper record of transactions
prescribed under Rule 3 of PML Rules. Registered Intermediaries shall maintain such records as
are sufficient to permit reconstruction of individual transactions, to provide evidence for
prosecution of criminal behaviour.

The following information need to be maintained for satisfactory audit trail:

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a) The beneficial owner of the account;
b) The volume of the funds flowing through the account; and
c) For selected transactions
I. the origin of the funds;
II. the form in which the funds were offered or withdrawn, e.g. cheques, demand
drafts etc.
III. the identity of the person undertaking the transaction;
IV. the destination of the funds;
V. the form of instruction and authority.

6.6.4 Information to be maintained

Intermediaries are required to maintain and preserve the following information in respect of
transactions referred to in Rule 3 of PML Rules:
 The nature of the transactions
 The amount of the transaction and the currency in which it is denominated
 The date on which the transaction was conducted; and
 The parties to the transaction.

6.6.5 Retention of Records

The records mentioned in Rule 38 of PML Rules and records of identify of clients have to be
maintained and preserved for a period of 5years. In situations where the records relate to on‐
going investigations or transactions which have been the subject of a suspicious transaction
reporting, they shall be retained until it is confirmed that the case has been closed.

6.6.6 Monitoring of transactions

 The intermediary shall pay special attention to all complex, unusually large transactions /
patterns which appear to have no economic purpose.
8
Rule 3 of the Prevention of Money‐laundering (Maintenance of Records) Rules, 2005 lays down following obligations
for maintenance of records. Every reporting entity shall maintain the record of all transactions including, the record of
(a) all cash transactions of the value of more than rupees ten lakhs or its equivalent in foreign currency; (b) all series of
cash transactions integrally connected to each other which have been individually valued below rupees ten lakh or its
equivalent in foreign currency where such series of transactions have taken place within a month and the monthly
aggregate exceeds an amount of ten lakh rupees or its equivalent in foreign currency; (c) all transactions involving
receipts by non‐profit organisations of value more than rupees ten lakh, or its equivalent in foreign currency; (d) all
cash transactions where forged or counterfeit currency notes or bank notes have been used as genuine or where any
forgery of a valuable security or a document has taken place facilitating the transactions; (e) all suspicious transactions
whether or not made in cash and by way of deposits and credits, withdrawals into or from any accounts in whatsoever
name they are referred to in any currency etc.(f) all cross border wire transfers of the value of more than five lakh
rupees or its equivalent in foreign currency where either the origin or destination of fund is in India (g) all purchase and
sale by any person of immovable property valued at fifty lakh rupees or more that is registered by the reporting entity,
as the case may be.
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 The intermediary may specify internal threshold limits for each class of client accounts
and pay special attention to transactions which exceeds these limits.
 The background including all documents/office records /memorandums/clarifications
sought pertaining to such transactions and purpose thereof shall also be examined
carefully and findings shall be recorded in writing.
 Further such findings, records and related documents shall be made available to auditors
and also to SEBI/stock exchanges/FIU‐IND/other relevant Authorities, during audit,
inspection or as and when required.
 These records are required to be preserved for five years as is required under the PMLA.
 The intermediary shall ensure that record of transactions as specified under Section 12 of
the Act, are reported to the Director, FIU‐IND.
 Compliance cell of the intermediary shall randomly examine a selection of transactions
undertaken by clients to comment on their nature i.e. whether they are in the nature of
suspicious transactions or not.

6.6.7 Suspicious Transaction Monitoring and Reporting

 Intermediaries shall ensure that appropriate steps are taken to enable suspicious
transactions to be recognised and have appropriate procedures for reporting suspicious
transactions.
 Any suspicious transaction shall be immediately notified to the Money Laundering Control
Officer or any other designated officer within the intermediary. The notification should
be in the form of a detailed report with details including specific reference to the clients,
transactions and the nature /reason of suspicion.
 The dealings with the client should be continued as normal and should not be informed
about the suspicion. In exceptional situations, consent may not be given to continue to
operate the account and transactions suspended.
 In case the clients abort or abandon transactions which are considered to be suspicious
when asked to provide details, the same should be reported as well irrespective of the
amount of transaction.
 Clients from high risk countries shall be subjected to measures such as enhanced scrutiny
of transactions, enhanced reporting mechanism, enhanced due diligence.

6.6.8 List of Designated Individuals/Entities

An updated list of individuals and entities which are subject to various sanction measures such as
freezing of assets/accounts, denial of financial services etc., as approved by the Security Council
Committee established pursuant to various United Nations' Security Council Resolutions (UNSCRs)
is available at the website http://www.un.org/sc/committees/1267/consolist.shtml.
Registered intermediaries are required to ensure that no account is opened for the names
appearing in the said list and also continuously verify the existing accounts to ensure they are not
linked to any of the names on the said list. Full details of accounts bearing resemblance with any
of the individuals/entities in the list should be immediately be intimated to SEBI and FIU‐IND.

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6.6.9 Procedure for freezing of funds, financial assets or economic resources or related
services

The Unlawful Activities (Prevention) Act, 1967 (UAPA) was enacted for the prevention of certain
unlawful activities of individuals and associations and for matters connected therewith. The
Government has issued an Order dated August 27, 2009 detailing the procedure for
implementation of Section 51A of the UAPA, relating to the purpose of prevention of, and for
coping with terrorist activities. In terms of Section 51A, the Central Government is empowered
to freeze, seize or attach funds and other financial assets or economic resources held by, on behalf
of or at the direction of the individuals or entities Listed in the Schedule to the Order.
The Stock Exchanges, Depositories and registered intermediaries shall carry out the following with
respect to “list of designated individuals / entities”:
 To maintain updated designated lists in electronic form and run a check to verify whether
such entities are holding any funds, financial assets or economic resources or related services
held in the form of securities with them.
 If particulars of any of the customers matches the particulars of designated
individuals/entities, stock exchanges, depositories and intermediaries shall immediately, no
later than 24 hours from the time of finding out such customer, inform full particulars of the
funds, financial assets or economic resources or related services held in the form of securities,
held by such customer on their books
(a) To the Joint Secretary, Ministry of Home Affairs by Fax and Telephone apart from being
sent by post and through e‐mail; and
(b) To the UAPA nodal officer at SEBI through fax, post and email; and
(c) To the UAPA nodal officer of the state/Union Territory (UT) where the account is held, as
the case may be; and
(d) To FIU‐IND.
If the details match beyond doubt, the entities should be prevented from conducting financial
transactions. A Suspicious Transaction Report (STR) should be filed with FIU‐IND.
Upon receipt of such information, verification will be conducted by the State Police / Central
Agencies and completed within 5 working days. If it is found that properties are held for the
benefit of the designated individuals/entities, an order to freeze these assets would be issued
within 24 hours of verification and conveyed electronically to the concerned depository under
intimation to SEBI and FIU‐IND.
6.6.10 Reporting to Financial Intelligence Unit‐India

In terms of the PML Rules, intermediaries are required to report information relating to cash and
suspicious transactions to the Director, Financial Intelligence Unit‐India
(FIU‐IND) at the following address:
Director, FIU‐IND,
Financial Intelligence Unit‐India,
6th Floor, Hotel Samrat,
Chanakyapuri,
New Delhi‐110021.
Website: http://fiuindia.gov.in

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The Cash Transaction Report (CTR) for each month shall be submitted to FIU‐IND by 15th of the
succeeding month. The Suspicious Transaction Report (STR) shall be submitted within 7 days of
arriving at a conclusion that any transaction, whether cash or non‐cash, or a series of transactions
integrally connected are of suspicious nature.

6.6.11 Designation of an officer for reporting of suspicious transactions

The Principal Officer identified should be of senior position and will be responsible for proper
discharge of the obligation relating to reporting of suspicious transactions to the authorities.
Names, designation and addresses (including email addresses) of ‘Principal Officer’ including any
changes shall be intimated to the Office of the Director‐FIU. The Principal Officer would act as a
central reference point in facilitating onward reporting of suspicious transactions and also play an
active role in identification and assessment of potentially suspicious transactions. It is advisable
that the ‘Principal Officer’ is of a sufficiently senior position reporting to senior management next
to the level of the Board of Directors and is able to discharge the functions with independence
and authority.

6.6.12 Furnishing of information to the Director
The designated Principal Officer of a reporting entity shall furnish the information with respect to
the transactions [referred to in clauses (A), (B), (BA), (C) and (E) of sub‐rule (1) of rule 3] every
month to the Director by the 15th day of the succeeding month.

The Principal Officer of a reporting entity shall furnish the information promptly in writing or by
fax or by electronic mail to the Director in respect of transactions referred to in clause (D) of sub‐
rule (1) of rule 39 not later than seven working days on being satisfied that the transaction is
suspicious.
The Principal Officer of a reporting entity shall furnish, the information in respect of transactions
[referred to in clause (F) of sub‐rule (1) of rule 3]10, every quarter to the Director by the 15th day
of the month succeeding the quarter.

6.6.13 Employees’ Hiring/Employee’s Training/ Investor Education

9
All suspicious transactions whether or not made in cash and by way of‐ (i) deposits and credits,
withdrawals into or from any accounts in whatsoever name they are referred to in any currency; (ii) credits
or debits into or from any non‐monetary accounts such as d‐mat account, security account in any currency
maintained by the banking company, financial institution and intermediary, as the case may be; (iii) money
transfer or remittances in favour of own clients or non‐clients from India or abroad and to third party
beneficiaries in India or abroad including transactions on its own account in any currency; (iv) loans and
advances including credit or loan substitutes, investments and contingent liability: (v) collection services in
any currency by way of collection of bills, cheques, instruments or any other mode of collection in
whatsoever name it is referred to.
10
All purchase and sale by any person of immovable property valued at fifty lakh rupees or more that is
registered by the reporting entity, as the case may be.
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6.6.13.1 Hiring of Employees

The registered intermediaries shall have adequate screening procedures in place to ensure high
standards when hiring employees. They shall identify the key positions within their own
organization structures having regard to the risk of money laundering and terrorist financing and
the size of their business, ensuring the employees taking up such key positions are suitable and
competent to perform their duties.

6.6.13.2 Employees’ Training

Intermediaries must have an ongoing employee training programme so that the members of the
staff are adequately trained in AML and CFT procedures. This should cover staff dealing with
clients such as front office, back office, Risk Management staff etc. They should be made aware
of the rationale behind these directives, obligations and requirements to implement them
consistently and be sensitive to the risks to their systems being misused.
6.6.14 Investors Education

Intermediaries shall prepare specific literature/ pamphlets etc. to educate the client, of the
objectives of the AML/CFT programme and also to sensitize them about the requirements of the
Act.

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Review questions

1. Record of transactions to be maintained under the Prevention of Money Laundering Act
includes cash transactions of the value of more than ________.
(a) Rs.10 lakh
(b) Rs. 20 lakh
(c) Rs. 25 lakh
(d) Rs. 1 crore
Ans: (a)
2. Which of the following is INCORRECT: Money laundering is a mechanism by which:
(a) Funds generated through criminal means are transformed as if they originated from a
legitimate source.
(b) Funds generated through regular business is deployed for new venture
Ans: (b)

3. “Every Banking Company, financial institution or intermediary shall maintain a record of which
of the following?
(a) All cash transactions of the value of more than Rupees ten lakhs or its equivalent in
foreign currency;
(b) All series of cash transactions integrally connected to each other which have been valued
below Rupees ten lakhs or its equivalent in foreign currency where such series of
transactions have taken place within a month;
(c) All cash transactions where forged or counterfeit currency notes or bank notes have been
used as genuine and where any forgery of a valuable security has taken place;
Ans: (d)

4. Records maintained under Rule 3 of the PMLA Rules should be maintained for
(a) 5 years
(b) 7 years
(c) 10 years
(d) 15 years
Ans: (a)

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Chapter 7 SEBI (Stock Brokers and Sub Brokers) Regulations, 199211

LEARNING OBJECTIVES:

After studying this chapter, you should know about the following aspects relating to the

SEBI (Stock Brokers and Sub Brokers) Regulations, 1992.

 Condition of registration of stock brokers and sub‐brokers
Cond

 Obligations and responsibilities of the brokers and sub‐brokers

 Action taken by the regulator in case of any contravention by brokers or sub‐
brokers of the provisions of the regulations
 Code of conduct for brokers and sub‐brokers

 Fees payable by brokers and sub‐brokers

 Regulation of transactions between clients and brokers
 DMA and Algorithmic trading

7.1 Introduction to SEBI (Stock Brokers and Sub Brokers) Regulations, 1992

The SEBI (Stock Brokers and Sub‐Brokers) Regulations, 1992 is prescribed for anyone who wishes
to register as a stock broker or its sub‐broker for doing any transaction or business in the securities
market. Stock brokers and sub‐brokers shall ensure that they comply at all times with the various
sections as given under this regulation.
7.1.1 Registration of Stock Brokers and Sub‐brokers

The stock brokers shall ensure that they comply at all times with the conditions of registration
under regulation 9 as follows:
 the stock broker holds the membership of the stock exchange;
 the stock broker shall abide by the rules, regulations and bye‐laws of the stock exchange;
 where the stock broker proposes change in control, he shall obtain prior approval of SEBI
for continuing to act as such after the change;
 he shall pay fees charged by the SEBI;
 he shall take adequate steps to redress investors’ grievances within 1 month of the date
of receipt of the complaint and keep SEBI informed about such complaints.
11
On July 30, 2018, the (Stock Brokers and Sub‐Brokers) (Second Amendment) Regulations, 2018 have
notified the omission of the word 'sub‐broker' in the title as well as elsewhere in the SEBI (Stock Brokers
and Sub‐Brokers) Regulations w.e.f April 1, 2019.
Refer SEBI Circular Ref. No. SEBI/HO/MIRSD/DoP/CIR/P/2018/117 Dated August 3, 2018: Category of Sub‐
broker are same as Associated Persons (AP). Sub‐brokers who do not choose to migrate to AP and/or TM
shall deemed to have surrendered their registration with SEBI as Sub‐broker w.e.f March 31, 2019.
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 he shall at all times abide by the Code of Conduct as specified in Schedule II of the SEBI
Stock Broker Regulations; and
 he shall at all times maintain the minimum networth as specified in Schedule VI of the
SEBI Stock Broker Regulations.

The sub brokers shall ensure to comply at all times the conditions of registration under the
regulation 11 and 11A as follows:
 No sub‐broker shall act as such unless he holds a certificate granted by SEBI under these
regulations.
 The application for registration shall be accompanied by a recommendation letter from a
stock broker of a recognised stock exchange with whom he is to be affiliated along with
two references including one from his banker.
 The application form shall be submitted to the stock exchange of which the stock broker
with whom he is to be affiliated is a member.

As per regulation 12A, any registration granted to a sub‐broker shall be subject to the following
conditions, namely:
 he shall abide by the rules, regulations and bye‐laws of the stock exchange which are
applicable to him;

 he shall pay the fees charged by the SEBI in the manner as specified by the
regulations;
 he shall take adequate steps to redress the grievances of the investors within one
month of the date of the receipt of the complaint and keep the SEBI informed of the
number, nature and other particulars of the complaints received from such investors;
and
 the sub broker is authorised in writing by a stock broker being a member of a stock
exchange for affiliating himself in buying, selling or dealing in securities.

It is also provided in regulation 15A that a director of a stock broker shall not act as a sub‐broker
to the same stock broker.
7.1.2 General Obligations and Responsibilities

The stock brokers and sub‐brokers general obligations and responsibilities are elaborated under
regulation 17 to 18B which are given below:
Under regulation 17(1), every stock‐broker shall keep and maintain the following books of
accounts, records and documents‐
 Register of transactions (Sauda Book);
 Clients ledger;
 General ledger;
 Journals;
 Cash book;
 Bank pass book;
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 Documents register containing, inter‐alia, particulars of securities received and delivered
in physical form and the statement of accounts and other records relating to receipt and
delivery of securities provided by the Depository Participants in respect of dematerialised
securities;
 Members' contract books showing details of all contracts entered into by it with other
members of the same exchange or counterfoils or duplicates of memos of confirmation
issued to such other member;
 Counterfoils or duplicates of contract notes issued to clients;
 Written consent of clients in respect of contracts entered into as principals;
 Margin deposit book;
 Registers of accounts of sub‐ brokers;
 An agreement with a sub‐ broker specifying the scope of authority and responsibilities of
the Stock‐Broker and such sub‐ broker;
 Client account opening form in the format as may be specified by the Board

Regulation 17(2) states that every stock‐broker shall intimate to SEBI the place where the books
of accounts, records and documents are maintained. Additionally, regulation 18, also states that
every stock broker shall preserve the books of account and other records maintained under
regulation 17 for a minimum period of 5 years. Under the stock broker regulation the requirement
of compliance officer is also mandated under the regulation 18A which states that every stock
broker shall appoint a compliance officer who shall be responsible for monitoring the compliance
of the Act, rules and regulations, notifications, guidelines instructions, etc. and for redress of
investors’ grievances. The compliance officer shall immediately and independently report to SEBI
any non‐compliance observed by him. Under regulation 18B, the stock broker shall not deal with
any person as a sub‐broker unless such person has been granted certificate of registration by the
SEBI.
SEBI has been issuing circulars and master circulars for registered trading members with respect
to these regulations. These circulars include, inter alia, requirement of base minimum capital.
7.1.3 Procedure for Inspection

Regulation 19 of the SEBI (Stock Brokers and Sub‐Brokers) Regulations gives SEBI the right to
inspect. SEBI may appoint inspecting authority to undertake inspection of the books of account,
other records and documents of the stock brokers, with or without notice. The purpose of the
inspection under regulation 19(1) would be to;
 Ensure that the books of account and other books are being maintained in the manner
required;
 Ensure that the provisions of the Act, rules, regulations and the provisions of the SCRA
and the rules made there under are being complied with;
 Investigate into the complaints received from the investors, other stock brokers, sub‐
brokers or any other person on any matter having a bearing on the activities of the
stock brokers; and
 Investigate suo‐motu, in the interest of securities business or investors’ interest into
the affairs of the stock broker.
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Whenever any such inspection (as per Regulation 19) is initiated, the stock‐broker has the
following obligations under regulation 21:
 It shall be the duty of every director, officer and employee of the stock‐broker, to produce
to the inspecting authority such books, accounts and other documents in his custody or
control and furnish him with the statements and information relating to the transactions
in securities market within such time as the inspecting authority may require.
 The stock‐broker shall allow the inspecting authority to have reasonable access to the
premises occupied by the stock‐ broker or by any other person on his behalf and also
extend reasonable facility for examining any books, records, documents and computer
data in the possession of the stock‐broker or any other person and also provide copies of
documents or other materials which, in the opinion of the inspecting authority are
relevant.
 The inspecting authority, in the course of inspection, shall be entitled to examine or
record statements of any member, director, and employee of the stock‐ broker.
 It shall be the duty of every director, officer and employee of the stock broker to give to
the inspecting authority all assistance in connection with the inspection, which the stock
broker may be reasonably expected to give.
The inspecting authority shall submit the inspection report to SEBI and based on the same, SEBI
may take such action as it may deem fit and appropriate. SEBI may also appoint a qualified auditor
under regulation 24, to investigate into the books of account or affairs of any stock‐broker. The
auditor so appointed shall have the same powers of the inspecting authority and the stock broker
shall have the same obligations as mentioned in the point above.

7.1.4 Action in case of Default

A stock broker or a sub‐broker who contravenes any of the provisions of the Act, rules or
regulations framed thereunder is liable for any one or more of the following actions –
(a) Monetary penalty
(b) Penalties as specified under the SEBI (Intermediaries) Regulations, 2008 including
suspension or cancellation of certificate of registration as a stock broker or sub‐broker
(c) Prosecution under regulation 24 of the Act.
7.1.4.1 Monetary Penalty

Under regulation 26, a stock broker shall be liable to adjudication proceedings for imposing
monetary penalty in respect of following violations:
a. Failure to file any return or report with SEBI.
b. Failure to furnish any information, books or other documents within fifteen days of issue
of notice by SEBI.
c. Failure to maintain books of accounts or records as per the Act, rules or regulations
framed thereunder.
d. Failure to redress the grievances of investors within thirty days of receipt of notice from
SEBI.
e. Failure to issue contract notes in the form and manner specified by the stock exchange of
which sub broker is a member.
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f. Failure to deliver any security or make payment of the amount due to the investor within
forty eight hours of the settlement of trade unless the client has agreed in writing
otherwise.
g. Charging of brokerage which is in excess of brokerage specified in the regulations or the
bye‐laws of the stock exchange.
h. Dealing in securities of a body corporate listed on any stock exchange on its own behalf
or on behalf of any other person on the basis of any unpublished price sensitive
information.
i. Procuring or communicating any unpublished price sensitive information except as
required in the ordinary course of business or under any law.
j. Counselling any person to deal in securities of any body‐corporate on the basis of
unpublished price sensitive information.
k. Indulging in fraudulent and unfair trade practices relating to securities.
l. Failure to maintain client account opening form.
m. Failure to segregate his own funds or securities from the client’s funds or securities or
using the securities or funds of the client for his own purpose or for purpose of any other
client.
n. Acting as an unregistered sub‐broker or dealing with unregistered sub‐brokers.
o. Failure to comply with directions issued by SEBI under the Act or the regulations framed
there under.
p. Failure to exercise due skill, care and diligence.
q. Failure to obtain prior approval of SEBI in case of change in control of the stock broker.
r. Failure to satisfy the net worth or capital adequacy norms, if any, specified by SEBI.
s. Extending use of trading terminal to any unauthorised person or place.
t. Violations for which no separate penalty has been provided under these regulations.
7.1.4.2 Action under SEBI (Intermediaries) Regulations including suspension or cancellation of
certificate of registration

Under regulation 27, a stock broker is liable to enquiry proceedings under SEBI (Intermediaries)
Regulations, if he –
i. ceases to be a member of a stock exchange; or
ii. has been declared defaulter by a stock exchange and has not been re‐admitted as a
member within a period of six months; or
iii. has been found to be not a fit and proper person by SEBI; or
iv. has been declared insolvent or order for winding up has been passed; or
v. any of the whole time director in case a broker is a company registered under the
Companies Act, 2013 has been convicted by a court for an offence involving moral
turpitude; or
vi. fails to pay fee as prescribed in the regulations; or
vii. fails to comply with the rules, regulations and bye‐laws of the stock exchange of which
it is a member; or
viii. fails to co‐operate with the inspecting or investigating authority; or
ix. fails to abide by any award of the Ombudsman or decision of SEBI under the SEBI
(Ombudsman) Regulations, 2003; or
x. fails to pay the penalty imposed by the Adjudicating Officer; or
xi. indulges in market manipulation of securities or index; or
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xii. indulges in insider trading in violation of SEBI (Prohibition of Insider Trading)
Regulations, 1992; or
xiii. violates SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to
Securities Market) Regulations, 2003; or
xiv. commits violation of any of the provisions for which monetary penalty or other
penalties could be imposed; or
xv. fails to comply with the circulars issued by SEBI; or
xvi. commits violations specified in regulation 26 which in the opinion of SEBI are of a
grievous nature.

Rationalisation of process relating to surrender of registration by sub‐brokers

i. The affiliating stock broker shall issue a public advertisement in a local newspaper
with wide circulation where the sub‐broker’s place of work is situated, informing the
investors/general public about the surrender of registration of his sub‐broker and not
to deal with such sub‐broker.
ii. Further, in case of transition from sub broker to Authorized Person (AP)(where the
sub broker surrenders registration while seeking approval as AP)with the same stock
broker and the same stock exchange, issue of advertisement in newspaper regarding
surrender of sub broker registration shall not be required. However, the affiliating
stock broker shall furnish an undertaking/ confirmation to the stock exchanges at the
time of surrender of sub broker registration that he has sent communication to the
clients of the sub broker individually about the surrender of sub brokership and also
the fact of approval as AP.
iii. The affiliating stock broker and/or stock exchange shall publish the details of sub‐
brokers whose registration has been surrendered or their new status as AP, as the
case may be on their respective websites for the information of the investors.
7.1.4.3 Prosecution

Under regulation 28, a stock broker is liable for prosecution as per regulation 24 of the SEBI Act
for any of the following violations –
a. Dealing in securities without obtaining certificate of registration from SEBI as a stock
broker.
b. Dealing in securities or providing trading floor or assisting in trading outside the
recognised stock exchange in violation of provisions of the SCRA or rules made or
notifications issued thereunder.
c. Market manipulation of securities or index.
d. Indulging in insider trading in violation of SEBI (Prohibition of Insider Trading) Regulations,
1992.
e. Violating the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to
Securities Market) Regulations, 2003.
f. Failure without reasonable cause –
o to produce to the investigating authority or any person authorized by him in this
behalf, any books, registers, records or other documents which are in his custody or
power; or
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o to appear before the investigating authority personally or to answer any question
which is put to him by the investigating authority; or
o to sign the notes of any examination taken down by the investigating authority.
g. Failure to pay penalty imposed by the adjudicating officer or failure to comply with any
of his directions or orders.
7.1.5 Code of Conduct

A stock broker or its sub broker needs to adhere to a particular code of conduct as prescribed in
the schedule II of the regulations, which has been discussed herein.

7.1.5.1 Code of Conduct for Brokers

A. General

1) Integrity: A stock‐broker, must maintain high standards of integrity, promptitude and fairness
in the conduct of all its business.
2) Exercise of Due Skill and Care: A stock‐broker must act with due skill, care and diligence in the
conduct of all its business.
3) Manipulation: A stock‐broker should not indulge in manipulative, fraudulent or deceptive
transactions or schemes or spread rumours with a view to distorting market equilibrium or
making personal gains.
4) Malpractices: A stock‐broker should not create false market either singly or in concert with
others or indulge in any act detrimental to the investors’ interest or which leads to
interference with the fair and smooth functioning of the market. A stock‐broker should not
involve itself in excessive speculative business in the market beyond reasonable levels not
commensurate with its financial soundness.
5) Compliance with Statutory Requirements: A stock‐broker should abide by all the provisions
of the Act and the rules, regulations issued by the Government, the SEBI and the stock
exchange from time to time as may be applicable to him.

B. Duty to the Investor

1) Execution of Orders: A stock‐broker, in its dealings with the clients and the general investing
public, should faithfully execute the orders for buying and selling of securities at the best
available market price and not refuse to deal with a small investor merely on the ground of
the volume of business involved. A stock‐broker also should promptly inform its client about
the execution or non‐execution of an order, and make prompt payment in respect of
securities sold and arrange for prompt delivery of securities purchased by clients.
2) Issue of Contract Note: A stock‐broker should issue without delay to its client or client of the
sub‐broker, as the case may be a contract note for all transactions in the form as specified by
the stock exchange.
3) Breach of Trust: A stock‐broker should not disclose or discuss with any other person or make
improper use of the details of personal investments and other information of a confidential
nature of the client which it comes to know in its business relationship.
4) Business and Commission:
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a) A stock‐broker should not encourage sales or purchases of securities with the sole object
of generating brokerage or commission.
b) A stock‐broker should not furnish false or misleading quotations or give any other false
or misleading advice or information to the clients with a view of inducing him to do
business in particular securities and enabling itself to earn brokerage or commission
thereby.
5) Business of Defaulting Clients: A stock‐broker should not deal or transact business knowingly,
directly or indirectly or execute an order for a client who has failed to carry out his
commitments in relation to securities with another stock‐broker.
6) Fairness to Clients: A stock‐broker, when dealing with a client, must disclose whether it is
acting as a principal or as an agent and should ensure at the same time that no conflict of
interest arises between him and the client. In the event of a conflict of interest, he should
inform the client accordingly and should not seek to gain a direct or indirect personal
advantage from the situation and also not consider clients’ interest inferior to his own.
7) Investment Advice: A stock‐broker should not make a recommendation to any client who
might be expected to rely thereon to acquire, dispose of, retain any securities unless it has
reasonable grounds for believing that the recommendation is suitable for such a client upon
the basis of the facts, if disclosed by such a client as to his own security holdings, financial
situation and objectives of such investment. The stock‐broker should seek such information
from clients, wherever it feels it is appropriate to do so.
7A) Investment Advice in publicly accessible media –
(a) A stock broker or any of its employees shall not render, directly or indirectly, any
investment advice about any security in the publicly accessible media, whether real time or
non‐real‐time, unless a disclosure of his interest including the interest of his dependent family
members and the employer including their long or short position in the said security has been
made, while rendering such advice.
(b) In case, an employee of the stock broker is rendering such advice, he shall also disclose
the interest of his dependent family members and the employer including their long or short
position in the said security, while rendering such advice.
8) Competence of Stock Broker: A stock‐broker should have adequately trained staff and
arrangements to render fair, prompt and competent services to its clients.

C. Dealing with other Stock Brokers

1) Conduct of Dealings: A stock‐broker shall co‐operate with the other contracting party in
comparing unmatched transactions. A stock‐broker should not, knowingly and wilfully deliver
documents which constitute bad delivery and shall cooperate with other contracting party for
prompt replacement of documents which are declared as bad delivery.
2) Protection of Clients Interests: A stock‐broker shall extend fullest cooperation to other stock‐
brokers in protecting the interests of its clients regarding their rights to dividends, bonus
shares, right shares and any other right related to such securities.
3) Transactions with Stock‐Brokers: A stock‐broker should carry out its transactions with other
stock‐brokers and shall comply with its obligations in completing the settlement of
transactions with them.
4) Advertisement and Publicity: A stock‐broker should not advertise its business publicly unless
permitted by the stock exchange. The Member, its Group companies/ third party or its
associate shall not offer any schemes/ leagues/ competitions and shall not issue any
advertisement for the same. Further, no celebrities shall form part of the advertisements.
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5) Inducement of Clients: A stock‐broker should not resort to unfair means of inducing clients
from other stock‐ brokers.
6) False or Misleading Returns: A stock‐broker shall not neglect or fail or refuse to submit the
required returns and not make any false or misleading statement on any returns required to
be submitted to SEBI and the stock exchange.

7.1.5.2 Code of Conduct for Sub‐Brokers

A. General

1. Integrity: A sub‐broker should maintain high standards of integrity, promptitude and fairness
in the conduct of all investment business.
2. Exercise of Due Skill and Care: A sub‐broker should act with due skill, care and diligence in the
conduct of all investment business.

B. Duty to the Investor

1. Execution of Orders: A sub‐broker in his dealings with the clients and the general investing
public must faithfully execute the orders for buying and selling of securities at the best
available market price. A sub‐broker shall promptly inform his client about the execution or
non‐execution of an order and also assist its client in obtaining the contract note from the
stock broker.
2. A sub broker shall render necessary assistance to his client in obtaining the contract note from
the stock broker.
3. Breach of Trust: A sub‐broker should not disclose or discuss with any other person or make
improper use of the details of personal investments and other information of a confidential
nature of the client which he comes to know in his business relationship.
4. Business and Commission:
o A sub‐broker shall not encourage sales or purchases of securities with the sole object
of generating brokerage or commission.
o A sub‐broker shall not furnish false or misleading quotations or give any other false
or misleading advice or information to the clients with a view of inducing him to do
business in particular securities and enabling himself to earn brokerage or
commission thereby.
o A sub‐broker shall not charge from his clients a commission more than one and one
half of one percent of the value mentioned in the respective sale or purchase notes.
5. Business of Defaulting Clients: A sub‐broker shall not deal or transact business knowingly,
directly or indirectly or execute an order for a client who has failed to carry out his
commitments in relation to securities and is in default with another broker or sub‐broker.
6. Fairness to clients: A sub‐broker when dealing with a client should disclose that it is acting as
an agent ensuring at the same time, that no conflict of interest arises between him and the
client. In the event of conflict of interest, the sub‐broker should inform the client accordingly.
He should not seek to gain any direct or indirect personal advantage from the situation and
shall not consider client’s interest inferior than his own.
7. Investment advice: A sub‐broker shall not make a recommendation to any client who might
be expected to rely thereon to acquire, dispose of, retain any securities unless he has
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reasonable grounds for believing that the recommendations is suitable for such a client upon
the basis of the facts, if disclosed by such a client as to his own security holdings, financial
situation and objectives of such investment.
8. Investment advice in publicly accessible media‐
(a) A sub‐broker or any of his employees shall not render, directly and indirectly any
investment advice about any security in the publicly accessible media, whether real time
or non‐real time, unless a disclosure of his interest including his long or short position in
the said security has been made, while rendering such advice.
(b) In case an employee of the sub‐broker is rendering such advice, he shall disclose the
interest of his independent family members and the employer including their long or
short position in the said security, while rendering such advice.
9. Competence of Sub‐broker: A sub‐broker should have adequately trained staff and
arrangements to render fair, prompt and competence services to his clients and continuous
compliance with the regulatory system.

C. Dealing with Stock Brokers

1. Conduct of Dealings: A sub‐broker shall cooperate with his broker in comparing unmatched
transactions. Sub‐broker shall not knowingly and wilfully deliver documents which constitute
bad delivery. A sub‐broker shall cooperate with other contracting party for prompt
replacement of documents which are declared as bad delivery.
2. Protection of client’s interest: A sub‐broker shall extend fullest co‐operation to his stock‐
broker in protecting the interests of their clients regarding their rights to dividends, right or
bonus shares, or any other rights relatable to such securities.
3. Transactions with Brokers: A sub‐broker should not fail to carry out his stock broking
transactions with his brokers nor shall he fail to meet his business liabilities or show
negligence in completing the settlement of transactions with them.
4. Advertisement and Publicity: A stock broker shall not advertise his business publicly unless
permitted by the stock exchange.
5. Inducement of Clients: A stock broker shall not resort to unfair means of inducing clients from
other brokers.

D. Dealing with Regulatory Authorities

1. General Conduct: A sub‐broker shall not indulge in dishonourable, disgraceful or disorderly or
improper conduct on the stock exchange nor shall he wilfully obstruct the business of the
stock exchange. He shall comply with the rules, bye‐laws and regulations of the stock
exchange.
2. Failure to give Information: A sub‐broker should not neglect or fail or refuse to submit to the
SEBI or the stock exchange with which it is registered, such books, special returns,
correspondence, documents and papers as may be required.
3. False or Misleading Returns: A sub‐broker should not neglect or fail or refuse to submit the
required returns and not make any false or misleading statement on any returns required to
be submitted to the SEBI or the stock exchange
4. Manipulation: A sub‐broker shall not indulge in manipulative, fraudulent or deceptive
transactions or schemes or spread rumours with a view to distorting market equilibrium or
making personal gains.
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5. Malpractices: A sub‐broker shall not create a false market either singly or in concert with
others or indulge in any act detrimental to the public interest or which leads to interference
with the fair and smooth functions of the market mechanism of the stock exchanges. A sub‐
broker should not involve himself in excessive speculative business in the market beyond
reasonable levels not commensurate with his financial soundness.
7.1.6 Fees Payable by Broker and Sub‐broker

Regulation 8 of the SEBI (Stock Brokers and Sub‐brokers) Regulation states that the brokers shall
pay fees as prescribed by the regulations. The schedule III of the regulation prescribes the manner
in which registration fees needs to be paid by the stock‐broker, the same is given below:
a. Where the annual turnover of the broker does not exceed rupees one crore during any
financial year, he shall pay a sum of rupees five thousand for each financial year;
b. Where the annual turnover of the stock‐broker exceeds rupees one crore during any
financial year, he shall pay a sum of rupees five thousand plus one hundredth of one per
cent of the turnover in excess of rupees one crore for each financial year;
c. After the expiry of five financial years from the date of initial registration as stock broker;
he shall pay a sum of rupees five thousand for every block of five financial years
commencing from the sixth financial year after the date of grant of initial registration to
keep his registration in force.
Every remittance of fees as referred to in (a) and (b) above should be accompanied by a certificate
to authenticate the turnover on the basis of which fees have been computed, duly signed by the
stock exchange of which the stock broker is a member or by a qualified auditor or as defined under
the Companies Act.

Every sub‐broker shall pay fees in the manner as given below:
i. Where a sub‐broker has been granted certificate of registration by SEBI before April 1,
2014;
o He shall pay a sum of ten thousand rupees for every block of five financial years
commencing from expiry of the block of five years for which the fee has been
paid.
ii. Where a sub‐broker is granted certificate of registration by SEBI on or after April 1, 2014;
o He shall pay a sum of twenty thousand rupees for the block of five financial years
commencing from the financial year in which registration has been granted; and
o After the expiry of the said block of five financial years, he shall pay a sum of ten
thousand rupees for every subsequent block of five financial years.

7.1.7 Regulation of Transactions between Clients and Brokers

SEBI vide its notification (No. SO 855 (E), dated 29‐11‐1994) have prescribed regulations for
transactions between clients and brokers. It shall be compulsory for all member brokers to keep
money of the clients in a separate account and their own money in a separate account. No
payment of transactions in which the member broker takes a position as a principal will be allowed
to be made from the clients account. However, there are circumstances under which transfer
from clients account to member brokers account would be allowed, the same is enumerated
below:
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(1) (2) (3)
A. Member Broker to Keep Every member broker shall keep such books of account, as
Accounts will be necessary, to show and distinguish in connection
with his business as a member –
i. Moneys received from or on account of and
money, paid to or on account of each of his
clients, and
ii. The moneys received and the moneys paid on
members own account.
B. Obligation to pay money Every member broker who holds or receives money on
into clients accounts account of a client shall forthwith pay such money to
current or deposit account at bank to be kept in the name
of the member in the title of which the word “clients” shall
appear. Member broker may keep one consolidated
clients account for all the clients or accounts in the name
of each client provided when a member receives a cheque
or draft belonging to the client and part to the member,
he shall pay the whole of such cheque or draft into the
clients account and effect subsequent transfer as per
prescribed guidelines.
C. What moneys to be paid No money shall be paid into clients account other than‐
into “clients account” i. Money held or received on account of clients;
ii. Such money belonging to the member as may be
necessary for the purpose of opening or
maintaining the account;
iii. Money for replacement of any sum which may by
mistake or accident have been drawn from the
account in contravention of point D (to be
discussed below)
iv. A cheque or draft received by the member
representing in part money belonging to the client
and in part money due to the member.
D. What moneys to be No money shall be drawn from clients account other than‐
withdrawn from “clients i. Money properly required for payment to or on
account” behalf of clients or for or towards payment of a
debt due to the member from clients or money
drawn on clients authority, or money in respect of
which there is a liability of clients to the members,
provided that money so drawn shall not in any
case exceed the total of the money held for the
time being for such each client.
ii. Such money belonging to the member as may
have been paid into the client account as
discussed under point C (ii) and C (iv).
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iii. Money which may by mistake or accident have

been paid into such account in contravention of
point C.

It shall also be compulsory for all member brokers to keep separate accounts for client’s securities
and to keep such books of account, as may be necessary, to distinguish such securities from his /
their own securities. Such accounts for clients securities shall inter alia provide for the following:‐
a. Securities received for sale or kept pending delivery in the market;
b. Securities fully paid for, pending delivery to clients;
c. Securities received for transfer or sent for transfer by the member, in the name of client
or his nominee(s);
d. Securities that are fully paid for and are held in custody by the Member as security/
margin etc. Proper authorisation from client for the same shall be obtained by the
member;
e. Fully paid for client’s securities registered in the name of member, if any, towards margin
requirement, etc.
The member brokers need to make the payment to their clients or deliver the securities
purchased within two working days of payout unless the client has requested otherwise. It is also
compulsory for the member broker to issue the contract note to the client for its purchase or sale
within twenty four hours of the execution of the contract. We will here further discuss the other
things which fall under the ambit of the client‐broker relationship.

7.1.7.1 Requirement Relating to Dealings between Client and Stock Broker

Client registration documents are segregated into mandatory and non‐mandatory parts. Client
agreement, Know Your Client (KYC) and the Risk Disclosure Document (RDD) constitute the
mandatory part. For registration of a client, along with the client application form, the client
agreement also needs to be filled. The agreement should cover details of all issues that clearly
define the relationship and the extent of liabilities between the client and the trading/clearing
member. The following areas are necessarily needed to be included in the agreement, however
additional clauses may also be inserted by the Exchange or the Broker:
 In case there in any change in the information provided by the client to the member at
the time of opening the account, the client shall immediately notify the member of such
change in writing.
 The agreement shall clearly specify the client’s responsibility for all investment decisions
and his complete understanding of the risks involved in trading of various derivatives
contracts. The member shall ensure that the client has read and signed the Risk Disclosure
Document (RDD).
 The agreement shall specify the nature of services provided by the broker e.g. trading
facilities, clearing facilities, advisory services, portfolio management services etc.
 The agreement shall indicate the rate of brokerage/commission/fee charged by the
broker in respect of various services provided by the member. The broker shall not charge
brokerage more than the maximum brokerage permitted as per the rules, regulations and
bye‐laws of the Exchange /SEBI.
 The client’s liability to pay margins as required by the trading/ clearing member or
exchange or clearing corporation within the stipulated time should be clearly specified. It
should also be indicated that if the broker finds it necessary, he should be authorised to
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levy and collect the additional margins over and above those imposed by the Exchange
/Clearing Corporation and the client shall be liable to pay the margins within the
stipulated time.
 The broker shall have the authority to liquidate /close out positions of the client for non‐
payment of margins, outstanding debts etc. Any amount of loss would be charged to the
client in such an event.
 The money deposited by the client shall be kept in a separate account by the member,
distinct from his own account and cannot be used by the broker for himself or for any
purpose other than the purpose mentioned by the client.
 The agreement may contain any other additional provisions as considered necessary by
the broker/exchanges.

7.1.7.2 Know Your Client (KYC) Form

SEBI has made filing of the ‘Know Your Client (KYC)’ form mandatory for the clients vide its
circular12. The broker is required to ensure that the client fills up the KYC, along with the ‘Client
Agreement and the Risk Disclosure Document’. In the KYC, the broker should ensure complete
details of client information, bank and depository account details, financial details of the
constituent, investment / trading experience, references, financial documents and signature of
the client are provided. The photograph, proof of address and identity and the Board resolution
for corporate clients permitting trading in derivative products are also required as a part of the
KYC. Clients should also indicate the segments in which they would like to transact.
SEBI introduced the usage of a uniform KYC process across all registered intermediaries through
the SEBI {KYC (Know Your Client) Registration Agency (KRA)}, Regulations, 2011. KRA acts as a
centralised KYC record keeping agency in the securities markets. The KYC details of the clients are
uploaded on the system of KYC Registration Agency by the intermediaries. This information is
available to all the SEBI registered intermediaries and can be accessed at the time of dealing with
the client. This has reduced the duplication of work.

Centralised KYC Registration Agencies (KRA)
Vide Notification dated November 26, 2015, the Government of India authorised the Central
Registry of Securitisation and Asset Reconstruction and Security Interest of India (CERSAI) to act
as and to perform the functions of the Central KYC Record Registry under the PML Rules 2005,
including receiving, storing, safeguarding and retrieving the KYC records in digital form of a
client.13
As per the 2015 amendment to PML (Maintenance of Records) Rules, 2005 every reporting entity
shall capture the KYC information for sharing with the Central KYC Records Registry (CKYCR) in the
manner mentioned in the Rules as per the KYC template for ‘individuals’ finalised by CERSAI.
Accordingly the KYC template finalised by CERSAI has to be used by the registered intermediaries
as Part I of the Account Opening Form for individuals. The registered intermediaries shall upload
the KYC data with Central KYC Records Registry (CKYCR) in respect of all individual accounts
12
SEBI circular ref. no. CIR/MIRSD/16/2011, dated August 22, 2011.
13
Client as defined in clause (ha) subsection (1) of Section 2 of the Prevention of Money Laundering Act,
2002 DATED November 2015.
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opened on or after August 1, 2016 where KYC is required to be carried out as per the circulars
issued by SEBI from time to time. Some of the key functions of Central KYC Registry have been
mentioned below:
 It shall be responsible for electronically storing, safeguarding and retrieving the Know
Your Customer (KYC) records and making such records available online to reporting
entites or Director.
 Information updated about a customer shall be disseminated on request by Central KYC
Registry to any reporting entity that avail the services of the Central KYC Registry in
respect of the customer.
 The services of the Central KYC Registry will be available on payment of prescribed fee, in
advance.
 It shall process the KYC records received from a reporting entity for deduplication and
issue a unique KYC Identifier for each client to the reporting entity.
Where a customer submits a KYC identifier to a reporting entity, then such reporting entity shall
download the KYC records from the Central KYC Registry by using the KYC Identifier and shall not
require a customer to submit the documents again unless:
 There is a change in the information of the customer as existing in the records of Central
KYC Registry.
 The current address of the client is required to be verified.
 The reporting entity considers it necessary in order to verify the identity or address of the
client, or to perform enhanced due diligence or to build an appropriate risk profile of the
client.
7.1.7.3 Risk Disclosure Document (RDD)

In order to familiarize the investors or the clients, the broker members are required to sign a risk
disclosure document (RDD) with their clients, informing them of the various risks associated with
trading in derivatives. The text of the RDD is provided in the regulations however, the exchanges
may also prescribe any additional disclosure requirements which are considered necessary by
them. RDD is mandatory for every client as per SEBI regulations.

7.1.7.4 Uniform Documentary Requirements for Trading

SEBI has prescribed the uniform formats of client registration form and broker client agreement
vide its circular no. SMD/Policy/Cir/5‐97 dated April 11, 1997. Additionally the format of the
broker‐sub‐broker agreement and the model format of the RDD was also prescribed by SEBI vide
its circulars issued from time to time. In order to bring about uniformity in documentary
requirements across different segments and exchanges and also to avoid duplication and
multiplicity of documents, SEBI in consultation with the exchanges has formulated uniform set of
documents which are as listed below:
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1. Client Registration Form: Uniform across all the segments and exchanges where the
broker is trading on different segments and exchanges.
2. Member Clients Agreement: Uniform across all exchange. However, a separate
agreement in the same format would be required for each of the exchanges where the
broker is trading on different exchanges.
3. Uniform Risk Disclosure Documents
4. Broker‐Sub‐broker Agreement
Though the aforementioned are the model formats, the stock exchange or the stock broker
may incorporate any additional clauses in the documents provided they are not in conflict
with any of the clauses in the model document, as also the Rules, Regulations, Articles, Bye‐
laws, Circulars, Directives and Guidelines.
The requirement of obtaining the client registration form may be waived for SEBI registered,
Mutual Funds (MFs), Venture Capital Funds (VCFs) and Foreign Venture Capital Investors
(FVCIs), Scheduled Commercial Banks (SCBs) etc.
7.1.7.5 Execution of Power of Attorney

The Power of Attorney (PoA) is a document that is executed by the client in favour of the stock
broker/sub‐ broker and depository participant to authorise the broker to operate the clients
demat account and bank account to facilitate the delivery of shares and pay‐in and pay‐out of
funds. In other words, the POA enables the stock broker to legally execute contracts on behalf of
the client. Generally the POA is taken from the clients who want to avail internet based trading
services. SEBI in order to standardise the norms, has prescribed guidelines to be followed by the
stock brokers /depository participants while obtaining POA.

POA favouring Stock Brokers

POA executed in favour of a stock broker by the client should be limited to the following:

1. Securities
i. Transfer of securities held in the beneficial owner account(s) of the client(s) towards
stock exchange related margin /delivery obligations arising out of trades executed by
the client(s) on the stock exchange through the same broker.
ii. Pledge the securities in favour of the stock broker for the limited purpose of meeting
the margin requirements of the client(s) in connection with the trades executed by
the clients on the stock exchange through the same broker. According to SEBI circular
dated June 22 2017, pledge of securities is permitted only if the same is done through
the depository system in compliance with regulation 58 of the SEBI (Depositories
and Participants) Regulations,1996.” Audit trail should be available with the stock
broker for such transactions.
iii. To apply for various products like MFs, public issues etc. pursuant to the instructions
of the client. However necessary audit trail should be maintained by the stock broker
to prove that the necessary application /act was made /done pursuant to receipt of
instruction from client.

2. Funds
i. Transfer of funds from the bank account(s) of the clients for the following:
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a. For meeting the settlement obligations of the client(s)/margin requirements of
the client(s) in connection with the trades executed by the clients on the stock
exchange through the same stock broker.
b. For recovering any outstanding amount due from the client(s) arising out of
clients trading activities on the stock exchanges through the same stock broker.
c. For meeting obligations arising out of the client subscribing to such other
products/facilities/services through the stock broker like MFs, public issues etc.
d. Towards monies/fees/charges etc. due to the stock broker /depository
participant payable by virtue of the client using /subscribing to any of the
facilities/services availed by the client at his/her instance.
All necessary audit trail should be available with the stock broker for any such transaction.
7.1.7.6 Unique Client Code (UCC)
It is mandatory for the broker to use the unique client code for all its clients. For this purpose the
broker shall collect and maintain in their back office the Permanent Account Number (PAN)
allotted by the Income Tax Department for all their clients. In case of other entities –
 Brokers shall verify the documents with respect to the unique code and retain a copy of
the document.
 The brokers shall also be required to furnish the above particulars of their clients to the
stock exchanges /clearing corporations and the same needs to be updated on a monthly
basis. Such information for a particular month should reach the exchange within seven
working days of the following month.
7.1.7.7 Contract Note
As already mentioned above, the trading member / broker have to ensure that the contract notes
are issued in the prescribed format within 24 hours of execution of the trades on the exchanges.
Copies of the contract and the proof of delivery/despatch are also to be maintained by the broker.
The contract notes should contain the signature of the authorised person, the UCC and PAN
details along with the trade price at which the trade was executed and the brokerage charged.
The contract number should also have a running serial number. The details of the dealing office
through which the deal was transacted and the PAN number of the trading member / broker
should also be mentioned on the contract note.

7.1.7.8 Electronic Contract Note

The contract notes can be issued by the brokers in electronic form authenticated by means of
digital signatures. All the members of the stock exchanges who are desirous of issuing Electronic
Contract Notes (ECNs) to their clients shall comply with the following conditions:‐
i. Issuing ECNs when specifically consented: The digitally signed ECNs may be sent only to
those clients who have opted to receive the contract notes in an electronic form, either
in the member‐client agreement /tripartite agreement or by a separate letter.
ii. Where to send ECNs: The usual mode of delivery of ECNs to the clients shall be through
email. For this purpose, the client shall provide an appropriate email account to the
member which shall be made available at all times for such receipts of ECNs.
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iii. Requirement of digital signature: All ECNs sent through the email shall be digitally signed,
encrypted, non‐tamperable and shall comply with the provisions of the IT Act, 2000.
iv. Format: The format of the issuance of the ECN is prescribed by the stock exchange and
the brokers need to conform to it.
7.1.7.9 Quarterly Statement of Accounts

To avoid disputes arising between clients and brokers pertaining to payments due to / from the
clients, the trading members need to adhere to the following:
 Statement of accounts for funds and securities should be sent to all the clients in such a period
not exceeding 3 months (quarter) within 30 days of the expiry of such period.
 The statement should account for all the receipts and deliveries/ payments during the
relevant period and not only the details of the holding as at end of the period.
 Maintain proof of despatch of such account statements.
 An error reporting clause giving thirty day time to revert back also should be incorporated in
the account statement. However, in cases where members maintain running accounts of the
clients and need to settle the accounts periodically, the error reporting clause in the
statement of accounts is 7 days.
However, there is an exception to the requirement of sending quarterly statement of
accounts to institutional clients, where the trades are settled through custodians.
7.1.8 Direct Market Access
Direct Market Access (DMA) is a facility which permits the brokers to offer clients direct access to
the exchange trading system through the broker’s infrastructure without manual intervention by
the broker. This was brought into effect vide the SEBI circular (MRD/DoP/SE/Cir‐7/2008 dated
April 3, 2008). Some of the advantages offered by DMA are direct control of clients over orders,
faster execution of client orders, reduced risk of errors associated with manual order entry,
greater transparency, increased liquidity, lower impact costs for large orders, better audit trails
and better use of hedging and arbitrage opportunities through the use of decision support
tools/algorithms for trading. As per the SEBI Circular, DMA facility was initially restricted to
institutional clients only. However the DMA facility has now been extended to the Foreign
Portfolio Investors (category I, II & III), Body Corporates and Primary Dealers also. 14

7.1.8.1 Operational Specifications

The broker should ensure sound audit trail for all the DMA orders and trades and be able to
provide identification of actual user‐id for all such orders and trades. The audit trail data should
also be available for at least 5 years. The DMA system shall have sufficient security features
including password protection for the user ID, automatic expiry of passwords at the end of a
reasonable duration and re‐initialisation of access on entering fresh passwords.

All DMA orders are tagged with unique identifiers as prescribed by the stock exchanges in order
to establish the audit trail.
14
SEBI Circular Ref. No. CIR/MRD/DP/9/2015 Dated May 26, 2015.
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7.1.8.2 Client Authorization
Brokers shall specifically authorise clients for providing DMA facility after fulfilling Know Your
Client (KYC) requirements and carrying out due diligence regarding clients credit worthiness, risk
taking ability, track record of compliance and financial soundness. Broker shall ensure that only
those clients who are deemed fit and proper for this facility are allowed access to the DMA facility.
Brokers shall maintain proper records of such due diligence. Brokers are required to provide to
the client or investment manager acting on behalf of a client availing the DMA facility with the
“Terms and condition” document.
7.1.8.3 Cross Trades
It is also to be noted that the brokers using DMA facility for routing client orders shall not be
allowed to cross trades of their clients with each other. All orders must be offered to the market
for matching.
7.1.8.4 Brokers liability
The broker shall be fully responsible and liable for all orders emanating through their DMA
systems. It shall be the responsibility of the broker to ensure that only clients who fulfil the
eligibility criteria are permitted to use the DMA facility.
7.1.8.5 Risk Management and Margin Requirements
Risk Management
DMA orders will be subjected to trading limits/exposure limits / position limits. DMA orders shall
be subjected to the following limits through automated risk management systems at the broker
end before being transmitted to the stock exchange systems:

 Order quantity / order value limit in terms of price and quantity specified for the client.
 All the position limits which are specified in the derivatives segment as applicable.
 Net position that can be outstanding so as to fully cover the risk emanating from the
trades with the available margins of the specific client.
 Appropriate limits for securities which are subject to FPI limits as specified by RBI.
Margins
SEBI circular requires the members / brokers to have a prudent system of risk management which
needs to be well documented in writing and be made accessible to the clients and the exchange.
The members have to ensure collection of margins and maintenance of margins in the approved
mode from the clients. Information related to margin applicable, utilised and required / balance
in respect of each client should be furnished to the client on a daily basis.
7.1.9 Algorithmic Trading
SEBI vide CIR/MRD/DP/09/2012 dated March 30, 2012 and CIR/MRD/DP/16/2013 dated May 21,
2013 has specified the guidelines for algorithmic trading. As per the circular, algorithmic trading
includes any order that is generated using automated execution logic.
7.1.9.1 Technology requirement
Stock Exchanges should:
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 Have procedures and system capability to manage the load on their systems to ensure
consistent and uniform response time to brokers.
 Whenever necessary undertake system up‐gradation to ensure speed of trade and
volume of data increased due to algorithmic trading.
 Put in place effective economic disincentives with regard to high daily order‐to‐trade ratio
of algo orders of the stock broker.
 Put in place monitoring systems to identify and initiate measures to impede any possible
instances of order flooding by algos.
7.1.9.2 Risk Management Requirement
Brokers’ system should have minimum order level risk controls such as:
 Price check: Orders should be within the price band specified by exchange or dummy
limits set up.
 Quantity and value limit check: Should not exceed maximum permissible order quantity
and order value set up by the stock exchanges.
 Stock Exchanges should have mechanism to identify dysfunctional algos and take
measures to disable them and remove outstanding orders originating from such algos.
 Cumulative Open Order Value check: Check on total value of unexecuted orders released
from the stock broker system for a single client.
 Automated Execution check– An algo shall account for all executed, unexecuted and
unconfirmed orders, placed by it before releasing further order(s) and capability to stop
release of further order in the event of the system going into loop.
 All algorithmic orders are tagged with a unique identifier provided by the stock exchange
in order to establish audit trail.
7.1.9.3 Stock broker requirements
Stock broker should:
 Have proper procedures, systems and technical capability to carry out trading through
the use of algorithms
 Have procedures and arrangements to safeguard algorithms from misuse or unauthorised
access.
 Have real‐time monitoring systems to identify algorithms and inform stock exchanges
immediately of any such incidence.
 Maintain logs of all trading activities to facilitate audit trail.
 Maintain record of control parameters, orders, trades and data points emanating from
trades executed through algorithm trading.
 Inform the stock exchange on any modification or change to the approved algos or
systems used for algos.

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Review Questions

1. The application for registration by a sub‐broker is required to be accompanied by a
recommendation letter from____________?
(a) Stock Exchange
(b) Stock Broker
(c) SEBI
Ans: (b)
2. Is the Stock broker required to pre‐intimate SEBI about shifting the location where it keeps its
books of accounts? State Yes or No.
(a) Yes
(b) No
Ans: (b)
3. A Stock Broker when dealing with a client must disclose whether it is acting as a Principal

/Agent. State whether True or False.
(a) True
(b) False
Ans: (a)
4. Statement of accounts for funds and securities should be sent to the client on what basis?

(a) Quarterly
(b) Annually
(c) Once in six months
(d) Fortnightly
Ans: (a)
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Chapter 8 Introduction to Stock Broking Operations



 Trade life cycle
 Front office, middle office and back office operations

 Margin trading

 Securities Lending and Borrowing Program

8.1 Trade Life Cycle

The transaction taking place to buy or sell securities is called “Trade”. A trade is the conversion of
an order placed on the exchange which results into pay‐in and pay‐out of funds and securities.
Trade ends with the settlement of the order placed.
 Trade in financial market means transaction to buy or sell securities.
 It originates with 2 orders, one from the buyer and another from the seller.
 When there is a match between the expectations of the buyer and the seller, the order
culminates into a trade.
o A single order (say buy order) can match with one or more orders (say sell orders)
thus resulting in multiple trades.
 Subsequent to trade execution, securities and funds are exchanged between the buyer
and the seller.
 All activities prior to matching of orders are called pre‐trade activities.
 All activities which take place subsequent to trade matching are called post‐trade
activities.

A snapshot of a typical trade life cycle is given in figure 8.1.

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Figure 8.1: A typical Trade Life Cycle

In order to fulfil a client’s request to buy or sell a security, the following steps are involved:
 Placing of the Order
 Risk management and routing of order
 Order matching and its conversion into trade
 Confirmation for institutional trade
 Clearing and settlement

These steps can be grouped into activities pertaining front office, middle office and back office of
a brokerage firm.
8.2 Front Office Operations

Front office operations consist of the following activities:
 On boarding the client
o Client Registration Form/ Know Your Client
o Unique Client Code
o Risk Disclosure Document
 Order Management
8.2.1 Client On‐Boarding
Client on‐boarding process includes:

 Account opening
 Know your Client process (KYC) and In person Verification (IPV)
 Member – Client Agreement
 Unique Client Code (UCC)
 Risk Disclosure Document
The detailed process is discussed below.
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8.2.1.1 Account Opening Process

The stock broker is required to make available a folder/book containing all the documents
required for registration of a client. The folder/book should have an index page listing all the
documents contained in it and indicating briefly the significance of each document.
SEBI has devised the uniform documentation to be followed by all the stock brokers / trading
members. Details of such documents are as follows:
 Index of documents giving details of various documents for client account opening.
 Client Account Opening Form which comes in two parts:
o Know Your Client (KYC) form.
o Document capturing additional information about the client.
 Document stating the rights and obligations of stock broker, sub‐broker and client for
trading on exchanges (including additional rights and obligations in case of internet /
wireless technology based trading).
 Uniform Risk Disclosure Documents (for all segments / exchanges).
 Guidance note detailing do’s and don’ts for trading on exchanges.

Apart from the above, the stock broker provides the following additional information to the
clients:
 A tariff sheet specifying various charges, including brokerage, payable by the client to
avoid any disputes at a later date.
 Document describing the Policies and Procedures of the stock broker.
 Information on contact details of senior officials within the stock broking firm and investor
grievance cell in the stock exchange, so that the client can approach them in case of any
grievance.
The folder/ book for account opening will have two parts: (a) Mandatory and (b) Non‐mandatory
Mandatory Documents
Mandatory documents consist of:
1. Client account opening form
2. Rights and obligations
3. Uniform risk disclosure documents
4. Guidance note on Do’s and Don’ts
5. Policies and procedures
6. Tariff sheet
Non – Mandatory Documents
Non mandatory documents could consist of:
 Any voluntary clause, terms and condition or document not in conflict with mandatory
clauses/document, rules, regulations, byelaws, circulars, directives and guidelines by SEBI
and Exchanges.
Members should make available the documents relating to rights & obligations, uniform risk
disclosure, do’s & don’t guidance note to the clients (registered after August 01, 2016) and
maintain appropriate logs in case the documents are sent electronically to the clients. Also they
should display the documents on their website in vernacular language.

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Client Account Opening Form
Client account opening form will have 2 parts:
 Know Your Client (KYC) form capturing the basic information about the client and
instruction/check list to fill up the form
 Document capturing additional information about the client related to trading account
The client will be required to sign the account opening form and also indicate preferences for
trading in different exchanges / segments. Investor should give specific authorisation to the stock
broker for availing running account facility, execution of power of attorney etc.
SEBI has prescribed a new simplified Account Opening Form ('AOF') or 'SARAL AOF' for new
individual investors participating in the cash segment of the Exchange but not availing facilities
such as internet trading, margin trading, derivative trading and use of power of attorney.

8.2.1.2 Know Your Client (KYC) and In Person Verification (IPV)
Know Your Client (KYC)
KYC is an acronym for “Know your Client”, a term commonly used for Customer Identification
Process. SEBI has prescribed certain requirements relating to KYC norms for Financial Institutions
and Financial Intermediaries including Mutual Funds and Stock Brokers to ‘know’ their clients.
This entails verification of identity and address, financial status, occupation and such other
personal information as may be prescribed by guidelines, rules and regulation. SEBI in
consultation with Unique Identification Authority of India (UIDAI) now allows brokers to accept e‐
KYC service provided by UIDAI as a valid process for KYC verification15.

The broker must ensure that the clients fill‐up the KYC form and submit it to them. There are
separate forms for individuals and non‐individuals. Brokers must also ensure that the following
documents are submitted along with the KYC forms by the clients.

PAN Card: The photocopy of the PAN card with original. The original PAN card is for verification
only and will be returned to the client immediately. Certain exemptions have also been issued by
SEBI in specific cases which are mentioned here after sufficient documentary evidence in support
of such claims are collected:
i. In case of transactions undertaken on behalf of Central Government and / or State Government
and by Officials appointed by Courts e.g. Official Liquidator, Court receiver etc.
ii. Investors residing in the state of Sikkim.
iii. UN entities / multilateral agencies exempt from paying taxes / filing tax returns in India.
iv. SIP of Mutual Funds upto Rs. 50,000 per annum.
v. In case of institutional clients, namely, FPIs, MFs, VCFs, FVCIs, Scheduled Commercial Banks,
Multilateral and Bilateral Development Financial Institutions, State Industrial Development
Corporations, Insurance Companies registered with IRDAI and Public Financial Institutions as
defined under section 4A of the Companies Act, 1956, Custodians shall verify the PAN card details
15
SEBI Circular No: CIR/MIRSD/ 09/ 2013 October 8, 2013
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with the original PAN card and provide duly certified copies of such verified PAN details to the
intermediary.

Proof of Address: List of documents is given hereunder, however documents having an expiry
date should be valid on the date of submission:
i. Passport/Voters Identity Card/Ration Card/Registered Lease or Sale agreement of
Residence /Driving license/Flat Maintenance Bill /Insurance Copy.
ii. Aadhaar letter issued by UIDAI.
iii. Utility bills like Telephone bill (only landline), Electricity bill or Gas bill‐‐Not more than 3
months old.
iv. Bank account statement /Passbook –Not more than 3 months old.
v. Self‐declaration by High Court and Supreme Court judges, giving the new address in
respect of their own accounts.
vi. Proof of address issued by any of the following: Bank managers of Scheduled commercial
Banks/Scheduled Co‐operative Banks/Multinational Foreign Banks/Gazetted
Officer/Notary public/Elected representatives to the legislative
assembly/Parliament/Documents issued by any Government or statutory Authority.
vii. Identity card /document with address. Issued by any of the following: Central /State
Government and its departments, statutory /Regulatory authorities, Public Sector
Undertakings, Scheduled Commercial Banks, Public Financial Institutions, Colleges
affiliated to universities and Professional Bodies such as ICAI, ICWAI, ICSI, Bar Council etc
to their members.
viii. For FPI / Sub account, Power of attorney given by FPI / Sub‐account to the custodians
(which are duly notarized and /or apostiled or consularised) that gives the registered
address should be taken.
ix. The proof of address in the name of the spouse may also be accepted.

Proof of Identity: The following documents are considered admissible as proof of Identity:
i. Unique Identification Number (UID) (Aadhaar)/ Passport/Voter ID Card/Driving License.
ii. PAN card with photograph
iii. Identity card/documents with applicants photo, issued by any of the following:
Central/State Government and its departments, Statutory/Regulatory Authorities, Public
sector Undertakings, Scheduled Commercial Banks, Public Financial Institutions, Colleges
Affiliated to Universities, Professional Bodies such as ICAI, ICWAI, ICSI, Bar council etc., to
their Members; and credit cards/Debit cards issued by banks.
If the proof of identity or address is in a foreign language, then translation into English is required.
In Person Verification (IPV) is also required to be made by the broker or by the person authorised
by him of each new client added on the books.
The client must also have a valid bank account from which transactions can be made for pay‐

in/out of funds. The details are to be given with the KYC. A cancelled cheque leaf with a copy of
the bank account statement/pass book should also be submitted at the time of opening the
trading account. This bank account will be mapped to the client’s trading account and thereafter,
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generally, payment will be accepted only from this account. A client can map more than one bank
account also, but should provide the proof of the same. The client must have also opened a demat
account with a DP for pay‐in/out of securities. A copy of the client master given by the respective
DP to the client should be submitted to the broker at the time of opening the trading account.
Normally the client prefers to open both trading and demat account with the same broker. In that
case the client is willing to give Power of Attorney (POA) in favour of the broker for smooth
functioning. SEBI has stipulated certain formats and stipulations with respect to POA to be
followed by the broker.
To facilitate smooth settlement of client’s account at periodic interval, instead of exchanging
cheques for each transaction, SEBI has approved brokers to collect running authority letter from
the client. However, the broker should settle the accounts at least once a quarter or earlier as per
the client preference.

In Person Verification (IPV)
SEBI vide letter no. MIRSD/DPS‐III/130466/2008 dated 2nd July 2008 has issued instructions to
the stock exchanges, that it shall be the responsibility of the stock broker to satisfactorily identify
his clients and to ensure in‐person verification by his own staff while registering clients and keep
complete audit trail for the same. SEBI has also mentioned that it would be stock brokers’
responsibility to provide client details as and when required.
Accordingly, stock brokers are required to ensure ‘in‐person’ verification by their own staff only
while registering the clients. Name and signature of the official who has done in‐person
verification and the stamp of the member should be incorporated in the client registration form.
In case of Stock brokers, their sub‐brokers or authorised Persons can perform the IPV.

8.2.1.3 KRA Agency (Know Your Client Registration Agency):
The members, after completing the client account opening procedures, are required to upload
the KYC details to the KRA agencies registered with SEBI. SEBI simplified the account opening
process for investors and made it uniform across intermediaries in the securities markets as
already mentioned above. Further, to avoid duplication of KYC process with every intermediary,
KRA system was developed for centralization of the KYC records in the securities markets. The
system was made applicable for new clients who opened accounts with the intermediaries from
January 1, 2012. The KRA is a centralized agency which maintains and makes available the
information provided by a client to an intermediary to comply with the KYC norms. Below
mentioned box details the guidelines for Intermediaries for KYC registration as given in the SEBI
(KRA) Regulations.

Guidelines for intermediaries
 Once the initial KYC of the new clients are done, the intermediary shall immediately upload
the KYC information on the system of the KRA and send the KYC documents (KYC application
form and supporting documents of the clients) to the KRA within 10 working days from the
date of execution of documents by the client and maintain the proof of dispatch.
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 In case a client’s KYC documents which have been sent to KRA is incomplete, the same shall
be communicated to the intermediary who shall forward the required information /
documents promptly to KRA.
 While uploading the clients’ data the intermediary shall ensure that there is no duplication of
data in the KRA system.
 The intermediary shall carry out KYC when the client chooses to trade/ invest / deal through
it.
 The intermediary is also required to follow the risk based due diligence approach. Also they
are required to conduct ongoing client due diligence based on risk profile and financial
position of the clients as prescribed by SEBI.
 The intermediaries shall also maintain electronic records of KYCs of clients and keeping
physical records would not be necessary. It shall promptly provide KYC related information to
KRA, as and when required.
 The intermediary shall have adequate internal controls to ensure the security /authenticity of
data uploaded by it.
8.2.1.4 Central KYC Records Registry
Government of India has authorized the Central Registry of Securitization and Asset
Reconstruction and Security interest of India (CERSAI), to act as, and to perform the functions of,
the Central KYC Records Registry under the PML Rules 2005, including receiving, storing,
safeguarding and retrieving the KYC records in digital form of a “client”. Accordingly, SEBI
amended its KYC directives and notified implementation of Central KYC Records Registry (CKYCR)
for all new individual clients on‐boarded w.e.f August 1, 2016. Registered intermediaries are
required to upload the KYC data with CKYCR, in respect of all individual accounts opened on or
after August 1, 2016, wherever KYC is required to be carried out as per the circulars issued by SEBI
from time to time and accordingly, shall take steps to prepare their systems for uploading the KYC
data.16 Also, members were given a window till December 31, 2016 to upload the KYC data of
individual clients registered prior to August 01, 2016. (CKYCR has been discussed in detail in
Chapter 7).
The e‐KYC service launched by UIDAI is accepted as a valid process for KYC verification, provided
the client has authorized the intermediary to access his data through UIDAI system.
8.2.1.5 Rights and Obligations (Member – Client Agreement)
SEBI with a view to simplify and rationalize the account opening process, had reviewed,
consolidated and updated all the documents/requirements prescribed in respect of account
opening process over the years. The simplification includes replacement of all client‐broker
agreements with the “Rights and Obligations‟ document, which shall be mandatory and binding
on the existing and new stock brokers (including trading members) and clients.
The core points of the “Rights and Obligations” document are:
16
SEBI Circular Ref. No. CIR/MIRSD/66/2016 dated July 21, 2016.
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Key points
 Stock Broker, sub broker and the client bound by rules, bye laws, regulations, circulars
issued by Stock Exchange, SEBI and Government authorities.
 Client to satisfy itself of the broker’s capability to deal in derivatives contracts.
 Stock broker to satisfy itself about the genuineness and financial soundness of the client
and its investment objectives.
Client information
 Client to furnish details as required in "Account Opening Form” and familiarise himself
with the mandatory provisions.
 Notify changes immediately in writing for any change in information submitted in
“Account opening form”.
 Stock Broker / Sub broker to maintain details of the clients confidentially.
Margins
 The client shall pay initial margins, withholding margins, special margins or such other
margins as applicable.
Transactions and settlement
 The client shall give any order for buy or sell of a security/derivatives contract in writing
or in such form or manner, as may be mutually agreed between the client and the stock
broker.
 The stock broker shall ensure to place orders and execute the trades of the client, only in
the Unique Client Code assigned to that client.
 Stock broker to keep client money/security in a separate account.
 Trades executed on the Exchange shall be subject to the jurisdiction of such court as
specified in the byelaws and regulations of the Exchange.
Brokerage
 Client to pay brokerage and statutory levies as prevailing from time to time.
 Stock broker not to charge brokerage more than the maximum brokerage permissible.
Liquidation and close out of position
Client understands that the stock broker shall be entitled to liquidate/close out all or any of the
client's positions for non‐payment of margins or other amounts, outstanding debts, etc
Dispute resolution
 The stock broker shall provide the client with the relevant contact details of the
concerned Exchanges and SEBI.
 The stock broker shall co‐operate in redressing grievances of the client
Termination of relationship
 The relationship between the stock broker and the client shall be terminated, if the stock
broker for any reason ceases to be a member of the stock exchange including cessation
of membership by reason of the stock broker's default, death, resignation or expulsion or
if the certificate is cancelled by the Board.
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 The stock broker, sub‐broker and the client shall be entitled to terminate the relationship
between them without giving any reasons to the other party, after giving notice in writing
of not less than one month to the other parties.
Additional rights and obligations
 The stock broker and client shall reconcile and settle their accounts from time to time (as
specified).
 The stock broker shall issue a contract note to his constituents for trades executed in such
format as may be prescribed by the Exchange.
 In case facsimile signatures (scanned signatures) are used on physical contract notes,
Members should have a well‐documented policy regarding its use duly approved by
appropriate authorities.
 The stock broker shall make pay out of funds or delivery of securities, as the case may be,
to the client within one working day of receipt of the payout from the relevant Exchange.
 The stock broker shall send a complete `Statement of Accounts’ for both funds and
securities in respect of each of its clients in such periodicity and format within such time,
as may be prescribed by the relevant Exchange, from time to time.
 The stock broker shall send daily margin statements to the clients.
Electronic contract notes (ECN)
In case, client opts to receive the contract note in electronic form, he shall provide an appropriate
e‐mail id to the stock broker. The client shall communicate to the stock broker any change in the
email‐id through a physical letter. If the client has opted for internet trading, the request for
change of email id may be made through the secured access by way of client specific user id and
password.
The stock broker shall ensure that all ECNs sent through the e‐mail shall be digitally signed,
encrypted, non‐tamperable and in compliance with the provisions of the IT Act, 2000.
The client shall note that non‐receipt of bounced mail notification by the stock broker shall
amount to delivery of the contract note at the e‐mail ID of the client.
Law and Jurisdiction
In addition to the specific rights set out in this document, the stock broker, sub‐broker and the
client shall be entitled to exercise any other rights which the stock broker or the client may have
under the Rules, Bye‐laws and Regulations of the Exchanges in which the client chooses to trade
and circulars/notices issued thereunder or Rules and Regulations of SEBI.
The stock broker and the client shall abide by any award passed by the Arbitrator(s) under the
Arbitration and Conciliation Act, 1996. The parties to the arbitration have right to appeal.
Internet and wireless technology based trading facility
Stock broker is eligible for providing this trading facility and shall comply with all requirements
applicable to internet based trading/securities trading using wireless technology as may be
specified by SEBI and the Exchanges from time to time.
The stock broker shall bring to the notice of client the features, risks, responsibilities, obligations
and liabilities associated with securities trading through wireless technology/internet/smart order
routing or any other technology.
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Policies and Procedures
The policies and procedures document should contain the following:
 Refusal of orders for penny stocks.
 Setting up client’s exposure limits.
 Applicable brokerage rate.
 Imposition of penalty / delayed payment charges by either party specifying the rate and
the period. The same should not result in funding.
 The right to sell client’s securities or close client’s position without giving notice to the
clients on account of non‐payment of client’s dues limited to the extent of settlement /
margin obligation.
 Internal Shortage.
 Conditions under which a client may not be allowed to take further position or the broker
may close the existing position.
 Temporarily suspending or closing a client’s account at the client’s request and
deregistering a client.

8.2.1.6 Unique Client Code
Once the formalities of KYC and other details thereon are complete, each client is assigned a
unique client code (UCC) by the broker. This acts as an identity for the client with respect to the
broker. SEBI has made it mandatory for all the brokers to use unique client codes for all clients
while entering orders on their behalf. It is also mandated by SEBI, that the unique client code be
mapped with the PAN number of the client. The broker has to inform the exchange the UCC and
the PAN details of the clients through an upload before entering into any trade for the client. If
the broker fails to register the unique client code with the exchange, he is liable to be penalized.
8.2.1.7 Risk Disclosure Document
In order to familiarize the investors or the clients, the broker members are required to sign a risk
disclosure document (RDD) with their clients, informing them of the various risks associated with
equities and derivatives trading. The text of the RDD is provided in the regulations however, the
exchanges may also prescribe any additional disclosure requirements which are considered
necessary by them. RDD is mandatory for every client as per SEBI regulations.
8.2.2 Order Management
Once the client has on‐board, he/she is ready to place orders through the broker to buy / sell
securities on the Stock Exchange. As per Exchange regulations and SEBI circular no:
SMD/Policy/IECG/1‐97 dated February 11, 1997, stock broker should maintain record of time
when the client has placed the order and reflect the same in contract note along with the time of
execution of the order.
A client can place order through various means viz., in writing, via telephone, through internet
trading terminal or through mobile phones. In case of institutional trades, they are permitted to
place order through Direct Market Access (DMA).
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8.2.2.1 Internet Based Trading (IBT) and Securities Trading using Wireless Technology
(STWT)

Investor may also place order using an internet trading terminal or mobile phones. Orders placed
through the IBT system go through automated risk management validations, before being
transmitted to the Stock Exchange systems. Once the order is accepted/trade executed, the
investor gets notification on their IBT terminals.
SEBI vides circular no: SMDRP/Policy/CIR‐06/2000 dated January 31, 2000 had specified the rules
relating to IBT and vide circular no: CIR/MRD/DP/25/2010 dated August 27, 2010 for STWT.
The core requirements are as follows:
 Stock Brokers wishing to offer IBT need to seek Stock Exchange approval and should have
a minimum net worth of Rs.50 lakhs.
 The broker should capture the IP (Internet Protocol) address (from where the orders are
originating).
 The brokers system should have built‐in high system availability to address any single
point failure.
 There should be secure end‐to‐end encryption for all data transmission between the
client and the broker through a Secure Standardized Protocol.
 A procedure of mutual authentication between the client and the broker server should
be implemented.
 The broker system should have adequate safety features to ensure it is not susceptible to
internal/ external attacks.
 In case of failure of IBT/ STWT, the alternate channel of communication shall have
adequate capabilities for client identification and authentication.
 In case of no activity by the client, the system should provide for automatic trading session
logout.
 The back‐up (on‐site and remote site) and restore systems implemented by the broker
should be adequate to deliver sustained performance and high availability.
 The following security features are mandatory for all Internet based trading systems:
a) User id
b) First Level password
c) Automatic expiry of passwords at the end of a reasonable duration. Re‐initialize
access on entering fresh passwords
d) All transaction logs with proper audit facilities to be maintained in the system.
e) Secured Socket Level Security for server access through Internet.
f) Suitable Firewalls between trading set‐up directly connected to an Exchange trading
system and the Internet trading set‐up.
8.2.2.2 Order placement and trade matching
Trading takes place on an electronic trading system on the exchange. An investor can choose
any of following types of orders:
 Limit order
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 Market order
 Stop Loss order
 Immediate or Cancel [IOC]
Limit order: In this case, the investor places the order with a specific price. It will be matched if a
corresponding buy / sell order with the same or better price exists in the market.
Market order: This is an order to buy or sell at the best price available in the market.
Stop loss order: Stop loss orders help to minimise loss in the event of an unusual market
movement. Stop loss orders carry two prices: Trigger price and limit price. Instead of limit price,
it can also be a market order. A stop loss order to buy (or sell) a security is released to the market
once the price of the security climbs above (or drops below) the trigger price.
Immediate or cancel (IOC): IOC order is an order to buy or sell shares that need to be executed
immediately upon placing the order. If not matched immediately, it will stand cancelled. If it is
partially matched, the remaining quantity will stand cancelled.
An electronic trading system allows the trader to perform/view the following functions:
 Order placement, modification and cancellation
 Trade execution – matching
 Trade modification and cancellation

Order entry, modification and cancellation:
While placing an order on the system, the following information is captured:
 Buy or sell
 Security name
 Quantity
 Price
 Client code
Once the order is received on the Exchange system, the broker/investor will get order
confirmation with unique order number which will also carry a timestamp. The order can be
modified before it is matched on the system. Similarly, it can also be cancelled before matching
takes place.

Trade execution
Trade execution takes place based on price time priority. Orders when entered are assigned a
unique order number and are time stamped.
Price‐time priority
 The best buy order/ best sell order will take priority over the next best buy/ next best sell
order.
 If there is more than one order with the same price, the order which came earlier will get
priority.
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 Best price for the buy order will be the order which has the highest price among the
orders which are available at that time of matching.
 Best sell order will be the order which is the lowest priced among the orders which are
available at the time of matching.
 This is called price‐time priority
Passive / active orders
 Orders are identified as active and passive orders.
 When a new buy or sell order is entered into the system, it is called the active order.
 Active order will try to match with a passive order.
 If a match is found, the trade execution takes place.
 When trade execution takes place, it is assigned the passive order price.
Other order matching rules
 An incoming active order may match with one or more passive orders based on price‐
time priority resulting in one or more trades.

Example:
Order book stacked in price‐ time priority
Buy quantity Buy price Sell price Sell quantity
450 850.25 850.30 300
823 850.15 850.40 850
1000 850.00 851.00 1000
1250 849.75 851.50 2000

When an active order for buying 400 shares @ Rs.850.45 is received, the matching will be as
follows:
 300 shares will be matched at Rs.850.30
 Balance 100 shares will be matched at Rs.850.40
8.3 Middle Office Operations

Middle office is managed by a separate team which is not involved in the order collection or the
settlement activity. Middle office, as the name suggests is in between the front and back office
functions. The core activities of the middle office team are:
 Setting risk limits and monitoring positions
 Carrying out surveillance activities

Risk Management

An efficient risk management system is integral to an efficient settlement system. The goal of a
risk management system is to measure and manage a firm's exposure to various risks identified
as central to its operations. For each risk category, the firm must employ procedures to measure
and manage firm‐level exposure. These are:
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Establish Standards and Reports: Every broker has a set of standards which they adhere to, and
these are the standards against which a client is measured. In general and not only among brokers,
certain standards must be met before rating a company or a client. These must be reported to
the management for their perusal and action.

Impose Position Limits and Rules: A key element of financial risk management is deciding which
risks to bear and to what degree. A firm needs to impose limits to cover exposures, and overall
position concentrations relative to systematic risks. SEBI and exchanges prescribe from time to
time Open position limit for various categories of investors in the Equity and Currency Derivative
segments.

Set Investment Guidelines and Strategies: A firm should outline investment guidelines and
strategies for risk taking in the immediate future in terms of commitments to a particular market
area, extent of asset‐liability mismatching, or the need to hedge against systematic risk at a
particular time. Risk management involves determining what risks a firm’s financial activities
generate and avoiding unprofitable risk positions. The board’s role is usually described as setting
the risk appetite of the organization; however this is not possible if risks are understated or ill
defined. Guidelines can advise on the appropriate level of active management, given the state of
the market and senior management's willingness to absorb the risks implied by the aggregate
portfolio.

Types of Risk

Operational risk is the risk of monetary loss resulting from inadequate or failed internal processes,
people and systems or external events. For the stock broker, operations risk is essentially risks
such as non‐payment, non‐delivery of scrip, denial of matched order by client/s, trading errors,
and sudden closure of banks where funds are deposited. The main risk arising from securities
activities is the market risk associated with proprietary holdings and collateral obtained or
provided for specific transactions.

Market risk refers to the possibility of incurring large losses from adverse changes in financial
asset prices such as stock prices or interest rates. This risk entails the erosion of value of
marketable securities and assets, due to factors beyond an enterprise’s control. Market risk is
usually affected by economic developments, political destabilization, rising fiscal gap, and
national debt, terrorism, energy price shocks, increase in interest rates, all resulting in a drop in
equity prices. It is mandatory for the brokers to collect adequate margin from its clients who trade
in Equity Derivative or Currency Derivative segment.

Regulatory risk occurs when the rules governing the securities industry are changed, giving rise
to potential loss. For example, the ‘customer first’ policy makes it difficult to trade house accounts
and therefore a broker may not be able to liquidate a position immediately, leading to potential
or actual loss. Regulatory requirement of brokers who need to maintain a higher net capital may
be hard to meet.

A stock broking firm must identify factors that can trigger operational, market, credit and
regulatory risks. It needs to establish procedures so that risk management begins at the point
nearest to the assumption of risks. This means adapting trade‐entry procedures, customer
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documentation, client engagement methods, trading limits, and other normal activities to
maintain management control, generate consistent data, and eliminate needless exposure to risk.

8.4 Back Office Operations

Broker back office performs the following main functions namely:
 Trade confirmation
 Computation of Brokerage
 Issuance of Contract notes
 Settlement of funds and securities
 Accounting

8.4.1 Trade related activities
8.4.1.1 Trade Enrichment
Trade Enrichment is performed automatically after each trade execution. In this step, all
necessary details for the clearing and settlement of securities for the cash market and settlement
of futures and option contracts are added. Trade enrichment is defined as process of including
additional information in one instruction in a trade which is already executed. Instructions can be
enriched either before or after matching. Instructions could include adding specific and relevant
data of settlement instruction, etc.

8.4.1.2 Updation of the security master file
This involves preliminary and confirmed information on securities issues in the form of a database
of electronic text files of securities information, including Reference Information such as security
type, instrument type, market symbol or ticker, security code, security description, issuer code,
maturity date, etc. This also includes custodian information such as location and type of custody.

8.4.1.3 Trade Allocation
In instances where a client has given the broker the consent in connection with the handling and
execution of the customer’s orders, the broker will allocate executions for the customer’s order
evenly on the basis of time priority and parity for participating orders. For example, hedge fund
makes a trade, and manages several portfolios. Often, they will choose to allocate their trade to
various portfolios for a number of reasons. Trade allocation specifically refers to this process, or
more specifically, how the trade is allocated (pro rata, all or nothing, etc).
A trade allocation system includes a computer system having a network interface over which
messages can be exchanged with an order management system. The computer system is also
coupled to a first database that stores data associating portfolios with different risk classes. A
second database stores instructions to configure the system to receive from order management
systems messages describing trades of financial instruments. Each message can include a financial
instrument identifier, a size of the trade, and a risk class identifier. The instructions also configure
the processor to query the first database for determining a portfolio that is associated with a risk
class identified by a risk class identifier in a message as well as to determine a target ratio for each
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of the portfolios. The processor then allocates the trade of the financial instrument among each
of the portfolios based on the target ratios. Allocating a trade of financial instruments among a
group of portfolios include receiving a message descriptive of a trade of a financial instrument.
The message can include a financial instrument identifier and a size of the trade. A collection of
portfolios are then identified based on a match between a risk class of the portfolio and the risk
class of the traded financial instrument. The trade is then allocated among each of the portfolios
based on a target ratio associated with each portfolio.

8.4.2 Brokerage

Brokerage firms have elaborate commission module (brokerage) to attract and retain clients.
Given below are the regulations for charging of brokerage.
 Brokerage rule for equity segment:
o Maximum brokerage is 2.5 percent of the trade value. For example, if the value
of share is Rs.10/‐ or less a maximum brokerage of 25 paise per share can be
collected.
o There is no minimum requirement.
 Brokerage rule for Futures and Options segment:
o Similar to equity segment except for options contract
o For options contracts, it can be 2.5 percent of the premium or Rs.100/‐ per
contract whichever is higher.

Trading member can be a full service broker, discount broker or online broker. Commission
charged can be different for different types of brokers.
 Full service broker charges higher commission
 Discount brokers charge a much lower commission
o They also don’t offer any other facility other than trading.
 Online brokers cater to niche segment of retail clients.
o Commission charged is lesser than what would be charged for a client placing
orders through a broker.
 Brokers also use multiple commission schemes such as
o Volume based commission
o Slab wise commission or
o Scrip wise commission.
Commission charges may differ for day square up versus delivery transactions.
8.4.3 Contract note
Contract note is a legal document issued by the broker to the client. It is a confirmation of the
trade executed by the broker on behalf of the client and legally enforceable with respect to the
transaction executed. It is a pre‐requisite document for filing an investor complaint / arbitration
proceedings.
Some of the key specifications relating to contract note are:
 Format of contract note is specified by the exchanges.
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 Contract note can be issued either in physical form or electronic mode.
 It should be issued within 24 hours from trade execution.
 Broker is required to maintain proof of issue of contract note to client.
 Should have running serial number initiated at the beginning of the financial year.
 Should be signed by authorised signatories.
 Rate specified in contract note should be same as trade confirmation slip.
 If contract note contains weighted average price for multiple trades arising out of single
order, individual trade details should be provided.
 Crucial information to be covered in the contract note are:
o Names of the authorized signatories
o The name, address, code no, SEBI Registration number of the Trading member
o Dealing / Main office details and address of the trading member
o Details of compliance officer
o Investor grievance contact details
o Security information / Contract Specification
o Original order placement time / order modification time
o Arbitration details
o Provision to print brokerage separately.
o The name, address, unique client code, PAN of the constituent
o Straight Through Processing (STP) is used in the case of institutional trades while
issuing ECN
8.4.3.1 Electronic Contract Note (ECN)

A Broker can also issue contract note in electronic form. For providing an Electronic Contract Note
(ECN), the client has to provide a signed consent letter. The client should also provide appropriate
email Id for receipt of ECN. Consent letter should also contain a clause that the client will intimate
the broker through physical letter in case of change in email Id. Broker should communicate to
the client that if there is no notification of bounced mail, it shall be considered that the contract
note has been delivered. ECNs should be encrypted and digitally signed. Log reports generated by
the system at the time of sending the contract notes are to be maintained. Log reports for non‐
delivered / rejected or bounced ECN should also be maintained. ECNs should be published on the
website of the broker. For ECNs published on the website, the access to retrieve ECNs is to be
enabled for clients by allotting a unique user name and password.
8.4.3.2 Straight Through Processing (STP)
Automation of the end to end processing of transactions is called STP and was introduced in Indian
markets in the year 2002. It involves use of a system to link front, middle, back office and General
Ledger. STP helps streamline processing across these systems and reduce settlement time and
eliminate errors. Institutional trades executed on the stock exchanges are required to be
processed through the STP System w.e.f July 01, 2004.
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8.4.4 Settlement
8.4.4.1 Procedure for receipt/payment of funds and securities from / to clients
SEBI vide its circular no. SEBI/MRD/SE/Cir‐ 33/2003/27/08 dated 27/08/2003 has specified
requirements relating to funds movement between broker / sub broker and their clients.
8.4.4.1.1 Funds
Brokers and sub‐brokers should not accept cash from the client whether against obligations or
as margin for purchase of securities and / or give cash against sale of securities to the clients. All
payments shall be received / made by the brokers from / to the clients strictly by account payee
crossed cheques / demand drafts or by way of direct credit into the bank account through EFT,
or any other mode allowed by RBI except where electronic payment fails/ rejected by the bank,
physical payment is permissible.

(a) If the aggregate value of pre‐funded instruments is Rs. 50,000 or more, per day per client,
the stock brokers may accept the instruments only if the same are accompanied by the
name of the bank account holder and number of the bank account debited for the
purpose, duly certified by the issuing bank. The mode of certification may include the
following:
I. Certificate from the issuing bank on its letterhead or on a plain paper with the
seal of the issuing bank.
II. Certified copy of the requisition slip (portion which is retained by the bank) to
issue the instrument.
III. Certified copy of the passbook/bank statement for the account debited to issue
the instrument.
IV. Authentication of the bank account‐number debited and name of the account
holder by the issuing bank on the reverse of the instrument.

(b) Maintain an audit trail of the funds received through electronic fund transfers to ensure
that the funds are received from their clients only.
The brokers shall accept cheques drawn only by the clients and also issue cheques in favour of
the clients only, for their transactions. However, in exceptional circumstances the broker or sub‐
broker may receive the amount in cash, to the extent not in violation of the Income Tax
requirement as may be in force from time to time.
8.4.4.2 Settlement of funds and securities – Running account
Settlement of funds and / or securities shall be done within 1 working day of the payout, unless
client specifically authorizes the broker / trading member in writing to maintain a running
account. Clients whose funds and securities are maintained on a running account basis have to be
settled by members on a monthly / quarterly basis as per the client preference.

In case a client wishes to maintain a running account for its funds and securities with the trading
member, the client has to authorize the broker/trading member in writing to retain its funds and
securities. Such authorization should also contain:
 Preference of the client as to whether the settlement of funds and securities should be
done on a monthly or quarterly basis.
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 A clause stating that the client may revoke the authorization at any time (i.e. without
notice). Accordingly, the actual settlement of funds and securities shall be done by the
member at least once in a calendar quarter or month, depending on the preference of
the client.
 While doing the settlement, for the clients having outstanding obligations on the
settlement date, a member may retain the requisite securities / funds towards such
obligations and may also retain the funds expected to be required to meet margin
obligations for next 5 trading days, calculated in the manner specified by the exchanges.
Stock brokers shall not grant any further exposure to the clients when debit balances arise
out of clients’ failure to pay the required amounts where such debit balances continues
beyond 5 trading days from the pay‐in date except where Margin trading facilities are
provided to the clients vide SEBI circular dated 13th June 2017.17
Securities
Similarly in the case of securities, giving / taking delivery of securities in “demat mode” should be
directly to / from the “beneficiary accounts” of the clients.

8.4.4.3 Statement of Accounts for funds and securities

A broker / trading member is required to send to the client ‘statement of accounts’ containing an
extract from the client ledger for funds, an extract from the register of securities displaying all
receipts and deliveries of securities and a statement explaining the retention of funds and / or
securities within 5 days from the settlement date.
The statement of accounts regarding settlement may be sent in hard or in soft form as per the
consent obtained from the client and POD / dispatch register / logs of email sent should be
retained by the member.
A broker / trading member could use any format for issue of statement of account at the time of
settling client’s accounts.
However the statement should necessarily contain the following details:
 Transactions / MTM / margins debited and reversed / pay in and pay out of funds for the
period from the date of last settlement done till the current settlement date.
 Security wise pay‐in and pay‐out / securities retained as margin / securities pledged for
the period from the date of last settlement done till the current settlement date.
 Closing balance of funds / securities available with the member on the date of settlement.
 An error reporting clause giving clients not less than 7 working days from the date of
receipt of funds / securities or statement, to bring any dispute arising from the statement
of account or settlement so made to the notice of the broker.
 A clause intimating the client that the client has provided a running account authorisation
which can be revoked at any time.
In addition to the statement of account for funds brokers/ trading members also need to provide
to their clients a statement explaining the retention of funds / securities.
17
SEBI/CIR/HO/MIRSD/MIRSD2/CIR/P/2017/64 dated June 22, 2017 (Enhanced Supervision of Stock Brokers/
Depository Participants)
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From compliance reporting angle, in case a broker / trading member has done monthly / quarterly
settlement of client accounts and has sent statement of accounts for funds and securities as well
as retention statement to the clients at the time of settlement as a part of settlement process, it
would be considered as regulatory compliant.
However, for clients who are opting for bill to bill pay‐in and pay‐out, the broker / trading member
is required to send statement of accounts for funds / securities at the end of quarter.
In case a client has not traded during the quarter / month and the trading member does not hold
any funds or securities for the client at any point of time during the quarter / month for which
settlement needs to be done, then the member may decide not to issue statement of account to
the client.

8.4.4.4 Banking and Demat account operations
Brokers should maintain a separate client bank account and constituent beneficiary account for
keeping client funds and securities respectively.
Similarly, brokers should segregate their own funds and securities from client funds/securities and
keep them in separate accounts. Brokers should report all their bank and demat account details
to the stock exchanges. Funds / securities of clients should not be deposited in own accounts. No
payments towards expenses / levies can be made from client bank account. Receipts from /
transfer to third parties, of funds and securities should not be effected in client bank account and
constituent beneficiary account.
8.4.5 Margins
8.4.5.1 Client Margin: Cash Segment

Brokers should have a prudent system of risk management to protect themselves from client
default. The risk management system followed by brokers should be well documented and be
made accessible to the clients and the Exchange. However, the quantum of margins and the form
and mode of collection of margins is left to the discretion of Members.
8.4.5.2 Client Margin: Derivatives Segment

In the Equity Derivatives segment, the client margins which are required to be compulsorily
collected shall include initial margin, exposure margin/extreme loss margin, calendar spread
margin and mark to market settlements on an upfront basis.18 Similar margin shall be collected
for Currency Derivatives segment.

Indicative forms through which margins from clients can be collected:
 Free and unencumbered balances (funds and securities) available with the member of
respective client in different segments of the Exchange.
18
SEBI Circular Reference No. SEBI/HO/MRD/DRMNP/CIR/P/2018/75 dated May 02, 2018.
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 Bank guarantee received towards margin, issued by any approved bank and discharged in
favor of the trading member.
 Fixed deposit receipts (FDRs) received towards margin issued by any approved bank and
lien marked in favor of the Member.
 Securities in dematerialised form actively traded on the Exchanges.
 Units of liquid mutual funds in dematerialised form.
 Government securities and Treasury bills in electronic form with appropriate haircut.
 Margins collected from entities related to the client which is certified by an independent
chartered accountant:
o In case of individuals having relationship as spouse, dependent children and
parents with clients.
o In case of HUF, any of the Co‐parceners.
o In case of a Trust, any of the trustees or beneficiaries.
o In case of Partnership firm, the partners, their spouse, dependent children and
parents.
o In case of Corporates, the promoters having controlling shareholdings, their
spouse, dependent children and parents.
8.4.5.3 Margin Report to the Clearing Corporation

Members (both trading and clearing) are required to collect upfront initial margins from all their
Trading Members/ Constituents. Clearing Members are required to compulsorily report, on a daily
basis, details in respect of the margin amount due and collected, from the Trading members /
Constituents clearing and settling through them. Similarly, Trading members are required to
report on a daily basis details in respect of the margin amount due and collected from the
constituents clearing and settling through them.

Members may report client margin details upto five working days after the trade date.
In case a member fails to collect requisite margin from the respective client on an upfront basis
and reports to the Clearing Corporation that margin collected from client is less than the actual
amount of margins required to be collected, it is termed as short reporting of margin collection
and shall attract applicable penalty.
8.4.5.4 Margin report to clients
Members should send margin related report to their clients on a daily basis, which should include:
 Client code and name, Trade day (T)
 Total margin deposit placed by the client upto day T‐1 (with break‐up in terms of cash,
Fixed Deposit Receipts (FDRs), Bank Guarantees (BGs) and securities)
 Margin utilized up to the end of day T‐1
 Margin deposit placed by the client on day T (with break‐up in terms of cash, FDRs, BGs
and securities)
 Margin adjustments for day T
 Margin status (balance with the member / due from the client) at the end of day T
8.4.5.5 Collateral management
Every trading member shall maintain proper records of collateral received from clients as under:
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 Receipt of collateral from client and acknowledgement issued to client on receipt of
collateral
 Record of return of collateral to client
 Credit of corporate action benefits to clients

Members should have adequate systems and procedures in place to ensure that client collateral
is not used for any purposes other than meeting the respective client’s margin requirements /
pay‐ins. Members should also maintain records to ensure proper audit trail of use of client
collateral.
8.4.5.6 Enhanced Supervision of Stock Brokers
SEBI vide its circular SEBI/HO/MIRSD/MIRSD2/CIR/P/2016/95 September 26, 2016 issued
guidelines for Enhanced Risk Based Supervision of broker dealers. The exhaustive guidelines cover
various areas such as:
a. Naming convention for client & proprietary bank / demat account as below:
b. Monitoring of client funds/securities
c. Additional requirements for weekly/monthly reporting of client funds
d. Monitoring of financial strength of stock brokers etc. Operational guidelines from Stock
Exchanges for reporting obligations are awaited.
e. Pledging of client securities:
 Permitted only in case of clients who have a debit balance in their ledger
 Funds raised shall not exceed the debit balance in the ledger of that client & be credited
to bank account tagged as Client account
 Pledge to be created only from beneficiary account tagged as Client account.
 Additional exposure not permitted if debit balances arise out of client’s failure to pay
required amount and continues beyond fifth trading day reckoned from date of pay‐in
 Stock Broker to send statement for pledge & funding to client
8.4.6 Books of accounts

The broker has to maintain the required books of accounts as per Rule 15 of SC(R) Rules 1957 and
Regulation 17 of SEBI (Stock Broker and Sub Brokers) Regulations, 1992. Stock brokers are
required to maintain separate books for each Exchange in which they operate. Further, for any
Exchange, a separate set of ledger accounts of clients is to be maintained for each particular
segment of the exchange in which the stock broker operates. The stock broker has to maintain a
mapping of the client IDs used at the time of order entry in the system with the client’s unique
client ID along with all the particulars given in the KYC form. The books that shall be maintained
by a broker include, register of transactions (Sauda Book), clients ledger, general ledger, journal,
cash book, bank book, securities register, counterfoils or duplicates of contract notes, margin
deposit book, register of accounts of sub‐brokers, KYC, agreements with clients and tripartite
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agreements with client and sub‐brokers. Some of these books/transaction records are briefly
discussed below.

8.4.6.1 Register of Transaction

Brokers are required to maintain a Register of Transactions or ‘Sauda Book’, which contains details
of all deals transacted by them on a day‐to‐day basis. These details are maintained settlement‐
wise. This register normally contains the transactions both for member’s own business and
business on behalf of clients on the Exchange. The Sauda Book is prepared by importing data into
the back office accounting system from the ‘trade file’ (NSE) or ‘BRK file’ (BSE) received from the
Exchange on a daily basis.

It contains details such as:

 Name of the scrip and scrip code
 Order number
 Order Time
 Trade number
 Trade Time
 Name of the client
 Client code
 Market Rate
 Net rate
 Quantity of scrip bought or sold
 Settlement number
 Date
8.4.6.2 Client Ledger
The client’s ledger, as the name suggests, has the details of all clients, and their transactions
through the broker.
8.4.6.3 General Ledger
The general ledger accounts for all general transactions including expenses, overheads, salaries,
petty cash, etc.
8.4.6.4 Journal
The journal is the accounting book of the general ledger. Any adjustment entries for e.g., interest
receivable, etc., are accounted here.
8.4.6.5 Cash and bank book
The cash and bank book contain records of all cash and cheque transactions and are normally
balanced daily.
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8.4.6.6 Security ledger
Stock Broker is required to maintain a register or ledger account of securities, client‐wise and
security‐wise, giving details viz. date of receipt of the security, quantity received, party from
whom received, purpose of receipt, date of delivery of the security, quantity delivered, party to
whom delivered and purpose of delivery

8.4.7 Types of transactions
8.4.7.1 Principal to Principal transaction

As per Section 15 of the Securities Contract Regulations Act, 1956 “no member of a recognised
stock exchange shall in respect of any securities enter into any contract as a principal with any
person other than a member of a recognised stock exchange, unless he has secured the consent
or authority of such person and discloses in the note, memorandum or agreement of sale or
purchase that he is acting as a principal”.
No such written consent or authority of such person is necessary for closing out any outstanding
contract entered into by such person in accordance with the bye‐laws.
As per the model bye‐laws specified by SEBI for stock exchanges “The contract notes issued by a
trading member to his clients for any transaction on a spot delivery basis shall be as a principal
and for any transaction other than on a spot delivery basis shall be as an agent, in accordance
with the provisions of the Rules, Bye‐laws and Regulations of the Exchange and shall be in such
form, as may be prescribed in the relevant Regulations. Contract notes shall disclose whether the
trading member has acted as a principal or as an agent.”
Such transactions can be entered only as spot delivery contracts and required to be reported to
the Exchange on the same day pursuant to SEBI circular no. SMD/RCG/CIR/(BKG)/293/95 dated
March 14, 1995 and Exchange Notice No.20040306‐9 dated March 6, 2004. The transactions done
on the spot basis are to be settled on the same day as the date of the contract or on the next day
as provided in section 2 (i) of the Securities Contracts (Regulation) Act, 1956
8.4.7.2 Negotiated deals /cross deals
As per SEBI circular SMDRP/POLICY/CIR‐32/99 dated September 14, 1999, all negotiated deals
(including cross deals) shall not be permitted except for those which are executed on the screens
of the exchanges in the price and order matching mechanism of the exchanges just like any other
normal trade.
Provided, however, that Foreign Portfolio Investors (FPIs) can avail of the provisions of the special
bargains on the exchanges in accordance with their bye‐laws or obtain suitable exemptions from
exchanges for purchases or sales between FPIs in such companies where the ceiling of FPI
investment of 24 percent or 30 percent as the case may be, has been reached.
Negotiated deals in listed corporate debt securities shall not be permitted and all such trades will
have to be executed on the price and order matching mechanism of the stock exchanges as in the
case of equities.
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Government debt securities and money market instruments are under the regulatory jurisdiction
of RBI and do not fall within the purview of SEBI. Therefore, the aforesaid decision will not apply
to such securities.
Exemptions would also be granted for dis‐investment of Public Sector Enterprises by SEBI on a
case to case basis. No Exchange shall allow the ‘All or None’ or ‘Minimum Fill’ order facility in their
trading system.
8.4.7.3 Proprietary trading regulations
As per SEBI Circular Ref. No. SEBI/MRD/Cir‐42/2003 dated November 19, 2003, every broker shall
disclose to his client whether he does client based business or proprietary trading as well. The
broker shall disclose this information upfront to his new clients at the time of entering into the
Know Your Client agreement. In case of a broker who at present does not trade on proprietary
account, chooses to do so at a later date, he shall be required to disclose this to his clients before
carrying out any proprietary trading.
8.4.7.4 Pro‐account Trading Terminal
Pro‐account implies proprietary account and is used by the broker to place orders for self‐purpose
i.e., for the broking firm itself. Stock Exchanges should ensure the following:
i. Facility of placing orders on “pro‐account” through trading terminals shall be extended
only at one location of the members as specified /required by the members.
ii. Trading terminals located at places other than the location which has been specified by
the member, shall have a facility to place orders only for and on behalf of a client by
entering client code details as required / specified by the Exchange / SEBI.
iii. In case any member requires the facility of using “pro‐account” through trading terminals
from more than one location, such member shall be required to submit an undertaking
to the stock exchange stating the reason for using the “pro‐account” at multiple locations.
iv. Exchange may, on case to case basis after due diligence, consider extending the facility of
allowing use of “pro‐account” from more than one location.

8.4.8 Role of information technology
Information Technology plays a very crucial role in the running of the stock broking business with
the end‐to‐end business of the broker being fully automated. The IT infrastructure supports the
brokerage firm in all 3 areas of its business i.e., front, middle and back office. With the
introduction of new business delivery models such as Internet Based Trading (IBT), mobile trading,
Direct Market Access (DMA), algorithmic trading and co‐location facility, the role of IT in the
broking business has only become more prominent.

The role of IT consists of:
 Software development and deployment
 Software modification in terms of enhancement with new functionalities and trouble‐
shooting / maintenance
 Telecommunication infrastructure support
 IT security management
 Hardware maintenance
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 Business continuity and Disaster Recovery mechanism

With the prevailing role of IT in the business, SEBI has specified various regulations to ensure that
there are no glitches in the running of the broking businesses to safeguard the investors. Some
of the important requirements include specifications for setting up IBT and mobile trading
technology, system audit on periodic basis, and software testing and release management
protocols.

SEBI vide its circular no: CIR/MRD/DP/24/2013 dated August 19, 2013 and CIR/MRD/DP/06/2014
dated February 07, 2017 has specified testing procedure to be followed for deployment of
software by the stock brokers. The software includes their trading system, real‐time risk
management systems and IBT, DMA, STWT, SOR and algorithmic trading systems.

Software testing framework includes the following:

Testing in a simulated test environment: Stock exchanges shall provide suitable facilities to
market participants / software vendors to test new software or existing software that have
undergone change.
New software or changes to existing software should be tested mandatorily through the testing
facility before putting it in production environment.
Mock testing: Regular mock testing shall be conducted by stock exchange at least once in a
calendar month to facilitate software testing. All user Ids approved for Algo trading should
participate in the mock. This should be verified by Stock Exchanges as well as by system auditors
and cover it in the periodic system audit report.
The system audit report may also include the audit of the operational risk management
framework to manage risk to systems, networks and databases from cyber‐attacks and threats.
Cyber‐attacks and threats attempt to compromise the Confidentiality, Integrity and Availability
(CIA) of the computer systems, networks and databases. Cyber security framework include
measures, tools and processes that are intended to prevent cyber‐attacks and improve cyber
resilience. Cyber Resilience is an organisation’s ability to prepare and respond to a cyber‐attack
and to continue operation during, and recover from, a cyber‐attack. The system audit should focus
on these aspects during the process of audit.
User Acceptance Test (UAT): The stock broker / trading member shall undertake UAT of the
software to satisfy itself that the newly developed / modified software meets its requirements.
Stock brokers / trading members shall also engage system auditor(s) to examine reports of mock
tests and UAT in order to certify that the tests were satisfactorily undertaken.

8.5 Margin trading19
Margin Trading is trading with borrowed funds/securities. It is essentially a leveraging mechanism
which enables investors to take exposure in the market over and above what is possible with their
19
Annexure 1: Master Circular for Stock Exchanges on Trading Part 1, dated March 2010.
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own resources. SEBI has been prescribing eligibility conditions and procedural details for allowing
the margin trading facility from time to time. Member‐brokers are allowed to provide margin
trading facility to their clients, in the cash segment, subject to the following conditions:
8.5.1 Securities eligible
Equity Shares that are classified as 'Group I security' shall be eligible for margin trading facility.
Group I securities are liquid securities which are traded at least 80% of the days over the previous
six months and impact cost for which over the previous six months is less than or equal to 1%.
(For securities that have been listed for less than six months, the trading frequency and the impact
cost shall be computed using the entire trading history of the scrip). .
8.5.2 Brokers eligible
Only corporate brokers with a “net worth” of at least Rs. 3 crore would be eligible to offer margin
trading facility to their clients. The “net worth” for the purpose of margin trading facility shall be
specified in SEBI (Stock Brokers and Sub‐Brokers) Regulations, 1992. mean “Capital” (excluding
preference share capital) plus free reserves less non allowable assets, i.e. fixed assets, pledged
securities, member’s card, non‐allowable securities, bad deliveries, doubtful debts and advances
(including debts and advances overdue for more than 3 months or given to associates), pre‐paid
expenses, intangible assets and 30 percent of the marketable securities.”
The broker shall submit to the stock exchange a half yearly certificate as on 31st March and 30th
September of each year, from an auditor confirming the net worth. Such a certificate shall be
submitted not later than 30th April and 31st October of every year.

Before providing margin trading facility to a client who has already availed of margin trading
facility from another broker, the broker is required to obtain a no‐objection certificate in writing
from the other broker. The other broker shall be required to convey his objection, if any, in
writing, within a period of 21 days from the date of receipt of query from the broker, failing which
the broker would be free to proceed with providing margin trading facility to the client.

The broker shall enter into an agreement with his client for providing the margin trading facility.
8.5.3 Sources of Funds
For the purpose of providing the margin trading facility, a stock broker may use own funds or
borrow funds from scheduled commercial banks and/or NBFCs regulated by RBI. Stock Brokers
may borrow funds by way of issuance of Commercial Paper (CP) and by way of unsecured long
term loans from their promoters and directors. The borrowing by way of issuance of CPs shall be
subject to compliance with appropriate RBI Guidelines. The borrowing by way of unsecured long
term loans from the promoters and directors shall be subject to the appropriate provisions of
Companies Act. The stock broker shall not use the funds of any client for providing the margin
trading facility to another client, even if the same is authorized by the first client.
8.5.4 Leverage and Exposure Limits
At any point of time, the total indebtedness of a stock broker for the purpose of margin trading
shall not exceed 5 times of its net worth. The maximum allowable exposure of the broker towards
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the margin trading facility shall be within the self‐imposed prudential limits and shall not, in any
case, exceed the borrowed funds and 50% of his “net worth”. While providing the margin trading
facility, the broker shall ensure that:
 exposure to any single client at any point of time shall not exceed 10% of the broker’s
maximum allowable exposure;
 exposure towards stocks purchased under margin trading facility and collateral kept in the
form of stocks are well diversified. Stock Brokers shall have appropriate Board approved
policy in this regard;
8.5.5 Margin requirements
In order to avail margin trading facility, initial margin required shall be as under:
Category of Stock Applicable margin
Group I stocks available for trading in the F&O VaR + 3 times of applicable ELM (*)
Segment
Group I stocks other than F&O stocks VaR + 5 times of applicable ELM (*)
(*) For aforesaid purpose the applicable VaR and ELM shall be as in the cash segment for a
particular stock.
The initial margin payable by the client to the stock broker shall be in the form of cash, cash
equivalent or Group I equity shares, with appropriate haircut as specified by SEBI. The stock
brokers shall be required to comply with the following conditions:
a. The stocks deposited as collateral with the stock broker for availing margin trading facility
(Collaterals) and the stocks purchased under the margin trading facility (Funded stocks) shall
be identifiable separately and no comingling shall be permitted for the purpose of computing
funding amount;
b. Collateral and Funded stocks shall be marked to market on a daily basis;
c. In case of increase in the value of Collaterals, stock brokers may have the option of granting
further exposure to their clients subject to applicable haircuts;
d. However, no such exposure shall be permitted on the increased value of funded stocks.
Stock Brokers shall ensure maintenance of the aforesaid margin at all times during the
period that the margin trading facility is being availed by the client. In case of short fall,
stock broker shall make necessary margin calls.

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8.5.6 Liquidation of securities by the broker in case of default by the client
The stock broker shall list out situations/conditions in which the securities may be liquidated and
such situations/conditions shall be included in the “Rights and Obligations Document”. The broker
shall liquidate the securities, if the client fails to meet the margin call to comply with the
conditions as mentioned in this circular or specified in the "Rights and Obligations Document"
specified by exchange.
8.5.7 Maintenance of Records
The broker shall maintain the following records:
 Separate client‐wise ledgers for funds and securities of clients availing margin trading
facility;
 Separate record of details (including the sources) of funds used for the purpose of margin
trading.
The books of accounts, maintained by the broker, with respect to the margin trading facility
offered by it, shall be got audited on a half yearly basis. The broker shall submit an auditor’s
certificate to the exchange/s, within one month from the date of the half year ending 31st March
and 30th September of a year certifying, inter alia, the extent of compliance with the conditions
of margin trading facility.
8.5.8 Disclosure Requirements
The stock broker shall disclose to the Stock Exchanges details on gross exposure towards margin
trading facility including name of the client, Category of holding (Promoter/promoter group or
Non‐promoter), clients' Permanent Account Number ("PAN"), name of the scrips (Collateral
stocks and Funded stocks) and if the stock broker has borrowed funds for the purpose of providing
margin trading facility, name of the lender and amount borrowed, on or before 12 noon on the
following trading day.
The Stock Exchanges shall disclose on their websites the scrip wise gross outstanding in margin
accounts with all brokers to the market. Such disclosure regarding margin trading done on any
day shall be made available after the trading hours, on the following day, through its website.
The Stock Exchanges shall put in place a suitable mechanism to capture and maintain all relevant
details including member‐wise, client‐wise, scrip‐wise information regarding outstanding
positions in margin trading facility and also source of funds of the stock brokers, on the exchange
both on daily as well as on cumulative basis.
8.5.9 Rights and Obligations for Margin Trading
The Stock Exchanges shall frame a Rights and Obligations document laying down the rights and
obligations of stock brokers and clients for the purpose of margin trading facility. The Rights and
Obligations document shall be mandatory and binding on the Broker/Trading Member and the
clients for executing trade in the Margin Trading framework.

The broker/exchange may modify the Rights and Obligations document only for stipulating any
additional or more stringent conditions, provided that no such modification shall have the effect
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of diluting any of the conditions laid down in the circular or in the Rights and Obligations
document.
8.5.10 Other Conditions
A broker shall take adequate care and exercise due diligence before providing margin trading
facility to any client. Any disputes arising between the client and the stock broker in connection
with the margin trading facility shall have the same treatment as normal trades and should be
covered under the investor grievance redressal mechanism, arbitration mechanism of the Stock
Exchange. SGF and IPF shall be available for transactions done on the exchange, whether through
normal or margin trading facility. However, any losses suffered in connection with the margin
trading facility availed by the client from the stock broker shall not be covered under IPF.
The stock brokers wishing to extend margin trading facility to their clients shall be required to
obtain prior permission from the exchange where the margin trading facility is proposed to be
offered. The exchange shall have right to withdraw this permission at a later date, after giving
reasons for the same.
8.6 Securities Lending and Borrowing Program (SLB)
Short Selling means selling of a stock that the seller does not own at the time of trade. Short selling
can be done by borrowing the stock through Clearing Corporation/Clearing House of a Stock
Exchange which is registered as Approved Intermediaries (AIs) under the Securities Lending
Scheme, 1997. Short selling can be done by retail as well as institutional investors. The Securities
Lending and Borrowing mechanism allows short sellers to borrow securities for making delivery.
The Clearing Corporations who are approved intermediaries provide the facility for lending and
borrowing through automated screen based platform where orders are matched on price time
priority. The participants quote the lending fee per share on the order matching platform. The
platform also provides for early recall and early repayment of securities lent and borrowed.

All categories of investors including retail, institutional etc. are permitted to borrow and lend
securities. The borrowers and lenders access the platform for lending/borrowing set up by the AIs
through the clearing members (CMs) (including banks and custodians) who are authorised by the
AIs in this regard.
8.6.1 Client on boarding
The Approved Intermediaries (AIs), CMs and the clients should enter into an agreement specifying
the rights, responsibilities and obligations of the parties to the agreement. The AIs allot a unique
ID to each client which shall be mapped to the Permanent Account Number (PAN) of the
respective clients. The AIs are required to put in place appropriate systemic safeguards to ensure
that a client is not able to obtain multiple client IDs.
8.6.2 Transaction cycle and market timing
The transactions are based on fixed monthly tenures with specified reverse leg settlement dates.
The tenure ranges from 1 day to 12 months based on the need of the market participants. The
specified reverse leg settlement day is the first Thursday of the corresponding month. Securities
traded in F&O segment are eligible for lending and borrowing under the scheme. The market
timings are 9.15 a.m. to 3.30 p.m.
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8.6.3 Settlement
The settlement cycle for SLB transactions shall be on T+1 basis. The settlement of lending and
borrowing transactions shall be independent of normal market settlement. The settlement of the
lending and borrowing transactions shall be done on a gross basis at the level of the clients i.e. no
netting of transactions at any level is permitted.
8.6.4 Short delivery
In the case of a lender or a borrower failing to deliver or return securities to the AI, the AI shall
conduct an auction for obtaining securities. In the event of exceptional circumstances resulting in
non‐availability of securities in auction, such transactions would be financially closed‐out at
appropriate rates, which may be more than the rates applicable for the normal close‐out of
transactions, so as to act as a sufficient deterrent against failure to deliver securities.
8.6.5 Risk Management
AIs are required to frame suitable risk management systems to guarantee delivery of securities to
borrower and return of securities to the lender. Position limits at the level of market, CM and
client shall be decided from time to time by AIs in consultation with SEBI. The position limit shall
be as under:
i. The market wide position limit for SLB transactions shall be 10% of the free‐float capital of the
company in terms of number of shares;
ii. No clearing member shall have open position of more than 10% of the market wide position
limit. The position limit for an institutional investor shall be the same as that for a clearing
member;
iii. The client level position shall not be more than 1% of the market wide position limit.
8.6.6 Margins
All transactions in SLB are subject to margin.

First Leg transactions
The borrower is levied only the lending fee on ‘T’ day.
Lenders may bring in early pay‐in of securities on the day of the transaction execution itself. In
such cases no margins are levied on the lender.
The following margins are levied on the Participants for lend transactions till the time the pay‐in
of securities is made:
 Mark to market margin end of day
 25 percent of the lending price
Lending price is the previous day closing price of the security in the capital market.

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Reverse Leg transactions
The borrower is levied margins in respect of reverse leg of transactions under SLBS. The following
margins are levied on the participants for a borrowed transaction from T+1 to the reverse leg
settlement day.
 Value at Risk Margins
 Extreme Loss Margins
 Mark to Market Margins
 Lending price
No margin is charged on the lender for the reverse leg.
8.6.7 Corporate action20
Details of treatment of corporate actions during the contract tenure are specified as below:

Treatment of Corporate Action

Dividend: The dividend amount would be worked out and recovered from the borrower on the
book closure /record date and passed on to the lender.

Stock split: The positions of the borrower would be proportionately adjusted so that the lender
receives the revised quantity of shares.

Other corporate actions: Other corporate actions such as bonus/merger/amalgamation/open
offer etc., the contracts would be foreclosed on the Ex‐date. The lending fee would be recovered
on a pro‐rata basis from the lender and returned to the borrower.

AGM/EGM: In the event of the corporate actions which is in nature of AGM/EGM, presently the
AIs are mandatorily foreclosing the contracts. It has been represented by market participants that
mandatory foreclosure during the life of the contract may not be necessary as, all lenders may
not be interested in taking part in the AGM/EGM. It has therefore been decided that the AIs shall
provide the following facilities to the market participants:
a. Contracts which shall continue to be mandatorily foreclosed in the event of AGM/EGM.
b. Contracts which shall not be foreclosed in the event of AGM/EGM.
8.6.8 Early recall / early repayment21

The lender / borrower shall be provided with a facility for early recall / repayment of shares.
In case the borrower fails to meet the margin obligations, the Approved Intermediary (AI) shall
obtain securities and square off the position of such defaulting borrower, failing which there shall
be a financial close‐out.
20
SEBI Circular Ref. No. CIR/MRD/DP/122/2017 Dated November 17, 2017.
21
SEBI/MRD/DoP/SE/Dep/Cir‐ 01 /2010 dated January 6, 2010 (Review of Securities and Lending framework).
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In case lender recalls the securities anytime before completion of the contract, the AI on a best
effort basis shall try to borrow the security for the balance period and pass it onward to the lender.
The AI will collect the lending fee from the lender who has sought early recall. In case of early
repayment of securities by the borrower, the margins shall be released immediately on the
securities being returned by the borrower to the AI. The AI shall on a best effort basis, try to
onward lend the securities and the income arising out of the same shall be passed on to the
borrower making the early repayment of securities. In case AI is unable to find a new borrower
for the balance period, the original borrower will have to forego lending fee for the balance
period. In case of early recall by lender or early repayment of securities by borrower, the lending
fee for the balance period shall be at a market determined rate.
8.6.9 Rollover Facility22
Any lender or borrower who wishes to extend an existing lent or borrow position shall be
permitted to roll‐over such positions i.e. a lender who is due to receive securities in the pay out
of an SLB session, may extend the period of lending. Similarly, a borrower who has to return
borrowed securities in the pay‐in of an SLB session, may, through the same SLB session, extend
the period of borrowing. The roll‐over shall be conducted as part of the SLB session.

The total duration of the contract after taking into account rollovers shall not exceed 12 months
from the date of the original contract. It is clarified that multiple rollovers of a contract by the
lender or borrower is permitted.

Rollover shall not permit netting of counter positions, i.e. netting between the ‘borrowed’ and
‘lent’ positions of a client.

8.6.10 Other points

Approved Intermediary (AI) shall provide suitable arbitration mechanism for settling the disputes
arising out of the SLB transactions executed on the platform provided by them. AIs shall
disseminate in public domain, the details of SLB transactions executed on the platform provided
by them and the outstanding positions on a weekly basis.

8.7 Computer Assisted Audit Techniques (CAAT)23

Computer Assisted Audit Techniques (CAATs) is nowadays being used in the audit profession. It is
the practice of using computers to automate the audit processes. CAATs normally includes using
basic office productivity software such as spreadsheet, word processors and text editing programs
and more advanced software packages involving use of statistical analysis and business
intelligence tools. The need for CAAT, depends on numerous factors, some of them are listed as
follows:
22
SEBI Circular Ref. No. CIR/MRD/DP/122/2017 Dated November 17, 2017.
23
Some portions have been borrowed from the “A Hand Book On Internal Audit ‐ Rajkumar S. Adukia”.

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(a) Audit Objective
(b) Nature of data to be examined
(c) Availability of skilled audit resource
CAATs include different types of tools and techniques, such as generalised audit software, utility
software, data for testing etc.

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Review Questions

1. Client‐On‐Boarding function is performed by ____________.

(a) Front office
(b) Middle office
(c) Back office
(d) Stock Exchange
Ans: (a)
2. For Securities Lending and Borrowing (SLB) transactions, who provides for suitable arbitration
mechanism for settling the disputes?

(a) SEBI
(b) Stock Exchanges
(c) Approved Intermediary
(d) Investor Association
Ans: (c)

3. When an investor gets the best available price in the market, he places which type of order?
(a) Stop loss order
(b) Limit order
(c) Market order
Ans: (c)

4. Contract note should be issued
(a) Within 24 hours of trade execution
(b) Within 48 hours of trade execution
(c) Within 3 days of trade execution
(d) Immediately upon a successful transaction
Ans: (a)

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Chapter 9 Risk Management



 Risk management framework for cash market

 Risk management framework for futures and options segment

 Annual and Compliance requirements by trading members

9.1 Risk Management Framework for Cash Segment24

A comprehensive Risk Management framework is the backbone of the Clearing Corporation (CC).
CC provides settlement guarantee i.e., it guarantees that the settlement of securities and funds
will take place even if there is a failure by a broker to fulfill their obligation. In order to safeguard
against such failures, CC is required to carry out the following risk management measures as
specified by SEBI through its various circulars.

Risk Management framework consists of the following components:
 Margin
 Liquid Asset
 Base minimum capital
 Pre‐trade risk control
 Risk Reduction mode

9.1.1 Margin
Margining is a process by which CC computes the potential loss that can occur to the open
positions held by the members. This is computed for both buy as well as the sell open positions.
Based on the computation, CC will ensure that the liquid assets deposited by members is sufficient
to cover the potential loss arrived at.

CC will compute and collect 3 kinds of margins namely:
 Value at Risk Margin (VaR) to cover potential losses for 99 percent of the days.
 Mark to market Loss margin: Mark to market losses on outstanding settlement
obligations of the member.
 Extreme loss margin: Margins to cover the loss in situations that lie outside the
computation arrived at based on VaR margin.

24
SEBI Circular Ref. No. MRD/DoP/SE/Cir‐07/2005 Dated February 23, 2005 and SEBI Master Circular for stock exchange
and clearing corporations dated May 26, 2015
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9.1.1.1 VaR Margin
The VaR Margin is a margin intended to cover the largest loss that can be encountered on 99
percent of the days (99 percent Value at Risk). For liquid stocks, the margin covers one‐day losses
while for illiquid stocks, it covers three‐day losses so as to allow the clearing corporation to
liquidate the position over three days.

For liquid stocks, the VaR margins are based only on the volatility of the stock while for other
stocks, the volatility of the market index is also used in the computation. Computation of the VaR
margin requires the following definitions:

Scrip sigma means the volatility of the security computed as at the end of the previous trading
day. The computation uses the exponentially weighted moving average method applied to daily
returns in the same manner as in the derivatives market.

Scrip VaR means the higher of 7.5 percent or 3.5 scrip sigmas.

Index sigma means the daily volatility of the market index (CNX Nifty or BSE Sensex) computed as
at the end of the previous trading day. The computation uses the exponentially weighted moving
average method applied to daily returns. Index VaR means the higher of 5 percent or 3 index
sigmas. The higher of the Sensex VaR or Nifty VaR would be used for this purpose. The VaR
Margins are specified as follows for different groups of stocks:

Liquidity One‐Day VaR Scaling factor VaR Margin
Categorization for illiquidity
Liquid Scrip VaR 1.0 Scrip VaR
Securities
(Group I)
Less Liquid Higher of 1.73 (square Higher of 1.73 times
Securities Scrip VaR and root of 3.00) Scrip VaR and 5.20
(Group II) three times times Index VaR
Index VaR
Illiquid Five times 1.73 8.66 times Index
Securities Index VaR (square root of VaR
(Group III) 3.00)

Collection
 VaR margin is collected on an upfront basis by adjusting against the total liquid assets of
the member at the time of trade.
 VaR margin is collected on the gross open position of the member. The gross open
position for this purpose would mean the gross of all net positions across all the clients of
a member including his proprietary position. For this purpose, there would be no netting
of positions across different settlements.
 The VaR margin so collected shall be released along with the pay‐in, including early pay‐
in of securities.

The applicable VaR margin rates shall be updated atleast 5 times in a day, which may be carried
out by taking the closing price of the previous day at the start of trading and the prices at 11:00
a.m., 12:30 p.m., 2:00 p.m. and at the end of the trading session.
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9.1.1.2 Mark to Market Margin
Mark to market loss is calculated by marking each transaction in security to the closing price of
the security at the end of trading. In case the security has not been traded on a particular day, the
latest available closing price is considered as the closing price. In case the net outstanding position
in any security is nil, the difference between the buy and sell values is considered as the notional
loss for the purpose of calculating the mark to market margin payable.

Mark to Market margin is collected in the following manner:

 CC collects mark to market margin (MTM) from the member/broker before the start of
the trading of the next day.
 The MTM margin is collected or adjusted against the cash/cash equivalent component of
the liquid net worth deposited with the Exchange.
 The MTM margin is collected on the gross open position of the member.
 The gross open position means gross of all net positions across all the clients of a member
including his proprietary position.
 There would be no netting across two different settlements.
 MTM losses for the day can be set‐off against MTM profits.
 The margin so collected shall be released along with the pay‐in, including early pay‐in of
securities.
9.1.1.3 Extreme Loss Margin

Extreme loss margin covers the expected loss in situations that go beyond those envisaged in the
99 percent value at risk estimates used in the VaR margin.

 The Extreme Loss Margin for any stock shall be higher of:
o 5 percent, and
o 1.5 times the standard deviation of daily logarithmic returns of the stock price in the
last six months.
 This computation shall be done at the end of each month by taking the price data on a
rolling basis for the past six months and the resulting value shall be applicable for the next
month.
 The Extreme Loss Margin shall be collected/ adjusted against the total liquid assets of the
member on a real time basis.
 The Extreme Loss Margin shall be collected on the gross open position of the member.
The gross open position for this purpose would mean the gross of all net positions across
all the clients of a member including his proprietary position.
 The Extreme Loss Margin so collected shall be released along with the pay‐in.
9.1.1.4 Margins not to exceed the purchase value of a buy transaction

In case of a buy transaction in cash market, VaR margins, Extreme loss margins and mark to market
losses together shall not exceed the purchase value of the transaction. Further, in case of a sale
transaction in cash market, the existing practice shall continue viz., VaR margins and Extreme loss
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margins together shall not exceed the sale value of the transaction and mark to market losses
shall also be levied.

9.1.2 Liquid Assets

The acceptable liquid assets and the applicable haircuts are listed below:

Item Haircut Limits
Cash Equivalents
Cash 0 No limit
Bank fixed deposits 0 No limit
Bank guarantees 0 Limit on exchange’s
exposure to a single bank
Securities of the Central 10 percent No limit
Government
Units of liquid mutual 10 percent No limit
funds or government
securities mutual funds
Other liquid assets
Liquid (Group I) Equity Same as the VaR margin Limit on exchange’s exposure
Shares for the respective to a single issuer
shares
Mutual fund units other Same as the VaR margin ‐
than those listed under for the units computed
cash equivalents using the traded price
on stock exchange, or
else, using the NAV of
the unit treating it as a
liquid security
Card value of eligible 50 percent if the last Eligible only for Extreme Loss
exchanges sale or auction of card Margin
in the exchange took
place during the last six
months.
75 percent if the last
sale or auction of card
in the exchange took
place during the last
twelve months but not
within the last six
months.
100 percent if no sale or
auction of card in the
exchange has taken
place during the last
twelve months.
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Corporate Bonds Fixed percentage based Not to exceed 10 percent of

or VaR based Haircut. A the total liquid assets of the
higher haircut may be clearing member.
considered to cover the
expected time frame
for liquidation. To begin
with the haircut shall be
a minimum of 10
percent

Notes:
The valuation of the liquid assets shall be done on a daily basis except for the card value which
shall be taken on the basis of the last sale or auction.
The Exchanges shall lay down exposure limits either in rupee terms or as percentage of the Trade
Guarantee Fund (TGF) / Settlement Guarantee Fund (SGF) that can be exposed to a single bank
directly or indirectly. The total exposure would include guarantees provided by the bank for itself
or for others as well as debt or equity securities of the bank which have been deposited by
members towards total liquid assets.
Not more than 5 percent of the TGF/SGF or 1percent of the total liquid assets deposited with the
Exchange, whichever is lower, shall be exposed to any single bank which has a net worth of less
than Rs. 500 crores and is not rated P1 (or P1+) or equivalent, by a RBI recognised credit rating
agency or by a reputed foreign credit rating agency, and not more than 50 percent of the TGF/SGF
or 10 percent of the total liquid assets deposited with the exchanges, whichever is lower, shall be
exposed to all such banks put together.
Mark to market losses shall be paid by the member in the form of cash or cash equivalents. Cash
equivalents shall be at least 50 percent of liquid assets. This would imply that other liquid assets
in excess of the total cash equivalents would not be regarded as part of total liquid assets.
The exchanges shall lay down exposure limits either in rupee terms or as percentage of the
TGF/SGF that can be exposed to a single issuer directly or indirectly and in any case the exposure
of the TGF/SGF to any single issuer shall not be more than 15 percent of the total liquid assets
forming part of TGF/SGF of the exchange.
As a transitional arrangement pending demutualization of stock exchanges, the value of the
membership card in eligible stock exchanges may be included as part of the member’s liquid
assets only to cover Extreme Loss Margin. To be eligible for this treatment, the exchange shall
maintain an amount equivalent to at least 50 percent of the aggregate card value of all members
in the form of cash and liquid assets.
9.1.2.1 Liquidity Categorization of Securities

The securities shall be classified into three groups based on their liquidity:

Group Trading Frequency Impact Cost
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Liquid Securities At least 80 percent of the Less than or equal to 1

(Group I) days percent
Less Liquid Securities At least 80 percent of the More than 1 percent
(Group II) days
Illiquid Securities Less than 80 percent of the N/A
(Group III) days

For securities that have been listed for less than six months, the trading frequency and the impact
cost shall be computed using the entire trading history of the scrip.

The trading frequency and impact cost shall be calculated on the 15th of each month on a rolling
basis and the categorisation shall be revised based on the new value. For the first month, till the
time of monthly review, a newly listed stock shall be categorised in that Group where the market
capitalization of the newly listed stock exceeds or equals the market capitalization of 80 percent
of the stocks in that particular group.
9.1.2.2 Calculation of mean impact cost

The mean impact cost shall be calculated in the following manner:
a) Impact cost shall be calculated by taking four snapshots in a day from the order book in
the past six months. These four snapshots shall be randomly chosen from within four fixed
ten‐minutes windows spread through the day.
b) The impact cost shall be the percentage price movement caused by an order size of Rs.1
Lakh from the average of the best bid and offer price in the order book snapshot. The
impact cost shall be calculated for both, the buy and the sell side in each order book
snapshot.
9.1.2.3 Margining Of Institutional Trades in Cash Market

All Institutional trades in the cash market would be subject to payment of margins as applicable
to transactions of other investors. Institutional trades shall be margined on a T+1 basis with the
margin being collected from the custodian upon confirmation of trade.
9.1.3 Shortfall of Margins / Pay‐in of funds

In case of any shortfall in Margin, the terminals of the broker shall be immediately deactivated.
In case of pay‐in shortfall, trading facility of the trading member shall be withdrawn and security
pay‐out withhold if:
 shortfall is in excess of the base minimum capital (BMC),
 If amount of shortage exceeds 20 percent of the BMC but less than the BMC on six
occasions within a period of three months,
Upon recovery of the complete shortages, the member shall be permitted to trade subject to his
providing a deposit equivalent to his cumulative funds shortage as the 'funds shortage collateral'
for a period of ten rolling settlements which shall not be usable for margin liabilities.
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The exchange may levy a penal interest of not less than 0.07 percent per day on the pay‐in
shortage of the member.

9.1.4 Base Minimum Capital

Members holding registration as "stock‐broker" in cash segment and "trading member" in
derivatives segment shall maintain BMC based on their risk profiles as prescribed in table below:‐

Categories BMC Deposit
Only Proprietary trading without Rs. 10 lakh
Algorithmic trading (Algo)
Trading only on behalf of Client (without Rs. 15 lakh
proprietary trading) and without Algo
Proprietary trading and trading on behalf Rs. 25 lakh
of Client without Algo
All Trading Members/Brokers with Algo Rs. 50 lakh

 For stock brokers / trading members of exchanges not having nation‐wide trading
terminals, the deposit requirement shall be 40 percent of the above said BMC deposit
requirements.
 The BMC deposit shall be maintained for meeting contingencies in any segment of the
exchange.
 For members having registration for more than one segment of the same exchange, it
shall be the highest applicable BMC deposit, across various segment.
 No exposure shall be granted against such BMC deposit.
 The Stock Exchanges shall be permitted to prescribe suitable deposit requirements, over
and above the SEBI prescribed norms, based on their perception and evaluation of risks
involved.
 Minimum 50 percent of the deposit shall be in the form of cash and cash equivalents.

9.1.5 Additional Margins

Exchanges/clearing corporations have the right to impose additional risk containment measures
over and above the risk containment system mandated by SEBI. However, it should be based on
objective criteria and shall not discriminate between members.

9.1.6 Margins from the Client

Members should have a prudent system of risk management to protect themselves from client
default. Margins are likely to be an important element of such a system. The same shall be well
documented and be made accessible to the clients and the Stock Exchanges. However, the
quantum of these margins and the form and mode of collection are left to the discretion of the
members.
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9.1.7 Provision of early pay‐in

Necessary systems shall be put in place to enable early pay‐in of funds. In cases where early pay‐
in of funds is made by the members, the outstanding position to that extent of early pay‐in shall
not be considered for computing the margin obligations. In cases where early pay‐in of securities
is made prior to the securities pay‐in, such positions for which early pay‐in (EPI) of securities is
made are exempt from margins.

9.1.8 Pre‐trade Risk Controls

Pre‐trade risk control helps prevent aberrant orders or uncontrolled trades.
9.1.8.1 Order‐level checks

Value/Quantity Limit per order:
Any order with value exceeding Rs. 10 crore per order shall not be accepted by the Stock Exchange
for execution in the normal market.
In addition, stock exchange shall ensure that appropriate checks for value and / or quantity are
implemented by the stock brokers based on the respective risk profile of their clients.

Cumulative limit on value of unexecuted orders of a stock broker:

Vide SEBI circular CIR/MRD/DP/09/2012 dated March 30, 2012, stock exchanges have been
directed to ensure that the trading algorithms of the stock brokers have a ‘client level cumulative
open order value check’.
Stock brokers should put‐in place a mechanism to limit the cumulative value of all unexecuted
orders placed from their terminals to below a threshold limit set by the stock brokers.

9.1.8.2 Dynamic Price Bands

Vide circular no. SMDRPD/Policy/Cir‐37/2001 dated June 28, 2001, stock exchanges had been
advised to implement appropriate individual scrip wise price bands in either direction, for all scrips
in the compulsory rolling settlement except for the scrips on which derivatives products are
available or scrips included in indices on which derivatives products are available.
For scrips excluded from the requirement of price bands, stock exchanges have implemented a
mechanism of dynamic price bands which prevents acceptance of orders for execution that are
placed beyond the price limits set by the stock exchanges.
Stock exchange shall set the dynamic price bands at 10 percent of the previous closing price for
the following securities:
 Stocks on which derivatives products are available,
 Stocks included in indices on which derivatives products are available,
 Index futures,
 Stock futures.
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In the event of a market trend in either direction, the dynamic price bands shall be relaxed by the
stock exchanges in increments of 5 percent.

9.1.9 Risk Reduction Mode

Stock exchanges shall ensure that the stock brokers are mandatorily put in risk‐reduction mode
when 90 percent of the stock broker’s collateral available for adjustment against margins gets
utilised on account of trades that fall under a margin system. Such risk reduction mode shall
include the following:

 All unexecuted orders shall be cancelled once stock broker breaches 90 percent collateral
utilization level.
 Only orders with Immediate or Cancel attribute shall be permitted in this mode.
 All new orders shall be checked for sufficiency of margins.
 Non‐margined orders shall not be accepted from the stock broker in risk reduction mode.
 The stock broker shall be moved back to the normal risk management mode as and when
the collateral of the stock broker is lower than 90 percent utilization level.

9.2 Risk Management Framework for F&O Segment

Risk Management framework for F&O will consist of the following:
 Margins
 Liquid Networth
 Liquid assets
9.2.1 Types of Margins
In the futures and options segment, the following types of margins are levied:
 Initial margin
 Exposure margin
 Premium margin
 Assignment margin
 Delivery Period margin for physical settlement of derivatives
9.2.1.1 Initial Margin Computation
Initial margin shall be payable on all open positions of Clearing Members, up to client level.
Initial margin for F&O segment is calculated on the basis of a portfolio (a collection of futures and
option positions) based approach. The margin calculation is carried out using software called ‐
SPAN® (Standard Portfolio Analysis of Risk). It is a product developed by Chicago Mercantile
Exchange (CME) and is extensively used by leading stock exchanges of the world.
SPAN® uses scenario based approach to arrive at margins. It generates a range of scenarios and
highest loss scenario is used to calculate the initial margin. The margin is monitored and collected
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at the time of placing the buy / sell order. The SPAN® margins are revised 6 times in a day ‐ once
at the beginning of the day, 4 times during market hours and finally at the end of the day.
Initial margin requirements shall be based on 99 percent Value at Risk (VaR) over a one day time
horizon. However, in the case of futures contracts, where it may not be possible to collect mark
to market settlement, before the commencement of trading on the next day, the initial margin
may be computed over a two day time horizon by applying an appropriate statistical formula. In
case of members who have opted for payment of MTM settlement on a T+0 basis, the initial
margin may be computed over a one day time horizon.

Calendar Spread Charge: In the case of futures and options contracts on index and individual
securities, the margin on calendar spread positions shall be calculated on the basis of delta of the
portfolio consisting of futures and options contracts in each month. A calendar spread position
shall be granted calendar spread treatment till the expiry of the near month contract.
The calendar‐spread margin shall be charged in addition to worst‐scenario loss of the portfolio.
The spread charge shall be 0.5 percent per month of spread on the far month contract subject to
a minimum margin of 1 percent and a maximum margin of 3 percent on the far side of the spread
with legs upto 1 year apart.
9.2.1.2 Exposure margins
Members shall be subject to exposure margins in addition to initial margins. The applicable
exposure margin shall be:
Index Futures contracts: The exposure margin shall be 3 percent of the notional value of the
futures positions, based on the last available trading price.
Short Index Options contracts: The exposure margin shall be 3 percent of the notional value of
the short open positions in options on index, based on the last available closing price of the
underlying index.
Futures contracts on individual Securities: The exposure margins shall be higher of 5 percent or
1.5 standard deviation of the notional value of gross open position in futures on individual
securities in a particular underlying.
Short Option contracts on individual Securities: The exposure margins shall be higher of 5
percent or 1.5 standard deviation of the notional value of short open positions in options on
individual securities based on the last available closing price of the underlying security.
For this purpose, the standard deviation of daily logarithmic returns of prices of the underlying
security in the normal market of Capital Market segment of the Exchange in the last six months
shall be computed on a rolling and monthly basis at the end of each month.
Calendar Spread: In case of calendar spread positions in futures contracts, exposure margin shall
be levied on one third of the value of the open position of the far month futures contract. A
calendar spread position shall be granted calendar spread treatment till the expiry of the near
month contract
9.2.1.3 Short Option Minimum Charge

Index Options: Short option minimum charge shall be equal to 3 percent of the notional value of
all short positions in index options. Notional value, with respect to an option contract, shall be
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computed as the product of the short open position in that option contract multiplied by the
previous day's closing price of the index futures contract, or such other price as may be specified
by the Clearing Corporation from time to time.

Options on individual securities: Short option minimum charge shall be equal to 7.5 percent of
the notional value of all short positions in options on individual stocks. Notional value, with
respect to an option contract, shall be computed as the product of the short open position in that
option contract multiplied by the previous day's closing price of the underlying security in the
normal market of Capital Market Segment of the Exchange, or such other price as may be specified
by the Clearing Corporation from time to time.

9.2.1.4 Minimum Percentage for Margins on Futures Contracts:
The minimum margin percentage on index futures shall be 5 percent which shall be scaled up by
look ahead period. The minimum margin percentage on stock futures shall be 7.5 percent which
shall be scaled up by look ahead period. Additionally, if the mean impact cost of a security exceeds
1 percent, the minimum margin percentage in such underlying shall be scaled by square root of
three.
9.2.1.5 Premium Margin
In addition to initial margin, premium margin is charged in the case of options contracts. Premium
Margin shall mean and include premium amount due to be paid to the Clearing Corporation
towards premium settlement, at the client level. Premium margin shall be levied till the
completion of pay‐in towards the premium settlement. The premium margin is paid by the buyers
of the options contracts and is equal to the value of the options premium multiplied by the
quantity of options purchased.
9.2.1.6 Assignment Margin
Assignment Margin shall be levied on assigned positions of the members (sellers) towards final
exercise settlement obligations for option contracts on index and individual securities.
Assignment margin shall be the net exercise settlement value payable by a member towards final
exercise settlement. Assignment margin shall be levied till the completion of pay‐in towards the
exercise settlement.
9.2.1.7 Delivery Period Margin
Appropriate delivery period margin shall be levied on the long and short positions marked for
delivery till the pay‐in is completed by the member. Once delivery period margin is levied, all other
applicable margins may be released. SEBI has specified that delivery period margins shall be
higher of:
a) 3% + 5 day 99% VaR of spot price volatility
Or
b) 20%
9.2.2 Initial margin requirement
For client positions initial margin requirements shall be netted at the level of individual client and
grossed across all clients, without any set‐offs between clients.
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For proprietary positions the initial margin requirements shall be netted at member level without
any set‐offs between client and proprietary positions.

9.2.3 Reporting and Disclosure

The derivatives exchange and clearing corporation shall submit quarterly reports to SEBI regarding
the functioning of the risk estimation methodology highlighting the specific instances where price
moves have been beyond the estimated 99 percent VaR limits. The clearing corporation / clearing
house shall disclose the details of incidences of failures in collection of margin and/or the
settlement dues on a quarterly basis. Failure for this purpose means a shortfall for three
consecutive trading days of 50 percent or more of the liquid net worth of the member.

9.2.4 Liquid Net Worth and Exposure Limits of a Clearing Member

The Liquid Net Worth is defined as under:
Total liquid assets deposited with the exchange/clearing corporation/house towards initial margin
and capital adequacy, less initial margin applicable to the total gross open positions at any given
point of time on all trades to be cleared through the clearing member.

The clearing member’s liquid net worth must satisfy both the conditions given below on a real
time basis:
Condition 1: Liquid Net Worth shall not be less than Rs 50 lakh at any point of time.
Condition 2: The mark to market value of gross open positions at any point of time of all trades
cleared through the clearing member shall not exceed 33 1/3 (thirty three one by three) times his
liquid networth.

The notional value of gross open positions at any point in time in the case of Index Futures shall
not exceed 33 1/3 (thirty three one by three) times the liquid net worth of a member. Exposure
limits are in addition to the initial margin requirements.

9.2.4.1 Liquid Assets

At least 50 percent of the total liquid assets shall be in the form of cash equivalents viz. cash, bank
guarantee, fixed deposits, T‐bills and dated government securities. Liquid Assets for the purposes
of initial margins as well as liquid net worth would include cash, fixed deposits, bank guarantees,
treasury bills, government securities or dematerialised securities (with prescribed haircuts)
pledged in favour of the exchange/clearing corporation or bank guarantees as defined hereunder.
Units of money market mutual funds and units of gilt funds may be accepted towards cash
equivalent component of the liquid assets of a clearing member. The unit shall be valued on the
basis of its Net Asset Value after applying a haircut of 10 percent on the NAV and any exit load
charged by the mutual fund. The valuation or the marking to market of such units shall be carried
out on a daily basis.
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Bank Guarantees
The clearing corporation / house would set an exposure limit for each bank, taking into account
all relevant factors including the following:
The Governing Council or other equivalent body of the clearing corporation / house shall lay down
exposure limits either in rupee terms or as percentage of the trade guarantee fund that can be
exposed to a single bank directly or indirectly. The total exposure would include guarantees
provided by the bank for itself or for others as well as debt or equity securities of the bank which
have been deposited by members as liquid assets for margins or net worth requirement.
Not more than 5 percent of the trade guarantee fund or 1 percent of the total liquid assets
deposited with the clearing house, whichever is lower, shall be exposed to any single bank which
is not rated P1 (or P1+) or equivalent, by a RBI recognised credit rating agency or by a reputed
foreign credit rating agency, and not more than 50 percent of the trade guarantee fund or 10
percent of the total liquid assets deposited with the clearing house, whichever is lower, shall be
exposed to all such banks put together.
The exposure limits and any changes thereto shall be promptly communicated to SEBI. The
clearing corporation shall also periodically disclose to SEBI its actual exposure to various banks.

Securities
Equity securities classified under Group I in the underlying cash market may be accepted towards
liquid assets in the derivative markets. Securities classified under Group I shall be those as defined
by SEBI from time to time. The equity securities shall be valued/marked to market on a daily basis
after applying a haircut equivalent to the respective VaR of the equity security. The list of
acceptable equity securities shall be updated on the basis of trading and mean impact cost on the
15th of each month. When a security is dropped from the list of acceptable equity securities, the
existing deposits of that security shall continue to be counted towards liquid assets till the end of
the month. Equity securities shall be in dematerialised form. Units of all mutual funds may also
be accepted as the securities component of liquid assets. The unit shall be valued on the basis of
its Net Asset Value (NAV) after applying a haircut equivalent to the VaR of the units NAV and any
exit load charged by the mutual fund. The valuation or the marking to market of such units shall
be carried out on a daily basis. The valuation / marking to market of all securities, including debt
securities, dated government securities and T‐bills, shall be carried out daily, with appropriate
haircuts.

Debt securities shall be acceptable only if they are investment grade. Haircuts shall be at least 10
percent with daily mark to market.

The total exposure of the clearing corporation to the debt or equity securities of any company
shall not exceed 75 percent of the trade guarantee fund or 15 percent of the total liquid assets of
the clearing corporation / house whichever is lower. Exposure for this purpose means the mark
to market value of the securities less the applicable haircuts. All securities deposited for liquid
assets shall be pledged in favour of the clearing corporation.
Reserve Bank of India (RBI) vide A. P. (DIR Series) Circular no. 2 dated July 19, 2007 has permitted
clearing corporations and clearing members –
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 to open and maintain demat accounts with foreign depositories and to acquire, hold,
pledge and transfer the foreign sovereign securities, offered as collateral by FPIs;
 to remit the proceeds arising from corporate action, if any, on such foreign sovereign
securities; and
 to liquidate such foreign sovereign securities if the need arises.
Further, Reserve Bank of India vide RBI/2012‐13/439 A.P. (DIR Series) Circular No. 90 dated March
14, 2013 has permitted FPIs to use, in addition to already permitted collaterals, their investments
in government securities and corporate bonds as collaterals in the F&O segment. In light of the
above, FPIs are permitted to offer the following collaterals ‐ government securities, corporate
bonds, cash and foreign sovereign securities with AAA ratings, for their transactions in F&O
segments. In this regard, the stipulations specified by SEBI and RBI with regard to the acceptance
of various collaterals shall be adhered to Clearing members are permitted to accept foreign
sovereign securities with “AAA” rating, (hereinafter referred to as “sovereign securities”) as
collateral from FPI client with the following necessary safeguards:
Before accepting sovereign securities as collateral from FPI, the clearing member shall enter into
a written agreement with the FPI and also with the clearing corporation, containing, inter alia, the
following terms:
i. In the event of any dispute regarding liquidation or return of the sovereign securities
tendered as collateral, or any other incidental matter, the courts in India will have
jurisdiction to decide such disputes. Alternatively, the agreement may contain an
arbitration clause.
The agreement shall also contain the right of the clearing corporation as well as the
clearing member to liquidate the sovereign securities tendered as collateral, in the event
of default by clearing member or FPI, as the case may be.
ii. The clearing member shall take due care to ensure that the sovereign securities tendered
as collateral are available for liquidation in the event of insolvency of the FPI or any
intermediary or any other person located overseas through whom the securities are held.
iii. The clearing corporation shall also take due care to ensure that sovereign securities
tendered as collateral are available for liquidation in the event of insolvency of the
clearing member or any intermediary or other person located overseas through whom
the securities are held.
iv. The clearing corporation shall take adequate care to ensure that the sovereign securities
accepted by it as margin are tendered under a mechanism which does not unduly hinder
timely liquidation in the event of default by the clearing member.
The clearing corporation shall value the collateral tendered by applying due haircuts. The haircut
may either be a fixed percentage or VaR based. A higher haircut may be considered to cover the
expected time frame for liquidation. A market determined price as obtained from an
internationally recognised data vendor shall be considered for valuation. The prices shall be
converted into rupee terms on a daily basis. The rupee value so used for conversion shall be the
“RBI Reference rate”. The RBI reference rate shall be disclosed by the clearing corporation to the
clearing members, so as to enable them to report the value of the margins collected from FPIs.
The sovereign securities tendered as collateral shall be treated as part of the cash component of
the liquid assets of the clearing member, and shall be subject to the condition that the value of
the sovereign securities shall not be more than 10 percent of the total value of the cash
component of the liquid assets of the clearing member. The existing procedure for acceptance
and release of collateral tendered by domestic investors in the case of domestic securities shall
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be adopted mutatis mutandis for the sovereign securities tendered by FPI, except to the extent
specifically provided otherwise. Further, Clearing Corporations while enabling the framework for
acceptance of corporate bonds as collateral for transactions of any entity, shall ensure that:
i. The bonds shall have a rating of AA or above (or with similar rating nomenclature) by
recognised credit rating agencies.
ii. The bonds shall be in dematerialised form.
iii. The bonds shall be treated as part of the non‐cash component of the liquid assets of the
clearing member and shall not exceed 10 percent of the total liquid assets of the clearing
member.
iv. The bonds shall have a fixed percentage based or VaR based haircut. A higher haircut may
be considered to cover the expected time frame for liquidation. To begin with the haircut
shall be a minimum of 10 percent.

9.2.4.2 Graded Surveillance Measure (GSM)

a) Securities and Exchange Board of India (SEBI) and stock exchanges in order to enhance
market integrity and safeguard interest of investors, have been introducing various
enhanced pre‐emptive surveillance measures such as reduction in price band, periodic
call auction and transfer of securities to Trade to Trade category from time to time. The
main objective of these measures is to;
a. alert and advice investors to be extra cautious while dealing in these
securities and
b. advice market participants to carry out necessary due diligence while
dealing in these securities.
b) In continuation to various surveillance measures already implemented, SEBI and
Exchanges, pursuant to discussions in joint surveillance meetings, have decided that along
with the aforesaid measures there shall be additional Graded Surveillance Measures on
securities which witness an abnormal price rise not commensurate with financial health
and fundamentals like Earnings, Book value, Fixed assets, Net‐worth, P/E multiple, etc.
c) The list of such securities identified under GSM shall be informed to market participants
separately and shall be available on exchanges website.
Additionally, Bombay Stock Exchange also introduced the “S+ Framework” which is an additional
surveillance measure for securities exclusively listed/traded on BSE board which are not part of
“Graded Surveillance Measure”. Restrictions similar to those under GSM apply to securities
notified under S+ Framework as well.

9.2.4.3 Additional Surveillance Measure (ASM)

SEBI and Exchanges, pursuant to joint discussions have introduced “Additional Surveillance
Measure (ASM)”, which includes Long term ASM framework and Short term ASM framework. ASM
framework is in conjunction with all other prevailing surveillance measures being imposed by the
Exchanges from time to time.

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The following four criteria shall be made applicable for selection of stocks in the Long Term ASM
Framework:
1. High–Low Price Variation (based on corporate action adjusted prices) in 3 months ≥ (150% +
Beta (β) of the stock * S&P BSE Sensex variation); and Concentration of Top 25 clients account ≥
30% of combined trading volume of BSE & NSE in the stock in last 30 days.
2. Close–to–Close Price Variation (based on corporate action adjusted prices) in the last 60 trading
days ≥ 100% + (Beta (β) of the stock * S&P BSE Sensex variation); and Concentration of Top 25
clients account ≥ 30% of combined trading volume of BSE & NSE in the stock in last 30 days.

3. Close–to–Close Price Variation (based on corporate action adjusted prices) in 365 days greater
than ≥ 100% + (Beta (β) of the stock * S&P BSE Sensex variation); and High–Low Price Variation
(based on corporate action adjusted prices) in 365 days ≥ (200% + (Beta (β) of the stock * S&P BSE
Sensex variation); and market capitalization of more than Rs. 500 crore; and Concentration of Top
25 clients account ≥ 30% of combined trading volume of BSE & NSE in the stock in last 30 days.

4. Average daily Volume in a month is ≥ 10,000 shares & > 500% of Average volume in preceding
3 months at BSE & NSE; and Concentration of Top 25 clients account ≥ 30% of combined trading
volume of BSE & NSE in the stock in last 30 days; and Average Delivery% is < 50% in last 3 months;
and Market Capitalisation is > Rs.500 Crore; and Close–to–close price variation (based on
corporate action adjusted prices) in last one month is > (50% + Beta (β) of the stock * S&P BSE
Sensex variation).

The following securities shall be excluded from the process of shortlisting of securities under ASM:
 Public Sector Enterprises and Public Sector Banks
 Securities already under Graded Surveillance Measure (GSM)
 Securities on which derivative products are available
 Securities already under Trade for Trade.

The following four criteria shall be made applicable for selection of stocks in the Short Term ASM
Framework:
(a) Stage 1: Criteria for Identification of Stocks:
Stocks witnessing Close‐to‐Close Price Stocks witnessing Close‐to‐Close Price

Variation (based on corporate action Variation (based on corporate action adjusted
adjusted prices) ≥ (± 25% + Beta (β) of the prices) ≥ (± 40% + Beta (β) of the stock * S&P
stock * S&P BSE Sensex variation) in 5 trading BSE Sensex variation) in 15 trading days.
days. AND
OR
AND
Concentration of Top 25 clients account ≥
Concentration of Top 25 clients account ≥ 30% of combined trading volume of BSE &
30% of combined trading volume of BSE & NSE in the stock in 15 trading days.
NSE in the stock in 5 trading days.
Stocks identified as per the above criteria in any of the exchanges shall be shortlisted under the
framework.
Action on the shortlisted stocks:
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1. Applicable margin rate for the shortlisted stock will be 1.5 times the existing margin OR 40%,
whichever is higher, subject to maximum rate of margin capped at 100%.
2. Top 10 clients based on the gross traded value, subject to their traded value greater than
Rs.10 lakhs, will be levied 100% margin on their traded value at End‐of‐Day (EoD).
3. On identification of stocks, Exchange shall seek clarification from the company whether there
is any corporate announcement that has not been disseminated to market. The clarification so
received shall be disseminated to the market.
4. A surveillance dashboard shall also be displayed on the Exchange website mentioning the
names of such stocks and other relevant details to inform the investors.
(b) Stage 2:
(c) Criteria:
Stocks witnessing Close‐to‐Close Price Stocks witnessing Close‐to‐Close Price
Variation (based on corporate action Variation (based on corporate action
adjusted prices) ≥ (± 25% + Beta (β) of the adjusted prices) ≥ (± 25% + Beta (β) of the
stock * S&P BSE Sensex variation) in any 5 stock * S&P BSE Sensex variation) in any 15
consecutive trading days during the 15 days consecutive trading days during the 45 days
following the inclusion in Stage I. following the inclusion in Stage I.
OR
AND AND
Concentration of Top 25 clients account ≥ Concentration of Top 25 clients account ≥
30% of combined trading volume of BSE & 30% of combined trading volume of BSE &
NSE in the stock during the above NSE in the stock during the above mentioned
mentioned 5 days period. 15 days period.
Action on the shortlisted stocks:
1. Applicable margin rate for the shortlisted stock will be 2.5 times the existing margin OR 80%,
whichever is higher, subject to maximum rate of margin capped at 100% on all clients.
2. Top 10 clients based on the gross traded value, subject to their traded value greater than Rs.10
lakhs, will be levied 100% margin on their traded value at End‐of‐Day (EoD).

9.3 Annual Compliance Requirements
9.3.1 Insurance Cover

As per SEBI circular no: SMD/SED/RCG/270/96 January 19, 1996 it is mandatory for all active
trading members to be insured. Trading members are required to renew their insurance cover
every year and submit proof to the Stock Exchanges annually.

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9.3.2 Audit Report

As per SEBI Circular SMD/SED/0072/92 dated December 31, 1992, and circular no. F.1/5/SE/83,
Government of India, Ministry of Finance, Department of Economic Affairs, Stock Exchange
Division, dated May 31, 1984, all members of the stock exchange (irrespective of their
constitution) shall get their books of accounts audited and submit the Audit Report in the format
prescribed therein.
Audit of the accounts of the members of Stock Exchanges should be completed within 6 months
from the closing of the books of accounts. In individual cases, an extension for a period not
exceeding 3 months may be granted by the Stock Exchange for adequate reasons.
The accounts of ‘active’ members of Stock Exchanges for every accounting year shall be audited
by qualified chartered accountants. An ‘active’ member of the Stock Exchange refers to a member
who has done business in securities even for a single day in the accounting year.
The annual audit of accounts of a member of the Stock Exchange will be of the nature of the
normal audit conducted in the case of companies, cooperative societies and other entities.
9.3.3 Appointment of compliance officer
In accordance with Regulation 18A of the SEBI (Stock‐brokers and Sub‐brokers) Regulations, 1992,
every trading member has to appoint a compliance officer. Compliance Officer shall be
responsible for monitoring the compliance of the trading members in respect of the Act, Rules,
Regulations, notifications, guidelines, instructions, etc. issued by SEBI or the Central Government
and for redressal of investor’s grievances.
Trading members have to intimate the Stock Exchange the information in respect of its
compliance officer including his/her name, father’s name, residential address & telephone
number, qualification and previous employment.

9.3.4 Trading through other trading members
SEBI vide their letter SEBI/MIRSD//Cir‐06/2004 dated January 13, 2004 has notified the revision
of norms relating to trading by members through other brokers of the same Stock Exchange or
other Stock Exchanges.
A stock broker/ sub broker of an exchange cannot deal with brokers/sub brokers of the same
exchange either for proprietary trading or for trading on behalf of clients, except with the prior
permission of the exchange. The stock exchanges while giving such permission, shall consider the
reasons stated by the brokers/sub brokers for dealing with brokers/sub brokers of the same
exchange and after carrying out due diligence allow such brokers/sub brokers to deal with only
one stock broker/sub broker of the same exchange.
A stock broker/sub broker of an exchange can deal with only one broker/sub broker of another
exchange for proprietary trading after intimating the names of such stock broker/sub broker to
his parent stock exchange.
As per Regulation 15(1) (e) of the SEBI (Stock Brokers and Sub Brokers) Regulations, 1992 a sub‐
broker shall not be affiliated to more than one stock broker of one stock exchange. A stock broker
of an exchange can deal with only one broker of another exchange on behalf of clients after
obtaining necessary registration as a sub broker.
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9.3.5 Internal Audit Report
The member shall carry out complete internal audit on a half yearly basis by an independent
qualified Chartered Accountant, Company Secretary or Cost and Management Accountant who is
in practice and does not have any conflict of interest.
The audit shall cover:
a) The existence, scope and efficiency of the internal control system,
b) Compliance with the provisions of the SEBI Act, 1992, Securities Contracts (Regulation)
Act 1956, SEBI (Intermediaries) Regulations, 2008, SEBI (Stock Brokers and Sub‐Brokers)
Regulations, 1992, circulars issued by SEBI from time to time, Bye Laws and Regulations
and circulars issued by the Stock Exchange / Clearing Corporation,
c) Data security and insurance in respect of operations, and
d) Efficacy of the investor grievance redressal mechanism and discharge of various
obligations towards clients.
The internal auditor shall submit the audit report to the member, who shall place it before its
Board of Directors/Proprietor/Partners and shall forward the same along with para‐wise
comments to the respective stock exchange/clearing corporation within two months from the
end of the half year period.
The Stock Exchange/Clearing Corporation shall analyse the audit reports received and take
appropriate follow up actions including remedial, penal and disciplinary against the members
where deficiencies are noted in the audit report or in case no audit report has been submitted.
The details of action taken should be intimated to SEBI within 6 months from the end of the half
year period.
The stock exchanges shall provide a mechanism to enable the internal auditor to report directly
to the stock exchanges in the event of non‐cooperation by the stock broker. Further, stock
exchanges shall ensure that the internal auditors monitor the corrective steps taken by the stock
brokers to rectify the deficiencies observed in the inspection carried out by SEBI/ stock exchanges
and the compliance thereof. The compliance status shall be made as part of the internal audit
report.25
9.3.6 Networth Certificate
A member is required to submit Networth Certificate on a half yearly basis as of 31st March by
30th April and as of 30th September by 31st October in the format prescribed by the Exchanges.

9.3.7 Networth certificate for margin trading
Only corporate brokers with a net worth of at least Rs.3 crores would be eligible to offer margin
trading facility to their clients. The “net worth” for the purpose of margin trading facility would
mean “Capital” (excluding preference share capital) plus free reserves less non allowable assets,
i.e. fixed assets, pledged securities, member’s card, non‐allowable securities, bad deliveries,
doubtful debts and advances (including debts and advances overdue for more than 3 months or
25
SEBI/HO/MIRSD/MIRSD2/CIR/P/2016/95 dated September 26, 2016 and SEBI
CIR/HO/MIRSD/MIRSD2/CIR/PB/2017/107 dated September 25, 2017
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given to associates), pre‐paid expenses, intangible assets and 30 percent of the marketable
securities.
The broker shall submit to the stock exchange a half‐yearly certificate, as on 31st March and 30th
September of each year, from an auditor confirming the net worth. Such a certificate shall be
submitted no later than 30th April and 31st October of the year.

9.3.8 System Audit Report
SEBI vide circular CIR/MRD/DMS/34/2013 dated November 06, 2013 specified the requirements
for system audit requirements for stock brokers / trading members.
As per the provisions of the circular, the stock brokers/ trading members using trading software
shall be required to do the following:
 Carry out system audit of their trading facility as per applicability criteria.
 System audit of trading system to be undertaken by a system auditor who fulfils the
eligibility norms.
 Obtain preliminary system audit report from the system auditor as per the prescribed
format.
 Submit preliminary system audit report to the Exchange after adding Management
comments.
 Take corrective action for the observations made by the system auditor on non‐
compliance / non‐conformities (NCs), if any, in the preliminary report and submit Action
Taken Report (ATR).
 If the follow‐on audit has been recommended by the auditor in preliminary audit report,
then schedule the same after taking necessary corrective actions and submit the Follow‐
on Audit Report.

9.3.8.1 System auditor eligibility norms
 Should have minimum 3 years’ experience in IT audit of securities market participants.
 Resources employed for the purpose of system audit shall have relevant industry
recognised certifications e.g. D.I.S.A., CISA or CISM.
 Should have experience in IT audit/governance frameworks and processes.
 Should not have any cases pending against its previous audited companies/firms, which
fall under SEBI’s jurisdiction, which point to its incompetence and/or unsuitability to
perform the audit task.
 Should not have conducted more than 3 successive audits of the stock broker / trading
member.

9.3.8.2 Terms of Reference (TOR) for System Audit
The system audit should cover the following areas:
 System controls and capabilities
 Risk management system
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 Password security
 Session management
 Network integrity
 Access controls
 Backup and recovery
 BCP/DR
 Segregation of data and processing facilities
 Back office data
 IT infrastructure management
 Software change management
 Smart Order Routing (SOR)
 Database security
 User management
 Software testing procedures
 Algorithmic trading
 Additional points such as Antivirus management, asset management, capacity
management, insurance, firewall etc.
9.3.8.3 Broker / Trading member category
The Broker / Trading members have been classified into different category depending on their
software usage and the type of trading carried out by them. Based on the category, the frequency
of audit are applicable.
Category of Only Exchange Exchange Exchange
member Exchange software + third software + third software, third
provided party software in party software in party software +
terminal locations <10 locations >10 algo
and <50 and >50
terminals terminals
Stock brokers / Once in 2 Once in 2 years Annual Half yearly
Trading members years
Stock brokers / Annual Annual Annual Half yearly
trading members
who are also
depository
participants or
are involved in
other financial
services

Based on the category, the Terms of Reference (TOR) is also defined.
9.3.8.4 Report Submission timeline

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National Stock Exchange
Audit period Preliminary Audit Action taken report Follow up audit report
Report (ATR) (if applicable)
Half yearly (April to October 31 November 30 December 31
September)
Half yearly (October April 30 May 31 June 30
to March)
Annual (April to April 30 May 31 June 30
March)
Once in 2 years (April April 30 May 31 June 30
– March for 24
months)
Metropolitan Stock Exchange of India Limited
Audit period System Audit Report Action taken report Follow up audit report
(SAR) (ATR) (If applicable) (if applicable)
Half yearly SAR (April November 30 December 31 January 31
to September)
Half yearly (October June 30 July 31 November 30
‐March)
Annual SAR June 30 July 31 November 30
Once in 2 years SAR June 30 July 31 November 30
(April – March for 24
months)
9.4 Quarterly Compliance Requirements
9.4.1 Disclosure by trading members of their holdings in listed companies
In order to increase transparency and provide correct picture of the actual shareholding of a listed
company, in consultation with SEBI, trading member and their group entities (where group
entities consists of promoter group, subsidiary/ies and associate entities) are required to submit
breakup of shareholding (held in their name or on behalf of the clients), to the Exchanges on a
quarterly basis to the Exchange if such holding is 1 percent or more of the share capital of a listed
company. The disclosure should be made within forty five days from the end of each quarter in
the format prescribed by the Exchange.
9.4.2 Quarterly compliance certificate on order limits
Trading members shall review and define the following limits and submit a compliance report on
quarterly basis:
 Quantity limit for each order
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 Value limit for each order
 User value limit for each user ID
 Branch value limit for each branch ID
 Spread order Quantity and Value Limit for derivatives contracts
The Compliance officer of the trading member shall submit a certificate on the above to the
Exchange on a quarterly basis confirming the following:
 That the limits are setup after assessing the risks of the corresponding user ID and branch
ID.
 The limits are setup after taking into account the member’s capital adequacy
requirements.
 All the limits are reviewed regularly and the limits in the system are up to date.
 All the branch or user have defined limits and no user or branch in the system has
unlimited limits on the above stated parameters.
Daily record of these limits is preserved and shall be produced before the Exchange as and when
the information is called for.
Compliance with respect to the above requirements should be monitored as a part of annual
system audit and system auditor shall verify the compliance officer’s certificates and confirm that
the systems and system records are maintained as prescribed by the Exchange.
9.4.3 Client‐wise funding report
SEBI vide its circular dated July 16, 2004 and June 29, 2005 has advised members to disclose their
net exposure towards their clients on a particular day (i.e. the maximum/peak exposure of funding
by the members for their clients) during a month in respect of the monthly disclosure requirement
of client funding. The disclosure shall include the temporary funding of the member for their
clients towards margin (retail clients), settlement obligations (both institutional and retail clients)
and margin trading as also the total. Members are required to upload the aforesaid details of the
previous month by the 7th day of the subsequent month. In case a member does not have any
details/information as per the prescribed format, they should submit a one‐time letter as per the
specified format stating that they have no details to be furnished. As and when a member does
client funding, such member shall be required to upload the details in the prescribed format
within the prescribed due date. Once a member has done client funding as above, such member
shall be required to furnish details every month, even if details are ‘Nil’ so as to avoid late/non‐
reporting charges.

9.4.4 Guidelines for execution of Power Of Attorney
Power of Attorney (POA) favouring Stock Brokers by the client should be limited to the following:
9.4.4.1 Securities
 Transfer of securities held in the beneficial owner account(s) of the client(s) towards stock
exchange related margin / delivery obligations arising out of trades executed by the
client(s) on the stock exchange through the same stock broker.
 Pledge the securities in favour of stock broker for the limited purpose of meeting the
margin requirements of the client(s) in connection with the trades executed by the clients
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on the stock exchange through the same stock broker. Necessary audit trail should be
available with the Stock Broker for such transactions.
 To apply for various products like mutual funds, public issues (shares as well as
debentures), rights, offer of shares, tendering shares in open offers etc. pursuant to the
instructions of the client(s). However, a proper audit trail should be maintained by the
Stock Broker to prove that the necessary application/act was made/ done pursuant to
receipt of instruction from client.

9.4.4.2 Funds
Transfer of funds from the bank account(s) of the clients for the following:
 For meeting the settlement obligations of the client(s)/ margin requirements of the
client(s) in connection with the trades executed by the clients on the stock exchange
through the same stock broker.
 For recovering any outstanding amount due from the client(s) arising out of clients trading
activities on the stock exchanges through the same stock broker.
 For meeting obligations arising out of the client subscribing to such other
products/facilities/services through the stock broker like mutual funds, public issues
(shares as well as debentures), rights, offer of shares, tendering of shares in open offers
etc.
 Towards monies/fees/charges, etc. due to the stock broker/depository participant/
principal payable by virtue of the client using/subscribing to any of the facilities/services
availed by the client at his/her instance.

Necessary audit trail should be available with the Stock Broker for such transactions.

The PoA executed in favour of a stock broker by the client should:
 identify/ provide the particulars of the beneficial owner account(s) and the bank
account(s) of the client(s) that the stock broker is entitled to operate.
 provide the list of clients and brokers Bank accounts and demat accounts where funds
and securities can be moved. Such bank and demat accounts should be accounts of
related party only.
 be executed in the name of the concerned SEBI registered entity only and not in the name
of any employee or representative of the stock broker.
 not provide the authority to transfer the rights in favour of any assignees of the stock
broker.
 be executed and stamped as per the rules / law prevailing in the place where the PoA is
executed or the place where the PoA is kept as a record, as applicable.
 contain a clause by which the Stock Broker would return to the client(s), the securities or
fund that may have been received by it erroneously or those securities or fund that it was
not entitled to receive from the client(s).
 be revocable at any time, without notice.
 be executed by all the joint holders (in case of a demat account held jointly). If the
constitution of the account is changed for whatever reason, a new PoA should be
executed.
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 authorise the stock broker to send consolidated summary of client's scrip‐wise buy and
sell positions taken with average rates to the client by way of SMS / email on a daily basis,
notwithstanding any other document to be disseminated as specified by SEBI from time
to time.

The PoA executed in favour of a stock broker by the client should not facilitate the broker to do
the following:
 Transfer of securities for off market trades.
 Transfer of funds from the bank account(s) of the clients for trades executed by the clients
through another stock broker.
 Open a broking / trading facility with any stock broker or for opening a beneficial owner
account with any depository participant.
 Execute trades in the name of the client(s) without the client(s) consent.
 Prohibit issue of Delivery Instruction Slips (DIS) to beneficial owner (client).
 Prohibit client(s) from operating the account.
 Merging of balances (dues) under various accounts to nullify debit in any other account.
 Open an email ID/ email account on behalf of the client(s) for receiving statement of
transactions, bills, contract notes etc. from stock broker / depository participant.
 Renounce liability for any loss or claim that may arise due to any blocking of funds that
may be erroneously instructed by the stock broker to the designated bank.

Stock broker should ensure that:
 A duplicate/ certified true copy of the PoA is provided to the Client(s) after execution.
 In case of merger/ demerger of the stock broker with another entity/ into another entity,
the scheme of merger/ demerger should be approved by High Court and one month prior
intimation given to the client about the corporate restructuring to facilitate investor/
client to continue or discontinue with the broker.
9.5 Other Compliances

9.5.1 Operations at Branch and Sub Broker Locations

Broker/ Trading member should undertake due diligence for the branches, sub brokers,
authorised persons etc. as given below:

 Ensure that receipt or payment of funds and securities are only from or to the respective
clients and not from other person (including sub‐broker, branch official, authorised
person, dealer, etc).
 Ensure that the persons operating the trading terminals use proper client code in respect
of the orders received from such clients and do not combine orders of different persons.
 Ensure that the no margin/pay‐in obligation/pay‐out adjustment is done among clients or
between clients and sub‐brokers, authorised persons, branch officials, dealers, etc.
 Ensure making and receipt of payments only by “Account Payee” cheque or by direct bank
debit/credit and not dealing in cash.
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 Ensure that sub‐broker, branch official, authorised persons, dealers, etc., do not issue
any contract note, bill, confirmation memo, debit/credit note etc., to the clients, unless it
is issued in the name of the Trading Member under written authorisation from it.
 If the trading member is also a depository participant for the client, sub‐broker,
authorised person, branch official, dealer etc., then to watch for unexplained, frequent or
large off‐market transfers.
 Undertake surprise inspections of such places to ensure prevention of any activity in
violation of the Regulations.
 It shall be the primary responsibility of the affiliated stock broker/trading member to
inspect the registered sub‐brokers.

9.5.2 Client Code Modification

SEBI vide its circular no: CIR/DNPD/6/2011 dated July 05, 2011 specifies that the stock exchanges
may allow modifications of client codes of non‐institutional trades only to rectify a genuine error
in entry of client code at the time of placing / modifying the related order. The stock exchange for
the said purpose shall consider the following:
 Waive penalty for a client code modification where stock broker is able to produce
evidence to the satisfaction of the stock exchange to establish that the modification was
on account of a genuine error.
 Not more than one such waiver per quarter may be given to a stock broker for
modification in a client code.
Explanation: If penalty waiver has been given with regard to a genuine client code
modification from client code AB to client code BA, no more penalty waivers shall be
allowed to the stock broker in the quarter for modifications related to client code AB and
BA.
 Proprietary trades shall not be allowed to be modified as client trade and vice versa.
 Stock Exchanges shall submit a report to SEBI every quarter regarding all such client code
modifications where penalties have been waived.

Notwithstanding the above, Stock Exchanges shall levy a penalty from trading members and credit
the same to its Investor Protection Fund (IPF) as under:

‘a’ as a percent of ‘b’ Penalty as a percent of ‘a’
≤ 5 1
>5 2

Where, a = Value (turnover) of non‐institutional trades where client codes have been modified by
a trading member in a segment during a month.
b = Value (turnover) of non‐institutional trades of the trading member in the segment during the
month.

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The Stock Exchange shall conduct a special inspection of the trading member to ascertain whether
the modifications of client codes are being carried on as per the strict objective criteria set by the
Stock Exchange and if ‘a’ as percent of ‘b’ as given in the table above exceeds 1 percent during a
month and take appropriate disciplinary action, if any deficiency is observed.

9.5.3 Monthly Compliances: Monitoring of client funds lying with the Stock broker by the
Exchanges
As required by SEBI’s enhanced supervision circular Stock brokers shall submit the following
data as on last trading day of every month (till March 31, 2018)26 to the Stock Exchanges on or
before the next 3 trading days:

The Aggregate value of

 Fund balances available in all Client Bank Accounts, including the Settlement Account,
maintained by the stock broker across stock exchanges.
 Collateral deposited with clearing corporations and/or clearing member (in cases where
the trades are settled through clearing member) in form of Cash and Cash Equivalents
(Fixed deposit (FD), Bank guarantee (BG), etc.) (across Stock Exchanges). Only funded
portion of the BG, i.e. the amount deposited by stock broker with the bank to obtain the
BG.
 Credit balances of all clients as obtained from trial balance across Stock Exchanges (after
adjusting for open bills of clients, uncleared cheques deposited by clients and uncleared
cheques issued to clients and the margin obligations).
 Debit balances of all clients as obtained from trial balance across Stock Exchanges (after
adjusting for open bills of clients, uncleared cheques deposited by clients, uncleared
cheques issued to clients and the margin obligations).
 Proprietary non‐cash collaterals i.e. securities which have been deposited with the
clearing corporations and/or clearing member (across Stock Exchanges).
 Non‐funded part of the BG across Stock Exchanges.
 Proprietary Margin Obligation across Stock Exchanges.
 Margin utilized for positions of Credit Balance Clients across Stock Exchanges.
 Unutilized collateral lying with the clearing corporations and/or clearing member across
Stock Exchanges.

26
As per SEBI Circular no.: CIR/HO/MIRSD/MIRSD2/CIR/PB/2017/107 dated September 25, 2017 stock
brokers, post March 31, 2018, are required to upload the data as on last trading day of every week on or
before the next 3 trading days.
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Review Questions

1. Extreme loss margin covers the expected loss in situations that go beyond
(a) 99 percent value at risk estimates
(b) 95 percent Value at risk estimates
(c) 90 percent value at risk estimates
(d) 69 percent value at risk estimates
Ans: (a)

2. Acceptable liquid asset will include
(a) Cash
(b) Liquid Group (I) equity share with Exchange specified exposure limit
(c) Bank Guarantee
Ans: (d)

3. Minimum margin percentage on index futures shall be:
(a) 7.5 percent scaled up by look ahead period
(b) 5 percent scaled up by look ahead period
(c) 10 percent scaled up by look ahead period
(d) 12.5 percent scaled up by look ahead period
Ans: (b)

4. Trading members are required to submit networth certificate at what intervals?
(a) Annually
(b) Half yearly basis
(c) Fortnightly
(d) As and when sought from SEBI
Ans: (b)
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Chapter 10 Clearing and Settlement Process



 Clearing and settlement entities and process in cash and derivatives markets

 Core Settlement Guarantee Fund
 Investor Protection Fund at Exchanges and SEBI Investor Protection and Education
Fund

 Outsourcing activities by brokers

10.1 Clearing and Settlement Process for Cash Market

The clearing and settlement process is handled by the Clearing Corporation (CC) of the stock
exchange. All trades are transferred to the CC either online or end of day. The CC then carries out
various steps to ensure settlement of funds and securities on the pre‐determined settlement
schedule.
10.1.1 Clearing Corporation / Clearing House

Clearing Corporation / Clearing house’s main role is to carry out clearing and settlement process
for its participants i.e., clearing members and provide settlement guarantee. CC acts as a counter
party to every trade through the process called novation thus ensuring that in the event of a
clearing member failing to fulfill their obligation, CC will step in and complete the settlement. In
the process of novation, the original trade between the two parties is cancelled and clearing
corporation acts as counterparty to both the parties to the trade.
10.1.2 Participants and their role

The Clearing process for Cash segment involves the following participants:
 Clearing Members who clear and settle trades
 Clearing Bank which handles the funds settlement
 Depositories which handle the security settlement
 Custodian, an entity which handles the clearing and settlement process for institutional
clients
10.1.2.1 Clearing Member

Clearing and settlement of transactions in F&O segment is handled by Clearing Members. Clearing
members can be of the following categories:
 Self‐Clearing Member (SCM): When a trading member clears and settles their own trade
they are called SCM.
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 Trading cum clearing member (TCM): Whenever a trading member decides to clear and
settle their own trades and trades for other trading members they are called as TCM.
 Professional Clearing Members (PCM). PCMs are clearing members who do not have a
trading membership. They clear and settle trades for trading members and institutional
clients. Typically Banks and custodians act as PCMs.
The Clearing Member and the Trading Member shall enter into an agreement which should clearly
state the nature of relationship between the two and should explicitly specify the duties,
responsibilities, obligations and code of conduct of the concerned parties. The Clearing Member
shall enter into a separate agreement with each of the trading member on whose behalf he will
be clearing trades. The agreement should cover the following:
Deposit from Trading Member: The Clearing Member shall specify the amount of deposit that
would be required to be deposited by the trading member with the clearing member. It shall
include the details of the minimum deposit at any point in time, the mode of payment, steps that
can be taken by the clearing member in case of any shortfall e.g. restriction on further trading,
close‐out of open positions etc. This shall be as agreed by the two parties or as prescribed by the
relevant authority from time to time.
Exposure limit: The agreement shall include the exposure limit details applicable to the trading
member. Such limits may be decided by the clearing member, subject to the requirements
prescribed by the relevant authority from time to time. The agreement shall also specify the
actions to be taken in case of an exposure limit violation e.g. the agreement may empower the
clearing member to close‐out open positions of the trading member or withdraw/disable the
trading facility of the trading member by intimation to the exchange/clearing corporation.
Commissions, Brokerage, other fees: The agreement shall indicate the rate of brokerage/
commission/ fee charged by the clearing member in respect of various services provided by him.
Types of services offered: The agreement shall specify the nature of services provided by the
clearing member e.g. clearing services, advisory services, portfolio management services etc.
Payment of margins: The clearing member shall collect margins from the trading member as
prescribed by the relevant authority from time to time. However, if the clearing member finds it
necessary, he shall be authorised to levy and collect additional margin over and above those
imposed by the exchange/ clearing corporation and the trading member shall be liable to pay the
margins within the stipulated time. Also, the clearing member shall ensure that the trading
member collects margins from his clients on a gross basis.
Liquidation/close‐out of positions: The clearing member shall have the authority to
liquidate/close‐out positions of the trading member for non‐payment of margins, outstanding
dues etc.
Liability to reimburse losses: The agreement shall specify the liability of the trading member to
reimburse any losses or financial charges arising from liquidation/close‐out of positions by the
clearing member as mentioned above.
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Client Registration by the trading member: The clearing member shall ensure that the trading
member undertakes registration of all his clients and that the requirements of Know Your Client
and Risk Disclosure Document are complied with. The trading member shall provide such details
to the clearing member.
Segregation of client money: The money deposited by the clients shall be kept in a separate
account by the trading member, distinct from his own account and he shall provide the details to
the clearing member.
10.1.2.2 Clearing Bank
Clearing Corporation empanels commercial banks as Clearing Banks for the purpose of funds
settlement. Funds to be paid and/ or to be received shall be settled through such branches of
banks which are designated as clearing banks. Every clearing member shall maintain and operate
a separate and distinct primary clearing account for the futures and options segment with any
one of the designated clearing banks. The primary clearing account shall be used exclusively for
clearing operations i.e., for settling funds obligation, payment of margins, penal charges, etc.
Clearing members shall irrevocably authorise the clearing banks to access their clearing accounts
for debiting and crediting their clearing accounts as per the instructions of the Clearing
Corporation and reporting of balances and other information as may be required. Clearing
members can deposit funds into these accounts in any form and can withdraw funds from these
accounts only in self name. Clearing members having funds obligation to pay shall have clear
balance of requisite funds in the clearing accounts on or before the stipulated funds pay‐in day
and the stipulated time. Clearing members shall not seek to close or de‐activate the clearing
accounts without the prior written consent of the Clearing Corporation. The clearing banks shall
debit/credit the clearing accounts of clearing members as per instructions received from the
Clearing Corporation.
The National Securities Clearing Corporation Limited (NSCCL) takes care of the clearing and
settlement on NSE. It is a fully owned subsidiary of NSE and is called the clearing corporation.
Indian Clearing Corporation Limited (ICCL) takes care of the clearing and settlement on BSE. It is a
subsidiary of BSE and Bank of India and is called the clearing house. Metropolitan Clearing
Corporation of India Ltd. (MCCIL) is the clearing corporation for all the trades executed on the
Metropolitan Stock Exchange of India Limited (MSXI) formerly known as MCX‐SX Stock Exchange.
10.1.2.3 Depository
In clearing and settlement process, the depositories facilitate transfer of securities from one
account to another at the instruction of the account holder. In the depository system both
transferor and transferee have to give instructions to its depository participants [DPs] for
delivering and receiving of securities. However, transferee can give 'Standing Instructions' [SI] to
its DP for receiving in securities. If ‘SI’ is not given, transferee has to give separate instructions
each time securities have to be received. Transfer of securities from one account to another may
be done for any of the following purposes:
a. Transfer due to a transaction done on a person to person basis is called 'off‐market' transaction.
b. Transfer arising out of a transaction done on a stock exchange.
c. Transfer arising out of transmission and account closure.
A beneficiary account can be debited only if the beneficial owner has given 'Delivery Instruction'
[DI] in the prescribed form. The DI for an off‐market trade or for a market trade has to be clearly
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indicated in the form by marking appropriately. The form should be complete in all respects. All
the holder(s) of the account have to sign the form. If the debit has to be effected on a particular
date in future, account holder may mention such date in the space provided for 'execution date'
in the form.

Any trade that is cleared and settled without the participation of a clearing corporation is called
off‐market trade, i.e., transfer from one beneficiary account to another due to a trade between
them. Large deals between institution, trades among private parties, transfer of securities
between a client and a sub‐broker, large trades in debt instruments are normally settled through
off‐market route. The transferor will submit a DI with 'off‐market trade' ticked off to initiate an
off‐market debit. The account holder is required to specify the date on which instruction should
be executed by mentioning the execution date on the instruction. The debit will be effected on
the execution date. DP will enter the instruction in the system of the depository participant (which
links the DP with its depository) if the instruction form is complete in all respects and is found to
be in order. This system will generate an 'instruction number' for each instruction entered. DP will
write the instruction number on the instruction slip for future reference. The instruction will be
triggered on the execution date. If there is adequate balance in the account, such quantity will be
debited on the execution date. If adequate balances do not exist in the account, then instruction
will wait for adequate balances till the end of the execution day. The account will be debited
immediately on receipt of adequate balances in the account. If adequate balances are not
received till the end of the day of the execution date, the instruction will fail. Transferee will
receive securities into the account automatically if SI were given to the DP at the time of account
opening. If SI is not given, transferee has to submit duly filled in 'Receipt‐Instruction' [RI] form for
every expected receipt. Exchange of money for the off‐market transactions are handled outside
the depository system.

A market trade is one that is settled through participation of a Clearing Agency. In the depository
environment, the securities move through account transfer. Once the trade is executed by the
broker on the stock exchange, the seller gives a delivery instruction to his DP to transfer securities
to his broker's account. The broker has to then complete the pay‐in before the deadline
prescribed by the stock exchange. The broker transfers securities from his account to Clearing
Agency of the stock exchange concerned, before the deadline given by the stock exchange. The
Clearing Agency gives pay‐out and securities are transferred to the buying broker's account. The
broker then gives delivery instructions to his DP to transfer securities to the buyer's account. The
movement of funds takes place outside the Depository system.
10.1.2.4 Custodian
Institutional clients such as FPIs and Domestic Financial Institutions (DFIs) settle their transactions
through an entity called custodian. Custodians are SEBI registered entities who are responsible
for the following functions:
 Maintaining accounts of securities for the institutional client
 Collecting benefits in respect of securities held
 Handling the clearing and settlement functions on behalf of the institutional clients in
co‐ordination with the trading members

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10.1.3 Clearing Process
10.1.3.1 Obligation Determination
The clearing process for cash segment consists of computation of final obligation for the
participants by computing their net open positions. At the end of trading day, all trades are
transmitted to the Clearing Corporation from the Exchange for the purpose of settlement. The
Clearing Corporation carries out a process called netting to arrive at the obligations of each
member. It is a multilateral netting of trades i.e., for each security, a single open position is
determined, whether buy or sell across all trades for that account. Based on the net obligation,
clearing members may have obligation to deliver or receive various securities as well pay or
receive net funds for each settlement.
The security to be delivered / received is settled through the depositories and the funds
settlement is carried out through the clearing banks.
A diagrammatic representation of the entire clearing and settlement process for cash segment is
given below:

Risk Management
Positions &
Margins
Member
Trading information, Clearing & Demat
System Trades, Prices Settlement Profit/loss computation, Transactions
Transaction creation,
Funds Process funds
transactions transactions,
Process demat Depository
transactions
Bank

10.1.3.2 Institutional Confirmation

Whenever a trade is executed in the cash segment on behalf of the institutional clients, the trading
members will transfer the said trade to the custodian (also called custodial clearing member) for
the purpose of confirmation. The custodian will either confirm or reject the trade based on
instructions received from their institutional clients. This process is called “Give up”. Once the
trades are confirmed, it will be the responsibility of the said custodian to deliver / receive funds
and securities on behalf of their client.
10.1.4 Settlement Process

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Settlement for cash market consists of security settlement through the depositories and funds
settlement through clearing banks.
10.1.4.1 Settlement Schedule

In April 2002, the Indian capital markets introduced T+3 rolling settlement cycle. The settlement
cycle of T+3 under the Rolling Settlement System, was shortened further to T+2 rolling settlement,
w.e.f. April 01, 2003.

Settlement Schedule for rolling settlement
The activity schedule is as under:

Day Time Activity
T Trade Day
T+1 By 1 p.m. Completion of custodial confirmation of
trades to CC/CH
By 2.30 p.m. Completion of process and download
obligation files to brokers/ custodians by
the CC/CH.
T+2 Until 10.30 a.m. Accept Pay‐in instructions from investors
into pool account
By 10.30 a.m. Submit final pay‐in files to the depository
and the clearing bank.
By 1.30 p.m. Pay‐out of securities and funds
On or before T+2 Auction Session
On or before T+3 Pay‐in/Pay‐out and close out of auction

10.1.4.2 Settlement of Funds

Funds settlement is carried out through the clearing banks. On the scheduled pay‐in day, accounts
of the clearing members who have to make pay‐in is debited across various clearing banks. After
verifying receipt of funds from all members and funding for any shortages, the CC will credit the
clearing bank accounts of the clearing members who have to receive funds at the scheduled pay‐
out time.
10.1.4.3 Settlement of Securities

Pay‐in is conducted on the scheduled pay‐in day, in accordance with the settlement calendar
periodically issued by the Clearing Corporation. Clearing members are required to maintain
settlement accounts (called clearing member pool account) at both depositories viz., NSDL and
CDSL and provide specific pay‐in instructions to depositories for effecting pay‐in. For pay‐in
through NSDL / CDSL a facility has been provided to members wherein delivery‐out instructions
will be generated automatically by the Clearing Corporation based on the net delivery obligations
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of its Clearing Members. These instructions will be released on the T+1 day and the securities in
the Clearing Members pool accounts will be marked for pay‐in.

Pay‐out shall be conducted on the scheduled payout day, in accordance with the settlement
calendar issued periodically by the Clearing Corporation in this regard.

Direct pay‐out to Beneficiary Account
A facility is provided to the clearing members to directly credit the pay‐out to investor’s
beneficiary account. For this, clearing members have to provide a file to the Clearing Corporation
for effecting pay out to investors' accounts for a particular settlement type and settlement
number. Clearing members have to mention the beneficial owner’s account number entitled to
receive the payout of securities.

10.1.4.4 Auction and Close Out
Failure of the seller to deliver securities will result in buy‐in auction for the shares by clearing
corporation schedule. In case of multiple settlements conducted on the same day, the auction
session for the first settlement shall be conducted on the same day and settled on the next day.
The auction for the second settlement shall be conducted on the next day along with the
shortages/auction of that day. The settlement of the same shall happen on the subsequent day.
The short delivering member is not allowed to offer in the auction for the respective security. The
auction amount shall be charged to the short delivering member. Failure to procure shares in
auction will result in close out.
The Close out Procedure is as below:‐
"The close out price will be the highest price recorded in that scrip on the exchange in the
settlement in which the concerned contract was entered into and up to the date of auction/close
out;
OR
20 percent above the latest available closing price at the exchange on the day on which auction
offers are called for whichever is higher.
Close out mark up of 5 percent would be applied in case of debentures and bonds which are
assigned a credit rating of AAA and above. However, for the other debentures and the bonds
without the AAA credit rating, the existing close out mark up of 20 percent shall be applicable as
is applicable in the case of equities.
The proceeds from Auction/ Close‐out should be used to settle the claim of the aggrieved party.
Any amount remaining thereof should be credited to the Investor Protection Fund instead of
crediting it to the defaulting party’s account.

10.1.5 Broker internal netting and shortage

Internal Shortage means one client of the broker delivers short quantity of any scrip against his
pay‐in obligation and where another client of the same broker has buy position in the same scrip
in that particular settlement, thus, leading to internal shortage at broker level. It should be
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ensured that the shares short delivered are received subsequently and in turn delivered to the
buyer. Further, in case of internal shortage, BSE has given option to broker to report the shortage
by prescribed time limit and in such case the BSE shall conduct the auction and deliver the shares
to the buyer.

10.2 Clearing and Settlement Process for Futures & Options Market
10.2.1 Participants and their role

The Participants for clearing and settlement process for futures and options segment consists of:
 Clearing Members who clear and settle trades
 Clearing Bank which handles the funds settlement
Details of these entities are similar to the cash segment.
10.2.2 Clearing Process – obligation / open position determination

The clearing process for futures and options segment consists of computation of daily obligation
and final obligation for the participants by computing their open position. At the end of trading
day, all trades are transmitted to the Clearing Corporation from the Exchange for the purpose of
settlement. The Clearing Corporation carries out a process called netting to arrive at the
obligations of each member. It is a multilateral netting of trades i.e., for each contract a single
open position is determined, whether buy or sell across all trades for that account. While arriving
at the net obligation, it is computed separately for proprietary position and individual client
position for each trading member which is then grossed across all trading members and their
clients at the clearing member level. This is called the net open position. A diagrammatic
representation of the entire clearing and settlement process for the futures and options segment
is given below:

Risk
Management
Positions &
Margins
Member information,
Trading Clearing and
System Trades, Prices Settlement • Obligation
determination
• Daily Mark to
Funds Market
transactions • Daily premium
settlement
Bank • Exercise and
assignment
• Final Settlement
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10.2.2.1 Institutional Trade Confirmation

Trades pertaining to institutional clients are transferred by trading members to the clearing
member of the institutional client through a process called “give up”. Such “give up” trades are
required to be accepted by the clearing member through a trade confirmation process. If the
trades are confirmed they become the obligation of the clearing member of the client. If rejected,
these trades revert to the trading member and become their obligation and hence require to be
settled by the clearing member clearing and settling the trades for the trading member.

10.2.3 Settlement Period

The pay‐in and pay‐out of daily mark to market settlement, final settlement of futures contracts,
premium settlement and the final exercise settlements of options contracts are carried out based
on the settlement schedule specified by the Clearing Corporation. Currently, all obligations are
cash settled in futures and options. Thus, the paying members are required to have clear balance
of funds in their clearing account towards their pay‐in obligation by the declared pay‐in time on
the settlement day. The pay‐out of funds shall be credited to the receiving members clearing
account thereafter. Currently, all settlements are effected on a T+1 day basis.

10.2.4 Daily mark to market and final Settlement

Daily mark to market settlement and final settlement in respect of futures contracts are cash
settled by debit/ credit of the clearing accounts of clearing members with the respective clearing
bank.
The open positions are marked to market to the daily settlement price at the end of trading day
to determine the mark to market settlement.
Daily settlement price for futures contracts shall be the closing price of such contracts on the
trading day. The closing price for a futures contract shall be calculated on the basis of the last half
an hour weighted average price of such contract. If a contract is not traded on a particular day in
the last half an hour, the Clearing Corporation computes a theoretical settlement price for the
purpose of settlement.
Based on the mark to market computation, members who have net mark to market losses should
make arrangement for funds on the pay‐in day and members who have net mark to market profit
will be credited with funds on the pay‐out day by the Clearing Corporation.
All positions of a clearing member in futures contracts, at the close of trading hours on the last
trading day of the contract, are marked to market at final settlement price (for final settlement)
and settled. The final settlement price will be the closing price of the underlying security.
SEBI in its circular SEBI/HO/MRD/DP/CIR/P/2018/67 dated April 11, 2018 has specified that all
stock derivatives will be physically settled in a phased manner. In its subsequent circular dated
December 31, 2018, it has specified the following roadmap for the phased implementation of the
physical settlement:
a. Stocks which are being cash settled shall be ranked in descending order based on daily market
capitalization averaged for the month of December 2018.
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b. Based on the ranking arrived at sub‐para 3(i)above, the bottom 50 stocks shall move to
physical settlement from April 2019 expiry onwards, the next 50 stocks from the bottom shall
move to physical settlement from July 2019 expiry onwards, and the remaining stocks shall
move to physical settlement from October 2019 expiry onwards.

10.2.5 Premium settlement for options contract

Premium settlement in options contracts on index and on individual securities is cash settled by
debit/ credit of the clearing accounts of clearing members with the respective clearing bank.

The premium payable or receivable value of clearing members shall be computed after netting
the premium payable or receivable positions at trading member level, for each option contract,
at the end of each trading day.

10.2.6 Exercise and Assignment

Currently option contracts shall be cash settled in F&O segment, by debit/credit of relevant
clearing accounts of relevant clearing members with the respective clearing bank towards the
exercise settlement value for each unit of the option contract.

Index options
Exercise style of index option contracts is European style wherein all in‐the‐money contracts get
automatically exercised on the expiry day. Exercise settlement shall be effected for all in‐the‐
money option contracts on the last trading day of an option contract. Long positions at in‐the
money contracts shall be assigned to short positions in option contracts with the same series on
a random basis. These positions are marked to the closing price of the underlying on that day and
the price difference is cash settled.
Exercise settlement in respect of index option contracts is cash settled by debit/ credit of the
clearing accounts of the relevant clearing members with the respective clearing bank. Index
option contracts, which have been exercised, shall be assigned and allocated to clearing members
at the client level with the same series.
Open positions, in an index option contracts, shall cease to exist after its expiration day.

Options on Individual Securities
Exercise style of option contracts on individual securities is European style wherein all in‐the‐
money contracts get automatically exercised on the expiry day. Exercise settlement is effected for
all in‐the‐money option contracts on the last trading day of an option contract. Long positions at
in‐the money contracts are assigned to short positions in option contracts with the same series
on a random basis. These positions are marked to the closing price of the underlying on that day
and the price difference is cash settled. Option contracts, which have been exercised, shall be
assigned and allocated to clearing members, at the client level on a random basis.

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10.2.7 Corporate Action Adjustments

Futures and Options contracts are adjusted for corporate action to ensure that the value of the
position on cum and ex‐date for corporate action continue to remain same. The adjustment is
carried out on the last day on which the underlying security is traded on cum basis after market
hours.

Adjustment
The F&O contract may be adjusted for any of the following based on the nature of the corporate
action.
a) Strike Price
b) Position
c) Market Lot / Multiplier

Various types of corporate actions for which adjustment is carried out are:

 Bonus
 Rights
 Merger / De‐merger
 Amalgamation
 Splits
 Consolidations
 Hive‐off
 Warrants, and Secured Premium Notes (SPNs)
 Extraordinary dividends

Methodology
The methodology for adjustment varies depending on the type of corporate action.

Bonus, Rights, Stock Splits and Consolidations
The methodology for these corporate actions will be:

Strike Price: The new strike price shall be arrived at by dividing the old strike price by the
adjustment factor as under.

Market Lot / Multiplier: The new market lot / multiplier shall be arrived at by multiplying the old
market lot by the adjustment factor as under.

Position: The new position shall be arrived at by multiplying the old position by the adjustment
factor as under.

The adjustment factor for Bonus, Rights, Stock Splits and Consolidations is arrived at as follows:
Bonus
Ratio ‐ A : B
Adjustment factor: (A+B)/B

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Rights
Number of Existing shares = A
Rights Entitlement
(Rights to subscribe) = B
Total Entitlement = A+B
Underlying close price on the last cum date = P
Issue price of the rights = S
Benefits per share = E
Benefit per Right Entitlement = (P – S)
E = (P‐S)/(A+B)
Adjustment Factor is = (P‐E)/P
Dividend if any, declared by the company along with rights shall be adjusted as per the
prevailing dividend adjustment policy.

Stock Splits and Consolidations
Ratio ‐ A : B
Adjustment factor: A/B

Adjustment in case of fractions
The above methodology may result in fractions due to the corporate action. With a view to
minimising fraction settlements, the following methodology shall be adopted:

1. Compute value of the position before adjustment
2. Compute value of the position taking into account the exact adjustment factor
3. Carry out rounding off for the strike price and market lot
4. Compute value of the position based on the revised strike price and market lot

The difference between 1 and 4 above, if any, shall be handled in such a manner by adjusting
strike price or market lot, so that no forced closure of open position is mandated.

Merger
The date of expiration for all the un‐expired contracts which shall cease to exist subsequent to
the merger shall be set as the last cum date. On the announcement of the record date, no fresh
month contracts will be introduced in the underlying which shall cease to exist subsequent to the
merger. Un‐expired contracts shall be compulsorily settled at the settlement price on the last cum
date. The settlement price shall be the last available closing price of such underlying.

Dividends
Dividends which are below 10 percent of the market value of the underlying stock, would be
deemed to be ordinary dividends and no adjustment in the strike price would be made for
ordinary dividends. For extra‐ordinary dividends, above 10 percent of the market value of the
underlying security, the strike price would be adjusted.

10.3 Core Settlement Guarantee fund27

27
SEBI Circular Ref. No. CIR/MRD/DRMNP/25/2014, Dated August 27, 2014.
Page 179 of 247

The Clearing Corporation (CC) of the Stock Exchange shall have a fund created called Core
Settlement Guarantee Fund (SGF) for each segment of the Exchange. This fund is set up to provide
settlement guarantee in the event of a clearing member failing to fulfill their settlement
commitments. The core SGF should be used to fulfill obligations of that failing member and
complete settlement without disrupting the normal settlement process.

10.3.1 Corpus
While deciding on the corpus of the SGF the CC should consider the following factors:

 Risk management system in force
 Current and projected volume/turnover to be cleared and settled by the CC on
guaranteed basis
 Track record of defaults of members (number of defaults, amount in default)

A Minimum Required Corpus (MRC) of the core SGF should be created subject to the following
conditions:

 The MRC shall be fixed for a month.
 By 15th of every month, CC shall review and determine the MRC for next month based
on the results of daily stress tests of the preceding month.
 CC shall also review and determine by 15th of every month, the adequacy of contributions
made by various contributors and any further contributions to the Core SGF required to
be made by various contributors for the next month.
 For every day of the preceding month uncovered loss numbers shall be estimated by the
various stress tests and highest of such numbers shall be taken as worst case loss
number for the day.
 Average of all the daily worst case loss numbers determined shall be calculated.
 The MRC for next month shall be higher of the average arrived at as above and the
segment MRC as per previous review

10.3.2 Contribution to Core SGF

Contributions of various contributors to Core SGF of any segment shall be as follows:

a) Clearing Corporation Contribution: CC to Core SGF shall be at least 50 percent of the MRC
which shall be from its own funds. CC contribution to core SGFs shall be considered as
part of its net worth.
b) Stock Exchange contribution: Stock Exchange contribution to Core SGF shall be at least 25
percent of the MRC (can be adjusted against transfer of profit by Stock Exchange as per
Regulation 33 of Securities Contracts (Regulation) (Stock Exchanges and Clearing
Corporations) (SECC), Regulations, 2012,which may be reviewed in view of these
guidelines).
c) Clearing Member primary contribution: If the CC wishes, it can seek risk based
contribution from Clearing Members (CMs) of the segment (including custodial clearing
members) to the Core SGF subject to the following conditions that:
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• total contribution from CMs shall not be more than 25 percent of the MRC,
• no exposure shall be available on Core SGF contribution of any CM (exposure‐free
collateral of CM available with CC can be considered towards Core SGF contribution of
CM), and
• required contributions of individual CMs shall be pro‐rata based on the risk they bring
to the system.
CC shall have the flexibility to collect CM primary contribution either upfront or staggered
over a period of time. In case of staggered contribution, the remaining balance shall be
met by CC to ensure adequacy of total Core SGF corpus at all times. Such CC contribution
shall be available to CC for withdrawal as and when further contributions from CMs are
received.
d) Any penalties levied by CC shall be credited to Core SGF corpus.
e) Interest on cash contribution to Core SGF shall also accrue to the Core SGF and pro‐rata
attributed to the contributors in proportion to their cash contribution.
f) CC shall ordinarily accept cash collateral for Core SGF contribution. However, CC may
accept CM contribution in the form of bank FDs and Central Government Securities28 too.
CC shall adhere to specific guidance which may be issued by SEBI from time to time in this
regard.

No exposure shall be available on Core SGF contribution of any CM. Contribution by individual
CMs shall be pro‐rata based on the risk they bring to the system. CC may utilise the Core SGF in
the event of a failure of member(s) to honour settlement commitment.

10.3.3 Default waterfall

In the event of a default, the utilisation of the Settlement Guarantee Fund shall be as per the
following order:

a) Monies of defaulting member (including defaulting member's primary contribution to
Core SGF(s) and excess monies of defaulter in other segments).
b) Insurance, if any.
c) CC resources (equal to 5 percent of the segment MRC).
d) Core SGF of the segment in the following order:
I. Penalties.
II. CC contribution to the extent of at least 25 percent of the segment MRC.
III. Remaining Core SGF: CC contribution, Stock Exchange contribution and non‐
defaulting members’ primary contribution to Core SGF on pro‐rata basis.
e) Proportion of remaining CC resources (excluding CC contribution to core SGFs of other
segments and INR 100 Crore) equal to ratio of segment MRC to sum of MRCs of all segments. INR
100 Crore to be excluded only when remaining CC resources (excluding CC contribution to core
SGFs of other segments) are more than INR 100 Crore.
28
SEBI/CIR/MRD/DRMNP/33/2017 dated April 26, 2017
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f) CC/SE contribution to Core SGFs of other segments (after meeting obligations of those
segments) and remaining CC resources to that extent as approved by SEBI.
g) Capped additional contribution by non‐defaulting members of the segment. The additional
contribution by non‐defaulting members shall be limited to a multiple of their primary
contribution to the SGF.
h) Any remaining loss to be covered by way of pro‐rata haircut to payouts.
10.3.4 Stress testing and back testing
CC shall effectively measure, monitor, and manage its credit exposures to its participants and
those arising from its payment, clearing, and settlement processes by stress testing and back
testing.

CC shall carry out daily stress testing for credit risk using at least the standardised stress testing
methodology prescribed for each segment by SEBI. CCs shall also develop own scenarios for a
variety of ‘extreme but plausible market conditions’ (in terms of both defaulters’ positions and
possible price changes in liquidation periods, including the risk that liquidating such positions
could have an impact on the market) and carry out stress testing using self‐developed scenarios.

10.4 Investor Protection Fund
In line with the notification No. F.No. 14/4/SE/85 dated August 22, 1985 from Central Government
and various circulars issued by SEBI, Stock Exchanges have set up and managed Investor
Protection Fund (IPF) to compensate clients who suffer financial loss due to their member being
declared defaulter. Vide circular no: MRD/DoP/SE/Cir‐38/2004 dated October 28, 2004 SEBI has
issued comprehensive guidelines for the stock exchanges to bring about uniformity to the
constitution, management and the utilisation of the IPF/CPF at the Stock Exchanges.
10.4.1 Guidelines for Investor Protection Fund (IPF) / Customer Protection Fund (CPF)
at Stock Exchanges

As per SEBI circular, the broad guidelines for the investor protection fund are as follows:
10.4.1.1 Constitution and Management

 The fund should be administered by way of a Trust created for the purpose.
 The Trust should have at least one public representative, one representative from the
registered investor associations recognised by SEBI and the Executive Directors/Managing
Directors/Administrators of the Stock Exchange.
 The Stock Exchange shall provide the secretariat for the IPF/CPF Trust.
 The Stock Exchange shall ensure that the funds in the IPF/CPF are well segregated and
that the IPF/CPF is immune from any liabilities of the Stock Exchange.
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10.4.1.2 Contribution

Contribution will consist of:‐
a) 1 percent of the listing fees received, on a quarterly basis.
b) 100 percent of the interest earned on the 1 percent security deposit kept by the issuer
companies towards public issue.
c) Difference between auction price and close out price.
d) Proceeds from the sale of securities written off by Foreign Portfolio Investors (FPIs) held by
them for their sub accounts, where the custodian is unable to determine claimant for various
reasons as per SEBI circular No. FITTC/FII/02/2002 dated May 15, 2002.
e) The amounts specified in pursuance of Regulation 28 (12) (e) (ii), Regulation 28 (13) and
Regulation 29 (2) of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997.
f) Contribution towards the IPF based on the transaction charges collected by Stock Exchanges,
as per Stock Exchange practice.

10.4.1.3 Manner of filing /inviting claims from investors

The Stock Exchange shall publish a notice inviting the legitimate claimants to file claims against
the defaulter member brokers within “specified time” which shall not be less than 90 days. The
Stock Exchange shall publish the notice in all the editions of at least one English national daily and
one regional language daily with wide circulation where the Stock Exchange is located. The notice
calling for claims should be displayed on the premises of the Stock Exchange and the website of
the Stock Exchange with details of the “specified period”, maximum compensation limit for a
single claim etc.
10.4.1.4 Eligible Claims

The claims received against the defaulter members during the specified period shall be eligible
for compensation from the IPF/CPF. If any eligible claims arise within three years from the date
of expiry of the specified period such claims shall be borne by the stock exchanges without any
recourse to the IPF/CPF. Provided any claims received after three years from the date of expiry of
the specified period may be dealt with as a civil dispute. No claim from a broker of associate of
the member broker shall be eligible for compensation from the fund. Claim arising out of
speculative transaction shall not be eligible for compensation. The claim should not be a sham or
collusive.
The Trust may use the arbitration mechanism to determine the legitimacy of the claims and also
seek the advice of the defaulters committee to sanction and ratify the payments to be made to
the investors.
10.4.1.5 Threshold Limit
The Stock Exchanges can fix suitable compensation limits, in consultation with the IPF/CPF Trust.
The amount of compensation for a single claim of an investor shall not be less than Rs. 1 lakh in
case of major Stock Exchanges viz., BSE and NSE, and Rs. 50,000/‐ in case of other Stock Exchanges.
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The Stock Exchange, in consultation with the Trust, shall review and progressively increase the
amount of compensation available against a single claim at least every three years. The Stock
Exchange shall disseminate this information to the public through a press release and its website.

10.4.1.6 Disbursements of claims from the IPF/CPF

The IPF/CPF Trust shall disburse the amount of compensation from the IPF/CPF to the investor
and such compensation shall not be more than the maximum amount fixed for a single claim of
an investor. The compensation shall be disbursed to the investor from the IPF/CPF in case there
is a shortage of defaulter broker’s assets after its realization. The Stock Exchange shall ensure that
the amount realised from the assets of the defaulter member is returned to the defaulter member
after satisfying the claims of the Stock Exchange and SEBI. And if the member holds multiple
membership, after satisfying claims of the concerned stock exchange, SEBI and other stock
exchanges.
10.5 SEBI Investor Protection and Education Fund

SEBI vide SEBI (Investor Protection and Education Fund) Regulations, 2009 has also provided for
setting up of an Investor Protection and Education Fund. This is set up by SEBI for the purpose of
protection of investors and promotion of investor education and awareness. As per the
regulations, the contribution for the fund will come from:
a) Contribution made by the Board;
b) Grants and donations given to the Fund by the Central Government, State Government
or any other entity approved;
c) Proceeds in accordance with the sub‐clause (ii) of clause(e) of sub‐regulation (12) and
the sub‐ regulation (13)of regulation 28 of the Securities and Exchange Board of India
(Substantial Acquisition of Shares and Takeovers) Regulations, 1997;
d) Security deposits, if any, held by stock exchanges in respect of public issues and rights
issues, in the event of de‐recognition of such stock exchanges;
e) Amounts in the Investor Protection Fund and Investor Services Fund of a stock exchange,
in the event of de‐recognition of such stock exchange;
f) Amounts forfeited for non‐fulfillment of obligations specified in Regulation 15B of the
SEBI (Buyback of Securities) Regulations, 1998;
g) Monies transferred in accordance with sub‐regulation (9) of regulation 45 of the SEBI ICDR
Regulations, 2009;
h) Amounts disgorged under section 11B of the SEBI Act or section 12 of the SCRA 1956 or
section 19 of the Depositories Act 1996;
i) Interest or other income received out of any investments made from the Fund;
j) Such other amount as SEBI may specify in the interest of the investors.

The fund will be utilised for the purposes aimed at investors such as:

 Educational activities including seminars, training, research and publications;
 Awareness programmes including through media – print and electronic;
 Funding investor education and awareness activities of Investors’ Associations recognised
by the Board;
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 Aiding investors’ associations recognised by the Board to undertake legal proceedings in
the interest of investors in securities that are listed or proposed to be listed;

10.6 Outsourcing by Intermediaries
SEBI vide its circular number: CIR/MIRSD/24/2011 dated December 15, 2011 has specified the
guidelines for outsourcing activities by intermediaries. As per the guidelines, outsourcing is
defined as the use of one or more than one third party either within or outside the group by a
registered intermediary to perform activities associated with services which the intermediary
offers.
10.6.1 Activities not to be Outsourced
As per SEBI circular, intermediaries are not allowed to outsource their core business activities and
compliance functions such as:

 execution of orders and monitoring of trading activities of clients in case of stock brokers
 dematerialisation of securities in case of depository participants
 investment related activities in case of Mutual Funds and Portfolio Managers
10.6.2 Other Obligations
The intermediaries are responsible for reporting of any suspicious transactions to FIU or any other
competent authority in respect activities carried out by the third parties.
10.6.3 Principles for outsourcing for intermediaries: Guidelines
10.6.3.1 Comprehensive policy for outsourcing
There should be a comprehensive policy for outsourcing which shall be the responsibility of the
Board or partners as the case may be.

The policy must:
 cover activities or the nature of activities that can be outsourced
 Authorities who can approve outsourcing of such activities
 Selection of third party to whom it can be outsourced

Policy should be based on an evaluation of risk concentrations, limits on the acceptable overall
level of outsourced activities, risks arising from outsourcing multiple activities to the same entity,
etc. There should be regular review of outsourcing policy.

10.6.3.2 Outsourcing risk management program
 There should be an outsourcing risk management program taking into account the scope
and materiality of the outsourcing activity.
 The materiality can be determined by:
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a) The impact of failure of a third party to adequately perform the activity on the
financial, reputational and operational performance of the intermediary and on the
investors / clients;
b) Ability of the intermediary to cope up with the work, in case of non‐performance or
failure by a third party by having suitable back‐up arrangements;
c) Regulatory status of the third party, including its fitness and probity status;
d) Situations involving conflict of interest between the intermediary and the third party
and the measures put in place by the intermediary to address such potential conflicts,
etc.
 When outsourcing to a group entity, systems shall be put in place to have an arm’s length
distance between the intermediary and the third party. Necessary disclosures in this
regard shall be made as part of the contractual agreement.
 Risk management practices should be identical between outsourcing to group entity and
unrelated third party.
 The records relating to all activities outsourced shall be preserved centrally and readily
accessible for review by the Board / senior management of the intermediary. These
records may form part of the corporate governance review by the management.
 Regular reviews by internal or external auditors of the outsourcing policies, risk
management system and requirements of the regulator shall be mandated by the Board
wherever felt necessary.
 The intermediary shall review the financial and operational capabilities of the third party
to assess its ability to continue to meet its outsourcing obligations.
10.6.3.3 Outsourcing arrangements with respect to obligations to customers and regulatory
supervision
Intermediary Obligations pertaining to outsourcing arrangements:

 The intermediary shall be fully liable and accountable for the activities that are being
outsourced.
 Outsourcing arrangements shall not affect the rights of an investor or client against the
intermediary in any manner.
 The intermediary shall be liable to the investors for the loss incurred by investors/client
due to the failure of the third party.
 Intermediary shall be responsible for investor grievance redressal arising out of
outsourced activity.
 The facilities / premises / data involved in outsourced activity shall be deemed to be those
of the registered intermediary.
 The intermediary, Regulator or the persons authorised by it shall have the right to access
the facility/ premises/ data anytime.
 Outsourcing arrangements shall not impair the ability of SEBI/SRO or auditors to exercise
its regulatory responsibilities such as supervision/inspection of the intermediary.

10.6.3.4 Selection and monitoring of third party

Intermediary should exercise due care, skill, and diligence in selection of the third party to ensure
that the third party has the ability and capacity to undertake the provision of the service
effectively.
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Due diligence by an intermediary shall include assessment of:
(a) Third party’s resources and capabilities.
(b) Compatibility of the practices and systems of the third party with the intermediary’s
requirements and objectives.
(c) Market feedback of the prospective third party’s business reputation and track record of
their services rendered in the past.
(d) Level of concentration of the outsourced arrangements with a single third party.
(e) Environment of the foreign country where the third party is located.
10.6.3.5 Outsourcing contract / agreement

The Outsourcing arrangement should be governed by written contract / agreements which should
cover the following:

a) Clearly define what activities are going to be outsourced, including appropriate service
and performance levels;
b) Mutual rights, obligations and responsibilities of the intermediary and the third party,
including indemnity by the parties;
c) Liability of the third party to the intermediary for unsatisfactory performance /other
breach of the contract;
d) Continuous monitoring and assessment of the third party, with right to intervene with
appropriate measures to meet legal and regulatory obligations;
e) Where necessary, conditions of sub‐contracting by the third‐party;
f) Unambiguous confidentiality clauses to ensure protection of proprietary and customer
data during the tenure of the contract and also after the expiry;
g) Responsibilities of the third party with respect to the IT security, contingency plans,
insurance cover, business continuity and disaster recovery plans, force majeure clause,
etc.;
h) Preservation of the documents and data by third party;
i) Mechanisms to resolve disputes arising from implementation of the outsourcing contract;
j) Termination of the contract, termination rights, transfer of information and exit
strategies;
k) Additional issues arising from country risks and potential obstacles if the activities are
outsourced to foreign third party;
l) Neither prevent nor impede intermediary from meeting its respective regulatory
obligations nor the regulator from exercising its regulatory powers; and
m) Ability to inspect, access all books, records and information relevant to the outsourced
activity by the intermediary or regulator;

10.6.3.6 Contingency plans

Separate contingency plan should be developed for each outsourcing arrangement which cover
matters stated below:

(a) Potential consequences of business disruption should be assessed in terms of:

 Contingency plans at the third party level.
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 Co‐ordination of contingency plans at both the intermediary and the third party.
 Contingency plans of the intermediary in the event of non‐performance by the third
party.

(b) Maintenance of appropriate IT security and robust disaster recovery capabilities by the
third party.
(c) Periodic tests of the critical security procedures and systems and review of the backup
facilities shall be undertaken by the intermediary to confirm the adequacy of the third
party’s systems.

10.6.3.7 Protection of confidential information

 Appropriate steps should be taken to protect proprietary and confidential customer
information and ensure that it is not misused or misappropriated.
 Employees of the third party should have limited access to the data handled on a “need
to know” basis and adequate checks and balances should exist to ensure the same.
 If third party provides similar services to multiple entities, adequate care should be taken
by the third party to build safeguards for data security and confidentiality.

10.6.3.8 Risks arising from concentration

In instances, where the third party acts as an outsourcing agent for multiple intermediaries, it is
the duty of the third party and the intermediary to ensure that strong safeguards are put in place
so that there is no co‐mingling of information /documents, records and assets.

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Review Questions

1. Settlement in cash market takes place on

(a) T+1 day
(b) T+2 days
(c) T+3 days
(d) T+7 days
Ans: (b)

2. Futures and options contract are:
(a) Cash Settled
(b) Physically settled
(c) Both (a) and (b)
Ans: (c)

3. Exercise style for options contracts in India is ____________.
(a) American style
(b) European Style
Ans: (b)

4. Contingency plan for outsourcing arrangement by brokers should provide for:
(a) Potential consequences of business disruption
(b) Maintenance of appropriate IT security and robust disaster recovery capabilities
(c) Periodic tests of the critical security procedures and systems
Ans: (d)
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Chapter 11 Investor Grievance Redressal



 Key measures by the regulator for investor protection

 Investor Grievance Redress Mechanism at brokerage firms, stock exchanges and
SEBI

 Arbitration Mechanism for settlement of disputes between clients and brokers

11.1 Investor Grievance

Investor is the back bone of securities market. Without adequate safeguard for investors, the
market will be weak and inefficient. The Preamble of SEBI also states that the function of SEBI is
"...to protect the interests of investors in securities and to promote the development of, and to
regulate the securities market and for matters connected therewith or incidental thereto".
A detailed procedure has been laid down by both SEBI as well as Stock Exchanges to address this
stated principle. In this Chapter, we will look at the various measures that have been instituted to
protect the investors and the procedures that exist to handle Investor grievances.
11.2 Investor Protection

In order to protect the investors, various regulations have been enacted by SEBI. The Stock
Exchange bye laws and regulations also provide for investor protection. Some of the key measures
taken include:

Unique Client Code: SEBI vide its circular no: SMDRP/Policy/CIR‐39/2001 dated July 18, 2001
made it mandatory for brokers to use unique client codes for all clients. For this purpose, brokers
shall collect and maintain in their back office the Permanent Account Number (PAN) allotted by
Income Tax Department for all their clients. Sub‐brokers will similarly maintain for their clients.
While entering an order on the trading system of the Stock Exchange, the broker has to identify
the order as either a proprietary order or client order. If it is a client order, the UCC of the client
is required to be captured in the order entry screen. This helps in multiple ways including tracing
of the client order for any disputes in the future.
Client – Broker Agreement: Every trading member shall enter into an agreement in writing with
each of his sub‐brokers and/or clients before accepting or placing orders on their behalf. Such
agreement shall include such provisions, requirements and conditions, as may be specified by
SEBI and/or the Exchange in this behalf from time to time. More specifically, the Client‐Broker
Agreement articulates the rights and responsibilities of the broker and the client and this
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document is the base for any future dispute resolution. The agreement covers matters relating to
placing of order, brokerage, close out procedure by broker when there is a client default, broker’s
responsibility towards investor grievance redressal including arbitration mechanism,
reconciliation of accounts on a quarterly basis etc.
Contract Note: Stock Brokers should ensure that contract notes are issued in the prescribed
format within 24 hours of execution of trades on the Exchange. The contract notes should be
issued on pre‐printed stationary and signed by an Authorised Signatory along with his/her name.
The contract note should contain the UCC and PAN of the client printed on it and have a running
serial number. Dealing office details and PAN of the Stock Broker should also be printed on the
contract note. Copies of contract notes and proof of delivery / despatch should be maintained.
Stock Brokers may issue Electronic Contract Note (ECN) with the consent of the client. ECNs
should be digitally signed and encrypted as per the provisions of IT Act, 2000. The ECNs should
sent to the email id provided by the client and the log reports of mails sent along with the records
of the rejected / bounced mails should also be maintained. In case of non‐delivery of ECNs,
contract note should be sent in physical form.

Trade verification: Stock Exchanges provide a ‘Trade Verification’ module on their website. This
module helps the investor to verify trades executed on their behalf on T+1 day. At any given point
of time, 10 trading days' data would be available for verification. The investor can compare their
trade details as mentioned in the contract note with the trade verification module. If there are
discrepancies, the matter can be escalated to the investor grievance cell of the Exchange. Apart
from this SEBI also requires Stock Exchanges to send transaction details to investor through SMS
and email alerts. Stock Exchanges will verify the details provided by brokers in terms of client
email id and mobile number. Upon confirmation from the investor, Stock Exchanges shall
commence sending transaction details directly to the investor.

Further, SEBI have directed all brokers to execute trades of clients only after keeping evidence of
the client placing such order. 29Brokers are required to maintain the specified records for a
minimum period for which the arbitration accepts investor complaints as notified from time
to time, currently three years. However in cases, where dispute has been raised, such records
shall be kept till final resolution of the dispute. The SEBI circular, also prescribes that in cases of
disputes the burden of proof will be on the broker to produce the above records for the
disputed trades’. However for exceptional cases example technical failure etc. where broker
fails to produce order placing evidences, the broker shall justify with reasons for the same and
depending upon merit of the same, other appropriate evidences like post trade confirmation by
client, receipt/payment of funds/securities by client in respect of disputed trade, etc. shall also be
considered.

Settlement of funds and securities: Settlement of funds and securities shall be made to the client
within 1 working day of the pay‐out by the Exchange. Client can specifically authorise the trading
member in writing to maintain a running account. In such a situation, settlement should be carried
out on a monthly/quarterly basis as per the client preference.

Statement of Account: Stock Brokers should send statement of accounts for funds and securities
to all the clients on a periodicity not exceeding three months (calendar quarter) within a month
29
SEBI Circular Ref. No. Cir/HO/MIRSD2/CIR/P/2017/108 dated September 26, 2017.
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of the expiry of the said period. The statements should have an account of all receipts and
deliveries / payments during the relevant period. Stock Brokers should maintain proof of dispatch
/ delivery for the same. Any error in the statement should be reported by clients within 30 days
of receipt of the statement from the stock broker. In respect of Stock Brokers who offer trading
facility to their clients through internet and provide to such clients an access to an on‐line account
viewing and print‐out facility, the 'Statement of Accounts' may be sent by email.

Additionally, SEBI in its directive to all the stock brokers have mandated the issuance of an Annual
Global Statement (AGS) to all their clients. The statement is required to be issued within 30 days
from the end of the financial year and is required to cover all transactions executed by the client
during the financial year.

Risk Disclosure Document: Stock Brokers should also issue a Risk Disclosure Document to their
clients before they start trading through them. SEBI has prescribed a model document covering
both capital market and futures and options market. The document inter‐alia states various risks
involved in trading including risk of stock price volatility, risk arising from corporate
announcements including market rumours, system risk and networking risk, implications of
leveraged trading and risks related to options trading. Clients are expected to familiarise
themselves about these risks before they commence trading.

11.3 Investor Grievance Redressal Mechanism

The Investors can escalate their grievances at 3 levels, i.e., brokerage firm, Stock Exchanges and
SEBI.
An aggrieved investor has recourse to the following entities to address their issues:
a) Investor cell of the brokerage house through whom they traded / Investor service cell of
a listed corporate entity if they are a shareholder of the entity and have grievances.
b) Escalate to the stock exchange’s investor grievance cell if the issue is not sorted out by
the Brokerage House/ Listed Company.
c) Arbitration Mechanism of the Stock Exchanges if the grievances do not get sorted out by
(a) or (b) above.
d) SEBI Investor Services Cell/SCORE.
11.3.1 Investor Grievance Mechanism at the Brokerage House / Listed Company

Typically large brokerage houses have a separate team handling investor complaints or it is
handled by the compliance officer. Whenever a Stock Broker receives an investor complaint they
are supposed to maintain details of such complaints in a register kept for this purpose. The
investor complaint received should be addressed within one month and there should not be any
complaint pending exceeding one month as on the last day of the relevant calendar quarter. If
any such complaint is pending, it will be the responsibility of the Compliance Officer of the firm
to take up the matter internally for resolution.

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11.3.2 Stock Exchange Investor Grievance Redressal Mechanism

Exchanges take up investor grievance issues on the following grounds:

Investor Services Cell of the Exchanges deals with the complaints of investors against the
Members of the Exchange or against the listed companies. Investors should lodge their complaints
in the format prescribed by the Exchange along with the supporting documents either by
registering their complaints in electronic mode through the website or by sending their
complaints to the nearest investor service centre.

Generally, the complaints of following nature are taken up for resolution by the Exchange.

Complaints against Exchange Members:
 Capital Markets/ Futures and Options Segment
 Non‐Issuance of the Documents by the Trading Member
 Non‐receipt of funds / securities
 Non‐receipt of margin/security deposit given to the Trading Member (TM)
 Non‐Receipt of Corporate Benefit (dividend / interest / bonus etc.)
 Auction value / close out value received or paid
 Execution of Trades without consent
 Excess Brokerage charged by Trading Member / Sub‐broker
 Non‐receipt of credit balance as per the statement of account
 Non‐Receipt of Funds / Securities kept as margin
 Excess Brokerage charged (other than on Option Premium)

Complaints against Listed Companies:
Public / Further offerings: Complaint regarding non‐receipt of:
 Allotment Advice, securities allotted, refund order
 Interest on delay in Redemption / Refund Amount
 Sale Proceeds of Fractional Entitlement
 Composite Application Form (CAF) for Rights offer Rights for (CAF) Application
 Securities purchased through a Rights Offer
 Letter of offer for Buyback

Corporate Actions: Complaint regarding non‐receipt of:
 Dividend
 Interest on Debentures, Bonds or other Debt Instruments
 Securities on account of a Bonus / De‐merger / Merger / Stock Split
 Redemption Amount

Transfer of Securities: Complaint regarding non‐receipt of:
 Securities after Dematerialization
 Securities after Transfer/Transmission
 Duplicate Certificate relating to Securities
 Non receipt of Annual Report

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SEBI vide its circular no: CIR/MRD/ICC/30/2013 dated 26/09/2013 has revised the procedure for
investor grievance handling mechanism at the Stock Exchange level. Given below is the
procedure:

 Stock Exchanges should ensure that the investor complaints are addressed within 15 days of
receipt of the complaint. If additional information is required, it should be sought within 7
days of receipt of complaint. If additional information is sought, the 15 days will be counted
from the date of receipt of information. The Exchange should also maintain record of
complaints which are not addressed within 15 days from the date of receipt of the complaint
along with reason for such delay.
 The Exchange can interact with the member and investor through email. For this purpose,
email id uploaded on UCC database will be used with regard to the investor and all
correspondence to the member will be to a dedicated email id created by them for this
purpose.
 If the issue does not get resolved within the stipulated time stated above, the conciliation
process will commence. The Investor Grievance Redressal Committee (IGRC) will be provided
15 days to amicably resolve the matter.
 If the matter is not resolved through the conciliation process, IGRC will determine the claim
value admissible to the investor.
 Upon conclusion of the proceedings of the IGRC, in case claim is admissible to the investor,
the Stock Exchange shall block the admissible claim value from the deposit of the member.
 The member will be provided 7 days’ time from the date of signing of the IGRC directions to
inform the Stock Exchange whether they wish to take up the matter to the next level of
resolution i.e. Arbitration.
 If the member does not opt for arbitration, the Stock Exchange shall release the blocked
amount to the investor after the said 7 days.
 If the member opts for arbitration, the Stock Exchange may initiate the following process
where the investor claim value is less than Rs.20 lakh30:
i. 50 percent of the admissible claim value or Rs. 2 lakh whichever is less shall be
released to the investor immediately from the IPF of the Stock Exchange.
ii. In case the arbitration award is in favour of the investor and the Member opts for
appellate arbitration then 50 percent of the amount mentioned in the arbitration
award or Rs. 3 lakh, whichever is less shall be released to the investor. The amount
released shall exclude the amount already released to the client at clause (i) above.
iii. In case the appellate arbitration award is in favour of the investor and the Member
opts for making an application under section 34 of the Arbitration and Conciliation
Act, 1996 to set aside the appellate arbitration award, then 75 percent of the amount
determined in the appellate arbitration award or Rs. 5 lakh, whichever is less shall be
released to the investor. The amount released shall exclude the amount already
released to the client at clause (i) and (ii) above.
iv. Before release of the said amounts from the IPF to the investor, the Stock Exchange
shall obtain appropriate undertaking/ indemnity from the investor against the release
of the amount from IPF, to ensure return of the amount so released to the investor,
in case the proceedings are decided against the investor.
v. In case the complaint is decided in favour of the investor after conclusion of the
proceedings, then amount released to the investor shall be returned to IPF from the
30
SEBI/HO/DMS/CIR/P/2017/15 dated February 23, 2017.
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blocked amount of the Member by the Stock Exchange and the rest shall be paid to
the investor.
 If an investor attempts either individually or in collusion with member or any other
stakeholder to misuse this process, appropriate action by the Stock Exchange should be
initiated including disqualification of that person involved from henceforth accessing the
benefit of this process. SEBI has power to take further action in this regard.
 Total amount released to an investor from IPF should not exceed Rs.10 lakh in one financial
year.
 If the investor loses the case at any stage of the proceedings or decide not to pursue further,
he/she shall refund the amount released from IPF back to IPF. If the investor fails to do so,
the following action will be initiated:
a) The investor (based on PAN details) will not be allowed to trade on any of the Stock
Exchanges till such time the amount is refunded.
b) Further, securities lying in the demat account (s) of the investor shall be frozen till the
amount is refunded.
c) The Stock Exchange may also resort to display of the names of such investors on their
website if considered necessary.

Arbitration time lines will be as follows:
As per SEBI circular no: CIR/MRD/DSA/24/2010 dated August 11, 2010, members are required to
file application for appellate arbitration within 1 month of the date of receipt of arbitration award.
As per section 34 (3) of the Arbitration and Conciliation Act, 1996 the Members have three
months’ time to make an application to set aside an arbitral award.

The members shall convey their intention to Stock Exchanges within 7 days of receipt of the
award, as regards whether such members desire to challenge the arbitration award/appellate
arbitration award in Court or not. If member does not convey the intention within 7 days, it would
be presumed that the member does not wish to challenge the award.

With a view to assist investors engaged in dispute resolution process, Stock Exchanges shall set
up facilitation desks at all investor service centres as specified by SEBI from time to time. These
facilitation desks would inter alia also assist investors in obtaining documents/details from Stock
Exchanges wherever so required for making application to IGRC and filing arbitration.

Currently, Investor Service Centres have been set up at across many locations to provide Investor
Grievance Redressal and Arbitration mechanism to investors by each Stock Exchange. BSE Limited
has its centres across 14 locations and NSE has across 23 locations.

11.3.3 SEBI Investor Grievance Handling Mechanism

SEBI’s investor protection has four elements i.e., Investor Education and awareness, disclosure
based regulations to help investors get adequate information, appropriate regulations to make
the market a safe place and finally a well‐established investor grievance redressal mechanism.

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SEBI has set up a department to handle investor grievances called Office of Investor Assistance
and Education (OIAE). SEBI takes up complaints arising out of activities covered under SEBI Act,
1992, Securities Contract Act, 1956, Depositories Act, 1996 and Section 24 of Companies Act,
2013.

SEBI takes up grievances relating to Listed companies, Stock Brokers, Sub brokers, Stock
Exchanges, Depositories, Depository Participants, RTA, Mutual Funds, Portfolio managers,
Bankers to an Issue, Credit rating agencies, Custodians, Debenture trustees, Merchant Bankers
and Underwriters. But primarily, many of the investor grievances relate to primary and secondary
market pertaining to listed companies and stock brokers.

As the first step, SEBI will forward the investor complaint to the respective Stock Exchange /
Depository in case of trading / settlement related issues and with the listed company in case the
issue is relating to the listed company.

If the response is inadequate or insufficient, follow up action is initiated. If progress is not
satisfactory, SEBI initiates action such as adjudication, direction, prosecution etc. In the case of
Listed Companies, SEBI expects them to respond in a prescribed format in the form of Action
Taken Report (ATR). If SEBI finds the response from the company is insufficient or inadequate,
follow up action is initiated. SEBI also has a separate department which looks into market
irregularities in terms of price manipulation and insider trading.

11.3.4 SEBI Complaints Redress System (SCORES)

SCORES is a web based centralised system to capture investor complaints and is available 24*7. It
allows investors to lodge their complaints and track the status online. When a complaint is ledged
on SCORES, an email acknowledgement is generated for reference and tracking. The system also
allows market intermediaries and listed companies to receive complaints lodged against them
electronically. If an investor submits a manual complaint, the same is scanned and captured on
SCORES.

Stock Exchanges and Depositories should identify a contact person from the Complaint Redressal
Department for matters relating to SCORES. The contact details of these resource persons should
be publicised widely through the websites of the Exchanges/Depositories. Investor complaints
should be addressed within 15 days from the date of receipt on SCORES. If additional information
is required, it should be sought within 7 days of receipt of Complaint. If additional information is
sought, the 15 days will be counted from the date of receipt of additional information. The
Exchange should also maintain record of complaints which are not addressed within 15 days from
the date of receipt of the complaint along with reason for such delay.

An investor who has lodged the complaint can verify the status by logging in the Scores system
(http://scores.gov.in/) using unique complaint registration number. Every complaint has an audit
trail and saved in a central database. If the complaint is successfully resolved the entity is advised
to send reply to complainant.
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11.4 Arbitration Mechanism

Stock exchanges provide arbitration mechanism for settlement of disputes between a client and
a member arising out of transactions executed on the Exchange. Arbitration is a quasi‐judicial
process of settlement of disputes between members, sub brokers and investors. Arbitration is a
quick mechanism to resolve disputes which could not be sorted out through the investor
grievance redressal mechanism. Either party to the dispute may choose the route of arbitration.
Once arbitration proceedings are initiated, the complaint filed with the investor services center
will be considered as closed.
11.4.1 Panel of Arbitrators
Stock exchanges maintain a panel of arbitrators for the purpose of arbitration. The number of
arbitrators in the panel is based on the number of arbitration proceedings that can be
simultaneously handed by each arbitrator to ensure that disputes are disposed off within
prescribed time.

Stock Exchanges must have fair and transparent criteria for inclusion of names in the panel of
arbitrators. While including an arbitrator in the panel Stock Exchanges shall take into account the
following factors:
a) Age
b) Qualification in the area of law, finance, accounts, economics, management, or
administration
c) Experience in financial services, including securities market.
d) Before including a name in the panel, the arbitrator shall provide the following
information:
• A declaration that he has not been involved in any act of fraud, dishonesty or
moral turpitude, or found guilty of any economic offence,
• Disclosure of the nature of his association with securities market,
• Disclosure of the names of his dependents associated with the securities market
as member, sub‐broker or authorised person, and
• An undertaking that he shall abide by the prescribed code of conduct.

The Stock Exchanges provide at least seven days of continuing education to every arbitrator each
year and also have a mechanism to appraise the performance of the arbitrator. The panel is
reconstituted at least once a year based on such appraisal. Training need of the arbitrators will be
catered by National Institute of Securities Markets (NISM) and the cost of training of arbitrators
may be incurred from Investor Service Fund (ISF).

11.4.2 Code of Conduct for Arbitrators
An arbitrator is required to follow the code conduct as under:

 Act in a fair, unbiased, independent and objective manner;
 Maintain the highest standards of personal integrity, truthfulness, honesty and fortitude
in discharge of his duties;
Page 197 of 247

 Disclose his interest or conflict in a particular case, i.e., whether any party to the
proceeding had any dealings with or is related to the arbitrator;
 Not engage in acts discreditable to his responsibilities;
 Avoid any interest or activity which is in conflict with the conduct of his duties as an
arbitrator;
 Avoid any activity that may impair, or may appear to impair, his independence or
objectivity;
 Conduct arbitration proceedings in compliance with the principles of natural justice and
the relevant provisions of the Arbitration and Conciliation Act, 1996, the SEBI Act, 1992,
the SCRA, 1956 and the Rules, Regulations and Bye‐laws framed there under and the
circulars, directions issued by the Government / SEBI;
 Endeavour to pass arbitral award expeditiously and in any case not later four months from
the date of appointment of arbitrator;
 Pass reasoned and speaking arbitral awards.

11.4.3 Arbitration Process

An application for arbitration can be filed within the time period specified as per the law of
limitation i.e., The limitation Act, 1963 which is 3 years from the date of dispute as of date.

The following documents need to be submitted while filing an arbitration application:
a) Application for arbitration in the prescribed format;
b) Statement of Case: Brief description of the case, date wise summary of events leading to
the dispute, basis of arriving at the dispute amount and relief sought through arbitration;
c) Payment towards cost of arbitration;
d) Statement of accounts /DP statement if the dispute pertains to funds or securities;
e) Copies of contract note, bills etc to substantiate the claim.

The arbitration application can be filed in the nearest Investor Service Centre of the Exchange.
While making the arbitration application, the applicant can give preference of arbitrator. On
admission of the matter, preference of the arbitrator is called for from the respondent. The final
choice of arbitrator is based on the preferences using a computerised process. The arbitrator /
panel of arbitrators will be appointed within 30 days from the date of receipt of application for
arbitration.

Each party to the arbitration has to deposit fee as follows:

Amount of claim/ Counter If claim filed within 6 months If claim filed after 6 months
Claim whichever is higher
< Rs. 10,00,000 1.3% subject to a minimum of 3.9% subject to a minimum of
Rs. 10,000 Rs. 30,000
> Rs.10,00,000 ‐ ≤ Rs. 13,000 plus 0.3 percent Rs. 39,000 plus 0.9 percent
Rs.25,00,000 amount above Rs. 10 lakhs amount
above Rs. 10 lakhs
> Rs. 25,00,000 Rs. 17,500 plus 0.2 percent Rs. 52,500 plus 0.6 percent
amount above Rs. 25 lakhs amount
Page 198 of 247

subject to maximum of Rs. above Rs. 25 lakhs subject to

30,000 maximum of Rs.90,000

The six month period is computed as follows:
 Six month period shall be computed from the end of the quarter during which the
disputed transactions were executed.
 Time taken by member to resolve the dispute of the investor or one month from date of
receipt of dispute by the member, whichever is earlier, is exempt while calculating the six
month period.
 Time taken by the Investor Service Cell of Exchange to resolve the dispute will be
exempted while calculating the six month period.

On issue of the arbitral award, the stock exchange will refund the deposit, if any, to the party in
whose favor the award has been passed and appropriate the deposit, if any, made by the party,
against whom the award has been passed, towards arbitration fees.

The respondent to the arbitration, will have to file a response to the arbitration application along
with choice of arbitrator and statement of defense with the required deposit amount. The
respondent can also make counter claim. The counter claim is arrived at by the respondent on the
basis of amount or shares/ monies due to him from the applicant.

The arbitrator panel fixes a date for hearing on which the investor and trading member have to
appear before the arbitrator panel to present their case. In case the claim amount is less than
Rs.25,000, the arbitrator may or may not hold hearings and pass the award based on the
documents submitted by both the parties. If the claim amount is more than Rs.25,000, the
arbitrator may hold hearing/s unless specifically denied by both the parties in writing.

An arbitration reference for a claim / counter claim up to Rs.25 lakhs is dealt with by a sole
arbitrator while that above Rs.25 lakh is dealt with by a panel of three arbitrators.

The arbitration reference will be concluded by way of issue of an arbitral award within four
months from the date of appointment of arbitrator(s). The Managing Director/ Executive Director
of the stock exchange may for sufficient cause extend the time for issue of arbitral award by not
more than two months on a case to case basis after recording the reasons for the same.

A party aggrieved by an arbitral award may appeal to the appellate panel of arbitrators of the
stock exchange against such award. The appeal should be filed within one month from the date
of receipt of arbitral award. The appellate panel will consist of three arbitrators who are different
from the ones who passed the arbitral award appealed against. The party filing an appeal before
the appellate panel should pay a fee not exceeding Rs.30,000 as prescribed by the Stock
Exchanges, in addition to statutory dues such as stamp duty, service tax etc. In case the party filing
the appeal is a client having claim/counter claim of upto Rs. 10 lakh, then the party shall pay a fee
not exceeding Rs. 10,000.

Page 199 of 247

The stock exchange will appoint an appellate panel of arbitrators within 30 days from the date of
receipt of application for appellate arbitration. The appeal will be disposed of within three months
from the date of appointment of appellate panel by issue of an appellate arbitral award. The
Managing Director/ Executive Director of the stock exchange may for sufficient cause extend the
time for issue of appellate arbitral award by not more than two months on a case to case basis
after recording the reasons for the same.

A party aggrieved by the appellate arbitral award may file an application to the Court of
competent jurisdiction in accordance with Section 34 of the Arbitration and Conciliation Act, 1996.

If the arbitration / appellate arbitration award is in favour of the client, the Stock Exchanges will
debit the amount of the award from the security deposit or other monies from the member and
keep it in a separate escrow account.

The arbitration award amount set aside will be paid to the client if no appeal is made to the
appellate panel and the time for making such appeal has expired.

The stock exchange shall implement the appellate arbitral award, by making payment to the
client, along with the interest earned on the amount that has been set aside if:
 No appeal has been made to a Court and as soon as the time period for making such
appeal expires or;
 when such an application has been made to the Court and it has been refused by the
Court or;
 Where an application has been made to the Court and where no stay has been granted
by such Court within a period of 3 months from the date of receipt of appellate arbitral
award by the party making the appeal.

11.4.4 Record and Disclosures

The stock exchange will have to preserve the following documents related to arbitration:
a) Arbitral and appellate arbitral award with acknowledgements, confirming receipt of
award by the disputing parties, permanently.
b) Other records pertaining to arbitration for five years from the date of arbitral award,
appellate arbitral award or Order of the Court, as the case may be
c) Register of destruction of records relating to (b) above, permanently.

Stock exchanges to disclose on their website the arbitration awards issued since April 1, 2007. The
Stock Exchanges will have to disclose on their website, details of disposal of arbitration
proceedings and details of arbitrator‐wise disposal of arbitration proceedings.

Page 200 of 247

Review Questions

1. Investor complaint can be related to

(a) Non‐Issuance of the Documents by the Trading Member
(b) Non‐receipt of funds / securities
(c) Non‐receipt of margin/security deposit given to the Trading Member
Ans: (d)

2. Investor grievance can be towards
(a) Listed Company
(b) Broker
(c) RBI
(d) Both (a) and (b)
Ans: (d)

3. When an Investor Complaint is received by the Stock Exchange it should be addressed
(a) Within 10 days
(b) Within 15 days
(c) Within 2 weeks
(d) Within 45 days
Ans: (b)

4. SCORES is the investor grievance redressal system of the
(a) Stock Exchange
(b) SEBI
(c) Stock Broker
(d) RBI
Ans: (b)

Page 201 of 247


ANNEXURES

Page 202 of 247

Annexure I
CERTIFICATE FOR INTERNAL AUDIT

We have examined the relevant books of accounts, records and documents maintained
by M/s. _______________, (name of the trading/clearing member) bearing SEBI
registration number ______________________) a member of the BSE Ltd. for the
following segments to fulfill the internal audit requirement as prescribed by SEBI vide
circulars dated August 22, 2008 & October 21, 2008, for the half year
ended_____________________.

Segments Activity SEBI
(Cash Segment /Derivatives Segment / (Trading/Clearing/Trading and registration
Debt Segment /Currency Clearing) number
Derivatives/Securities Lending &
Borrowing segment)

The purpose of this audit is to examine that the processes, procedures followed and the
operations carried out by the Trading Member/Clearing Member are as per the applicable Acts,
Rules, Regulations, Bye‐laws and Circulars prescribed by SEBI and the Stock Exchange.

We have obtained all the information and explanations, which to the best of our knowledge and
belief were necessary for the purpose of this internal audit. In our opinion proper books of
accounts, records & documents, as per the regulatory requirement have been maintained by the
member, so far as it appears from examination of the books.

We have conducted the audit within the framework provided by SEBI/Stock Exchange for the
purpose of this internal audit.

To the best of our knowledge and belief and according to the information and explanations given
to us, no material fraud / non‐compliance /violation by the member is observed during the course
of this audit.

Based on the scrutiny of relevant books of accounts, records and documents, we certify that the
member has complied with the relevant provisions of SEBI Act, 1992, Securities Contracts
(Regulation) Act 1956, Securities Contracts (Regulation) Rules 1957, SEBI (Stock Brokers and Sub‐
Brokers) Regulations, 1992 and various circulars of SEBI. The member has complied with the Rules,
Bye‐laws, Regulations of BSE and various circulars issued by the Stock Exchange and Clearing
Corporation/Clearing House.

We declare that we do not have any direct / indirect interest in or relationship with the member
or its directors / partners / proprietors / management and also confirm that we do not perceive
any conflict of interest in such relationship / interest while conducting internal audit of the
member.
Page 203 of 247


In our opinion and to the best of our information and according to the explanations given to us
by the proprietor/partner(s)/director(s)/compliance officer, the Report provided by us as per the
Annexure and subject to our observations, which covers the entire scope of the audit, is true and
correct.

__________________
Company Secretary / Cost and Management Accountant / Chartered Accountant
(Seal & Signature)

(Name of the Proprietor / Partner)

Membership no. / CP. No.

Place:‐

Date:‐

Page 204 of 247


FORMAT OF INTERNAL AUDIT REPORT

The Trading Member ________ (Name of the member) is servicing ___ number of active* non
institutional clients, ___ number of active* Institutional clients and also doing/ not doing proprietary
trading/only doing proprietary trading. ___________ no. of clients have been registered by the
Member during the Audit period.

The Member is providing/not providing Internet trading facility, Margin Trading facility, DMA facility,
Algo trading facility, IML facility and is also using Co‐location facility (strike off whichever is not
applicable).

Member has ___ no. of branches in the beginning of the audit period, ___ no. of branches were opened
during the period, ___ no. of branches were closed during the period. Member has inspected _____
branches, ______Sub Brokers and _____APs during the inspection. (Strike off whichever is not
applicable). The Member operates _______ number of Bank accounts and ______ number of DP
accounts.

*Clients who has done single trade during the audit period.

S.N
Area of
o. Observations of Internal Auditor Management Comments
Verification
Compliance Remarks in No. of No. of Whether Remarks
Status case of samples instance Auditor (Para wise,
{C ‐Complied non‐ verified where comment where
NC‐Not complied non‐ s auditor has

Complied status complianc accepted reported
N.A‐ Not e is non‐
Applicable} observed Y‐ Yes compliance)
N‐ No
Client registration
documentation
1 /Anti Money
Laundering
compliance
All relevant Client
Registration
Documents
executed with
clients in
A C / N.C / N.A Y / N
compliance with
SEBI circulars and
supporting
collected from the
clients are
Page 205 of 247

available and are

easily retrievable.
UCC is allotted to

all the clients
registered during
B the audit period & C / N.C / N.A Y / N
the same is timely
uploaded to the
Exchange.
No clauses are
included in any of
the documents
executed with the
clients‐
a) which dilutes
responsibility of
member or
b) which is in
conflict with any
of the clauses in
C mandatory C / N.C / N.A Y / N
documents, Rules,
Bye‐laws,
Regulations,
Notices,
Guidelines &
Circulars issued by
SEBI & Exchanges
or
c) Which is not in
the interest of the
Investor?
All the mandatory
clauses/document
s and Annexures
such as KYC,
details relating to
trading account ,
rights and
D C / N.C / N.A Y / N
Obligation, Dos
and Don’ts , RDD
and Tariff sheet as
stipulated by
SEBI/Exchanges
have been
included in the
Page 206 of 247

mandatory
section of the
Account opening
kit executed with
the clients.
In‐person
verification is
done by
Employee, Sub
broker or
Authorised person
only and the date
of verification,
name, designation
and signature of
the official who
has done in‐
person
verification and
the Rubber Stamp
is incorporated in
the client
E C / N.C / N.A Y / N
registration form

In case, in‐person
verification of
non‐resident
clients is not done,
attestation of KYC
documents is
done by Notary
Public, Court,
Magistrate, Judge,
Local Banker,
Indian Embassy/
Consulate General
in the country
where the client
resides.
Any changes in
address, bank
account or demat
account is carried
F C / N.C / N.A Y / N
out on receipt of
written request
along with
documentary
Page 207 of 247

proof from the

respective client
Trading member
has taken
documentary
evidence in
support of
G financial C / N.C / N.A Y / N
information
provided by the
client for equity
derivatives
segment.
Client details
including financial
details are
reviewed
periodically and
H C / N.C / N.A Y / N
updated for
clients in
compliance with
Exchange
circulars.
Trading code and
the unique client
code allotted to a
client and the e‐
mail id furnished
by the client for
the purpose of
receiving ECN and
I other details, are C / N.C / N.A Y / N
communicated by
the trading
member through
the client account
opening form or
otherwise in
writing to the
client.
Member has
identified the
beneficial owners
of the client ( non‐
J C / N.C / N.A Y / N
individuals) and
has taken
reasonable
measures to verify
Page 208 of 247

the identity of

such person as per
SEBI Circular
CIR/MIRSD/2/201
3 dated January
24, 2013
Member has a
process to identify
the authority of
K the person who is C / N.C / N.A Y / N
placing orders on
behalf of the
client.
Risk profiling of
the clients has
been done as per
the written down
L C / N.C / N.A Y / N
policy of the
trading member
as per the PMLA
master circular.
Member has
adopted sufficient
due diligence
process for clients
M C / N.C / N.A Y / N
according to their
risk profile as per
the PMLA master
circular.
Member is having
a clearly defined
policy for
acceptance of
clients and has
ensured that an
account is not
N C / N.C / N.A Y / N
opened where the
member is unable
to apply
appropriate client
due diligence
measures/KYC
Policies.
Member has
identified clients
O C / N.C / N.A Y / N
of special category
(CSC) as per the
Page 209 of 247

PMLA master
circular.
The Client has

opted and signed
against stock
exchange as well
P as market C / N.C / N.A Y / N
segment where he
intends to
trade/traded
during the year.
Copies of
complete set of
client registration
documents
including POA
executed by the
Q C / N.C / N.A Y / N
client was
delivered to the
client free of
charge and within
7 days of upload
of UCC.
Authorizations
from the client
sought in non‐
mandatory
R C / N.C / N.A Y / N
document are
separate & do
have client’s
specific consent.
Trading members 1st
had displayed the October
set of standard 2016 to
S documents/polici C / N.C / N.A 31st Y / N
es on their own March,
website for 2017
information.
The member has
uploaded the E
mail ID and the
Mobile number of
T C / N.C / N.A Y / N
the client in the
UCI database as
per the details
given by the client
Page 210 of 247

in the client

registration
documents.
Member having
websites have
prominently
displayed a
message on their
Member’s
U websites C / N.C / N.A Y / N
website
informing their
clients to update
their E mail IDs &
Mobile numbers
with the member.
Member has
complied with the
requirement of
uploading the KYC
information with
the SEBI
registered KRAs
for all the clients
on a continuous
basis within the
prescribed time
V limit as per SEBI C / N.C / N.A Y / N
circular
MIRSD/Cir‐
26/2011 dated
December 23,
2011 and
MIRSD/Cir‐5/2012
dated April 13,
2012 and
complied with the
provisions of the
Circular.
Member has
downloaded KYC
information from
KRA system for
W C / N.C / N.A Y / N
new clients who
are already
registered with
KRA
Member has
X uploaded the KYC C / N.C / N.A Y / N
data with CKYCR,
Page 211 of 247

in respect of all

individual
accounts opened
on or after August
1, 2016 by
October 31, 2016.
Member has
uploaded the KYC
data of individual
clients registered
Y prior to August C / N.C / N.A Y / N
01, 2016 with
CKYC by
December 31,
2016
Trading Member
has prominently
displayed on
account opening
kits, Website
Advertisement,
publication,
notice board and
display board,
portal website (if 1st
any) the following October
details‐ 2016 to
Z i) name of the C / N.C / N.A 31st Y / N
member as March,
registered with 2017
SEBI,
ii) its own logo, if
any,
iii) its registration
number,
iv) its complete
address with
telephone
numbers.

Page 212 of 247

Member has
made available
the documents
relating to rights &
obligations,
uniform risk
disclosure
document, do’s &
A
don’t to the C / N.C / N.A Y / N
A
clients (registered
after August 01,
2016) either in
electronic or
physical mode as
per the
preference of the
client.
Member has
maintained
appropriate logs
in case the
documents
relating to rights &
obligations,
A
uniform risk C / N.C / N.A Y / N
B
disclosure
document, do’s &
don’t are sent
electronically to
the clients,
registered after
August 01, 2016.
Members have
displayed the
documents
relating to rights & 1st
obligations, October
A uniform risk 2016 to
C / N.C / N.A Y / N
C disclosure 31st
document, do’s & March,
don’t in 2017
vernacular
languages on their
own website.
Page 213 of 247

Member has
undertaken
appropriate due
diligence w.r.t fit
& proper
requirement of
clients dealing
A with listed Stock
C / N.C / N.A Y / N
D Exchanges and
sent text of
Regulation 19 &
20 of SECC
Regulations, 2012
to such clients
along with the
contract notes
Order
management and
2.
risk management
systems
Trading member
has well
1st
documented risk
October
management
2016 to
A policy including C / N.C / N.A Y / N
31st
policy on Margin
March,
collection from
2017
clients/Trading
members.
Member has a
sound system for
collecting and
reporting client
margin collection
to the Exchange as
per the
Exchange/Clearin
B g Corporation C / N.C / N.A Y / N
requirement. In
case of any
irregularity
observed,
mention the
instances where
false reporting is
observed
Page 214 of 247

Member has not

funded its clients
in contravention
to Exchange/SEBI
requirement.
(Exchange notice
C C / N.C / N.A Y / N
no. 20150515‐1
dated May 15,
2015 and
20151029‐34
dated October 29,
2015)
Member has 1st
correctly reported October
details of client 2016 to
D C / N.C / N.A Y / N
funding, if any, to 31st
the exchange March,
2017
Trading member 1st
has not October
undertaken or 2016 to
was not party to 31st
or has not March,
facilitated any 2017
E C / N.C / N.A Y / N
fund based
activity through
financier including
any associate,
related or third
party entities.
Checks are in 1st
place to ensure October
that no 2016 to
unauthorized 31st
F C / N.C / N.A Y / N
orders are March,
executed from 2017
any of the
terminals.
In case of dormant 1st
accounts, if the October
account is 2016 to
reactivated then 31st
there are checks March,
G C / N.C / N.A Y / N
in place to ensure 2017
that account is
operated by the
relevant client
only.
Page 215 of 247

Initial and other

margins are
collected from
respective clients
in the prescribed
form of funds,
H fixed deposit C / N.C / N.A Y / N
receipts, bank
guarantees and
approved/liquid
securities with
appropriate
haircut.
Proper systems
1st
are in place to
October
ensure timely
2016 to
collection for pay‐
I C / N.C / N.A 31st Y / N
in from the
March,
respective client
2017
as per settlement

schedule.
Proper monitoring
mechanism is in
place to review
long outstanding
debit balances in
clients’ account
and recovery of
J the same. Give C / N.C / N.A Y / N
age wise analysis
of debts
outstanding for
more than 30 days
and the recovery
pattern for the
same
Trading member
has implemented
proper internal 1st
code of conduct October
and adequate 2016 to
K C / N.C / N.A 31st Y / N
internal controls
March,
to ensure that 2017
proper checks and
balances are in
place with respect
Page 216 of 247

to SEBI Circular

Cir/ ISD/1/2011,
dated March 23,
2011 and
Cir/ISD/2/2011
dated March 24,
2011 on the
subject
‘Unauthenticated
news circulated by
SEBI registered
market
intermediaries
through various
modes of
communication.
Trading member 1st
has not October
outsourced their 2016 to
31st
core business
March,
activities and 2017
compliance
L functions and C / N.C / N.A Y / N
adhered to the
provisions of SEBI
circular
CIR/MIRSD/24/20
11 dated 15th Dec
2011.
The member has 1st
not recovered October
from the clients, 2016 to
excess amount 31st
towards short March,
margin penalty 2017
M C / N.C / N.A Y / N
levied by the
Exchange/
Clearing
Corporation in the
derivative
segment.
Page 217 of 247

In case the 1st
member has October
passed on the 2016 to
short margin 31st
penalty to the March,
clients, the 2017
N C / N.C / N.A Y / N
member has
provided the
relevant
supporting
documents to the
clients.
Member has 1st
drafted and October
implemented 2016 to
Surveillance policy 31st
O as per the C / N.C / N.A March, Y / N
Exchange notice 2017
no. 20130307‐21
dated March 07,
2013.
Member has 1st
implemented October
appropriate 2016 to
checks for value 31st
and / or quantity March,
based on the 2017
respective risk
profile of their
P C / N.C / N.A Y / N
clients as per the
provisions of SEBI
Circular
CIR/MRD/DP/34/
2012 dated
December 13,
2012.

Member has put 1st
in place systems October
to ensure that 2016 to
cumulative value 31st
of all unexecuted March,
Q orders placed C / N.C / N.A 2017 Y / N
from their
terminals are
below a threshold
limit as per the
provisions of SEBI
Page 218 of 247

Circular
CIR/MRD/DP/34/
2012 dated
December 13,
2012.
In case the 1st
Member or its October
group entities 2016 to
holds more than 31st
1% of share March,
capital of a listed 2017
company, the
R C / N.C / N.A Y / N
same has been
disclosed to the
Exchange as per
Exchange notice
no. 20131129‐20
dated November
29, 2013.
Member has
taken adequate
documentary
evidences as
specified in SEBI
circular
CIR/MRD/DP/20/
2014 dated June
20, 2014 in case of
S participants taking C / N.C / N.A Y / N
positions in CD
segment in excess
of the applicable
position limits
based on
underlying
exposure
specified in the
said circular.
Contract notes,
Client margin
3 details and
Statement of
accounts
Contract notes are
sent in the
A C / N.C / N.A Y / N
prescribed format
and within
Page 219 of 247

specified time
limit.
Trading member
has issued
contract notes
only for trades
B done under the C / N.C / N.A Y / N
rules, byelaws &
regulations of the
Exchange and not
otherwise.
All prescribed
details including
running serial 1st
number, name October
and signature of 2016 to
C authorized C / N.C / N.A 31st Y / N
signatory, dealing March,
office details and 2017
brokerage are
contained in
contract note.
Daily Margin
statement is
issued to the
D C / N.C / N.A Y / N
respective clients
with the details as
specified.
Proof of delivery /
dispatch/ log for
dispatch of
Contract Notes/
E C / N.C / N.A Y / N
Statement of
Accounts/ daily
margin is
maintained.
Member has 1st
complied with October
regulatory 2016 to
requirements 31st
related to March,
F C / N.C / N.A Y / N
Electronic 2017
contract notes
(ECN) if contract
notes are sent
electronically.
Page 220 of 247

Trail of bounced 1st

mails is October
maintained and 2016 to
G physical delivery is C / N.C / N.A 31st Y / N
ensured in case of March,
bounce mails for 2017
ECNs
Complete
statement of
accounts for funds
and securities are
issued on a
H C / N.C / N.A Y / N
quarterly basis to
clients (wherever
applicable), with
error reporting
clause.
Details regarding 1st
appointment of October
Compliance 2016 to
Officer and 31st
I C / N.C / N.A Y / N
changes there in, March,
if any, have been 2017
informed to the
exchange.
Trading Member
has prominently
displayed on
contract notes,
statement of
funds and
securities,
correspondences
with the clients 1st
the following October
details‐ 2016 to
J i) name of the C / N.C / N.A 31st Y / N
member as March,
registered with 2017
SEBI,
ii) its own logo, if
any,
iii) its registration
number,
iv) its complete
address with
telephone
numbers,
Page 221 of 247

v) the name of the
compliance
officer, his
telephone
number and e‐
mail address.
Trading member
has not
K created/provided C / N.C / N.A Y / N
e‐mail ids for
clients.
1st
Member has October
collected physical 2016 to
letters from the 31st
L clients who have C / N.C / N.A March, Y / N
requested for 2017
change in e‐mail
id.

In case facsimile 1st
signatures are October
used on physical 2016 to
contract notes, 31st
M Member has C / N.C / N.A March, Y / N
maintained well‐ 2017
documented &
approved policy
regarding its use.
Dealing with
4 clients’ funds and
securities
Client’s funds and
securities are used
only for the
purpose of the
A respective client’s C / N.C / N.A Y / N
transactions. If
not instances to
be provided in
remarks column.
Funds raised by
pledging client
securities were
B utilised for C / N.C / N.A Y / N
respective client
only. List of
instances to be
Page 222 of 247

provided in
remarks column in
case of non‐
utilisation of
proceeds for
respective client.
Constituent 1st
beneficiary October
account or client 2016 to
bank accounts are 31st
used for March,
authorized 2017
C purposes only. In C / N.C / N.A Y / N
case of any
irregularity
observed,
mention the
instances in detail
separately.
No cash dealings 1st
with clients are October
done in violation 2016 to
D C / N.C / N.A Y / N
of the prescribed 31st
norms. March,
2017
In case where 1st
aggregate value of October
banker’s cheque / 2016 to
31st
demand draft /
March,
pay order is of Rs 2017
50,000 or more
per client per day,
then the same are
accompanied with
E name of bank C / N.C / N.A Y / N
account holder
and number of
bank account
debited, duly
certified by issuing
bank as per the
provisions of SEBI
Circular
CIR/MIRSD/03/20
Page 223 of 247

11, dated June 9,

2011.
Member 1st
maintains audit October
trail of the funds 2016 to
31st
received and
March,
systems are in 2017
F C / N.C / N.A Y / N
place to ensure
that the funds are
received from
their respective
clients only.
Receipts/payment 1st
of funds and October
receipt/delivery of 2016 to
securities are 31st
G C / N.C / N.A Y / N
received/transferr March,
ed from/to 2017
respective clients
only
Payments to 1st
clients are not October
made from 2016 to
H C / N.C / N.A Y / N
proprietary bank 31st
accounts. March,
2017
Client’s funds /
securities are
transferred to
respective clients
within one
I working day of C / N.C / N.A Y / N
payout from
Exchange in case
of no running
account
authorization.
Page 224 of 247

Constituent
securities
received as
margin is not
utilized for
execution of
J C / N.C / N.A Y / N
proprietary trades
or trades in the
name of
Directors/ Key
Promoters/
shareholders
The Delivery of
securities to
constituent is not
K C / N.C / N.A Y / N
made from
Proprietary
account.
Excess Brokerage
was not charged
L on trades C / N.C / N.A Y / N
executed on the
Exchange.
Member’s Bank 1st
books and bank October
statements for 2016 to
each bank 31st
account are March,
reconciled and 2017
reconciliation
M statement for the C / N.C / N.A Y / N
same is prepared
periodically and
there are no long
pending
outstanding
reconcilable
items.
Register of 1st
Securities and October
Holding statement 2016 to
from depositories 31st
N for each DP C / N.C / N.A March, Y / N
account are 2017
reconciled and
reconciliation
statement for the
Page 225 of 247

same is prepared

periodically.
Dividend and
other corporate
1st
benefits received
October
on behalf of
2016 to
clients is
O C / N.C / N.A 31st Y / N
paid/credited/pas
March,
sed on to the
2017
respective clients

account without
any delay.
Trading member
has taken consent
from the client
regarding monthly
P C / N.C / N.A Y / N
/quarterly
settlement in the
running account
authorisation.
Trading member
has done actual
settlement of
funds & securities
as consented by
Q C / N.C / N.A Y / N
the client
(monthly/quarterl
y) in the running
account
authorisation.
Trading member
has sent
statement of
accounts for
funds/securities
containing an
extract from the
R C / N.C / N.A Y / N
client ledger for
funds & securities
displaying all
receipts/deliverie
s of
funds/securities
while settling the
Page 226 of 247

account
explaining
retention of
funds/securities.
Trading member
has not done any
inter‐client
adjustment for
S C / N.C / N.A Y / N
the purpose of
client level
quarterly/monthl
y settlement.
The following
statutory levies/
fee/ charges are
not collected from
clients in excess of
actuals levied on
the members. 1st
Such as‐ October
i) Securities 2016 to
T Transaction Tax, C / N.C / N.A 31st Y / N
ii) SEBI turnover March,
fees, 2017
iii) Exchange
Transaction
Charges
If Excess is
collected, please
give complete
details.
The running
account
authorization
taken by trading
member from
client(s) is dated
and contains a
U C / N.C / N.A Y / N
clause which
explicitly allows a
client to revoke
the said running
account
authorization at
any time and
Page 227 of 247

would continue
until such
revocation.
Member has put 1st

in place systems October
for dealing with 2016 to
conflict of interest 31st
V C / N.C / N.A Y / N
as per SEBI circular March,
CIR/MIRSD/5/201 2017
3 dated August 27,
2013.
Member has not 1st
transferred funds October
from client bank 2016 to
W account to any C / N.C / N.A 31st Y / N
third party or any March,
other non‐client 2017
account
Member has not 1st
transferred funds October
to its Group 2016 to
X companies/ C / N.C / N.A 31st Y / N
Associates from March,
client bank 2017
accounts.
Payment for own 1st
trades (PRO) are October
not made from 2016 to
Y C / N.C / N.A Y / N
client bank 31st
accounts. March,
2017
Member is not 1st
operating any October
assured returns 2016 to
schemes and 31st
Z mobilizing C / N.C / N.A March, Y / N
deposits from 2017
investors. If yes,
please provide
details.
Member has not 1st
taken securities October
AA C / N.C / N.A Y / N
from any client for 2016 to
purposes other 31st
Page 228 of 247

than margin or March,

meeting the 2017
client’s obligation.
Member has
ensured that the
funds & securities
available in the
client bank/s and
client beneficiary
account/s 1st
together with October
balances available 2016 to
AB with clearing C / N.C / N.A 31st Y / N
Member and March,
funds with 2017
clearing
corporation are
not less than the
funds and
securities payable
to the client at all
times.
Banking and
5 Demat account
operations
Member 1st
maintains October
separate bank 2016 to
account for client 31st
funds and own March,
funds. 2017
A Also separate C / N.C / N.A Y / N
beneficiary
account for clients
securities and
own securities are
maintained by the
member.
Clients funds and 1st
securities are October
segregated from 2016 to
B C / N.C / N.A Y / N
own funds and 31st
securities. March,
2017
Member has 1st
C reported all their C / N.C / N.A October Y / N
Bank & DP 2016 to
Page 229 of 247

account details to 31st
the Exchange as March,
required by SEBI 2017
circular dated
September 26,
2016 & BSE
notice no.
20161027‐1 dated
October 27, 2016
and Notice No
20161017‐17
dated October 17,
2016 and
20161122‐24
dated November
22, 2016.
Terminal
6 operations and
systems
Trading terminals
are located in the
head office,
A branch office of C / N.C / N.A Y / N
the Member or
the office of sub
broker only.
Trading terminals
are operated by
approved
B persons/approved C / N.C / N.A Y / N
users with valid
NCFM/BCSM/NIS
M certification.
Correct Terminal
details are
C C / N.C / N.A Y / N
reported to the
Exchange.
Member has
ensured that
associated
persons
functioning as
D C / N.C / N.A Y / N
compliance officer
employed has
obtained NISM
series III A
certification :
Page 230 of 247

- Within one year

from the date of
his/her
employment
after March 11,
2013.
- By March 10,
2015 for
compliance
officers
employed as on
the date of SEBI
notification (i.e.
March 11, 2013)
Member has
ensured that all
associated person
as defined in SEBI
Notification LAD‐
NRO/GN/2010‐
11/21/29390
dated December
E C / N.C / N.A Y / N
10, 2010 have
valid NISM series
VII certification –
(Securities
Operations and
Risk Management
Certification
Examination).
Management of
branches / sub
7
brokers and
internal control
In case of closure
of branch (if any),
A advance notice of C / N.C / N.A Y / N
the same is sent to
clients.
There is a 1st
monitoring October
mechanism to 2016 to
B identify sudden C / N.C / N.A 31st Y / N
increase / March,
decrease in client 2017
level turnover
Page 231 of 247

from any specific

branch.
Periodic 1st
inspection of October
branch / sub 2016 to
broker/Authorise 31st
C C / N.C / N.A Y / N
d person is March,
conducted and 2017
reports are
maintained.
Member has 1st
adequate follow October
up mechanism in 2016 to
case of adverse 31st
D C / N.C / N.A Y / N
observations March,
during branch/sub 2017
broker/AP
inspections.
Trading member 1st
has not dealt with October
unregistered 2016 to
E C / N.C / N.A Y / N
intermediaries for 31st
transactions on March,
the Exchange. 2017
1st
The member has October
not shared 2016 to
commission/ 31st
brokerage with March,
entities with 2017
whom trading
members are
F C / N.C / N.A Y / N
forbidden to do
business / another
trading member /
employee in the
employment of
another trading
member.

Investor
8 grievance
handling
Member is 1st
A maintaining a C / N.C / N.A October Y / N
register of 2016 to
Page 232 of 247

investor 31st
complaints. March,
2017
Member has a 1st
sound system of October
resolution of 2016 to
B investor C / N.C / N.A 31st Y / N
complaints in a March,
time bound 2017
manner.
A designated 1st
email id for October
investor grievance 2016 to
C is created and C / N.C / N.A 31st Y / N
informed to the March,
investors and 2017
Exchange.
Complaints 1st
received on the October
designated email 2016 to
D C / N.C / N.A Y / N
ID are being 31st
looked into to March,
address the same. 2017
The member has 1st
informed the October
Stock Exchange/ 2016 to
Investor about the 31st
E C / N.C / N.A Y / N
actions taken for March,
the redressal of 2017
grievances of the
investor.
The member has 1st
taken adequate October
steps to resolve 2016 to
the complaints 31st
F C / N.C / N.A Y / N
within 30 days March,
from the date of 2017
receipt of the
complaint.
Information about
the grievance
1st
redressal
October
mechanism as
2016 to
G specified by SEBI C / N.C / N.A Y / N
31st
circular
March,
CIR/MIRSD/3/201
2017
4 dated August 28,
2014 is displayed
Page 233 of 247

at all the offices of
the Member for
information of the
investors
Maintenance of

Books of
9
Accounts
Prescribed books 1st
of accounts, October
registers, records 2016 to
and client master 31st
are maintained March,
A C / N.C / N.A Y / N
with the required 2017
details and for the
stipulated period
as per regulatory
requirements.
Register of 1st
securities is October
maintained client 2016 to
B C / N.C / N.A Y / N
wise‐scrip wise. 31st
March,
2017
All Entries for 1st
receipt and October
payment/transfer 2016 to
C of securities are C / N.C / N.A 31st Y / N
duly recorded in March,
the register of 2017
securities.
Exchange wise 1st
separate books of October
accounts are 2016 to
C / N.C / N.A Y / N
D maintained. 31st
March,
2017
Prior approval has 1st
been obtained by October
member for 2016 to
E change in C / N.C / N.A 31st Y / N
shareholding/ March,
directors/constitu 2017
tion.
Prior approval has 1st
been obtained in October
F C / N.C / N.A Y / N
case the member 2016 to
has traded with 31st
Page 234 of 247

another member March,

of the Exchange. 2017
Member has 1st

intimated the October
Exchange in case 2016 to
G they have traded C / N.C / N.A 31st Y / N
with member of March,
another stock 2017
exchange.
All 1st
advertisements October
are issued after 2016 to
prior permission 31st
of the Exchange. March,
Further, the 2017
advertisements
H specifically C / N.C / N.A Y / N
comply with the
requirements of
Exchange notice
no. 20151217‐17
dated December
17, 2015.

Stock Broker/ 1st
Group October
companies/ third 2016 to
party/associate of 31st
stock broker has March,
not offered any 2017
schemes/leagues/
competitions
which involves
distribution of
price monies and
I has not issued C / N.C / N.A Y / N
advertisement for
the same. Further,
the stock broker
has not carry out
advertisements in
which celebrities
form part of the
advertisement.
Refer to Exchange
Notice No.
20160812‐22
Page 235 of 247

dated August 12,

2016.

Notice board & 1st
SEBI registration October
certificate of the 2016 to
J Trading Member C / N.C / N.A 31st Y / N
was displayed at March,
the location of 2017
audit.
Trading member 1st
has not dealt with October
suspended/defaul 2016 to
ter/expelled 31st
K C / N.C / N.A Y / N
members and March,
entities prohibited 2017
from accessing
market.
Systems &
Procedures
pertaining to
10 Prevention of
Money
Laundering Act,
PMLA, 2002
Details of 1st
appointment of October
Principal Officer & 2016 to
Designated 31st
A C / N.C / N.A Y / N
Director and any March,
changes therein 2017
are intimated to
FIU‐India.
The member has 1st
adopted and October
implemented 2016 to
B C / N.C / N.A Y / N
written guidelines 31st
prescribed under March,
PMLA, 2002. 2017
The Member has 1st
adequate system October
in place that 2016 to
allows continuous 31st
C monitoring of C / N.C / N.A March, Y / N
transactions and 2017
generates alerts
based on set
parameters for
Page 236 of 247

suspicious
transactions.
Adequate systems 1st
& procedures are October
in place for 2016 to
scrutinizing the 31st
D alerts to arrive at C / N.C / N.A March, Y / N
suspicious 2017
transactions and
to report the same
to FIU
Member has 1st
adequate systems October
& procedures in 2016 to
E place to ensure C / N.C / N.A 31st Y / N
screening of March,
employees while 2017
hiring.
As per the 1st
provision of October
Prevention of 2016 to
Money laundering 31st
Act, 2002 record March,
of transactions, its 2017
nature and its
F C / N.C / N.A Y / N
value are
maintained and
reserved by the
member as
prescribed under
Rule 3,7 & 8 of
PMLA.
Member has 1st
ongoing training October
program for 2016 to
employees so that 31st
G C / N.C / N.A Y / N
staff are March,
adequately 2017
trained in AML &
CFT procedure.
Member has 1st
taken adequate October
measures to carry 2016 to
H C / N.C / N.A Y / N
out & document 31st
risk assessment to March,
identify, assess 2017
Page 237 of 247

and mitigate its

money laundering
and terrorist
financing risk.
Member has
complied with the
requirements of
the various FATF
I public statements C / N.C / N.A Y / N
and updated
UNSC lists which
are circulated by
the exchanges
Member has done 1st
the online October
registration with 2016 to
j FIU‐India and has C / N.C / N.A 31st Y / N
got the FIU March,
Registration no. 2017
(FIU‐REID)
11 Transfer of trades
Trades were
executed in
respective clients
account and are
not transferred
from one client
code to another
client code or
from client code
to pro or vice‐
A C / N.C / N.A Y / N
versa in the back
office of the
member.
In case of such
transfers, if any
specific pattern is
observed
instances to be
provided in
remarks column.
All client code 1st
modifications October
were done to 2016 to
B C / N.C / N.A Y / N
rectify a genuine 31st
error in entry of March,
client code and no 2017
Page 238 of 247

patterns were
observed.
If any pattern is
observed, please
give instances in
remarks column.
Systems are put in 1st
place to monitor/ October
prevent the use of 2016 to
client code 31st
modification March,
facility for 2017
C C / N.C / N.A Y / N
purposes other
than correcting
mistakes arising
out of client code
order entry.

The trades 1st
modified by the October
member to the 2016 to
“ERROR” code 31st
have been settled March,
in ERROR account 2017
D C / N.C / N.A Y / N
and not shifted to
some other client
code. If not
complied, please
provide the
details.
Trading Member 1st
has a well‐ October
documented error 2016 to
policy to handle 31st
E client code C / N.C / N.A March, Y / N
modifications, 2017
approved by their
board/manageme
nt.
12 Margin Trading
Member has 1st
obtained specific October
approval from the 2016 to
exchange, in case 31st
A C / N.C / N.A Y / N
he is providing March,
margin trading 2017
facility to his
clients.
Page 239 of 247

Member has 1st

regulatory 2016 to
B C / N.C / N.A Y / N
requirements 31st
related to margin March,
trading. 2017
Proprietary
13
Trading
If member is doing
pro trading, then
member has
A C / N.C / N.A Y / N
disclosed this
information to his
clients.
If member is doing 1st
pro trading from October
multiple locations, 2016 to
the member has 31st
B C / N.C / N.A Y / N
obtained prior March,
approval from the 2017
Exchange in this
regard.
14 Internet Trading
1st
Member has October
obtained specific 2016 to
approval from the 31st
A exchange, in case C / N.C / N.A March, Y / N
he is providing 2017
internet trading
facility to his
clients.
1st
Member has October
complied with 2016 to
regulatory 31st
B C / N.C / N.A Y / N
requirements March,
related to internet 2017
trading.

Execution of
15 Power of
Attorney (POA)
The POA executed
with the client (if
A C / N.C / N.A Y / N
any) is in the
favor of the
Page 240 of 247

member and it is
not in favor of any
other person.
The Power of
Attorney executed
in favour of
trading member is
only limited to the
purposes as
allowed and
B C / N.C / N.A Y / N
adheres to the
Provisions of SEBI
Circular
CIR/MRD/DMS/13
/2010 and
CIR/MRD/DMS/28
/2010.
The PoA executed
does not prohibit
C operation of C / N.C / N.A Y / N
trading account by
client(s).
The Member has
adopted sufficient
internal controls
D C / N.C / N.A Y / N
to ensure that
POA is not
misutilised.
Flagging of POA
has been
undertaken in the
UCC with respect
E C / N.C / N.A Y / N
of all clients
registered after
February 13th,
2015
Operations of
Professional
Clearing
member/
16
Members
clearing trades of
other trading
members
All the mandatory 1st
clauses have been October
A C / N.C / N.A Y / N
included in CM ‐ 2016 to
TM agreement 31st
Page 241 of 247

(wherever March,
applicable). 2017
The Clearing 1st
member custodial October
participant 2016 to
agreements are 31st
B executed in C / N.C / N.A March, Y / N
prescribed 2017
formats
(wherever
applicable).
Statement of 1st
accounts has been October
sent to trading 2016 to
C member/custodia C / N.C / N.A 31st Y / N
l participants. March,
2017

The clearing
member had
collected
appropriate and
D adequate margins C / N.C / N.A Y / N
in prescribed
forms from
respective trading
members.
Margin collection
reported to
Exchange is in
E accordance with C / N.C / N.A Y / N
margins actually
collected from
trading member.
Exposure allowed
to trading
members was
F based on requisite C / N.C / N.A Y / N
margins available
with the clearing
member.
Securities
Lending &
17
Borrowing
Scheme
Member has 1st
A obtained specific C / N.C / N.A October Y / N
approval from the 2016 to
Page 242 of 247

exchange for 31st

offering SLBS. March,
2017
Member has 1st
regulatory 2016 to
B C / N.C / N.A Y / N
requirements 31st
related to SLBS. March,
2017
Compliance
status of last
inspection carried
18
out by SEBI/
Exchanges/
Internal Auditor
Member has
complied with the
qualifications/viol
ations made in last
A SEBI inspection C / N.C / N.A Y / N
report. If not
complied (NC)
then give status of
compliance.
Member has
complied with the
qualifications/viol
ations made in last
Exchange
B C / N.C / N.A Y / N
inspection report.
If not complied
(NC) then give
status of
compliance.
Member has
complied with the
qualifications/viol
ations made in
latest half yearly
C C / N.C / N.A Y / N
Internal Audit
report. If not
complied (NC)
then give status of
compliance.

Comments of the

19 auditor on any

other area
Page 243 of 247

The last half years
Internal Audit
Report was
20 placed/ approved C / N.C / N.A Y / N
by the Board/
Proprietor/
partners.

We certify that we have conducted the audit by adhering to the samples size as prescribed by the Exchange.
We do not validate the management comments provided by the member in the above report.

We have taken management explanations wherever the information available on the underlying documents
were not sufficient to arrive at a decision on the level of compliance.

In addition to the above we would like to draw attention of the concerned persons to following issues which
in our considered view is a high risk item:

S.No. Observation Remarks

For ___________________ (Name of the Audit Firm)

Signature of the Auditor : _____________________

Name of the Auditor : ______________________

Membership No. : _____________________

Stamp of the Audit Firm : _____________________

Points to be noted:

The guidelines prescribed here are only indicative in nature and not exhaustive. It does not in any way
limit the scope of the internal audit. The guideline has been prepared based on the regulatory
requirements (as per relevant Acts, Rules, Regulations and circulars) which keep on developing from time
to time. The auditors should peruse them and update the scope of the audit. The auditors should clearly
indicate ‘Complied’ indicating Compliance, ‘Not Complied’ indicating Non‐compliance and ‘N.A’
wherever ‘Not Applicable’.

The report shall also include the following.

1. Management comments

a) In case of any non‐compliances/findings/observations/qualifications by the auditor the management
responses should be given to the Exchange against each point.
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b) The trading member to mention the date on which the report has been presented to the
Board/Management/Audit Committee/Proprietor for their approval and indicate corrective and
preventive actions taken by the management for addressing the deficiencies along with the timeliness
of when the agreed suggestions would be implemented .

c) In case of receipt of internal audit reports without management comments / only certificate and no
report, the same shall be treated as non‐submissions.

2. Points to be noted the Internal Auditor

a) Auditor to comment on improvements brought about in the operations between the last audit and the
current audit.

b) A statement by the auditor that the provisions of SCRA 1956, SEBI Act 1992, SEBI (Stock Brokers and
Sub‐brokers) Regulations 1992, SCRR 1957, Rules, Bye laws, Regulations, circulars of SEBI, agreements,
Bye laws of Exchange/Clearing Corporation, data security and insurance have been covered in the
audit.

c) Auditor shall specifically declare about direct / indirect interest in or relationship with the member or
its shareholders / directors / partners / proprietors / management if any and also confirm that they do
not perceive any conflict of interest in such relationship / interest while conducting internal audit of
the said member.
d) Membership number allotted by the affiliated professional body should be quoted at the bottom of
the report as provided in the format. Each page of the report shall be signed and stamped by the
auditor.

e) Annexure to be attached by auditors
In case any violations/qualifications/observations are observed by the auditor the same shall be
submitted as annexure with complete details and should be quantified specifying the number of
instances, value etc. and the evidences should be enclosed with the Internal Audit Report.

f) Sample size indicated in the format above is minimum sample size. The auditor may increase the
sample size as it may deem fit. It is desirable that the sample selected is representative sample of the
population. The auditor may refer to the relevant sampling standards (Standard on Internal Audit
(SIA) 5) – Sampling prescribed by the Institute of Chartered Accountants of India. (ICAI).

g) The internal audit report should be submitted to the Exchange as per the report format specified
above.

h) In case where internal audit report submitted is incomplete and not as per the guidelines like sample
size not given, only certificate submitted without report, same would be treated as non‐submission of
internal audit report. Exchange reserves the right to advise a Member to change it’s auditor if quality
of the report is not satisfactory or the audit is not carried out as per guidelines.

i) If in the opinion of the auditors, any observation related to any area also possesses a risk relating to
Anti Money Laundering (AML) or Combating Financing of Terrorism (CFT) then such observation should
be highlighted clearly specifying the risk relating to it.
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Page 246 of 247

Annexure II

Guidance for Verification in the respective areas
All the trading members / clearing members, who have traded / cleared at least one trade on any
segment, are required to submit the internal audit report and ensure adherence in the following
areas. The Annexure 1 gives a list of the various areas which needs to be verified for compliance
with SEBI regulations/ Stock Exchange Circulars etc. Further, this section will also include a cross
reference to the sections in the workbook where the same has been discussed.

Sr. Reference with Chapter
Verification of Compliance with
No No. /Section No.
1 Client registration documentation Chapter 8; Section 8.2.1
Chapter 8; Section 8.2.2
2 Order management and risk management systems
and Section 8.3
Chapter 8; Section 8.4.3,
3 Issue of Contract notes, Client margin details and Statement of accounts
8.4.51 and 8.4.4.3
4 Dealing with clients’ funds and securities Chapter 8; Section 8.4.4
Chapter 8; Section
5 Banking and Demat account operations
8.4.4.4
Chapter 8; Section
6 Terminal operations and systems
8.2.2.2
7 Management of branches / sub brokers and internal control Chapter 9; Section 9.5.1
8 Investor grievance handling Chapter 11
9 Maintenance of Books of Accounts Chapter 8; Section 8.4.6
Systems and Procedures pertaining to Prevention of Money Laundering Chapter 6
10
Act, PMLA, 2002
11 Client Code Modification Chapter 9; Section 9.5.2
12 Margin Trading Chapter 8; Section 8.5
Chapter 8; Section
13 Proprietary Trading
8.4.7.3
Chapter 8; Section
14 Internet Trading
8.2.2.1
15 Execution of Power of Attorney (POA) Chapter 9; Section 9.4.4
Operations of Professional Clearing member / Members clearing trades Chapter 10; Section
16
of other trading members 10.1.2.1
17 Securities Lending and Borrowing Scheme Chapter 8; Section 8.6
Annexure I‐Format of
Compliance status of last inspection carried out by SEBI / Exchanges /
18 internal audit report.
Internal Auditor
Section 18

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NISM Series XIV Internal Auditors For Stock Brokers December 2018 PDF

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NISM: Internal Auditors of Stock Brokers Certification Examination

 The buyer of the option pays the strike price to buy the underlying asset, if it is a call

PMLA imposes obligation on banking and financial institutions and intermediaries to carry out

iii. Money which may by mistake or accident have

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3. A Stock Broker when dealing with a client must disclose whether it is acting as a Principal

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The client must also have a valid bank account from which transactions can be made for pay‐

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Corporate Bonds Fixed percentage based Not to exceed 10 percent of

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Liquid Securities At least 80 percent of the Less than or equal to 1

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