Problem of plenty

With the arrest of three brokerage officials, the Economic Offences Wing has finally acknowledged the part played by market intermediaries in defrauding investors of ₹5,600 crore in the National Spot Exchange Limited scam. The investigation and arrests made so far revolved around the procedural irregularities at the exchange, the role of its promoter and other large members who had defaulted on their payment obligation. While the part played by the exchange is undeniable, intermediaries who acted as the interface between the investors and the exchange are also partially responsible for the scandal. The NSEL allowed trading in forward contracts despite its mandate to facilitate spot trades alone, allowed short selling in the contracts, and did not maintain a securities guarantee fund. But the product was sold to investors across the country by brokerages. As the Bombay High Court rightly observed, brokers were not unaware about the legal status of the transactions.

The three arrested catered to thousands of clients and had a trading exposure of more than ₹35,000 crore to the exchange. According to the Economic Offences Wing, these brokerages are alleged to have committed offences both off the exchange platform and on it. They had marketed paired contracts on the NSEL as a fixed-return product. It can be argued that investors ought to have suspected irregularity, since trading in commodities cannot guarantee assured returns. But many investors in the country depend on broker advice — in stocks, commodities or currency. Deceiving such gullible investors erodes the integrity of the entire financial market. The brokers are also alleged to have committed fraud on the exchange platform by executing trades from fictitious accounts, using client accounts to transact without their consent, and in some instances, manipulating the unique client code. Some brokers have allegedly helped the exchange in showing higher volumes by putting in circular trades.

This could just be the tip of the iceberg. The EOW is investigating 139 broking houses for similar offences. The scam exposes the deteriorating ethical standards of some intermediaries in the financial markets. There are over 7,000 brokers and 43,000 sub-brokers registered with the equity market regulator. Many of them cater to clients in other segments such as commodity, currencies and derivatives. In the face of increasing competition from large, professionally-run broking houses and shrinking margins due to the increased trading in derivatives, their ability to earn enough to keep their business going is reducing, making them compromise the interest of the client. The onset of online trading too is affecting margins of many of these small businesses. The investigation could be a blessing if it leads to an overhaul in the industry. If weaker brokerages exit the business and only the stronger ones survive, the cause of protecting investors in financial markets will be better served.

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