Misuse of power of attorney (PoA) given by clients to stockbrokers has been a sore point in Indian stock markets, with cases such as the Karvy Stock Broking matter showing how PoA can be manipulated by brokers to suit their own ends. The Securities and Exchange Board of India (SEBI) has issued some new guidelines, which can prevent a repeat of Karvy-type situation where shares of clients who did not owe any funds to the broker were also transferred to the margin/pool account by misusing the PoA given by clients. Now, a new document - Demat Debit and Pledge Instruction (DDPI) - will replace PoA for the purpose of pledging and repledging of stocks for margin purpose. Here is a lowdown on the development.

Problems with PoA

PoA is a legal document giving authority to another person to operate the investor's demat account and bank account to facilitate the delivery of shares and pay-in and pay-out of funds. Giving PoA to the stock broker is not mandatory, hence it should not be insisted upon by the stock broker/stock broker depository participant for opening a client account. Generally, the PoA is taken from clients/investors who want to avail internet-based trading services.

As per SEBI norms, PoA should be utilised for transfer of securities held in the beneficial owner account of the client towards stock exchange-related deliveries/settlement obligations on trades executed by the same client on the exchange through the same stock broker. It can also be used for pledging/re-pledging of securities in favour of the trading member (TM)/clearing member (CM) for the purpose of meeting margin requirements in connection with the trades executed by the investor.

The problem is, the PoA has been at the centre of continuing broker frauds. In the case of Karvy, fraud was committed through the alleged illegal diversion of clients’ securities worth ₹2,800 crore and pledging of these securities with banks/NBFCs for seeking loans and subsequent loan default. Simply put, PoA was used to illegally transfer investor shares.

Demat debit and pledge instruction

While executing a PoA, authorisation is given by the client to the stock broker and depository participant, to access the Beneficial Owner (BO) account of the client to meet settlement obligations.

In order to make the process more transparent and simpler, SEBI i has introduced the Demat Debit and Pledge Instruction. Under this DDPI, clients will explicitly agree to authorise the stock broker and depository participant to access their BO account for the limited purpose of meeting pay-in obligations for settlement of trades executed by them. This will come into effect from July 1.

DDPI will serve the same purpose of PoA and significantly mitigate the misuse of PoA. This is because the use of DDPI will be limited to two use cases.

The investor may use the DDPI or opt to complete the settlement by issuing physical Delivery Instruction Slip (DIS) or electronic DIS themselves.

The securities transferred on the basis of the DDPI provided by the investor will be credited only to the investor's trading member pool account. The DDPI will be registered in the investor demat account.

Read the SEBI circular on DDPI at https://tinyurl.com/sebiddpi

Safer, but not panacea for all frauds

The DDPI can be executed only if the investor provides his/her explicit consent for the same, including internet-based trading. The DDPI also needs to be adequately stamped. The DDPI can be digitally signed by the clients.

What happens to existing PoAs? In the interim, will this disrupt trading?

The existing PoAs will continue to remain valid till the time investor(s) revokes them.

So, the broker should not directly/indirectly compel clients to execute the DDPI or deny services to the client if the client refuses to execute the DDPI.

Hence, there is expected to be no disruption in trading activities.

Note that any future incidence of broker defaults/misdoings can never be avoided just because the gaps in the PoA route have been plugged. Every time such an incident comes to the fore, SEBI changes regulations to prevent such occurrences. In December 2018, SEBI brought in norms standardising broker books and records to make inspection and comparison of data easier. In January 2019, the regulator told brokers to report day-wise stock and fund balance with them. In June 2019, SEBI directed brokers to stop raising funds by pledging clients’ shares, and insisted on segregation and reporting of clients’ stocks and funds.