The problem is with the broking model and what brokers are allowed to do, notes Debashis Basu.
If you are a retiree and have opened a broking account with any of the large brand-name stockbrokers, the following events could happen to you.
You will get a call from the 'relationship manager' of your broking firm making verbal promises of helping you earn a steady return every month by selling call and put options on the Nifty.
He will explain to you that the trading positions are hedged and hence, there is nil or negligible risk.
You hand over your investment portfolio of Rs 1.25 crore spread across 57 scrips, many of them being blue-chips like Hindustan Unilever, Asian Paints, Pidilite, and Dabur.
The broker opens a futures and options (F&O) account for you and makes some profit. The only way he could have promised a steady return is by selling calls and puts. This works very well when market volatility is low.
When you sell options and the market remains in a narrow range, the options lose value and go to zero at the end of the month and you pocket your gains.
Then comes a market crash, one of those steep falls that happen once in a while, for which no one is prepared -- least of all your broker and the smooth-talking expertise-free relationship manager.
When the market crashes, the 'puts' which you have sold and which were making steady money for you shoot up and become higher in value, inflicting huge losses.
Suddenly, the friendly broker has a different tone.
You are asked to pay up or your Rs 1.25 crore stash of blue-chip shares, which are with the broker, will get sold.
You protest, but the system, created and tinkered with endlessly by the market regulator, is on the broker's side.
The broker sells your life savings.
This is a real life story of a retiree.
Here is another real-life story of an investor who is part of a business group with operations in multiple countries. He started trading in F&O in October last year and had booked a profit of Rs 65 lakh till February this year.
The broker 'advised' him to invest in the IPO of SBI Cards, which he did.
In the crash of March, he lost Rs 10.43 crore in F&O and claims to have lost another Rs 7.51 crore when the broker sold the SBI Cards shares in his account to recover mark-to-market losses.
The client claims that he did not know the broker had built up a huge position in F&O.
The broker, one of the best brand names in the business, points out that all trades were executed with the knowledge and consent of the client's authorised person.
It had sent contract notes and text messages confirming the trades and net ledger balances.
The number of people who lost money in such F&O trading is endless.
In recent years, thousands of investors have lost money in a dozen stockbroking firms that went bankrupt.
Some brokers are also said to have misappropriated client money running into thousands of crores.
Remember, stockbroking, like every aspect of the securities market, has been extremely closely regulated in the past 28 years after the Securities and Exchange Board of India came into existence.
Brokers have to pass exams, put in place six policies including the code of conduct, and are subjected to regular audit and inspection by the exchanges.
And yet, dealing with stockbrokers can mean malfeasance, horrible advice, bad faith, incompetence, and outright fraud.
What is going wrong?
The problem is with the broking model and what brokers are allowed to do.
Sebi has slowly plugged issues such as misuse of power of attorney, buying and selling on clients' accounts without their knowledge, and misusing client money and securities. It did this with new rules, disclosure, and compliance requirements.
In a similar vein, now that brokers have been found helping themselves to clients' securities for margin trading, Sebi wants to fix the problem with a cumbersome system of pledge and re-pledge of securities.
Introducing new rules quickly shut up those who ask, 'What is Sebi doing?' But this is mere patchwork on a broken model.
Sebi needs to go back to the basics and question the role and function of a stockbroker, and which needs of investors they are fulfilling.
R H Patil, pioneer of modern stock exchanges in India and an original thinker, always felt we did not need stockbrokers at all.
Interestingly, Sebi has maintained that investors don't need brokers to buy mutual funds, which are another risk asset.
I am not suggesting that we do away with stockbrokers, but Sebi must start thinking of fundamentally redesigning the role of stockbrokers so that they can do no harm.
Here is what we need to debate. Until Sebi was set up, stockbrokers were the only market intermediaries and they performed multiple functions.
Then specialised intermediaries were licensed, such as portfolio managers, depositories, custodians, investment advisors, and research analysts; each is covered by specific Sebi regulations.
So, there is no reason to allow brokers to perform any of these functions any more. Advisors and research analysts can offer stock advice; banks, depositories, and custodians can handle transacted assets; and portfolio managers can manage investment.
Stockbrokers can be limited to executing trades -- like a toll operator.
Investors suffer because brokers continue to don the hats of advisor, custodian, and portfolio manager, doing each of these badly.
Interestingly, some new-age brokers have a business model like a toll operator and, not surprisingly, are yet to be accused of malfeasance or acting in bad faith.
This should obviously be the standard model if Sebi wants to make the market safer.
Feature Presentation: Rajesh Alva/Rediff.com