Introduction
The Securities and Exchange Board of India (‘SEBI’) has amended the SEBI (Stock Brokers) Regulations, 1992 through its Notification dated 27.06.2024[i]. The amended regulation known as SEBI (Stock Brokers) (Amendment) Regulations, 2024 (‘Amended Regulation’) will come into effect after publication in the Official Gazette.
The Amended Regulation introduces a pivotal new Chapter, IVA—Institutional Mechanism for the Prevention and Detection of Fraud or Market Abuse. This chapter, which includes new regulations (18E to 18I), significantly enhances the existing mechanisms. It defines key terms like ‘Designated Directors’, ‘fraud’, ‘mule account’, ‘market abuse’, ‘suspicious activity’, etc., ensuring absolute clarity in the regulatory framework. This new chapter is not just a change but a significant step towards a more secure and transparent market, underlining the importance of the update.
The Amended Regulation mandates stockbrokers to set up robust surveillance systems and internal controls proactively. These are not just crucial for monitoring trading activities and detecting fraud or market abuse, but they also require immediate attention. The regulation also requires stockbrokers to document their policies and procedures, establish realistic alert thresholds, and regularly evaluate and update their systems to stay current with market trends and regulatory changes. This proactive approach is necessary to ensure ongoing compliance and transparency in their operations.
Key Changes in the Amended Regulation
Systems for surveillance of trading activities and internal controls
Stockbrokers must establish adequate systems for surveillance of trading activities and internal controls to ensure compliance with regulatory requirements and detect potential fraud or market abuse by clients, employees, or authorised persons.
Obligations of the stock broker and its employees
Stockbrokers must follow a number of strict guidelines in order to maintain operational integrity and regulatory standards. Firstly, KYC surveillance systems should be set up and maintained to confirm clients' identities. Additionally, surveillance systems tailored to the intricacy of transactions and corporate operations should be installed to monitor orders and trades fully. They must also record all the policies, procedures, roles and responsibilities as well as reporting guidelines and corrective action methods and examine and update these systems and procedures on a regular basis, i.e., at least once a year, to keep up with the changing market conditions and legislative requirements.
Moreover, stock brokers must ensure that proprietary accounts are exclusively used for proprietary trades, preventing misuse. They are also tasked with strictly restricting trading terminals to authorized personnel at approved locations to maintain control and oversight. Additionally, stock brokers must actively detect potential mule accounts or suspicious activities, employing robust measures for early detection and prevention. Furthermore, employees are mandated to promptly report any knowledge of fraud, market abuse, or suspicious activities to senior management, fostering a culture of vigilance and compliance within the organization.
Escalation and reporting mechanisms
The regulation requires rigorous oversight strategies for stockbrokers to ensure compliance and accountability. Firstly, under the direction of the Board of Directors or the Audit Committee, stockbrokers must conduct quarterly assessments of their internal control and reporting systems. They must emphasize quick action and openness by reporting any questionable activity to stock exchanges within 48 hours of discovery.
Stock brokers are also required to provide thorough, half-yearly reports to stock exchanges that include information on suspicious activity, fraud cases, and possible abuses of the market. Any violations of risk management procedures, surveillance rules, or internal controls must be immediately notified, along with a thorough account of the corrective measures to rectify the problem. Further, stockbrokers are advised to consult stock exchanges for information on handling suspicious activity when there is a suspicion of legal infractions but no confirmation. These steps are intended to fortify market monitoring, improve regulatory compliance, and cultivate investor trust in the honesty of stock broker business practices.
Whistle-Blower Policy
A stock broker is required to establish and uphold a written whistleblower policy that permits staff members and other interested parties to discreetly voice concerns on suspected unfair, dishonest, or unethical business activities as well as legal or regulatory infractions. There should be whistleblower protection mechanisms in this policy. The Audit Committee or a comparable organization must receive complaints against any member of the Board of Directors, including the Managing Director, CEO, designated directors, important managerial staff, and promoters. The Compliance Officer should be contacted with any complaints against other staff members.
Our Analysis
The Amended Regulation, which SEBI has issued, aims to improve the processes for detecting fraud, preventing market abuse, and boosting overall governance to strengthen stockbrokers’ regulatory environment. To accomplish these goals, reliable monitoring and KYC systems, transparent policy and procedure documentation, frequent reviews, and a safe outlet for whistleblowers are essential.
The aforementioned amendments highlight SEBI's proactive stance in enhancing regulatory supervision and control within the stock brokerage sector. SEBI's new laws aim to foster a transparent, equitable, and well-regulated environment in the securities market, fostering investor confidence and long-term market growth.
End Note
[i] Notification No. SEBI/LAD-NRO/GN/2024/186.
Authored by Maarij Ahmad, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.