What happens when Brokers go Bankrupt or are Busted?

27 Nov 2020  Read 8795 Views

Trading directly in the stock market can be quite overwhelming. Wouldn't it be nice if there was some intermediary who can connect the investors/traders with the ever-changing stock market?

Well, obviously, that's what brokers are for! They help the investors and traders with smooth, long term investing and trading in return for some brokerage fee.

Because of this ease in transactions, the services of brokers are quite popular among investors. But, where there is a pro, there is also a corresponding con. In this broker situation, the biggest con or in financial terms, the biggest risk is of the brokerage firm going bankrupt or worse, cheating you.

So, in this situation, what should a trader do? To get the answer to this question, keep reading further into the blog.

Who are brokers, and what do they do?

Brokers or brokerage firms are licensed bodies under SEBI who participate in the market on behalf of the investors (long-term investors) or traders (frequent buyers and sellers of shares). People interested in trading, open their Demat accounts under the brokers, and permit them to trade on behalf of them.

But always keep in mind that even if they are licensed, regularly check the trading statements and keep an eye on the broker. Because many times, brokers indulge in trading without the consent of investors or traders to earn extra profits. To avoid such speculations, it is best to first check the broker before going ahead with them.

SEBI's Regulation on Brokers

The Indian market regulator SEBI also helps in regulating these stockbrokers through their strict guidelines. Here some of its policies that help in protecting the Indian investors and traders are:

1. High entrance fee:

To start a brokerage firm, a huge fee is required to submit to SEBI. This rule helps in keeping away unwanted brokers out of the market. This restriction on entry keeps the market from getting saturated with brokers.

2. Prior permission from investors/traders:

To trade in shares, the brokers will have to get permission from the Demat a/c owners. Basically, in order to complete a trade, a T PIN is required, which is only known to the Demat a/c owner, thus restricting the brokers from gaining profits at the expense of innocent investors and traders.

There is also something called a Power of Attorney (PoA). It is a document that if signed by the investor or trader, permits the brokers to undertake quick buying and selling of shares if there is any profit-making opportunity. If as an investor or trader, you sign this document, make sure to check every transaction that the broker makes using the PoA.

3. Provide statements:

If the investors and traders want to see their records of trading, the brokers are obligated to provide the records. These regulations aim towards keeping the brokers from committing any fraud. However, there is also a possibility that they go bankrupt.

So, let us now address the main issue: what happens if a stockbroker goes bankrupt?

Stockbrokers going bankrupt

Under all the regulations and restrictions placed by SEBI and also with NSE and BSE keeping an eye, if a brokerage firm goes bankrupt, the investors/traders don't have to worry too much. The only thing that they need to worry about is their trading account.

When trading is done, you need to add a huge amount of money to your trading account to buy shares. With bankruptcy, this trading account can be at a loss. Long term investors usually have zero trading balance because they put money and use it all for buying their long term investment shares.

But on the other hand, traders who actively trade in the market, constantly have some balance in the trading account, so they need to take certain measures to protect that amount.

Now, you must be thinking about the shares in each Demat a/c.

Here's the thing, as said above brokers are just intermediaries; they don't have the shares. The shares are actually with the depositories known as CDSL and NSDL. To give a brief introduction of these depositors, they store the shares in electronic form just like a bank does with your money.

So ultimately, the shares are with the depositors and not the brokers. Thus, when a stockbroker goes bankrupt, there is no need to worry about the shares; they will still be under the name of the investor/traders. This is called the segregation of assets.

When do brokers get stated as Defaulters?

When brokers go against any norms that are placed by SEBI or the corresponding stock exchange, the broker may get stated as a defaulter.

For them to be stated as a defaulter, a broker may have:

  • Made transactions without the permission of the traders/investors.

  • Not transferred the funds related to the shares, to the traders/ investors.

  • Undertaken trading to earn personal profits using traders/investor's accounts.

All such negation towards the regulations by brokers can lead to severe actions and investigation by the SEBI. And if proven wrong, the brokerage firm will be stated as the defaulter.

What to do as investors/traders if brokers go bankrupt?

The following actions need to be taken by the traders to protect themselves against loss in case brokers go bankrupt or bust.

1. Regarding the trading account

SEBI has thought ahead and has created a fund called Investor Protection Fund (IPF) specifically for situations like this. To get a claim from this fund, the traders need to file for the claim as soon as the broker goes bankrupt.

  • If the claim is filed immediately, then the trader can get compensated up to 15 lakhs by the IPF.

  • If filed within 3 years of the bankruptcy, then the compensation amount is determined by the IPF.

  • If the claim is filed after 3 years, then the trader will not be compensated by the IPF.

So it is best to file for the claim immediately after the brokerage firm goes under bankruptcy to gain maximum compensation.

2. Regarding the shares

The shares are anyways with the depository (CDSL or NSDL) so, when a brokerage firm goes under bankruptcy, the traders' shares will be transferred to some other brokerage firm based on the suggestions of the said traders.

                                        

Some bankruptcy cases in India

Date of bankruptcy declaration

Brokerage firm

September 2008

Kass Securities Pvt. Ltd

September 2008

Himgiri Fincap Ltd.

July 2007

Madan & Co. Ltd.

December 2004

Alba Capital Markets P Ltd.

Conclusion

Brokers and brokerage firms do make the task of trading easy, but one should not completely leave them unattended even if they are a trusted firm. It is advisable to regularly check the trading records and also keep a close eye on the working and reputation of the brokers.

If at any point in time, as an investor or trader you feel like the brokerage firm is cheating you, you are free to file a complaint with the SEBI or the corresponding stock exchange (NSE/BSE). A proper action will be taken to investigate the firm.

However, bankruptcy is not the only issue that any investor or trader trading through a broker should worry about.

The stock market is a place for vigilant people. Things happen very quickly, so for investors and traders, such changes need to be rapidly judged to make the maximum out of it.

About the Author: Ananya Mitra | 10 Post(s)

Ananya is a CFA aspirant. Other than nurturing the dream of becoming a financial analyst since high school, she likes to indulge in words both of fiction and non-fiction.

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