No penalty on brokers if wrong-client trades annulled

To escape penalisation, brokers would have to transfer the trades executed in the wrong client name or code to an 'Error Account', and not to some other client, and then liquidate the same.

However, brokers would face monetary penalties, being imposed from this month, if the trades are transferred to some other client by citing error in punching the name of the client, even if such an error is genuine.

The error being genuine would only save them from further regulatory actions. If brokers find that the errors have not happened at their end, they might pass on the liability to the investors, but the exchanges would collect the penalty from the brokers.

The genuine errors include those due to communication, punching or typing in cases of the original and modified client code or name being similar to each other. The changes made within 'relatives', as defined under the Companies Act, 1956, are also considered genuine errors.

The penalties came into effect from August 1 after Sebi decided to penalise brokers for transfer of trades from one client to another, citing errors. It was feared that the practice was aimed at facilitating flow of black money and evasion of taxes in stock market.

However, the rules have been relaxed a bit after consultations held by the Sebi with various stock exchanges.

Subsequently, the capital market regulator issued a fresh circular to the stock exchanges informing them of changes, effective from Monday.

"Any transfer of trade to error account of the broker would not be treated as modification of client code and would not attract any amount of penalty, provided the trades in error account are subsequently liquidated in the market and not shifted to some other client code," Sebi said.

For easy identification of error account, brokers will have to register a fresh client code as 'ERROR' with the stock exchange for the account classified by them as error account.

Also, brokers would have to put in place well-documented error policy approved by their board and management, and would be required to inform the exchange on a daily basis the reasons for modification of client codes.

Subsequently, penalties would be still levied on all client modifications, except those transferred to 'error accounts', Sebi said.

Sebi introduced the penalties after it came across a loophole in regulations that was being abused by stock brokers for facilitating tax evasion and flow of black money through fictitious trades in lieu of hefty commissions.

To remove this anomaly, Sebi has powered stock exchanges to penalise the brokers transferring trades from one trading account to another after terming them as 'punching' errors.

The penalty would be between 1-2 per cent of the value of shares traded in the 'wrong' account, as per the new rules that came into effect from August 1.

In a widely-prevalent but secretly operated practice, the people looking to evade taxes approach certain brokers to show losses in their stock trading accounts, so that their earnings from other sources are not taxed.

These brokers are also approached by people looking to show their black money as earnings made through stock market.

In exchange for a commission, generally 5-10 per cent of the total amount, these brokers show desired profits or losses in the accounts of their clients after transferring trades from other accounts, created for such purposes only.

The brokers generally keep conducting both 'buy' and 'sell' trades in these fictitious accounts so that they can be used accordingly when approached by such clients.

In the market parlance, these deals are known as profit or loss shopping. While profit is purchased to show black money as earnings from the market, the losses are purchased to avoid tax on earnings from other sources.

As the transfer of trades is not allowed from one account to the other in general cases, the brokers show the trades conducted in their own fictitious accounts as 'punching' errors.

The regulations allow transfer of trades in the cases of genuine errors, as at times 'punching' or placing of orders can be made for a wrong client.

To check any abuse of this rule, Sebi has asked the bourses to put in place a robust mechanism to identify whether the errors are genuine or not. At the same time, the bourses have been asked to levy penalty on the brokers transferring their non-institutional trades from one account to the other.

The penalty would be one per cent of the traded value in wrong account, if such trades are up to five per cent of the broker's total non-institutional turnover in a month.
The penalty would be 2 per cent of trade value in wrong account, if such transactions exceed five per cent of total monthly turnover in a month.