Improving Stock Sales Practices of Intermediaries

Stock intermediaries around the world, such as brokers and sub-brokers, who recommend and sell securities to clients, are regulated by the securities regulatory agencies of the countries where they operate as well as the stock exchanges of which they are members. However, the stock intermediation industry has been facing several problems over the years on account of inappropriate business practices. These include acquisition of clients without following proper know-your-client (KYC) norms and peddling complex financial products (such as derivatives) to clients, particularly individuals, who do not possess sufficient sophistication to bear the high risk involved in such products.

Further, the stock analysts within these broking entities have been found to have conflicts of interest that impinge on their independence of analysis while providing recommendations to “buy” or “sell” a particular stock. In fact, a few years ago, the (now infamous) Eliot Spitzer, then Attorney General of New York State, prosecuted analysts for issuing rosy recommendations on Internet stocks that they themselves knew were not valuable, and forced settlements that ran into hundreds of millions of dollars. The problems associated with the action arose from the fact that many of these analysts that issued recommendations on companies were affiliated to investment banking arms that were taking those very companies to the public markets through IPO during the Internet boom, and that clearly constituted a conflict of interest.

Regulations regarding sales practices by brokers and analyst conflicts of interest have not been very stringent in India, as compared to more developed markets. However, that is likely to change with SEBI’s Proposed Policy for Improvement in Sales Practice by the Members of the Stock Exchanges that was issued yesterday. The policy document is available here.

Key measures proposed include strengthening KYC norms, sales practices, fair dealing with customers regarding derivatives or new financial products, tackling conflicts of interest and improving recordkeeping.

Comments are due on the proposal before April 15, 2008.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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