[Snigdha Dash is a 3rd year B.A.LL.B.(Hons.) student from National Law University, Odisha]
The market’s abundance of traders, providers, platforms, brokers, and communication channels has created an environment susceptible to potentially malevolent activities. Exploiting vulnerabilities to gain unauthorized access to trading accounts and execute illicit transactions, such as in currency trading, has become a worrisome issue. While the Securities and Exchange Board of India (“SEBI”) previously introduced a feature that allowed investors to voluntarily freeze their demat accounts, trading accounts remained unprotected.
In response to this, SEBI issued a circular on January 12, 2024. This circular introduces a provision allowing investors or clients to voluntarily freeze or block their trading accounts. The aim is to address current security vulnerabilities in the stock market. To ensure the prompt implementation of this measure, SEBI has set deadlines for brokers. They are required to establish a framework by April 1, 2024, and enforce it by July 1, 2024.
This post explores the newly introduced voluntary freezing feature. Subsequently, it conducts an in-depth analysis of the rationale behind this development, highlighting SEBI’s client-centric initiatives. Finally, it delves into the transition from the traditional call and trade option to the contemporary online model, showcasing the industry’s adaptation to digital advancements.
Overview, Rationale and Significance of the Circular
SEBI has stipulated a framework allowing clients to voluntarily freeze or block online access to their trading accounts. Such a measure, occasioned due to apprehensions surrounding suspicious activities, will come into effect from April 1, 2024. A trading account, integral for securities transactions, connects the demat account with the bank account. Individuals set it up through a stock broking firm, gaining access to a stock exchange’s platform.
The stock exchanges are instructed to take the following actions within 15 days from the issuance of this circular. Firstly, they are to inform stock brokers about the circular’s provisions and publish them on their websites. Secondly,they must collaboratively issue operational guidelines, developed in consultation with stakeholders, and a standard operating procedure for monitoring circular implementation. Thirdly, they are required to make necessary amendments to relevant bye-laws, rules, and regulations to implement the circular provisions. Lastly, the exchanges ought to communicate to SEBI the status of circular implementation in their monthly development report.
The stock broking industry in India has transitioned to online platforms, where investors utilize login credentials provided by stock brokers. However, there is a need for account freezing or blocking capabilities. Investors often encounter suspicious activities in their trading accounts and express the need for a prompt resolution, emphasizing the urgency of implementing a system for blocking trading accounts. This is similar to the existing features for blocking ATM and credit cards.
The significance of freezing trading accounts cannot be understated as it safeguards investor assets from unauthorized access, fraudulent activities, or any other irregularities such as insider trading. Investors may observe unexpected transactions, unapproved access, or other red flags that prompt the need for immediate action. The ability to freeze their accounts serves as an important tool for preventing further harm and mitigating potential losses. The circular at hand is crucial to deal with potential vulnerability of trading accounts to hacking, which could lead to users being unable to access their accounts. The dissemination of the new procedure is essential, as it reduces the risk of unauthorized trades.
SEBI’s Approach So Far
This circular also goes in tandem with the SEBI’s consultation paper dated January 16, 2023, which proposed the utilization of blocked funds by investors to trade in the secondary market, thereby eliminating the necessity to transfer funds upfront to a stockbrokers. This proposal ensures settlement visibility at the client level, which encompasses both pay-ins and pay-outs, by directly settling funds and securities between the client and the clearing corporation (“CC”). SEBI emphasizes on implementing a process designed to protect clients’ assets from potential misuse, broker defaults, and the associated risks to their capital.
SEBI also implemented the EPI Blocking Mechanism which froze clients’ demat accounts, whereby securities provided as early pay-in (“EPI”) are restricted. These securities are blocked in favor of the CC in the demat accounts of clients engaging in sale transactions. If a sale transaction is not carried out, then the shares will persist in the client’s demat account and shall be released from the block at the conclusion of the trading day (“T-day”). This measure came into effect from August 1, 2021 mandating all EPI transactions starting November 14, 2022. In addition, under the Prohibition of Insider Trading Regulations, 2015 (“PIT Regulations”), SEBI has extended the practice of freezing trading accounts of top company executives during “trading window closures” to all listed companies in a phased manner.
From Calls to Clicks
Building on its client-centric initiatives, SEBI has been instrumental in driving a transformative shift in trading practices. Moving away from the conventional reliance on the call-and-trade option, there is a notable shift towards embracing digital tools for trade execution. This strategic move reflects an evolution in trading practices, emphasizing the efficiency and convenience inherent in digital platforms. The transition signifies a departure from traditional methods that heavily depended on phone-based trading. Leveraging the benefits of the rapidly advancing online landscape enhances accessibility and streamlines the overall trading experience.
The recent circular issued by the SEBI addressing the voluntary freezing or blocking of trading accounts represents a crucial step towards enhancing investor protection and security in the dynamic financial landscape. The move acknowledges the evolving challenges in the market like insider trading, threats of hacking highlights the vulnerability of trading accounts to malicious activities.
To maintain the trust of investors, it is pertinent to ensure the proper safeguarding of investors’ funds and securities, minimizing the risk of misuse or default by a stock broker. The advancing regulatory framework has aimed to leverage technology in detecting early warning signals for potential misuses of funds and securities by stockbrokers. Nevertheless, there is a strong demand for more innovative solutions to address any potential loopholes and further reduce the risk of stock brokers misusing investors’ funds and securities.
– Snigdha Dash