Investor Control Redefined - A Comprehensive Review Of SEBI’s Voluntary Freezing Mechanisms In Trading Accounts
Author: LawSphereX
Category: Corporate & Insolvency
Published:
Updated:
INVESTOR CONTROL REDEFINED: A COMPREHENSIVE
REVIEW OF SEBI’S VOLUNTARY FREEZING MECHANISMS IN TRADING ACCOUNTS
Sayandeep Chakraborty, KIIT School of Law
ABSTRACT
This paper delves into two circulars issued by the Securities and Exchange Board of India (SEBI) and the National Stock Exchange (NSE) on the 12th of January and 8th of April 2024 respectively, allowing investors and clients to voluntarily block or freeze their trading accounts through trading members. At the very outset, the paper explores the necessity of such step in light of the rapid growth of online trading in India, and then goes on to discuss the status of implementation of the provisions of the Circular so far. By examining the relevant provisions of the circular and the proposed framework and key concepts in details, the paper sheds light on the intricacies of this regulatory development. Furthermore, it conducts comparisons with existing laws governing the freezing of Demat accounts and other financial instruments like Credit cards.
The analysis culminates in an exploration of the prospective positive impacts of the circular on investors, clients, and the overall Indian stock market landscape. Through comprehensive examination, the paper discusses the grey areas in the Circular, thus contributing to a deeper understanding of regulatory measures aimed at enhancing investor protection and fostering a conducive trading environment.
I.
INTRODUCTION
In a significant move aimed at furthering the cause of investor protection and bolstering investor protection, the Indian stock market regulator, SEBI issued a circular pertaining to the provision of the facility of voluntary freezing of online Trading accounts to clients. Dated January 12, 2024, and published under the subject - “Ease of Doing Investments by Investors - Facility of voluntary freezing/blocking of Trading Accounts by Clients”, this circular marked a crucial development in SEBI's continual efforts to safeguard the interests of investors in India's financial markets. This circular becomes ever so significant against the backdrop of the global growth of India’s stock markets. According to the New York-based global news agency Bloomberg, India currently has the world’s fourth-largest stock market in terms of market capitalization.
The combined value of all shares listed on Indian markets touched $4. 33 trillion1 on January 22, 2024, overtaking Hong Kong’s market cap. India’s National Stock Exchange (NSE) is also the world’s largest derivative exchange in terms of number of contracts traded2. In September 2023, the National Stock Exchange announced that the investor base registered with the NSE crossed the 8-crore mark for the first time in history. According to a report from multinational services firm PricewaterhouseCoopers (PwC), the value of digital transactions in India went up by a mammoth 58% in FY 2023, as compared to FY 20223. Such rapid growth in online trading and online transactions triggers the need for increased safeguards for investors and consumers. This Circular is seen as a major step towards SEBI’s goal of enhancing surveillance and fostering transparency in India’s security market ecosystem.
In this analysis, we delve into the key provisions of the circular and its potential impact on market participants. II.
RESEARCH
METHODOLOGY
This paper adopts a comprehensive research methodology to examine the circular issued by SEBI regarding the provision of the facility for voluntary freezing of trading accounts by clients. The methodology encompasses several key components aimed at thoroughly analyzing the circular, evaluating its proposed procedures, assessing its impact on clients and investors,
1 Ashtosh Joshi, India Tops Hong Kong as World’s Fourth-Largest Stock Market, Bloomberg (12 February
2024), https://shorturl.at/kuvCV.
2 Abhishek Vishnoi and Ashutosh Joshi, India Now Has World’s Largest Derivatives Exchange by Volume,
Bloomberg (12 February 2024,) https://shorturl.at/oyz39. 3 Kanishk Sarkar, Tanmay Bhatt et al, The Indian payments handbook – 2023–2028, PwC (12 February 2024) https://shorturl.at/vC068. and identifying potential loopholes or grey areas.
1 Document Analysis
The primary method involves a meticulous examination of the circular itself, dated January 12, 2024, titled “Ease of Doing Investments by Investors - Facility of voluntary freezing/blocking of Trading Accounts by Clients”. This analysis entails a detailed review of the circular's contents, including its objectives, provisions, guidelines, and directives.
2. Analysis
of Proposed Framework: The paper discusses the circular published by the National Stock Exchange (NSE) on April 8th, 2024, laying down a framework for the implementation of the Circular.
3 Impact Assessment
The research culminates through an assessment of the potential impact of the circular on clients, investors, and the overall securities market ecosystem. This assessment considers factors such as investor confidence, market stability, ease of doing business, and the efficacy of investor protection measures.
4 Examination of Grey Areas and Loopholes
A critical aspect of the methodology involves identifying and analyzing any grey areas or loopholes in the circular. This entails scrutinizing the language, provisions, and implementation framework of the circular to identify potential ambiguities, inconsistencies, or areas lacking clarity.
5. Conclusion
and Recommendations: Based on the findings of the analysis, the research
methodology
culminates in the formulation of conclusions and recommendations. These conclusions offer insights into the effectiveness of the circular in achieving its objectives and addressing investor protection concerns. III. JURISPRUDENCE BEHIND THE CIRCULAR SEBI, under Section 11(1) of the SEBI Act, 1992, along with Regulation 30 of the SEBI (Stock Broker) Regulations, 1992, has been vested with the authority to issue the Circular on Voluntary Freezing of Trading Accounts by clients. This section delineates the responsibilities of SEBI, emphasizing “its duty to safeguard investors' interests and foster the comprehensive growth of the securities market”. Additionally, Section 11(2) confers upon SEBI the power to “regulate stock exchanges and other securities markets”4, as well as to “curb fraudulent and unfair trade practices within these markets”5.
The Circular explicitly refers to Regulation 30 of the SEBI (Stock Broker) Regulations, which was instituted following a 2013 Amendment Act called the “SEBI (Stock Brokers and Sub-brokers) (Second Amendment) Regulations, 2013”. Regulation 30, housed within Chapter VII of the Regulations, authorizes SEBI to stipulate “norms, procedures, processes, manners, or guidelines through Circulars to all stock exchanges” and other entities for the effective implementation of the Stock Broker Regulations. This legislative framework underscores SEBI's pivotal role in ensuring the integrity and efficiency of India's securities market, thereby bolstering investor confidence and market stability. The Circular, by empowering SEBI to intervene promptly in cases of suspicious activity, fortifies investor protection mechanisms and enhances market transparency.
Through this initiative, SEBI aims to foster a level playing field for all market participants, thereby promoting fair and orderly conduct within the securities market. Moreover, the Circular's reliance on Regulation 30 underscores the regulatory flexibility afforded to SEBI, enabling it to adapt swiftly to evolving market dynamics and emerging challenges. This proactive approach not only instills investor confidence but also strengthens SEBI's regulatory oversight, thereby contributing to the overall stability in India's financial ecosystem. IV. PROCEDURE PROPOSED BY SEBI’S CIRCULAR SEBI aims to enhance the ease of doing business and the ease of investment in the securities markets in India.
Under the Circular, the Brokers’ Industry Standards Forum (ISF) had been vested with the responsibility of proposing a framework to allow Trading Members to facilitate clients to freeze their Trading accounts in case of suspicious activities. This decision was taken in consultation with the Brokers’ ISF. This framework was to be finalized by April 01, 2024, under the supervision of stock exchanges and in consultation with SEBI. SEBI’s Circular had mandated the proposed framework to contain these key components: • Detailed policy on the voluntary freezing of the online access of the trading account of the client, including details of the modes through which clients may request freezing of their trading account, issue of acknowledgement by Trading Members, and the timelines for 4 Securities and Exchange Board of India Act, 1992, §11(2)(a), No. 15, Acts of Parliament, 1992 (India).
5 Ibid. §11(2)(e).
processing a client request. • Guidelines on actions to be taken by Trading Members on receipt of a client request for freezing. • Guidelines on the procedure of re-enabling clients’ accounts for trading. • The intimation to be provided by trading members to clients with respect to the introduction of the facility to block trading accounts. IV.I. Trading Members In the context of the Circular, it is imperative that we delve into the meaning and role of Trading Members. According to the NSE, a Trading member is an individual, corporate entity, limited liability partnership or partnership firm that is entitled to execute trades on its own account and also on behalf of clients. Every Trading Member has a unique TM-ID. According to Bye-Law
7.2 of the SEBI Model Bye-Laws of Stock Exchanges, the Exchange does not recognize any
parties to any transaction on the Stock Exchange unless they are registered as its trading members6. Every transaction of purchase or sale of securities between the trading member and its client is deemed to have been made between two principals, for the purpose of the transaction7. IV. II. Role of Trading and Demat Accounts In the domain of investments, the terms Demat account and Trading account are used parallelly. Although both these accounts are essential in the context of stock market investments, they serve two very different purposes. A Demat literally means a “Dematerialized Account”. As the name suggests, is an account used to hold shares, bonds, mutual funds, and other securities in a de-materialized or electronic form instead of physical storage.
As defined by SEBI, the process of Dematerialization involves the conversion of an investor's or client’s physical share certificates into an equivalent quantity of securities in electronic format. As per Section 8 of the Depositories Act of 1996, “every person who subscribes to securities offered by an issuer shall have the option either to receive the physical security certificates or to hold securities with
6 SEBI Model Bye-Laws of Stock Exchange, 2003, Bye-Law 7.2., Securities and Exchange Board of India,
2003 (India).
7 Ibid. Bye-Law 7.4.
a depository”. In case an investor opts to hold securities with a depository, all securities must be dematerialized and in a fungible form8. In India, two Depository organizations registered with SEBI, namely the National Securities Depository Limited (NSDL) and the Central Depository Services Limited (CDSL), are responsible for maintaining Demat accounts. At the request of investors, these depository organizations hold securities such as shares, debentures, bonds, and others in electronic form through registered depository participants.
As per the RBI, Depository Participants are mostly in the nature of “public financial institutions, scheduled commercial banks, foreign banks operating in India (with due RBI approval), state financial corporations, stock brokers, custodians, clearing corporations, clearing houses, Non-Banking Financial Companies etc” that are treated as agents of the depository. The owner of such securities is called the Beneficial Owner. The purpose of a Demat account is the holding and safekeeping of securities of investors. It facilitates the easy and hassle-free transfer of such dematerialized securities between accounts or between investors based on the instructions of the beneficial owner, also eliminating issues that are associated with physical certificates like theft, damage and forgery. A Trading Account, on the other hand, serves a different purpose.
A trading account enables the buying and selling of various financial instruments like stocks and derivatives. It is connected to the investors’ bank accounts as well as Demat accounts. A trading account helps the client trade on multiple platforms like the equity market, the commodity market and even the currency market. The purpose of a trading account is to make trading accessible. An online trading account facilitates research by making available reports on various securities. A trading account also provides complete access to different financial documents such as quarterly reports, analytics and other relevant documents on the performance of a stock. V.
FRAMEWORK LAID DOWN BY BROKERS’ INDUSTRY STANDARDS FORUM As per the mandate in the Circular issued by SEBI on January 12th, the framework proposed by the Brokers’ ISF was published by the National Stoke Exchange (NSE) in Circular9 dated 8th April, 2024. The primary provisions of the proposed framework are: • Trading Members offering internet or mobile trading are mandated to provide clients with at least two communication options to request voluntary freezing of their trading account
8 Depositories Act, 1996, §9, No. 22, Acts of Parliament, 1996 (India).
if suspicious activity is detected. The available options include Email communication, SMS from registered mobile number, IVR/tele-calling, Chat bot, Trading Member’s app or website, or any other legally verifiable method. • If a Trading Member provides an email ID and/or telephone number for clients to request voluntary blocking of their accounts, the ID or number should be dedicated solely for this purpose. The designated email ID should be named “stoptrade@domainname. com”. • Upon receiving a request through any of these communication modes, the Trading Member shall take the following actions: Ø Upon receiving the request, the Trading Member must: • Validate that the request is genuinely from the client as per the specified guidelines. • Issue an acknowledgment to the client. • Freeze/block the online access of the client's trading account.
• Simultaneously cancel all pending orders in the client's account. Ø After freezing/blocking the client’s trading account, the Trading Member must send a notification to the client’s registered mobile number and email ID. This communication should confirm that the online access to the trading account has been frozen/blocked and that all pending orders have been canceled. Additionally, it should include instructions for re-enabling online access to the trading account. Ø Within one hour of freezing/blocking the trading account, the client should be informed about any open positions and contract expiry details to avoid unwanted delivery settlements. This time limit may be shortened after a six-month review to further protect investors from suspicious activities.
• The freezing of the client's online trading account should be completed within the specified timeline: Time of Request Timelines for issuing acknowledgement and blocking of online access Request received during trading hours Within 15 minutes and within 15 minutes before trading begins Request received after trading hours Before the start of next trading session and within 15 minutes before trading starts. • The Trading Member must have a mechanism to verify that the request to block online access to the trading account is indeed from the respective client. • The Trading Member must keep records/logs of requests to freeze/block online trading account access, confirmations of the freeze/block, and any cancellations of pending orders sent to clients.
• If the Trading Member fails to block online access within the prescribed timelines, they will be held responsible for any trades executed from the time the request is received until the online access is successfully frozen. • To re-enable the client’s online access to the trading account, the Trading Member must perform due diligence by validating the client’s request and then unfreeze/unblock the online access. The NSE published another Circular10 on July 6th, 2024 requiring all NSE Trading members to submit the report on compliance with SEBI’s Circular by July 22nd, 2024.
10 Circular Reference No. 47/2024, National Stock Exchange.
VI. PARALLELS WITH VOLUNTARY BLOCKING OF DEMAT ACCOUNTS AND
DEBIT/CREDIT CARDS There exist provisions for the voluntary blocking of Demat accounts and credit/debit cards by clients. The voluntary freezing facility for Demat accounts and credit or debit cards is instrumental in enhancing consumer protection and safeguarding against unauthorized transactions. It empowers clients to take proactive measures to secure their financial assets and personal information, thereby mitigating the risk of fraud and unauthorized usage. In the case of Demat accounts, Bye-Law 7. 3 of the National Securities Depository Limited (NSDL) Bye- Laws provides that clients have the option of voluntary freezing of their Demat accounts with the Depository Participants in order to render the account inoperable for a limited period of time.
On the client opting for voluntary freezing of his account, the Depository Participant of such client shall not affect any debit entry or any such other transaction unless the client instructs freezing the account to be withdrawn or modified11. Bye-Law 9. 3 deals with the procedure in which freezing of a Demat account is carried out. The Client who is the Beneficial Owner can request the freezing of his account maintained with a Depository Participant by giving instructions to the Participant or to the Depository12. Bye-Laws 9. 3. 2 and 9. 3. 3 mention that the Depository Participant or the Depository shall freeze the Demat account according to the instructions received from the Client13. Customers also have the right to voluntarily block their ATM Debit cards and Credit cards.
By opting to freeze their cards temporarily, clients can prevent any unauthorized debits or transactions, ensuring that their funds remain secure during periods of heightened security concerns or suspected fraudulent activities like the prevention of fraud and unlawful usage of the card without the due authorization of the owner. Banks have been advised through RBI Circulars to block cards instantly on being informed of their loss or otherwise, and other formalities like the registering of FIR etc can be allowed to follow later on14. The Reserve Bank of India issued a Circular on the 21st of April in 2022 called the “Master Direction on Credit Card and Debit Card – Issuance and Conduct Directions, 2022”. Card issuers were instructed
11 NDSL Bye-Laws, 2016, Bye-Law 7.3.1, National Securities Depository Limited, 2016 (India).
under the Circular to freeze a card right away on being informed of its loss or otherwise15. This facility provides clients with greater control over their financial accounts and helps instill confidence in the banking and financial system by demonstrating a commitment to customer safety and security. Additionally, the prompt action required by banks and financial institutions to block lost or stolen cards upon notification from the cardholder underscores the importance of swift response in mitigating potential losses and preventing further unauthorized usage. VII. IMPACT OF THE MOVE ON CLIENTS AND INVESTORS The introduction of this circular and the consequent developments are poised to yield a manifold positive impact on investors and clients, as well as the broader securities market landscape.
By delegating Trading Members with the proactive responsibility of freezing trading accounts upon clients' applications in response to suspected fraudulent or suspicious activities, the circular substantially bolsters investor protection measures. This proactive approach serves as a crucial shield, shielding investors from potential financial losses stemming from unauthorized or fraudulent transactions. The outlined framework laid down by the Brokers’ ISF meticulously lays out procedures for the expedited processing of requests to freeze or block trading accounts, thereby ensuring swift action in addressing suspicious activities and minimizing adverse repercussions on affected investors and the market at large.
Such a pivotal initiative unmistakably underscores SEBI's unwavering commitment to upholding transparency, fairness, and orderliness within the Indian securities market framework. This strategic move is expected to significantly boost investor confidence and trust in the regulatory authority, fostering increased participation in the market and reinforcing overall market stability. The circular's roll-out is poised to foster a more resilient, transparent, and secure securities market environment, thereby conferring benefits upon investors, clients, and stakeholders alike. Stock Exchanges have been expressly mandated to establish an efficient reporting mechanism to monitor Trading Members' compliance with the circular.
Additionally, Stock Exchanges are advised to undertake necessary measures to implement the circular effectively, including system enhancements, amendments to relevant bye-laws and rules, and dissemination of the circular's contents among Trading Members. These proactive measures are anticipated to further fortify the regulatory framework and engender a robust and dynamic 15 Master Direction - Credit Card and Debit Card – Issuance and Conduct Directions, 2022, Direction 23(d), Reserve Bank of India, 2022 (India). securities market ecosystem. It is noteworthy that Stock Exchanges are required to submit a compliance report to the Board by August 31st, 2024, reflecting their adherence to the circular's directives, ensuring the timely and effective implementation of the regulatory measures outlined therein.
Furthermore, the specified deadline of August 31st, 2024, underscores the urgency and significance attached to Stock Exchanges' compliance with the circular's provisions. This deadline serves as a pivotal milestone in the regulatory timeline, ensuring the expeditious and comprehensive implementation of the circular's directives to bolster investor protection and market integrity. VIII. GREY AREAS AND POTENTIAL SHORTCOMINGS A thorough scrutinization of the circular brought out by the NSE dated April 8th, 2024 laying down the framework for voluntary blocking of trading accounts access through Trading Members reveals a some grey areas and a number of avenues which need more clarity. The framework conspicuously vests a spree of responsibilities in Trading Members without considering the practicality of their implementation.
Firstly, providing multiple channels for clients to request the freezing of their trading accounts could lead to inconsistencies, delays, or mishandling of requests if these channels are not effectively managed. Each channel of communication merits different levels of monitoring, response times, and reliability. If different channels are monitored with varying degrees of diligence, some requests might be overlooked or delayed. Some communication modes like tele-calling involve manual processing, which means the presence of dedicated personnel to attend to such channels at all times. Trading Members will unarguably have to invest manpower and technical expertise into maintaining multiple communication channels, which might affect their productivity.
Secondly, in the absence of clear penalties or mechanisms to address delays in freezing accounts, Trading Members might not be incentivized to act promptly. The framework mentions that the in case the trading member fails to freeze the client’s account withinin the stipulated timelines, the member will “be responsible” for all trades till the account is blocked. The framework is bereft of much-needed clarity on what such failure would entail. Thirdly, the process of reactivation of trading accounts has not been laid down with clarity. It has been provided that Trading Members shall re-enable access to the trading account after carrying out necessary due diligence, but no timelines have been laid down. The framework is lacking a system of notifications that keeps the client updated on the status of the due diligence of their account.
IX.
CONCLUSION
The examination of SEBI's circular and NSE’s framework regarding the voluntary freezing of trading accounts reveals its significance in addressing the ever-evolving trading landscape in India, especially against the backdrop of the immense growth in online trading. By navigating and scrutinizing the intricacies of the framework’s provisions and drawing comparisons with existing regulatory frameworks, this paper has provided valuable insights into its potential impact on investors and the broader stock market ecosystem in India. Having said that, it is imperative to acknowledge the grey areas identified within the framework. Addressing these uncertainties will be crucial in ensuring the effectiveness and fair implementation of this regulatory measure.
In the end, it can be concluded that continual dialogue and collaboration between the Board, market participants, and stakeholders will be essential in refining and strengthening the regulatory framework to foster investor confidence and market integrity in India's dynamic trading landscape.