Beyond the Rules: The Dangers of Shifting Sands in Stock Broking Industry

[By Santripta Swain]

The author is a student of National Law University Odisha.



Recently, SEBI has been heavily criticised for its conflicting and lackadaisical approach in dealing with the securities matters. The Appellate Courts of different forums – the Supreme Court, High Court, or Securities Appellate Tribunal (SAT) have time and again been disappointed with the market regulator for its persistent non-compliance and, at times, non-uniformity in investigations as well as adjudication of various securities law matters. Thus, raising the question of its enforcement. 

A similar instance was observed in the matter of IIFL Securities. SAT in the Matter of IIFL Securities has partly set aside the order of Whole Time Member (WTM) and Adjudicating Officer (AO). The violation of misuse of clients’ funds along with the WTM order barring the Appellant from dealing with new clients for two years were set aside, and the order for not maintaining different nomenclature for clients’ account and proprietary account was allowed. 

SEBI, at times, has been lauded for its strict norms. For instance, in the matter of Karvy Stock Broking Ltd – which gave us the perspective why stricter norms are necessary for preventing a series of fraudulent activities in the form of misuse of clients’ fund by the stock brokers (it has its own tales to tell). In another Adani-Hindenburg matter, the Supreme Court has sided with the SEBI for not blindly relying on the Hindenburg report, as such foreign reports should not be treated as gospel truth. 


SEBI, based on its own investigation in the past, has found out that stock brokers have misused clients’ funds to meet their own settlement obligations or in some cases high net-worth clients’ settlement obligations. Additionally, SEBI found out that these intermediaries in order to raise fresh funds, pledge clients’ securities vehemently without their consent – such misuse of clients’ funds/securities was found to be in contrary to the principle and spirit of SEBI – protecting the rights of the investors. 

Therefore, SEBI through a press release in 2020, stated that it has developed an in-house supervisory system to detect misuse of clients’ securities by the brokers. 

Further SEBI, through various circulars on enhanced supervision of stock brokers has mentioned the standard operating procedures for the stock brokers and other intermediaries on how to segregate clients’ funds from their own proprietary funds. SEBI also made the NSE the watchdog in the workings of such intermediaries and initiate inspections as and when it felt necessary, while keeping the market regulator in loop in the matter. 

The IIFL Securities (Appellant) is one of the many matters where SEBI has been criticised for its non-uniformity in penalising the alleged. Additionally, SAT also cautioned that SEBI should always work in the public interest. And in my humble opinion, the term public is inclusive of investors, brokers, and all other stakeholders in the securities market – meaning SEBI has a larger purpose to serve than to be termed as a rigid regulator. 


The SEBI in the matter of IIFL Securities was concerned with the probable misuse of clients’ funds due to the non-segregation of such funds from proprietary trading fund. SEBI for the first time, through its Circular of 1993,  mandated segregation of clients’ funds from the proprietary ones, which, according to the SEBI Circular of 2016 and follow-up Circulars of 2017, were in furtherance of the Circular of 1993. And the whole crux of the matter revolves around how this mixing of funds is in violation to the SEBI Circular of 1993. 

SEBI in the present matter took two things into consideration the Circular of 1993 and the Circular of 2016. SEBI’s whole stance was dependent on the fact that the Appellant failed to segregate clients’ funds from its own proprietary funds – potential misutilisation of clients’ funds. On top of that, SEBI’s Adjudicating Authority initiated two different proceedings for the same offence citing a long investigation period, hence the segregation – which the SAT found peculiar, as such segregation of matter was unnecessary and created an unwanted legal hurdle. 

Case Issue 

SEBI’s take on the issue was that the Appellant had failed to segregate the client’s fund from its own; therefore, there is a high possibility of misutilisation of client funds. I say this as a possibility because SEBI used a formula to establish such misutilisation without any concrete investigation to find such anomalies, which we would analyse in detail further as we go through the blog. 

In order to understand the same, the Respondent (SEBI) referred to the formula that was first mentioned in the Circular of 2016. 

G = (A+B) – C 

A = Aggregate of fund balances available in all Client Bank Accounts, including the Settlement Account, maintained by the stock broker across Stock Exchanges 

B = Aggregate value of collateral deposited with Clearing Corporation and/or clearing member in form of Cash and Cash Equivalents (Fixed deposit (FD), Bank guarantee (BG), etc.) (across Stock Exchanges). Only funded portion of the BG, i.e. the amount deposited by stock broker with the bank to obtain the BG, shall be considered as part of B. 

C = Aggregate value of Credit Balances of all clients as obtained from trial balance across Stock Exchanges (after adjusting for open bills of clients, uncleared cheques deposited by clients and uncleared cheques issued to clients and the margin obligations. 

From the aforementioned formula, if the value of G is negative, then it indicates that clients’ funds are being utilised for settlement obligations or for stock brokers own purposes. 

Based on the recommendation of the Designated Authority (DA) – cancellation of the registration of certificate, the WTM (power exercised under Reg. 27 and Reg. 28 of the Intermediaries Regulation) restrained Appellant from onboarding new clients for a period of two years. Further, the AO also initiated parallel proceedings on similar facts and therefore issued two separate Show Cause Notices (SCN), and accordingly, a penalty of INR 1 Crore against each SCN was levelled against the Appellant. 


The Tribunal found a major short fall in SEBI’s stance on the case. First, if the Appellant had violated the provisions of Circular of 1993, then why SEBI had put reliance on Circular of 2016 – why was the formula even used to implicate the appellant?  

Subsequently, the Tribunal found out that the Circular of 2016 removes some ambiguity from that of the Circular of 1993 – the non-funded portion of the bank guarantee was excluded while using the formula. Hence, such amendments cannot have retrospective effects. 

Second, the tribunal disagreed with the interpretation of the Circular of 1993 given by the SEBI. The Circular mandates the segregation of client’s funds from proprietary funds. While the Appellant combined client funds with its own for the sake of business convenience in making upfront payments to the stock exchange through a pool account, there was technically no violation of the circular of 1993. Further, the Tribunal sided with the Appellant, asserting that once the money leaves the client’s account for settlement obligations, it no longer belongs to the client. 

Therefore, the Tribunal found out that there was no actual misutilisation of clients’ fund. Instead, it found that the nomenclature of clients’ account was in contrary to the Circular of 1993. Thus, a penalty of INR 20 Lakhs was imposed on the Appellant and both the WTM and AO orders were set aside. 


SEBI’s case relied on the amended formula in the 2016 Circular, which excluded the non-funded portion of the bank guarantee. They claimed this interpretation was consistent with the earlier 1993 Circular. However, the SAT objected to the retrospective application of this formula, raising concerns about its fairness. 

While SEBI adhered to a rigorous interpretation of the client fund segregation requirement in this case, their failure to take into account the underlying context and mitigating factors resulted in a substantial penalty for the Appellant. 

First, When the Appellant pointed out that since the Stock Exchange requires upfront payment of trade settlements, therefore, for the ease of conducting business, it created a pool account. This according to SEBI was found to be non-segregation and further misuse of clients’ funds. But the 1993 Circular never prohibited the creation of a pool account, and it allowed the stock broker to debit the clients’ account for their obligations. Thus, plain reading shows that whether the debited amount goes to the pool account or settlement account becomes irrelevant.  

Second, the severity of SEBI’s punishment has raised serious concerns – 

  1. the penalty of 2 years ban imposed by the WTM is seen as a misuse of Regulation 26 of the Intermediaries Regulation, as such a ban is beyond the scope of Reg. 26. Coimbatore Flavours & Fragrances Ltd is one of such cases where the scope of Reg 26 was tested by this Tribunal,  
  2. the business of stock broking is highly competitive, meaning an INR 2 Crores monetary penalty and a 2-year ban is enough to virtually shut down the business of the Appellant. 

Third, the inconsistency found in the WTM Order and the AO Order when the Appellant’s conduct was similar, when the matter was taken up by both the adjudicating authorities. The WTM disbelieved any misuse of client funds, even when reasonably and logically the creation of pool account was an operational ease and that in respect of SEBI’s inspection mandate, such practice was withdrawn by the Appellant. Conversely, the AO noted that the Appellant’s conduct was not in violation of the Circular of 1993, yet it went ahead and imposed a monetary penalty. This inconsistency raises serious concerns about the fairness and regulatory coherence of evaluating and adjudicating the Appellant’s conduct. 

Some of the most fundamental questions that were raised before the Tribunal showed the lack of clarity on the part of SEBI. Questions such as retrospective application of Circular of 2016, differentiation between 1993 and 2016 Circulars, what was the process mentioned in both the circulars for payment of bank guarantees from both clients and brokers – were unanswerable by the SEBI. This shows that SEBI’s implications are poorly thought out. 


SEBI’s enforcement policy requires a more balanced approach to investigations and adjudications, prioritizing the public interest. The IIFL case highlights the shortcomings of the current approach. Contradiction to the governing law should be dealt on basis of two facets – first, retrospective application of regulation, circulars, and Act and second, prima facie allegation showing violation of law. Imposing deterrence without fundamental consideration of implicated allegations, could lead to a market working under constant fear of non-compliance. 

What we saw in this case was that SEBI’s accusation of non-compliance and the actual non-compliance that SAT found are only partially correct. The reason for a two-facet approach is to allow a more flexible enforcement policy. Strict interpretation of law should be traded with strict enforcement very cautiously – as and when necessary, especially in regulatory realm. This is because market players will find it difficult to operate with lesser flexibility in the securities market. This kind of scenario will give SEBI a more enhanced power to forcibly create an equilibrium state between enforcement and compliance. Further where legislations are meant to be a decisive factor for attaining natural state of equilibrium between enforcement and compliance, SEBI’s stricter enforcement will only act in negative to such state of ideality. As seen in IIFL matter SEBI’s dynamic shift as what constitutes compliance and what does not make it confusing for the market players to find a safe passage through the non-playing field. 

Even Madhvi Puri Buch, Chairperson of SEBI stated that the over-engineering of statutes will only be self-destructive for the good guys and the bad guys will be taking advantage of such chaos. 

In a game with multiple players, and SEBI being the rule maker, has the power to make the rules prior to the start of the game. Once the game starts, it continues to run indefinitely. SEBI can make changes to the game’s rule book from time to time and players can accordingly play the game fair and square. But SEBI’s authority to impose such new rules retrospectively is wrong as this will ruin the game, the players will be held liable left right centre – the whole game will collapse. Therefore, participants to know the rules of the game before hand, and the spirit cannot be changed midway. 

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