The Securities and Exchange Board of India (Sebi) on Tuesday warned the National Stock Exchange (NSE) for its failure to bring to the regulator’s notice high client code modifications by trading members in March 2010.
During investigations, Sebi found client code modifications in excess of Rs 55,000 crore were done by brokers in a single month, which NSE failed to disclose to the regulator. It was also found that client code modifications were largely done by the top 10 brokers and their few clients.
Changing client codes within 30 minutes after the market closed was a normal practice followed by brokers for rectifying ‘genuine’ errors and mistakes which may have occurred during the trading hours.
However, the income tax department in a complaint to the Union finance ministry had said the facility was being misused and brokers transferred gains or losses from one person to another by changing the code, in the garb of correcting an error. These gain or loss-book entries were then used to evade taxes. The ministry had asked Sebi to investigate client code changes.
During the Sebi investigations, NSE had pointed out that it had already initiated disciplinary action proceedings against six out of the 10 brokers for carrying out large value of modifications.
“A stock exchange, being the first-level regulator, has to sense the aberrations in the market and alert Sebi, so as to work out modalities for preventing any harm to the investors and to promote healthy development of the securities market,” Sebi said in its order.
Sebi in its show-cause notice dated January 2011, had alleged NSE failed to provide the information and clarifications sought by Sebi. It also alleged the exchange failed to conduct the special audit of the client code modification as advised by Sebi and failed to put an appropriate mechanism for supervising the modification of client codes.
In August 2011, exchanges were asked to form criteria for client code changes. Currently, there are two broad parameters for client code changes — if the original client code/name and modified client code/name are similar to each other but such modifications are not repetitive, and if the original client code and modified client code belong to a family. (Family for this purpose includes spouse, dependent parents, dependent children and a Hindu undivided family).
Stock exchanges have also designed a monthly penalty structure for client code modifications for non-institutional trades in the equity derivatives and currency derivatives segment. In addition to this penalty structure, suitable disciplinary action proceedings would be initiated in cases where the value of modified trades of non-institutional clients is significant.
