Stock brokers told: Markups on clients' debit balance violation of guidelines: SECP bench

An Appellate Bench of the Securities and Exchange Commission of Pakistan (SECP) Thursday conveyed to the stock market brokers that charging markups on continued debit balance of their clients is a violation of guidelines, dated July 3, 2013, issued by the Commission.

In this regard, the two-member SECP Appellate Bench has issued an order against a Trading Right Entitlement Certificate holder of the Pakistan Stock Exchange (PSX), and reduced penalty of fine from Rs 1,000,000 to Rs 500,000 on the broker.

Brief facts of the case are that the appellant is a Trading Right Entitlement Certificate holder of the PSX, licensed as a securities broker with the Commission and a clearing member of the National Clearing Company of Pakistan Limited (NCCPL). The Appellant was not registered as a financee/financier for Margin Financing (MF), Margin Trading System (MTS) and securities lending and borrowing with NCCPL under the NCCPL Regulations, 2015 (the NC Regulations) read with Securities (Leveraged Markets and Pledging) Rules, 2011 (the Rules). However, subsequent to the issuance of the Show Cause Notice (the SCN), the broker obtained registration as a financee/financier for MF, MTS and securities lending and borrowing. The Commission conducted a compliance review under section 79(3) of the Act (the Review) to ascertain the broker's compliance with the regulatory framework regarding financing and extending credit (the Framework) during the period from March 1, 2016 to November 30, 2016. The Review revealed non-compliances of the Appellant.

In view of the record, the SECP Appellate Bench has no doubt that violations of the framework regarding failure to collect margins, recovery of MtM losses and failure to make additional disclosures in quarterly accounts were established against the Appellant. The Bench is of the view that instead of issuance of warning against the afore-stated three violations, the Respondent (SECP Adjudication Department) should have imposed monetary penalty on the appellant. As per law the SECP Adjudication Department was empowered to suspend, cancel the Appellant's license and impose monetary penalties, however, by issuing warning a lenient view was taken. The Bench has considered the representatives' conduct during the hearing whereby, they have not specifically contested the issuance of warning against the above three instances. "Therefore, we restrain ourselves to convert the warning into monetary penalty on three above counts."

The SECP Appellate Bench has noted that the Appellant (stock broker) has never denied the existence of the receivables (continued debit balances) from its clients. The Bench has reviewed the contents of the memorandum of the appeal wherein, the Appellant had stated that receivables from the clients had been decreased significantly.

The Bench has no doubt that as per Rule 34 of the Rules, extending credit to clients through modes other than permissible under Rule 34 of the Rules was a grave violation and the appellant was not licensed to operate in that manner.

Furthermore, charging markups on continued debit balance of clients was also a violation of para 2.1 of the guidelines dated July 3, 2013 issued by the Commission.

The Bench is of the view that the appellant's failure to stop charging markup on receivables (continued debit balances) from its clients after Review and FL Review is evidence that it has undermined the sanctity of the framework.

The Bench is not inclined to accept the appellant's assertion that it only recovered late payment charges to cover the Appellant's financial and administrative cost because the Appellant's receivable policy clearly describe that "no markup would be charged if client makes payment of his receivable before settlement."

The Bench believes that this policy statement implies that the Appellant will charge markup if receivables are not paid before settlement. The Bench has also reviewed the record which revealed that even after the FL Review, the appellant never stopped its practice of charging markup on clients' receivable and as of July 5, 2017 aggregate markup was Rs 41.10 million.

The said Appellate Bench of the Securities and Exchange Commission of Pakistan (SECP) also declared that the stock brokers cannot self-enhance Financing Participation Ratio, (FPR) ratio under the regulatory framework regarding financing and extending credit (the Framework), as brokers are bound to maintain 25 percent FPR ratio under NCCPL regulations, 2015.

The Bench has also examined the Representatives arguments with regard to the enhanced FPR ratio of 35%. The Bench is of the view that when NC Regulations had provided 25% FPR ratio then the appellant was bound to maintain that ratio; therefore, self-enhancement is a clear violation o the framework.

Accordingly, the representative's arguments that withholding of mark to market (MtM) profits of the clients who failed to maintain 35% FPR, caused increase in debit balance, are not plausible and insignificant to distort the findings of the impugned order.

The Bench is of the view when NCCPL Regulations, 2015 (NC Regulations) had provided 25% Financing Participation Ratio (FPR) then the appellant was bound to maintain that ratio, therefore, self-enhancement is a clear violation of the Framework, the SECP Appellate Bench said.