The Assured-Return Scheme and the Splintered Position Limit
A SEBI-registered commodity broker has a referral arrangement with AgriWealth Research, an unregistered firm. AgriWealth's principal is also an authorised person of the broker. AgriWealth charges clients 2% per month on a 'commodity portfolio' and advertises a target return of 18–24% annually with 'capital protection through hedging'. It has advised 140 clients to buy the same far-month contract in a base metal. Accounts of the principal's relatives and of two employees hold 38% of the open interest in that contract. The broker's compliance officer also finds that the principal's proprietary account bought from a client account at a price 0.4% away from the prevailing market price, and that Rs 2.1 crore of client collateral sits in the broker's own account. The brokerage-sharing agreement states that AgriWealth 'guarantees' the broker Rs 50 lakh of monthly brokerage.
1. List the specific breaches, naming the conduct and the category of regulation each falls under.
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Several distinct breaches, not one:
- Unregistered investment advice and portfolio management: AgriWealth charges fees for advice and runs a 'portfolio' without registration under the SEBI (Investment Advisers) Regulations or the portfolio manager route.
- Assured or targeted returns with 'capital protection' claims: this is a fraudulent and unfair trade practice under the SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations; hedging cannot guarantee a return.
- Broker liability for its authorised person: an AP's advisory conduct is the broker's responsibility, and sharing brokerage with an unregistered entity that advises clients is not a permitted referral.
- Position-limit circumvention: splitting a single economic position across relatives' and employees' accounts to hold 38% of open interest defeats the client-level limit and may indicate acting in concert or benami trading.
- Off-market transfer / crossing: a proprietary account buying from a client account away from market price is a non-genuine trade and mispricing.
- Misuse of client collateral: Rs 2.1 crore of client collateral in the broker's own account breaches client-fund segregation and, if used for proprietary margin, constitutes misappropriation.
2. What should the compliance officer do first, in what order, and what are the consequences if the broker does nothing?
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The order matters. First, preserve evidence: trade logs, the referral agreement, the AP register, collateral statements and bank records. Second, stop the harm: suspend the principal's AP status, disable the referral arrangement, block the off-market trade pattern, and move the Rs 2.1 crore of client collateral to a segregated client account or return it, restoring the daily collateral report. Third, remediate limits: recompute aggregate positions treating related accounts as one economic beneficiary, and bring them within limits by squaring off, which may mean realising losses.
Fourth, report: a material finding of misappropriation and unauthorised advice must go to SEBI and the exchange; silence is itself a compliance failure.
If nothing is done, the broker faces penalty and possible cancellation of registration, personal liability of the compliance officer and key management, disgorgement, and investor claims. The settlement guarantee fund does not cover misappropriation of client collateral.
3. The broker argues that AgriWealth is an independent entity and that the referral arrangement is only for client sourcing. Does that shield the broker? Explain.
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No. The principal is an authorised person of the broker, which means the broker has held him out as competent to deal with clients and must supervise him. Acts within the scope of that authorisation bind the broker, whether or not the client signed an agreement with AgriWealth. The 'sourcing only' label fails on the facts: AgriWealth charges a monthly fee, prescribes the contract, and advertises returns, which is advisory activity, not lead generation.
A broker cannot outsource its regulatory duties. Client onboarding, suitability, margin collection, order execution on the exchange's matching engine, and collateral custody remain the broker's, and any arrangement that shares brokerage for advisory activity by an unregistered person is a breach regardless of the contract's wording.
The Rs 50 lakh brokerage 'guarantee' also points the other way: an arrangement under which an unregistered entity effectively runs the client book for a revenue commitment suggests the broker has deferred its own controls, which aggravates rather than mitigates the breach.