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When Delhi-based Shyam Sundar was hospitalised this year, his wife received several calls from the relationship manager of his stock broker. He wasn't calling to ask how her husband was doing, but for permission to transact in the futures and options (F&O) segment on Sundar's behalf. Though she told him to wait till her husband had recovered, the relationship manager went ahead and executed the transactions. When Sundar got home from hospital, he discovered that the unauthorised transactions had led to a loss for him.


This horror story has a somewhat happy ending. Sundar complained to the broking house, but they claimed he had authorised the transactions. Only when Sundar threatened to complain to Sebi did the broking house relent and make good the loss.
Sundar won because he had an airtight case. The broker had no evidence that the deals had been authorised. Sebi rules make it mandatory for brokers to maintain records of telephone calls with clients. However, not all investors are so lucky. Brokers manage to get away by exploiting loopholes in the law, because few investors are aware of the rules or their rights. Let us see how brokers take investors for a ride, and how you can avoid falling into these traps.

Don't Sign Away Your Rights

The first pitfall comes at the time of opening a trading account with a broker. You are given a lengthy application form and a voluminous agreement booklet with clauses in small print. Very few investors have the patience to go through the fine print or the ability to decipher the legalese. The relationship manager helpfully puts crosses at the places you need to sign on the agreement. Do so without reading the clauses and you could be headed for disaster.

What should you do?

Take time to go through the form and the agreement. In particular, pay attention to the power of attorney (PoA) section. The PoA allows the broker to transact on your behalf. When you sign on the dotted line on the PoA pages, you basically sign your rights away. In 2010, Sebi issued new guidelines for PoA to intermediaries following large-scale complaints of misuse.


Some investors blindly sign on the form with a brokerage firm and give PoA for moving funds from their bank accounts, whenever required. However, this convenience can cost them dearly if their brokerage firm executes unauthorised trades from their accounts. Ideally, the investor should transfer money from his savings account to the brokerage account whenever needed.

Don't Churn And Burn

Once you sign up as a customer, the stock broker will start bombarding you with phone calls, stock recommendations and SMSes, all of which urge you to buy this stock or sell that one. Before you fall for the bait, remember that the broker's goal is to get you to buy and sell at a furious pace. Whether you make or lose money on these deals, he will earn his brokerage.

What should you do?

Do not blindly accept the broker's recommendations. Instead, for each suggestion, conduct your own checks. Are the company's fundamentals sound? Is the valuation attractive? Similarly, when the broker recommends a sale, find out whether the company's fundamentals have been damaged. Or has the stock become over-valued?
It's often said that if your stock portfolio can beat a mutual fund or the broader market, you are in the wrong profession. Check the returns from your stock investment. If, after a year or so, you find that your direct investment portfolio has underperformed a broader index, such as the Sensex or the Nifty, quit direct investing and put your money in actively managed funds or low-cost index funds.

Don't Be Lured Into The F&O Trap

Warren Buffett calls them the financial weapons of mass destruction. Though derivatives have their uses, these leveraged instruments can become very dangerous in the hands of retail investors. Still, the F&O segment has a very high retail participation. This is also the area where the maximum cases of unauthorised trading take place. It's easy to lure clients by telling stories of how some clients have made fabulous sums of money by trading in F&O. Customers often give consent to the relationship manager to trade on their behalf. More often than not, losses follow and the customer is left holding the can.

What should you do?

Derivatives are essentially meant for hedging and should have no place in the small investor's portfolio. Nip the problem in the bud and don't opt for trading in the derivative segment when you fill up the account opening form. Novice investors who don't understand derivatives should not opt for this segment at all.

 

If you have already signed up for investing in the F&O segment, keep a close eye on all the SMSes and e-mails from your broker.

Don't Believe All Brokerage Reports

Brokerage houses regularly come out with reports on stocks. Before you base your decision on these reports, keep in mind that the financial services industry is facing a crunch. With commission rates on the decline, most brokerage firms rely on earnings from investment banking: helping companies raise capital through public issues of shares and bonds. A firm that wants to get the investment banking mandate from a company would hardly issue a negative report on it. Not surprisingly, the number of 'buy' reports exceeds 'sell' reports.

What should you do?

Should you then rely on brokerage house reports? Yes, but with a few caveats. Gathering information on a company is difficult. You may read its annual reports and track reports on it in the business media. Nonetheless, you may miss out on crucial information because the management only reveals such information to analysts.


Read brokerage reports, but not from just one brokerage house. See what different analysts have to say about a stock. When it comes to assessment of forward earnings, valuation and target price, make your own judgement.


You can get unbiased reports from independent research firms which sell their research reports and don't have investment banking arms. Canada-based Veritas is one such independent research firm.

 

For further information on the topic you can CONTACT Prajna Capital on 94 8300 8300 by leaving a missed call.

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Invest in Tax Saving Mutual Funds ( ELSS Mutual Funds ) to upto Rs 1 lakh and Save tax under Section 80C.

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