1. 27 th June 2016 Internal Audit of Stock Broking Ideate | Innovate | Integrate

2. IDEATE | INNOVATE | INTEGRATE 2 Introduction- In India, the two most prominent Stock exchanges are the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). The NSE is the country's largest exchange, which means it sees the most amount of shares bought or sold in a day. The BSE stands second but is the oldest; it was established way back in 1875. What makes up a stock exchange? Its members, the stock brokers People like you and me just cannot go to a stock exchange and buy and sell shares. If we want to do so, we have to get in touch with someone who is a member of the stock exchange. This means we need to talk to a stockbroker. Stock brokers buy and sell shares for themselves, known as Proprietary Trading, to make a profit. They also buy and sell shares on behalf of people like you and me and take a commission for doing so. Every stockbroker has to be registered with the Securities and Exchange Board of India(SEBI), which is the stock market regulator. A stock broker is a regulated professional individual, usually associated with a brokerage firm or broker-dealer, who buys and sells stocks and other securities for both retail and institutional clients through a stock exchange in return for a fee or commission.

3. IDEATE | INNOVATE | INTEGRATE 3 Scope of Audit- Broad Areas of activities undertaken by Stock Broker which are subject to audit are given below: Client Registration & Documentation Order Management & Risk Management System Contract notes, Client margin details & Statement of accounts Dealing with client funds & securities Terminal operations and systems Management of branches & sub-brokers Investor Grievance Handling Maintenance of books of accounts PMLA Guidelines

4. IDEATE | INNOVATE | INTEGRATE 4 Scope of Audit-(Contd.) Client Registration & Documentation- SEBI has devised the uniform documentation to be followed by all the Stock brokers/trading members for new client registration. Some of the Mandatory documents relating to Client Registration are listed below: Know your client form capturing the basic information about the client e.g. Identity Proof, Address Proof, PAN etc. Documents capturing additional information about the client related to trading account e.g. Products (Mutual Fund, Shares, ETF etc.) client wants to participate in, consent for digital contract note, internet trading, nomination facility etc., Income details etc. Uniform Risk Disclosure Documents Guidance Note detailing Do’s and Don’ts for trading on exchanges Document describing Policies and Procedures of Stock Brokers Document detailing the rate\ amount of brokerage and other charges levied.

5. IDEATE | INNOVATE | INTEGRATE 5 Scope of Audit- (Contd.) Order Management & Risk Management System-  Order Management –  The broker member should maintain record of time when the client has placed the order and reflect the same in contract note along with the time of execution of the order.  Trading Members shall inter alia put in place limits for: Quantity limit for each order Value limit for each order User value limit for each user ID Branch value limit for each branch ID Security wise limit for each user ID –for CM (Optional) For FO and CD, Spread order Quantity and Value Limit  Compliance officer shall submit a certificate to the Exchange on a quarterly basis regarding compliance of above. System Auditor shall confirm that the systems and system records are maintained as prescribed

6. IDEATE | INNOVATE | INTEGRATE 6 Scope of Audit- (Contd.) Order Management & Risk Management System-(Contd.)  Risk Management–  Members should have a prudent system of risk management to protect themselves from client default. Margins are likely to be an important element of such a system. The same shall be well documented and be made accessible to the clients and the Stock Exchanges. However, the quantum of the margins and the form and mode of collection are left to the discretion of the members.  Margins may be in form of : Bank guarantees and Fixed deposits Government securities and Treasury bills, Units of mutual funds in dematerialized /electronic form and any other such collaterals, as may be specified by Clearing Corporation from time to time Free and unencumbered Balances (funds and securities) available with the member of respective client in different segments of the Exchange Funds/securities in the clients bank/ DP account of the client for which the client has given POA in favor of the member  Trading member should have a well-documented error policy to handle client code modifications, approved by their board/ management

7. IDEATE | INNOVATE | INTEGRATE 7 Scope of Audit- (Contd.) Contract notes, Client margin details & Statement of accounts -  Contract Notes–  As per clause B(2) of code of conduct for sub brokers specified under regulation 7 of SEBI Stock Broker and Sub broker regulations1992, “A stock broker shall issue without delay to his client or client of the sub-broker a contract note for all transactions in the form specified by the stock exchange”.  Trading members shall issue the contract note for purchase/ sale of securities to a client within 24 hours of the execution of the contract.  Contract Note must contain the following. SEBI Registration number of the trading member Dealing Office details of the trading member Trading code and Unique Client Code Brokerage Statutory and Regulatory levies etc.  The digitally signed Electronic Contract Note (ECN) may be sent only to those clients who have opted to receive the contract notes in an electronic form.  The proof of delivery i.e. log report generated by the system at the time of sending the contract note shall be maintained by the Trading Member.  In addition to ECN, trading member shall simultaneously publish the ECN on his designated web-site in a secured way and enable relevant access to the clients.

8. IDEATE | INNOVATE | INTEGRATE 8 Scope of Audit- (Contd.) Contract notes, Client margin details & Statement of accounts –(Contd.)  Client Margin Details–  Margin details are to be issued to client on daily basis for both Cash and Derivatives Market. Daily Margin to mention Name, Email ID, Telephone No. and address of compliance officer.  Minimum information to be included in the Margin statement is given below. Details of collateral deposited. Collateral utilized. Collateral status (available balance /due from clients ) with break up in terms of cash, Fixed Deposit receipts (FDR’s), Bank Guarantee and securities.  Statement of Accounts  Trading members are required to issue quarterly/monthly statement of accounts (as consented by client) for both funds and securities. Statement of accounts should contain error reporting clause. Periodical statement of accounts to the clients, shall mention therein that their running account authorization would continue until it is revoked by the clients.

9. IDEATE | INNOVATE | INTEGRATE 9 Scope of Audit- (Contd.) Dealing with client funds & securities – Receipt/ Payments of funds is only by Account payee cheques; or Demand drafts; or Direct credit into the bank account through NEFT; or any other mode allowed by RBI. Trading members should not accept cash from the client whether against obligations or as margin for purchase of securities and/ or give cash against sale of securities to the clients. The Trading Members shall make pay out of funds or delivery of securities, as the case may be, to the Constituent within one working day of receipt of the pay out from the Exchange unless trading member has taken running account authorization in the prescribed format Actual settlement of funds and securities shall be done by the broker across Exchange and segments, at least once in a calendar quarter or month depending on preference of the respective client. Trading member should ensure periodic reconciliation of client beneficiary account/s and the register of securities on a quarterly basis. Statement of accounts for funds & securities should be sent at the time of settlement along with an extract statement explaining the retention of funds/ securities. Statement of accounts for funds & securities as well as retention statement sent to the clients at the time of settlement as a part of settlement process, would be considered adequate compliance for the purpose of sending quarterly statement of accounts for funds/ securities.

10. IDEATE | INNOVATE | INTEGRATE 10 Scope of Audit- (Contd.) Terminal operations and systems –  CTCL terminals need to be located only in the office of the Trading Member or in the office of their registered sub- brokers.  Following should be ensured: Upload of CTCL terminal to the Exchange before activation. All information to be correctly uploaded in the prescribed format particularly user name, location of the terminal and CTCL id. Any change in the uploaded details to be immediately uploaded to the Exchange.  Trading terminal should be operated by approved persons only. Management of branches & sub-brokers  Notice Board should be displayed containing required details, at all places where trading terminals are located including registered offices and branch offices of trading member, sub-broker/ AP offices. Display of copy of SEBI Registration Certificate, Sub-Broker and AP Registration certificate should be displayed at the prominent place within the office.

11. IDEATE | INNOVATE | INTEGRATE 11 Scope of Audit- (Contd.) Investor Grievance Handling – Trading member should have adequate mechanism to monitor / redress complaints lodged with branches / sub brokers. Trading member is required to maintain complaint register. Trading members are required to design an exclusive e-mail ID for grievance redressal division in which the investors would be able to register their complaints. Members are required to update the mobile numbers/ e-mail ID so their clients to the Exchange and display the message on the home page of their respective websites (if any) at a prominent place. Members should prominently display basic information about grievance redressal mechanism at their offices

12. IDEATE | INNOVATE | INTEGRATE 12 Scope of Audit- (Contd.) Maintenance of books of accounts –  The members of the Exchange are required to maintain the following books of accounts and records as per Rule 15 of the Securities Contracts (Regulation) Rules, 1957 and Regulation 17 of the SEBI (Stock Brokers and Sub-Brokers) Rules, 1992. Some of them are listed below: Register of Transactions (Sauda Book) / Daily Transaction List Clients Ledger Bank Pass Book Documents Register /Inward-Outward Register showing full particulars of shares and securities received and delivered Members’ contract Counterfoils or duplicates of contract notes issued to clients Margin Deposit Book Register of accounts of sub-brokers  If a member of the Stock Exchange also holds membership of any other recognized Stock Exchange or in a different segment of the same Exchange, (e.g., Derivatives Segment) then such member is required to maintain a separate set of books of accounts, records and documents for trades executed on each recognized stock exchange or each segment of the exchange.  The auditor should verify whether the member is maintaining all the above books, documents etc. and they are up to date.

13. IDEATE | INNOVATE | INTEGRATE 13 Scope of Audit- (Contd.) PMLA Guidelines – All Members have to register themselves on the FINnet Gateway for reporting financial transactions to FIU-IND. Members have to carry out risk assessment to identify, assess and take measures to mitigate its money laundering and terrorist financing risk All reporting to the FIU with respect to the transaction of the clients shall be maintained and preserved for a period of five years from the date of the transaction. Member should appoint a Designated Director and intimate details of such director to the FIU and Exchange.

14. IDEATE | INNOVATE | INTEGRATE 14