Sales Practices and Investor Protection — the duty you owe the client

The sentence this chapter turns on

That is not a slogan. It is the standard against which every rule in this chapter is written, and the chapter carries 5% of the paper.

The workbook's framing is worth absorbing: the finance sector has the responsibility of ensuring stable markets and supporting the real economy, and giving good advice and having excellent customer service is a precondition for long-term success of any financial institution. Sales should be customer led and always accompanied by correspondingly efficient and appropriate advice.

Five ways naive investors get hurt

"High return" or "risk-free" investments. Be careful of opportunities promising spectacular profits or guaranteed returns. Someone may claim unrealistic returns from "low-risk investment opportunities" — but no investment is risk-free. Returns are related to the risk taken, so there cannot be a product in the market that gives high return in a risk-free manner.

Investment advisor services. An adviser has a duty to act in the best interest of the clients. But investors should review their monthly account statements and conduct annual reviews of their plans, watching for abnormal changes.

Unsuitable investment recommendations. Some unscrupulous intermediaries sell products that do not meet the investment objectives and risk profile of that investor. The workbook's own example is precise: a stock broker advising a senior citizen with low risk tolerance to deal in futures, options or penny stocks.

Churning. Securities professionals making unnecessary and excessive trades in customer accounts for the sole purpose of generating commissions. Investors should investigate any abnormally high trading activity in their monthly statements.

Investor seminars. Advisers may pitch unsuitable products. Investors should avoid rushed decisions and seek objective third-party advice before committing funds.

Contact rules — learn the timing

These are examinable almost verbatim.

• Sales agents will only call between 9 am and 8 pm, unless it is at the customer's request. Calls must be at reasonable times, recognising that reasonable varies in different locations and different types of households
• As soon as possible on making contact, identify yourself, the company you represent, and your purpose
• Take account of the customer's personal circumstances and comply with diversity obligations
• End the discussion and leave the premises immediately at the customer's request
• Voluntarily cease contact with a customer who clearly indicates that contact is inconvenient, unwelcome or inappropriate
• A contact number must be left with any customer, on request
• Must not exploit a person's inexperience, vulnerability, credulity or loyalties
• Maintain records, including the date of contact, to allow subsequent identification of the sales agent involved — which is what makes any later complaint traceable

And at all times: be courteous and professional, refrain from making false assumptions, in particular over potential returns, and avoid the use of high pressure or luring tactics.

Understanding the client's risk profile

The workbook defines risk carefully. In investments, risk refers not only to the chance that a person may lose his capital but more importantly to the chance that the investor may not get the desired return.

For fixed income instruments with a definite interest rate there is little risk of missing the desired return — though credit or default risk exists. For market oriented investments, risk means the probability of the investor not getting the desired or expected returns.

The risk/return trade-off: the greater the risk accepted, the greater must be the potential return as reward for committing one's funds to an uncertain outcome. As the level of risk rises, the expected rate of return should also rise, and vice versa.

A risk-averse investor prefers secure investments and holds higher portfolio allocations to debt and fixed income. A less risk-averse investor wants greater exposure to equity and other risky investments.

Risk tolerance depends on these parameters:

And the horizon rule: the longer the investment horizon, the more risk can be integrated into financial expectations.

The workbook is also honest about why this is hard. Investors' objectives are often poorly developed and unrealistic; it is difficult for people to describe in their own words their attitudes about risk; new investors may not understand many of the financial and risk concepts presented by advisors; and it is very difficult for the financial advisor to arrive at an accurate risk profile.

It closes with a warning against shortcuts: a single investment model will fit all — the lifecycle approach — does not work.

The Risk Disclosure Document

Why not put everything in equities, given that equities have outperformed over long periods? Because there have been many instances in which stocks have underperformed in the short run, and in fact have had negative returns — and it is difficult to exactly predict these periods. So there is more risk in owning stocks with a short horizon than with a long one.

The Risk Disclosure Document highlights the risks involved in trading on stock exchanges, and the rights and obligations of the broker and their clients. Brokers must make their clients understand the risks involved in trading derivatives and get a copy of the RDD signed by their clients at the time of client on-boarding.

And note the ranking: options are a more complex derivative product than futures, because evaluating the fairness of the option premium is difficult.

The three main risks

All three are heightened by leverage. A futures client deposits only a fraction of the entire contract value as margin; an options client pays a premium that is a small amount relative to the size of the contract. That small initial capital outlay can encourage clients to build up large derivatives positions beyond their risk tolerance, and such clients stand to lose large amounts if the market turns.

Risks by position

Futures clients. Contracts are marked to market and settled daily. On an unfavourable move the client must deposit the notional loss — and if this is not deposited within the stipulated time, the broker may liquidate the position wholly or in part, with the client liable for the resulting losses. They also face sudden increases in margin rates during volatility, and the inability to execute trades or close out positions during volatile periods when liquidity dries up.

Option buyers. Options are a wasting asset. The buyer pays the premium up front; if the price of the underlying does not change in the anticipated direction before expiry, the option becomes worthless on the expiry date — and unless the buyer closes out beforehand, he is exposed to the risk of losing the entire or a large part of the premium within a short span of time.

Option sellers. Unlike option buyers, whose losses are limited to the premium already paid, the option seller's risk is unlimited. The option seller can lose many times the amount of premium he has collected.

That asymmetry is the single most important sentence in the chapter to say aloud to a client before they write their first option.

Unique Client Code

After KYC, the broker allots a Unique Client Code (UCC). It is linked to the PAN and serves as an exclusive identification of the client. It was introduced to facilitate maintaining a database of clients and to strengthen KYC norms.

The broker must upload the UCC details to the stock exchanges and clearing corporation, and the client's trading account is activated only after the UCC is generated and mapped with the client's name, address and other KYC details.

There is a protective purpose too. Because there have been many instances of brokers diverting or misappropriating a client's securities, SEBI asked exchanges and depositories to map clients' UCC with their demat accounts — which simplifies reconciliation of any mismatch between securities pay-in and pay-out generated by the clearing corporation and the actual transfer of securities by the depositories.

Digital KYC for persons with disabilities

Following a Supreme Court judgement dated 30 April 2025 emphasising easy access to financial services for persons with disabilities, intermediaries dealing in derivatives must ensure the digital KYC process is accessible. Specifically:

• An account can be opened with the signature of a guardian
• eKYC is available for persons with disabilities
• eKYC normally requires the applicant to blink as proof of liveliness. A blind person who cannot perform this test should not be denied the benefits of eKYC. Intermediaries may use alternate parameters — facial expressions, nodding of the head, the client showing an OTP while clearly visible on screen, real time video recording, and displaying copies of documents on the screen.

Suspicious Transaction Reporting

Under AML and CFT regulations, certain transactions must be reported to the Financial Intelligence Unit – India (FIU-IND), set up by the Government to detect possible money laundering. In deciding whether a transaction is suspicious, the broker must be guided by the definition of a suspicious transaction under the PMLA rules.

Examples given:

• Clients whose identity verification seems difficult, or who appear not to cooperate
• Asset management services where the source of funds is not clear or not in keeping with the client's apparent standing or business activity
• Substantial increases in business without apparent cause
• Clients transferring large sums to or from overseas locations with instructions for payment in cash
• Attempted transfer of investment proceeds to apparently unrelated third parties

The procedure, which is heavily tested:

• Any suspicious transaction must be immediately notified to the Money Laundering Control Officer or other designated officer within the intermediary
• Dealing with the client must be continued as normal until told otherwise
• The client must NOT be told of the report or the suspicion
• Operation of the account may be discontinued, transactions suspended or other action taken only in exceptional circumstances
• The Principal Officer / Money Laundering Control Officer and compliance, risk management and related staff must have timely access to client identification data, CDD information, transaction records and other relevant information

The reason the client is never told is straightforward: warning a suspect defeats the investigation, and is itself an offence in most AML regimes.

Social media disclosure

With the increasing use of social media platforms, SEBI has advised regulated entities and their agents to prominently disclose their registered name and registration number on the home page of their social media handles, as well as at the beginning of each video or content relating to the securities market that they upload — so that their content can be clearly distinguished from that of unregistered persons.

The grievance ladder

Step 1 — the exchange's Investors Grievance Division (IGD). The Exchange resolves disputes by coordinating with the member and the complainant. Having a proper grievance mechanism is a key regulatory function of SEBI in monitoring exchanges under SECC Regulation 2012, and an ongoing condition for eligibility of membership of the Exchange under Brokers Regulation 2026.

The exchange entertains complaints against trading members on these grounds:

The filing guidelines:

• First send the complaint to the Exchange with whom the member is registered, and then to SEBI
• In writing, in English, Hindi or any regional language, and duly signed by the client
• No fee is chargeable
• Frivolous or vexatious complaints which are vague, anonymous or pseudonymous or trivial in nature are not entertained

Step 2 — SCORES. If the response is unsatisfactory, approach SEBI through the SEBI Complaints Redressal System, a web-based centralized grievance redress system. Complaints are made online, acknowledgement is generated instantaneously with a unique complaint registration number for tracking. The complaint is forwarded online to the entity, which must upload an Action Taken Report (ATR) and resolve the complaint within 21 days after receiving intimation from SEBI.

Step 3 — SMARTODR. The Online Dispute Resolution portal, established by the Market Infrastructure Institutions (MIIs), provides a centralized, accessible and efficient means of resolving disputes relating to listed companies, stock brokers, depository participants and other SEBI-regulated entities. It uses online conciliation and arbitration, with the process starting from the initial grievance filing and potentially leading to arbitration if initial conciliation efforts fail.

Six categories of grievance it covers: