Chapter 10: Sales Practices & Investor Protection
NISM Series VIII — Equity Derivatives | 5% weightage | ~5 exam questions
What this chapter is about
The "ethics and conduct" chapter. How should brokers behave? What complaints can investors raise? What documents must be signed? What is SCORES? Five questions, all about knowing the rules of conduct and the investor protection framework. Easy marks if you read this carefully once.
Key concepts
Know Your Client (KYC) — brokers must understand their client's:
- Financial situation and risk-bearing capacity
- Investment objectives and knowledge of derivatives
- Brokers should NOT recommend derivatives to clients who don't understand or can't afford the risk
- Recommendation must be SUITABLE for the client's profile
Risk Disclosure Document (RDD):
- Broker is COMPULSORILY required to get RDD signed at the time of CLIENT REGISTRATION
- It informs clients of ALL risks in derivatives trading
- Must be signed BEFORE any trading begins
- Cannot be conveyed verbally — must be a signed document
Segregation of funds:
- Broker MUST maintain separate bank accounts for:
- Client funds (completely separate from broker's own funds)
- Margins collected from clients (separate account)
- Client money CANNOT be attached for the broker's own (proprietary) obligations — ever
- PRO account = broker's own trades | CLI account = client trades (must be clearly segregated)
Running account settlement:
- Client funds must be settled on the first Friday of the month (monthly settlement)
- OR first Friday of the quarter (quarterly settlement, per client mandate)
- Brokers cannot hold client funds indefinitely
Ethical sales practices — what brokers MUST do:
- Be courteous and professional
- Disclose all risks honestly
- Never use high-pressure or luring tactics
- Never promise spectacular or guaranteed returns
- Never suggest penny stocks to unsuitable clients
- Never recommend derivatives to clients who cannot understand or bear the risk
- Senior citizens, low-income families = should NOT be pushed into derivatives
Investor Grievance Redressal:
SCORES (SEBI Complaints REdress System) — SEBI's web-based centralized complaint system. Tracks complaints and their resolution status.
What complaints can exchanges take up for redressal: ✅ Non-receipt of funds or securities ✅ Non-receipt of documents (member-client agreement, contract notes, settlement accounts) ✅ Non-receipt of funds/securities kept as margin ✅ Trades executed without adequate margins ✅ Delay/non-receipt of funds ✅ Squaring up of positions without client consent ✅ Unauthorized transactions in client's account ✅ Excess brokerage charged by Trading Member/Sub-broker ✅ Unauthorized transfer of funds from commodities to other accounts
What exchanges CANNOT take up: ❌ Complaints regarding land dealings between client and broker ❌ Transactions already subject to arbitration proceedings ❌ Claims for notional losses (loss that didn't actually happen) ❌ Claims for opportunity loss
AML/CFT — Anti-Money Laundering:
- Suspicious transactions must be reported to FIU-IND (Financial Intelligence Unit — India)
- Regulated under AML/CFT regulations (NOT SEBI insider trading, NOT FEMA)
- Brokers must have written AML procedures
No investment is risk-free:
- No product genuinely gives high returns in a risk-free manner
- If it sounds too good to be true, it is
- "Guaranteed returns" = red flag, investor beware
- This concept appears as a True/False question frequently
Real market example
A sales agent at a brokerage approaches a retired school teacher with no market experience. She has ₹10 lakh in savings. The agent convinces her to trade Nifty options, promising "guaranteed 20% monthly returns."
This violates multiple NISM conduct rules:
- Derivatives not suitable for someone with no market knowledge
- "Guaranteed returns" is explicitly prohibited
- High-pressure luring tactics are banned
- The broker should have established her risk profile first
If she loses money and complains:
- She files on SCORES
- The exchange can take up her complaint (unauthorized/unsuitable trade)
- The broker faces suspension, penalty, or both
Trap Alert
Trap 1: "Complaints regarding notional losses can be taken up by the exchange" → FALSE Notional losses (theoretical losses that didn't actually crystallise) are NOT covered. Only actual losses from specific violations.
Trap 2: "Complaints in arbitration proceedings can be taken up by exchange" → FALSE If a matter is already before arbitration, the exchange cannot also take it up. One forum at a time.
Trap 3: "Land dealings between client and broker can be taken up by exchange" → FALSE Completely outside the exchange's jurisdiction. Land dealings are a civil/court matter.
Trap 4: "Risk disclosure can be conveyed verbally to the client" → FALSE Must be a SIGNED DOCUMENT at the time of registration. Verbal communication is not sufficient.
Trap 5: "Client money can be used by the broker to meet his own obligations in an emergency" → FALSE NEVER. Client money is completely ring-fenced. The broker's proprietary obligations have zero claim on client funds.
Trap 6: "All types of investors should invest some portion in derivatives" → FALSE Derivatives are NOT suitable for everyone. Senior citizens, risk-averse investors, and those without understanding should NOT be pushed into derivatives.
Trap 7: "SCORES is the exchange's risk management system" → FALSE SCORES = SEBI's web-based COMPLAINT REDRESSAL system. Nothing to do with risk management.
Must-remember rules
- RDD (Risk Disclosure Document) = must be signed at registration, BEFORE trading
- Client funds = completely separate from broker's funds, cannot be attached for broker's obligations
- PRO account = broker's own trades | CLI account = client trades
- Running account settlement = first Friday of month (monthly) or quarter (quarterly)
- SCORES = SEBI's complaint redressal system (web-based)
- Exchange can resolve: unauthorized transactions, non-receipt of funds, excess brokerage, unsigned positions
- Exchange CANNOT resolve: notional losses, land dealings, matters in arbitration
- No investment gives risk-free high returns — ever
- Suspicious transactions → reported to FIU-IND under AML/CFT
- Brokers must NOT use high-pressure tactics or guarantee returns
- Derivatives NOT suitable for all investors — suitability assessment required
Weightage note
5% = ~5 questions. Typically: 1 on SCORES, 1-2 on which complaints exchange can/cannot handle, 1 on client fund segregation, 1 on risk disclosure document. All definitional, no calculations.
Quick revision — 60 second scan
- RDD = signed document at registration, mandatory
- Client funds = ring-fenced, cannot touch for broker obligations
- SCORES = SEBI's web complaint system
- Exchange handles: unauthorized transactions, non-receipt of funds, excess brokerage
- Exchange cannot handle: notional losses, land dealings, arbitration matters
- No risk-free high returns product exists
- Suspicious transactions → FIU-IND under AML/CFT
- Brokers: no pressure tactics, no guaranteed return promises
- Running account: settled first Friday of month/quarter