Financial crimes: Brokers' own capital determines risk clients are exposed to

Tamha Securities’ paid-up capital was Tk 110 million only when it was caught to have siphoned off Tk 513 million from its clients' funds in November 2021.
With such a low investment of its own, the broker had been handling investor portfolios worth Tk 1 billion.
Fund misappropriation by four brokerage firms, including Tamha, between 2019 and 2021 drew attention anew to the matter of regulatory capital that a broker must have to minimize risk to investors.
But negative equity and repeated time extensions to meet provisioning requirement against unrealised losses in the brokers' own portfolios make it imperative for the regulators to set a minimum paid-up capital that they must have for the sake of safety of stock investors.

When stock brokers themselves have nothing much to lose in the regulatory action against them for mishandling clients' money, they are more likely to commit financial crimes.
Yet, paid-up capital of 91 TREC (trading right entitlement certificate) holders of the Dhaka Stock Exchange (DSE) is still below Tk 50 million.
A majority of these stock brokers are the exchange's primary shareholders. At first, they were entities owned by individuals and were later transformed into companies.
Even after the change in their legal entity, the brokers have continued to show reluctance in expanding their paid-up capital and retained earnings.
On the other hand, institutional brokers -- subsidiaries of banks and financial institutions -- have sufficient paid-up capitals and support from parent companies.
That explains why institutional brokers have not embezzled clients' money.
"Clients of the brokers that have insignificant paid-up capitals and do not retain profits definitely are vulnerable," said Ahsan H Mansur, executive director of the Policy Research Institute of Bangladesh (PRI).
There must be a minimum threshold of paid-up capital and it should be increased from time to time, he added.
The vice-president of the DSE Brokers Association of Bangladesh, Md. Sajedul Islam, however, disputed the view of Mr Mansur.
He said banks had portfolios worth thousands of crores despite their low paid-up capitals. "Paid-up capital doesn't matter much when clients have confidence in the broker."
But investors, who had entrusted their money to the scam-hit brokers, had faith in them too.
Paid-up capital is just a small component of the total capital in the numerator while calculating risk-based capital adequacy ratio.
The Bangladesh Securities and Exchange Commission set the ratio in May 2019 at 1.20 times total risk requirements, which all brokers should comply with.
Regulatory capital is the minimum total capital that a broker should maintain in continuing its operation. Total capital includes retained earnings, capital reserve, provision, unrealised fair value gain, paid-up capital and share premium.
For general stock brokers, the regulatory capital is Tk 50 million whereas the amount is Tk 150 million for a fully functional stock-broker and stock-dealer.
Many stock brokers have been enduring negative equities and have not kept provision against those. The last time they got time extended until 2025 to keep provision against unrealised losses in their portfolios.
This is the backdrop to the emphasis on paid-up capital.
Earlier on several occasions, Mohammad Asadur Rahman, company secretary of the DSE, urged TREC holders to expand their capital base.
Md. Moniruzzaman, managing director of Prime Bank Securities, said the capital adequacy ratio requirement could not be met without provisioning negative equity and unrealised losses.
Meanwhile, the DSE's primary brokers have had opportunities to enhance paid-up capital with financial gains.
They took away the proceeds from the sale of their 25 per cent stake in the DSE to a Chinese consortium in 2018 in the process of demutualisation. Each broker received Tk 37.84 million from the deal.
They also received cash dividends from the stock exchange over the years but did not retain enough of the profits.
The DSE distributed an aggregate amount of Tk 956 million in cash dividends to TREC holders for the last five years.
While distributing the money, the DSE management asked the stock brokers to use a portion of the fund received to boost their paid-up capital.
The intermediaries also bagged huge profits from their own investments in stocks during the heydays of the capital market.
But none of the financial gains has had any reflection on paid-up capital.
Mohammad Rezaul Karim, spokesperson of the securities regulator, said risk that stock investors were exposed to was assessed by the capital adequacy ratio.
With other sources of capital left unexploited, he said, "The stock brokers will have to increase their paid-up capital. Otherwise, their capital adequacy ratio will be less than needed."
After the demutualisation, the DSE issued licences to new brokers, raising the number of TREC holders from 250 to 390. The new TREC holders began operations with a paid-up capital of Tk 50 million.
The securities regulator issued a directive in October 2022 on reportage of brokers' capital adequacy ratio online.
The exact number of the TREC holders which so far have fully complied with the capital adequacy provision could not be known.
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