In recent weeks, a flurry of complaints has emerged on social media platforms like Twitter, concerning brokers engaged in running illegal proprietary trading desks. These desks enable traders to utilize their trading terminals for conducting proprietary trading, where brokers deploy their own capital to buy and sell stocks and derivatives. Commonly referred to as prop trading firms in the market, these operations have come under increasing scrutiny.
Moneycontrol reached out to two traders who were actively involved in equity derivatives trading through proprietary broking firms, both of whom chose to remain anonymous. They shed light on the operating mechanism, which bears resemblances to Multilevel Marketing (MLM) schemes. Proprietary broking firms hire traders who, in turn, recruit more traders, working collaboratively as a team. However, due to heightened vigilance from the National Stock Exchange (NSE), this business model may face prohibition.
One trader, responsible for overseeing a group of ten traders, disclosed, “To become a team lead, a trader is required to deposit Rs 1 crore or more, allowing him to take positions worth Rs 5 crore or more. The specifics vary depending on the agreement with the main broker. Subsequently, the team lead recruits traders under him, each with a capital of Rs 10-20 lakh. This capital is pooled from all traders and transferred to the broker, who, in turn, allocates funds and sets individual trading limits based on their track record and experience.”
Private companies often serve as intermediaries for depositing funds into broking firms, leaving no clear transaction evidence between brokers and traders. The approach may vary across firms, with some accepting deposits directly from traders through vaguely-worded agreements. What makes this practice illegal is the misrepresentation of traders as employees or consultants on the payroll of the proprietary broking firm, despite them being the firm’s clients.
When a broker identifies as a proprietary trading firm in the stock exchange, client engagement is not permissible. However, brokers provide traders with access to their application programming interface (API) feeds, allowing them to use their algorithms on the trading platform. By disguising these traders as employees, brokers breach two stock exchange rules: only authorized broker employees may utilize trading terminals, and brokers cannot finance their clients’ trades.
This strategy offers traders substantial leverage, enabling them to take positions far exceeding what traditional broking firms permit. In essence, a trader depositing Rs 1 crore with a proprietary broking firm can engage in trading activities ranging from Rs 5 crore to Rs 15 crore, depending on the agreement. For proprietary broking firms, this arrangement proves profitable as they earn interest on the funds lent to traders, typically around 12 percent annually. Moreover, they receive rebates on exchange transaction taxes from the NSE when turnover surpasses a certain threshold, and they have profit-sharing agreements with traders.