internal audit

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ramprasad (Querist)
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24 November 2007 what are the areas of audit importance in case of audit of stock broking firm. please address to my query.

R.V.RAO

R.V.RAO (Expert)
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24 November 2007
1. As per the SEBI Circular no. SMD/SED/0072/92 dated December 31, 1992
members of stock exchanges are required to get their annual accounts audited by
Chartered Accountants within 6 months from the closing of books of accounts and
submit a copy of the same to stock exchanges within 30 days of the receipt of the
audit report. This requirement of conduct of annual audit of stock brokers
emanates from GOI directive No. F.1/5/SE/83 dated May 31, 1984 which enjoins
stock brokers to get their books of accounts audited by qualified Chartered
Accountants.
2. As all the active members of stock exchanges are covered under the annual audit,
standards of compliance of these members may be enhanced considerably if apart
from financial aspects, the annual audits also cover certain key regulatory aspects
relating to financials and member’s dealing with clients and major
deficiencies/non conformance with regulatory requirements are reported in the
form of Annexure to the report.
3. Apart from financial aspects, the annual audit report may contain the
following points:
4.1 MAINTENANCE OF BOOKS OF ACCOUNTS:
Auditors may examine if the broker has been maintaining the required books of accounts
as per Rule 15 of SC(R) Rules 1957 and Regulation 17 of SEBI (Stock Broker and Sub
Brokers) Regulations, 1992. Any non maintenance of books of accounts by the broker
may be specifically commented by the auditor.

4.2 LIST OT TRADING TERMINALS:
Auditors may give a city-wise list of all trading terminals granted by the member. It may
also be examined by the auditors whether such trading terminals have been given by the
member only at its registered office, branch office and the registered sub broker’s office.
Grant of any unauthorized trading terminal by the broker to its clients etc. may be
reported by auditors in their report.
4.3 TURNOVER DETAILS:
The turnover of the member may be given across different exchanges in the following
format:
CASH SEGMENT:
(Figures in Rs. crore)
Exch. Pro A/c As % of
Total
Turnover
Retail
clients
As % of
Total
Turnover
Inst.
Clients
As % of
Total
Turnover
Total
Turnover
DERIVATIVES SEGMENT:
(Figures in Rs. crore)
Exch. Pro A/c As % of
Total
Turnover
Retail
clients
As % of
Total
Turnover
Inst.
Clients
As % of
Total
Turnover
Total
Turnover
WDM/DEBT SEGMENT:
(Figures in Rs. crore)
Exch. Pro A/c As % of
Total
Turnover
Retail
clients
As % of
Total
Turnover
Inst.
clients
As % of
Total
Turnover
Total
Turnover
Page 3 of 7
4.4 SEGMENT WISE INCOME STATEMENT
A segment wise break up of income earned by the member may be given to throw light
on various activities being undertaken by the broker and their contribution to the overall
revenue model of the broker. As a typical example, the audit report may contain income
of the broker in the form of exchange-wise brokerage earned, interest income, income
from investment consultancy, income from portfolio management services, income from
DP operations etc.
4.5 STATEMENT OF CHANGES IN SHAREHOLDING PATTERN:
The statement should give shareholding pattern of the entity. All those holding 5% or
above as on the close of year ending for which audit is conducted should be given in the
audit report. The report should also indicate all the major changes in the shareholding
pattern of the entity during the period under review.
The information to be given may be in the following format:
As on March 31, 2003 As on March 31, 2002 S No. Name of persons/entities
(To be given for all those
holding more than 5% of
the total shareholding)
No. of shares
held
% of
sharehold
ing
No. of
shares
held
% of
sharehold
ing
4.6 STATEMENT OF NET WORTH:
A statement of net worth as per the formulae prescribed by SEBI/stock exchange may be
given under the para. Further the entity’s financial position may be judged in terms of its
net worth and overall exposure in the market/obligations due to various entities. Financial
soundness of the entity would be an important parameter to have an overall view about
the operations of the member.
4.7 EXAMINATION OF THE ROLE OF COMPLIANCE OFFICER:
The auditors may examine the role of the compliance Officer, whom all stock brokers are
required to appoint as per the SEBI (Investment advice by Intermediaries) (Amendment)
Regulations, 2001. The role may be examined in light of the competence, qualifications,
experience and seniority of the compliance officer, nature of reporting pattern,

information flow in the organization, especially that related to non conformance as
provided by stock exchanges etc., detailed scrutiny if any, carried out by compliance
officer during the year and follow up action on the report of the compliance officer etc.
4.8 MARGIN COLLECTION AND PAYMENT:
The system of collection of margins from clients may be examined by the auditors and
any deviation from regulatory requirement concerning the same may be reported in the
audit report. Vide SEBI circular no. SMD/Policy/Cir-12/2002 dated May 17, 2002, it has
been decided that brokers should collect upfront margin from clients. However for the
collection of 10% upfront margin from clients, only trades which would result in a
margin of Rs 50,000 or more should be considered. In other words, if clients position
exceeds Rs. 5 lacs the broker would be necessarily required to collect 10% margin from
the clients.
The implementation of gross margining system at the broker level may also be checked in
line with SEBI Circular no. SMDRP/policy/Cir-34/01 dated June 21, 2001. Vide this
circular no netting across different clients is permitted and the broker is required to pay
margins on the basis of gross position across all clients.
Any deficiencies observed in this respect may be reported by the auditors in the form of a
para on non compliance.
4.9 SEGREGATION OF CLIENTS FUNDS AND OWN FUNDS
Auditors may carry out a detailed analysis of various bank accounts being operated by the
member. The analysis may throw light on the following regulatory concerns:
1. Non- segregation of clients funds and own funds.
2. Misutilisation of clients funds.
A few of the important requirements as laid down in SEBI Circular no.
SMD/SED/Cir/93/23321 dated November 18, 1993 issued in respect of maintaining a line
of segregation between own funds and clients funds are as under:
Every member broker shall keep such books of accounts, as will be necessary, to show
and distinguish in connection with his business as a member -
? Moneys received from or on account of each of his clients and,
? the moneys received and the moneys paid on Member’s own account.

WHAT MONEYS TO BE PAID INTO AND DRAWN FROM “CLIENTS
ACCOUNT”
A. No money shall be paid into clients account other than -
1. Money held or received on account of clients;
2. Such money belonging to the Member as may be necessary for the purpose of
opening or maintaining the account;
3. Money for replacement of any sum which may by mistake or accident have been
drawn from the account in contravention of para B given below;
4. A cheque or draft received by the Member representing in part money belonging to
the client and in part money due to the Member
B. No money shall be drawn from clients account other than
1. Money properly required for payment to or on behalf of clients or for or towards
payment of a debt due to the Member from clients or money drawn on client’s
authority, or money in respect of which there is a liability of clients to the Member,
provided that money so drawn shall not in any case exceed the total of the money so
held for the time being for such each client;
2. such money belonging to the Member as may have been paid into the client account
under para A [2] or A [4] given above;
3. money which may by mistake or accident have been paid into such account in
contravention of para A above.
It is generally observed that the balances lying in clients account also contain a portion
representing brokerage which members don't withdraw every settlement. However as an
when need arises, payments or withdrawals are made from clients account itself for
different purposes and it is submitted that such withdrawal is always less than the amount
of brokerage attributable to the broker. In such a case auditors may make an analysis of
total brokerage due to the broker and total withdrawals made to form a view about the
misutilsation of clients funds.

If any non compliance with regulatory requirement in this regard is observed by auditors
specific instances may be brought out in the form of Annexure to the auditors report.
4.10 PAYMENT OF STAMP DUTY:
Auditors may verify whether appropriate stamp duty has been paid by brokers in line
with provisions of the Stamp Act. An analysis of broker’s transactions and accounts may
be carried out to arrive at the quantum of stamp duty payable and actually paid by the
brokers. Any shortfall in payment may be brought out in the report by auditors.
4.11 BORROWINGS/EXTENT OF LEVERAGE:
Auditors may verify whether the borrowings/lending being done by the broker is in
connection with or incidental to/consequent upon securities business. The quantum of
borrowings/lending made by the member, terms and conditions and tenor of borrowings
may also be analysed by auditors to form a view about the extent of leverage being
exercised by the member in relation to his operations. In case the borrowings are
excessive, which in the opinion of auditors are likely to impact the safety of operations of
the member, auditors may comment on the same. Similarly in case of lending done by the
member, quantum and soundness of such lending in terms of quality of assets, age-wise
analysis and collectibility may be commented upon by the auditors.
4.12 EXPOSURE LIMIT:
Auditors may on a random and test check basis analyse the total gross exposure of the
broker based on its base minimum capital and additional base minimum capital deposited
with the exchange. Such an exposure would take into account the position of the member
across all the exchanges as well outside the exchange for any spot transactions etc either
through his own outfit or through other members as a client.
4.13 RECEIVABLES/PAYMENT AND DELIVERIES TO CLIENTS:
Auditors may examine the practices and procedures of the members in so far as they
relate to payment of money and giving deliveries to clients within the prescribed time
limit. Such examination would include general observations regarding practices of the
member on these aspects. However if delay is on account of default of the client or
request by the clients to withhold securities/money, it may be ignored. Auditors may also
examine and verify the credit/debit balances lying in books for a considerable period and should form an opinion if adequate provisioning have been made in the books for those
debit balances, which have remained unrecovered for a considerable period of time.
4.14 MODE OF PAYMENT:
As per regulatory requirements, brokers 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. All payments should be received / made by the brokers from /
to the clients strictly by account payee crossed cheques / demand drafts or by way of
direct credit into the bank account through EFT. The brokers shall accept cheques drawn
only by the clients and also issue cheques in favour of the clients only, for their
transactions. However, in exceptional circumstances the broker or sub-broker may
receive the amount in cash, to the extent not in violation of the Income Tax requirement
as may be in force from time to time.
4.15 RELATED PARTY TRANSACTIONS:
Auditors may make specific comments about the transactions of the member with related
parties/associates of the member. Such comments should include the following areas:
Details of outstanding borrowings/lending made to such entities.
Details of transactions done with such entities
Brokerage/other income earned on account of dealing with such entities or any
commission/brokerage/interest paid to such entities.(SOURCE:WWW.SEBI.GOV.IN)
R.V.RAO