I. LEGAL FRAMEWORK

1. Statutory Sources:

• SCRA, 1956 Sec 18A: Derivatives are legal only if traded on recognized stock exchange
• SEBI Act, 1992: Sec 11 power to regulate derivatives
• SEBI (Stock Brokers) Regulations, 1992: Code of conduct, margin, client segregation
• RBI / FEMA: Currency derivatives - USD/INR, Cross-currency - governed by RBI Circular 2020
• SEBI Master Circulars:
  - Equity Derivatives - SEBI Circular dated May 16, 2024 & Oct 1, 2024
  - Commodity Derivatives - Master Circular dated Aug 4, 2023 (amended 2024)
  - Currency Derivatives - SEBI/HO/MRD2/DCAP/CIR/2021/ etc.

2. What is Allowed?
Exchange Traded Derivatives (ETD) only - Index Futures/Options, Stock Futures/Options, Commodity Futures/Options, Currency Futures/Options. OTC derivatives allowed only for banks under RBI.

II. 7 PILLARS OF COMPLIANCE FOR BROKERS / TRADING MEMBERS

Pillar 1: Eligibility & Client Onboarding

• Risk Disclosure Document (RDD) mandatory in vernacular
• No derivatives for clients who are minors, unfit
• FPI, Mutual Fund, PMS have separate limits under their own regulations

Pillar 2: Margin Compliance [Most Penalized]

• Upfront collection: SPAN + Exposure + Calendar Spread + Net Premium
• Peak Margin: 4 random snapshots per day - margin must be >= peak obligation
• 50% must be in cash equivalent since July 2021
• No use of one client's securities for another - prohibited under Reg 26(xiii)

Pillar 3: Position Limits
SEBI tightened this in 2024-25:

Equity Index Derivatives:

• End of Day: Client level Rs 500 cr, Trading Member Rs 1500 cr (FutEq)
• New Intraday: Net Rs 5,000 cr and Gross Rs 10,000 cr per entity on FutEq basis
• Exchanges to prepare joint SOP within 30 days for monitoring and penalty framework

Commodity Derivatives:

• Exchanges must monitor real-time and ensure no breach intraday and EOD
• Revised penalty: Violation up to 2% of limit = formula or Rs 10,000 lower; >2% = formula or Rs 2 lakh lower - capped at Rs 2 lakh per client

Currency Derivatives: Gross open position across all contracts not to exceed 15% of total OI or USD 1 bn, whichever higher

Pillar 4: Reporting & Surveillance

• Daily client margin report to CC by T+1
• Correct reporting of margin in FO and CD segment - false reporting = violation of Master Circular dated April 1, 2013
• Real-time trade surveillance for manipulation

Pillar 5: Segregation of Funds & Securities

• Client collateral to be held in separate demat - pledge/re-pledge mechanism via depository
• Pledging client securities to raise own funds = violation of Clause A(1)(5) of Code of Conduct

Pillar 6: Risk Management & Liquidation

• Broker must square off if margin shortfall
• MTM settlement T+1

Pillar 7: Code of Conduct & Audit

• Annual system audit, quarterly internal audit, maintenance of margin books for 5 years

III. LANDMARK CASE LAWS

A. Margin & Segregation Cases

1. SMC Global Securities Ltd vs SEBI (SAT Jan 31, 2014)
Issue: Does SEBI retain power if exchange empowered to penalize for short-collection per circular Aug 10, 2011?
Held: Ultimate power rests with SEBI. Exchange power does not oust SEBI. Short-collection is actionable under SEBI Act. Broker cannot claim immunity

2. GRD Securities Ltd vs NSE (DAC Order)
NSE found false reporting of Rs 2.05 cr margin in CD segment. DAC imposed equal penalty. SAT in appeal held: Exchanges should not follow SEBI circulars mechanically, they can levy lesser penalty based on facts. Important for mitigation.

3. Grishma Securities vs SEBI (Oct 28, 2013)
Broker argued margin management is its prerogative. SAT: No circular authorizes use of funds/securities of clients to cover margin of others. Such action prohibited under Regulation 26(xiii) - liable for monetary penalty

4. Radar Securities vs SEBI (2003) - Followed in Time Capital Ltd
Broker maintained margin details as downloaded file, not book. SAT: Not a grave violation to warrant suspension. Principle of proportionality established.

B. Market Manipulation / Synchronized Trading Cases - Applies heavily to Derivatives

5. SEBI vs Kishore R. Ajmera (2016) 6 SCC 368 - SC
SC held synchronized trades / reversal trades that create artificial volume are manipulative even if no price impact. Created artificial liquidity in derivatives = fraud.

6. SEBI vs Rakhi Trading Pvt Ltd (2018) - SC
Fictitious trades in Nifty Options that created false liquidity. SAT had said derivatives cannot influence Nifty index. Supreme Court set aside SAT, held: Stock market is not platform for fraudulent practice; creation of false liquidity in options is market manipulation under PFUTP Regulations.

7. SEBI vs Rajeev Vasant Sheth (Civil Appeal 4905 of 2022) & SC judgment dated 11.08.2026 in SEBI vs Rajeev Vasant Sheth
SAT had set aside SEBI order on ground of no profit motive, funds used for debt restructuring. SC overturned SAT: Selling shares while in possession of UPSI constitutes insider trading even if no profit made. Possession + trading = presumption. Purpose of proceeds irrelevant

8. SEBI vs Abhijit Rajan (2022)
Contrast to above. SC dismissed SEBI appeal, held motive to profit is essential in certain context. Shows evolving jurisprudence on mens rea.

C. Commodity Position Limit Case

9. Ferrer Securities (FSPL) - SEBI Ex-Parte Interim Order WTM/MPB/NRO/154/2018
By raising funds by pledging clients' securities and not reporting correct margin in CD and FO, FSPL violated Code of Conduct and Master Circular. License suspended.

IV. Current Penalty Framework 2024-26