A stock broker or depository participant audit centres on verifying that client funds and client securities are actually segregated from the broker's own proprietary funds and securities at all times, as SEBI's regulations require, and were never used — even temporarily, even overnight — to fund the broker's own trading positions, margin obligations, or operating expenses, together with testing that margin reported to the exchange or clearing corporation on behalf of clients genuinely reflects the client's own collateral rather than being inflated through client-code modifications, cross-client funding, or securities pledged without client authorisation.
Client fund segregation
SEBI's framework requires brokers to maintain client funds in designated client bank accounts, separate from the broker's own accounts, and specifically prohibits using one client's funds or securities to meet another client's obligations or the broker's own. The audit's job is to test this at a transaction level, not just confirm a client bank account exists on paper.
- 01Reconcile the client bank account balance to the sum of individual client credit balances daily, for a sample of days through the yearA shortfall on any day — the pooled client account holding less than the sum of what clients are owed — is evidence of funds having moved out, even if the shortfall was later made good.
- 02Test for inter-client fundingReview for transactions where one client's margin shortfall appears to have been covered using another client's credit balance or securities, which is prohibited regardless of whether both clients consented informally.
- 03Trace any movement of funds from the client account to the broker's own accountLegitimate movements (brokerage due, specific charges) should be documented and within permitted limits; any other movement needs a clear, defensible basis.
- 04Check securities pledge and re-pledge activity against client authorisationSEBI's framework around pledging client securities for margin requires specific client authorisation mechanisms (via the depository's pledge system) — test that securities pledged on the client's behalf actually have the required authorisation on record, not just an old, blanket power of attorney.
Regulatory requirement
SEBI's specific regulations on client fund segregation, upfront margin collection, the running account settlement cycle, and the pledge/re-pledge mechanism for client securities have been revised multiple times in recent years. Confirm the current circulars applicable for the audit period before concluding on compliance.
Margin reporting
Brokers report client margin obligations and collateral to the exchange or clearing corporation, and SEBI's enhanced surveillance mechanism treats mismatches — a broker reporting margin collected that doesn't match what the client's own account actually shows — as a serious finding. The audit should independently test a sample of client margin reporting against the client's actual ledger and collateral position, not rely on the broker's own reconciliation statement.
- Sample client accounts and trace the margin reported to the exchange back to the client's actual fund and securities balance on the reporting date.
- Test for client code modifications, which can be used to shift a position (and its margin obligation) between accounts after execution — a legitimate error-correction mechanism, but one with a tightly defined and auditable use case.
- Check short-collection or non-collection of margin reported to the exchange is accurate and not understated to avoid penalty or disclosure.
- Review the broker's own proprietary trading margin separately from client margin to confirm no blending of the two in the reporting.
A broker whose client bank account reconciliation shows recurring, brief shortfalls that are corrected before month-end reporting is a pattern worth investigating specifically — a shortfall that reverses before the reporting date is still a shortfall that happened, and a sample taken only at month-end will not catch it.
This is practical guidance written for audit teams, not an authoritative statement of any standard or statute. Standards, forms and timelines change. Check the current text issued by the ICAI and the relevant authority before relying on anything here in an audit file.
Related resources
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