Tata Motors’ Futures slumps & causes massive loss
Prasad GVSV Bhavana, a punter based in Hyderabad, was supremely bullish about the prospects of Tata Motors, the blue-chip automobile behemoth.
Accordingly, he packed his portfolio with a massive consignment of Tata Motors’ futures.
As of 9th August 2017, on the eve of Tata Motors’ quarterly results, he held a treasure trove of 30,000 August 2017 futures, 30,000 September 2017 futures and 30,000 October 2017 futures.
Unfortunately for Prasad, Tata Motors reported poor results on 10th August 2017 with the result that there was a massive slump in the prices of Tata Motors Futures contracts.
By the EOD, Prasad was staring at a MTM (Mark-to-Market) loss of Rs. 32,76,000 on his holdings of the Tata Motors futures.
Zerodha panics, dumps Prasad’s holdings to cover margin shortfall
The steep slump in the prices of Tata Motors Futures contracts triggered alarm bells in Zerodha’s H.Q. because Prasad had a shortfall of margin amounting to Rs. 30.50 lakh.
Without waiting for Prasad’s consent, Zerodha squared off 75,000 shares of Tata Motors’ futures at whatever price could be realized for it.
Zerodha claimed that it was authorized to do so under Clause 19 of the Risk Disclosure document which empowers Zerodha to liquidate/ close out all of a client’s position for non-payment of margins etc.
It is also made clear in the Risk Disclosure document that all losses on account of such liquidation have to be borne by the client.
Prasad fumes, claims he was never informed of the margin shortfall by Zerodha
At this stage, we have to compliment Prasad because instead of meekly accepting what Zerodha claimed, he decided to battle them.
He alleged that Zerodha was at fault for the margin shortfall because they never sent/ delayed sending the email and SMS regarding the margin statement.
He also claimed that he had sufficient holdings in other stocks etc which could have been used to bridge the margin shortfall.
He alleged that Zerodha’s abrupt move of liquidating his holdings led the price to fall more than it would have in normal circumstances and that he suffered more loss than he would have if he had himself liquidated the holdings.
Zerodha is part of ‘Bear cartel’?
In a masterstroke, Prasad turned the tables on Zerodha.
He alleged that they or their employees may be part of a “Bear cartel” which would have benefitted from the slump in Tata Motors’ stock price and that there may be “foul play” in the abrupt dumping of his holdings by Zerodha.
Zerodha acted in undue haste to liquidate positions of
COMPLIANT customer and caused him huge losses: 1st Arbitration panel
A distinguished panel of three arbitrators examined threadbare the claims and counter-claims of Prasad and Zerodha.
After a lot of pontification about the facts, the panel found Zerodha guilty of not sending proper SMS and email messages regarding the margin statements.
“Admittedly, the margin statements would be ready later in the night and could be sent only by the next day. As such, the client cannot be expected to work out the complex SPAN margin, etc dynamically and take appropriate corrective action,” the Panel observed.
It also held that Zerodha “cannot set aside the responsibility to provide the margin statements promptly so that the clients can take the required action”.
Zerodha was also slammed for cryptic SMS messages.
“The SMS messages sent by the Respondent did not provide details regarding the extent of shortfall and the amounts required to make good the shortfall. As such, the Applicant could not have immediately remitted the required amounts,” the expert panel held.
Ultimately, the arbitrators held that Zerodha acted in undue haste to liquidate the positions of a COMPLIANT customer, causing him huge losses.
It was held that if only Zerodha had waited a little longer, Prasad could have remitted the required funds. In that case, his outstanding positions could have been dealt with by him as per his plans.
Compensation to Prasad
The Panel noted that if Prasad had sold off the Tata Motors’ futures by himself, he could have realized Rs. 365.70 lakh.
However, because of Zerodha’s action, Prasad could only realize Rs. 284.82 lakh.
Zerodha was ordered to pay Prasad the difference between the two amounts being Rs. 36.78 lakh as compensation.
“This loss is not a notional loss, as the Respondent had unfairly squared off the positions causing actual loss to the Applicant,” it was held.
However, Prasad’s claim for compensation of Rs. 5 lakh for “mental agony” was rejected by the experts.
How did Zerodha allow person with income of Rs. 1 to 5 lakh to take exposure of Rs. 4 crore? Appellate Arbitration Panel
Zerodha rushed to an appellate panel to challenge the order of the arbitration panel.
However, this turned out to be tactical blunder because Zerodha got an earful for its poor practices.
The Appellate Panel (by majority) accused Zerodha of not undertaking proper due diligence of clients before registering them for derivative and high leverage transactions.
It was noted that while Prasad had an annual income of between one to five lakhs, he was allowed exposure amounting to Rs. 4 crore in the Tata Motors’ futures.
“It is concluded that appellant is not conducting proper due diligence of the clients, not assessing the financial and risk profile of the clients, profiling the risk bearing capacity of clients especially in derivative products. Respondent is allowed to take leverage position 80 times of his annual income,” the majority held, damning Zerodha.
Zerodha encourages rampant speculation
The majority of the Appellate Panel was clearly on the warpath against Zerodha.
They accused Zerodha of “encouraging heavy volume and rampant speculation and creating extraordinary turnovers”.
They advised Zerodha that it has to “guide and counsel” its clients as per their financial background and risk taking capacity in derivative products.
Clients should be advised of the risks and rewards associated with derivative products and complexities involved in derivative trading, it was held.
“Proper due diligence and client profiling is necessary for healthy and cordial business relationship between trading member and client,” the majority observed.
The majority worked out the loss suffered by Prasad at Rs. 28.95 lakh and ordered Zerodha to pay him the amount with interest.
Minority upholds Zerodha’s stand
However, all was not lost for Zerodha because Hon’ble Ms. A. M. Durga Kumari decided to defy her colleagues and dissented from their view.
Hon’ble Durga Kumari slammed Prasad for not monitoring the price movement of Tata Motors and accused him of displaying “lack of seriousness disregarding his high stakes in the stock”.
The dissenting arbitrator was also not impressed by Prasad’s defense that he did not receive the email and SMS.
She held that Prasad ought to have logged into his account on Zerodha’s website and ascertained the details himself.
“The basic and primary responsibility lies with the Respondent (Prasad) to take care of his investments. Being fully aware of the impending volatility of the Tata Motors on the 10th August 2017, he failed to monitor the status of his Futures Contracts of the said stock, in spite of having such high stakes and instead tried to shift his responsibility to the Appellant (Zerodha),” the lady arbitrator held.
“The Respondent (Prasad) could not explain as to why he did not make use of the web portal provided by the Appellant to know the status of his account. Instead, he made complaints like his phone did not work, a contract note was not received in email, and he was not conversant with Span marginal calculation and so forth. These ground are on thin ice and not maintainable, considering that he is a signatory to the internet agreement,” Durga Kumari held in a firm tone.
Prasad is a novice?
Hon’ble Durga Kumari further suggested that Prasad was a novice and “ought to have educated himself about the risks involved in Futures Market, the conditions, clauses, procedures and policies applicable and the usage of internet applications”.
She appears to have deep knowledge about the working of the markets because she rightly observed “the inherent trade risks in Futures Market, the mechanism and dynamics of Futures market need alertness and readiness to supply funds within very short notice and keen monitoring of stock prices on real time basis”.
Ultimately, she branded Prasad as a novice by holding that “his conduct in handling the matter clearly shows that he did not gear himself up to operate in Futures market” and did not act with the “required urgency and seriousness in the matter considering his heavy stakes in the stock”.
Zerodha was issued a clean chit and it was held that it was “professional and fair” in its conduct and that “the squaring off was required as per the parameters on which this market works”.
Novices should be disbarred from dealing in derivatives?
Keeping aside the legalities of the matter, it appears prima facie that Zerodha goofed up by allowing a novice access to complex derivatives products, even though these products have been described as “weapons of mass destruction” by none other than Warren Buffett.
Also, allowing a person with an annual income of Rs. 1 to Rs. 5 lakh to rack up exposure of Rs. 4 crore appears to be clear buffoonery on Zerodha’s part.
Hopefully, Zerodha will learn from the bitter lesson and either totally ban novices from dabbling in derivatives and/ or will educate them properly about the risks and rewards, as suggested by the Hon’ble Arbitration Panel!