In a major setback to lenders, the Securities and Exchange Board of India (Sebi) has said lenders — ICICI Bank, HDFC Bank, IndusInd Bank and Bajaj Finance — did not verify the title of securities unauthorisedly pledged by Karvy Stock Broking (KSBL) and they merely relied on the representation of KSBL while giving loans to the broking firm.
Sebi had, in a late evening order on Friday, rejected the plea of lenders to return the clients’ shares pledged by Karvy. The regulator also suggested that the remedy for lenders “lies against KSBL before civil court of competent jurisdiction”.
“It cannot be said that representors (lenders) acted in good faith as required under Section 178 of the Indian Contract Act, 1872,” Sebi said. “The issue whether lenders have exercised proper due diligence or has complied with applicable laws pertaining to loans against shares, can be looked into by the concerned regulator, if so deemed fit. KSBL was not authorised to pledge securities,” it said.
The big question is: why did lenders give funds to Karvy without checking the status of collateral (title of pledged securities)?
According to Sebi, such pledge did not pass any title as KSBL was not the owner of the securities. “Thus, KSBL did not pass any title or interest in these securities to the representors as KSBL itself was not having any title to such securities. The principle that holder in due course gets good title applies in case of negotiable instruments like cheques, bills of exchange, promissory notes, etc. where the holder is for consideration and without notice of the defect in the title of transferor. The said principle is not applicable in respect of goods/shares i.e. other than negotiable instruments and reliance placed on the same for unauthorised pledge is wholly misplaced,” Sebi said while rejecting the plea of lenders. On November 22, Sebi barred Karvy from taking new brokerage clients and also prevented it from using the power of attorneys given by its clients after the brokerage was found to have allegedly misused clients’ securities and pledged them with banks to raise funds.
Banks and finance companies have Rs 1,415-crore exposure to Karvy Stock Broking through the loan against securities funding route. ICICI Bank has the maximum exposure of Rs 875 crore which was created only on October 1, 2019. IndusInd Bank has an exposure of Rs 105 crore, HDFC Bank Rs 195 crore, DCB Bank Rs 55 crore and Axis Bank Rs 85 crore, according to RoC filings.
According to Sebi, the current investments mentioned in the balance sheet of KSBL for the FY2018-19 shows that KSBL was showing securities valuing Rs 27.79 lakh only. Similarly, KSBL was holding securities worth
Rs 28.01 lakh, as on March 31, 2018 and securities worth Rs 35,143 as on March 31, 2017, whereas the lenders together have extended loans, against shares having value to the extent of Rs 2,873 crore as on September 16, 2019 which later reduced to Rs 2,319 crore as on November 19, 2019.
“In the absence of corresponding trade instruction, pledging of securities of such clients is also unauthorized and hence, in law not treated as valid pledge. Reliefs sought by the representors are not tenable and the remedy for the representors lies against KSBL before civil court of competent jurisdiction,” Sebi said.
Last week, the National Securities Depository said nearly 90 per cent — 82,559 — of duped investors got back their securities and the remaining ones would get their securities after clearing their dues, forcing Bajaj Finance to move the SAT. Private sector banks joined the Bajaj Finance petition against transfer of shares to investors later. SAT told them to move Sebi again for a suitable order. As most of the shares were kept as securities for loans given by banks to Karvy, any “unilateral” transfer of shares to investors will have a major impact on their lending business, banks said.
The NSE which submitted a report to the Sebi observed that KSBL has misused power of attorney given by its clients. “KSBL has sold client securities in the market in disguised manner through own controlled entities and used the funds for its own purposes. KSBL in order to hide its misdeed has not even reported the DP account (No. 11458979) in the submissions made by it to the NSE from January 2019 to August 2019. It is only during inspection by NSE, this account came to the notice,” Sebi said. KSBL transferred a net amount Rs 1,096 crore to its group company Karvy Realty between April 2016 and October 2019.
On December 2, the NSE and the BSE suspended Karvy Stock Broking’s trading licence for all segments due to “non-compliance of the regulatory provisions of the bourses”.