On November 22, the Securities and Exchange Board of India (Sebi) banned Karvy Stock Broking Ltd (KSBL) from taking fresh business for allegedly misappropriating money and securities belonging to its investors in order to fund its real estate arm, Karvy Realty.
While Sebi says Karvy transferred Rs 1,096 crore to its real estate business, market estimates say the sum involved could be around Rs 2,000 crore. The regulator is learnt to be also looking into similar manipulation involving thousands of crore by several other broking houses, which could potentially create a crisis of confidence in the stock market.
What has Karvy done?
Sebi has moved against Karvy for violating norms, including transferring client shares to itself, and pledging client shares to raise money, which it diverted to its real estate arm. Many of Karvy’s over 2.40 lakh clients have complained to the regulator about money and securities not coming to their trading accounts. Karvy allegedly misused client accounts without informing them, or reporting to the depository or the stock exchange.
Securities lying in Depository Participant (DP) accounts belong to clients, who are their legitimate owners. KSBL had no legal right to create any pledge on those securities. If at all client securities are pledged, it should be done only in order to meet the obligations of the respective clients.
In a report submitted to Sebi, the National Stock Exchange of India (NSE) said that KSBL misused the power of attorney given by its clients to clandestinely sell client securities through entities controlled by it, and used the funds for its own purposes.
To hide its misdeed, KSBL did not report the DP account (No. 11458979) in its submissions to the NSE from January to August 2019. This was detected only during inspection, the NSE said.
How much money was involved?
The Sebi order said a net amount of Rs 1,096 crore was transferred by Karvy Stock Broking to Karvy Realty. However, the scam is likely to be worth about double that amount, or even more — the NSE’s preliminary probe of August 19, was carried out with a limited purpose, and covered only the period from January 1, 2019 onward.
While customers are looking to the stock exchanges for the money and securities allegedly siphoned off by Karvy from their accounts, Sebi is reportedly investigating similar diversions of funds from clients accounts by other broking houses. The Sebi (Stock-Brokers and Sub-Brokers) Regulations, 1992 specify that the stock broker must “segregate his own funds or securities from the client’s funds or securities”, and must not use “the securities or funds of the client for his own purpose or for purpose of any other client”.
So, how does this system work?
Big stock brokers such as Karvy, finance companies, and banks offer online trading on both the NSE and the Bombay Stock Exchange. These brokers have trading platforms that allow their customers to trade online in equities, buy debt papers, mutual funds, commodities, and currencies, and participate in public issues. The client opens a demat account with a depository and a bank, and in some cases gives power of attorney to the broking firm to act on their behalf.
The securities received in pay-out, against which payment has been made by the client, should be transferred to the demat account of the client within one working day of the pay-out. Securities kept in the ‘client unpaid securities account’ should either be transferred to the demat account of the client upon fulfilment of the client’s funds obligation, or should be disposed of in the market within five trading days after the pay-out.
Were there any regulatory gaps?
Sebi tightened the relevant portions of its 1992 Regulations further through a circular on June 20, 2019.
It said: “With effect from September 1, 2019, clients’ securities lying with trading members/clearing members… cannot be pledged to banks/NBFCs for raising funds even with authorization by client.” Also, clients’ securities already pledged shall be unpledged by August 31, 2019, and returned to the clients after fulfilment of pay-in obligation.
The circular said that in case of default on payment by a client, brokers will have to hold the securities for up to five days, after which they can liquidate the securities.
Both the stock exchanges and Sebi had, in fact, begun to tightening norms for brokers several months ahead of the June 20 circular.
In December 2018, Sebi standardised books of accounts and records in order to make it easy to carry out inspections and compare. The following month, brokers were asked for weekly reports of day-wise securities and balances of clients, International Securities Identification Number (ISIN), and DP accounts.
In March 2019, a reconciliation exercise of matching depository records and exchange records was started. Between April and June, Sebi directed the depositories — National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL) — and depository participants to provide pledged details of all brokers.
A leading market expert said Karvy had carried out a “robbery” by breaking laws and norms. This expert likened Karvy’s action to a promoter of a bank withdrawing depositors’ money for personal use.
Industry sources said it is no longer possible for brokers to pledge clients’ securities except with the Clearing Corporation of India (CCIL) and clearing members — that is, within the exchange system. Cases of pledging outside the system date from the period prior to Sebi’s June circular, they said.
Will investors lose money?
While Karvy allegedly misused securities of thousands of its investors, industry sources say as of now, there is no default — and the value of securities pledged is more than the money taken out by the broker. Government sources confirmed that investors’ money will not be lost.
Market sources said in case the funds available with Karvy are insufficient, investors may get their money through NSDL insurance, or from the Investor Protection Fund (IPF) set up to guard against default by members of exchanges (brokers).
However, some exchange officials told The Indian express that the IPF cannot be used to make good investors’ losses, if any, in this case because, even though securities were taken out and pledged, there was no trade — and “IPF money can only be used in case a trade has happened”.
Don’t miss from Explained | Lok Sabha Speaker and unruly MPs: What House rules say
📣 The Indian Express is now on Telegram. Click here to join our channel (@indianexpress) and stay updated with the latest headlines