Market regulator Securities and Exchange Board of India (SEBI) has penalised stock exchanges—Bombay Stock Exchange (BSE) and National Stock Exchange (NSE)—for "laxity" on their part in detecting the misuse of clients' securities worth Rs2,300 crore by Karvy Stock Broking Ltd (KSBL).
In two separate orders, SEBI has imposed a fine of Rs3 crore on BSE and Rs2 crore on NSE.
The matter relates to KSBL misutilising client securities worth Rs2,300 crore, belonging to more than 95,000 clients, by pledging them from just one demat account. The funds raised against the pledge were used by KSBL for itself and its group entities. The scale of misuse by Karvy points to the loss to investors which can potentially be caused when irregular conduct is not detected on time.
KSBL and its group entities utilised this money for raising Rs851.43 crore from eight banks and non-banking financial companies (NBFCs).
"Without doubt, it was KSBL which misused clients' securities by unauthorisedly pledging them, and was thus responsible for loss caused by pledging securities which it did not own, including loss to investors as well as loss to banks and NBFCs who loaned funds to KSBL against securities which did not belong to KSBL," as per the orders passed by the market watchdog on 12th April. SEBI added that the exchanges had a 'casual approach' while scrutinising Karvy in the previous years.
SEBI noted that KSBL, being member of BSE and NSE, was under regulatory supervision of the exchanges. “There was laxity on the part of exchanges, which resulted in delayed detection of the misconduct by KSBL and the bourses need to be held accountable for the same,” SEBI stated.
While adjudging quantum of penalty under Section 15-I, SEBI took into consideration the following factors :
a) the amount of disproportionate gain or unfair advantage, wherever quantifiable, made as a result of the default;
b) the amount of loss caused to an investor or group of investors as a result of the default;
c) The repetitive nature of the default.
Accordingly, the market watchdog has imposed penalties on the two exchanges for the delay in detection of misuse of client securities by KSBL.
The orders come after SEBI along with NSE and BSE conducted a joint inspection of KSBL from June 2019.
The market regulator had checked the details of the inspection as well as action taken by the exchanges against Karvy conducted between 2016 and 2019. SEBI further asked the BSE and NSE to furnish the procedure they followed to ascertain the reconciliation of clients' securities.
The market regulator identified lapses on the part of both exchanges. SEBI had, in 2019, passed an ex-parte ad-interim order against Karvy when the issue came to light. Following the efforts by SEBI, exchanges and depositories, the brokerage firm's clients recovered their dues.
Subsequently, a forensic auditor was appointed by NSE and preliminary report was forwarded by it to SEBI in November 2019, based on which the regulator passed an interim order and then confirmatory order on the non-compliances observed with respect to the pledging/misuse of client securities by KSBL.
In its 2019 order, SEBI had directed depositories to allow transfer of securities from the one demat account to respective beneficial owners who had paid in full against the securities under the supervision of NSE. Following the market regulator's order, securities were returned to clients.
In December 2019, National Securities Depository Limited (NSDL) had announced that securities were returned to 82,559 clients from the KSBL demat account. Further, NSE, in November 2020, had said that funds and securities worth Rs2,300 crore belonging to KSBL investors were settled.
Following the brokerage firm's probe, SEBI changed rules around pledging of shares to thwart misuse by brokers. The markets regulator removed the concept of power of attorney that earlier authorised brokerages get access to client securities.
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