Karvy Default: For Once SEBI Acts Quickly To Protect Retail Investors’ Interest
On Monday, 2nd December, the market regulator, Securities and Exchange Board of India (SEBI) asked NSDL (National Stock Depository Ltd) to transfer investors’ shares that were pledged by Karvy Stock Brokers Limited (KSBL), back to their respective depository (demat) accounts. This is an excellent move at a time when there is hardly any good news for the average saver. KSBL, one of the largest market intermediary and brokerage firms, had helped itself to investors’ shares held in demat accounts opened with it and pledged them to borrow heavily. The loans were transferred to Karvy group entities, mainly to a realty company.  
 
Karvy has borrowed money from a clutch of banks and finance companies—Bajaj Finance, HDFC Bank, Axis Bank, ICICI Bank, IndusInd Bank and Kotak Mahindra Bank, among others. Bajaj Finance rushed to the Securities Appellate Tribunal (SAT) against the directive today. SAT has ordered a stay on any further transfer of shares back to clients (this could affect over 7,000 of Karvy’s clients) and directed the regulator to hear the lenders’ concerns by tomorrow and pass orders by 10th December. KSBL owes Rs345 crore to Bajaj Finance and it has already issued a loan-recall notice to the firm.
 
All this is along expected lines. Corporate India, with their battery of expensive lawyers, is good at ensuring that the justice system works efficiently for them by getting stay orders or interim orders or simply delaying proceedings. It is rarely that the regulator shows the wisdom to go back to basics and act in line with its core responsibility. But its quick action on Monday evening ensured that the scale of equity, for once, was tilted in favour of retail investors, not forcing them to run from pillar to post to salvage their investments. 
 
Under the preamble of the Securities & Exchange Board of India Act, SEBI is mandated with three principal objectives. Of these, the first is “To protect the interests of investors in securities”; the other two are to promote the development of the securities market and to regulate it. 
 
At a time when the regulator has been rapped for closing investor complaints without even examining them, it is good to see SEBI put the interests of a large number of retail investors first by ensuring that shares, that were illegally pledged by Karvy, were returned to investors’ demat accounts.
 
The practice, so far, has been different. In a slow and unequal justice delivery system, the disaggregated retail savers (depositors or investors) are always the losers. The big players and their expensive lawyers not only dictate policy but, often, can steamroller courts as well. SEBI’s action, this time, has reversed the process and protected the small investor, even as multiple other issues are contested and thrashed out in court. 
 
The money involved is enormous—over Rs2,013.77 crore—belonging to 82,559 investors. The remaining investors (of a total of approximately 90,000-95,000) would get their shares credited after paying what is due to KSBL. Simultaneously, SEBI escalated its action against KSBL by suspending its trading licence with immediate effect.
 
For the banks and corporates, who are crying foul, the money recoverable from Karvy is hopefully less than the value of shares pledged. Most of them would have multiple business relationships with C Parthasarathy, Karvy’s promoter-chairman, and his group entities; so their ability to enforce their rights and recover dues is significantly higher. 
 
 
On 22nd November, SEBI cracked down on KSBL with a hard-hitting, ex-parte, interim order barring it from taking on new clients or using the Power of Attorney (PoA) provided by its clients. The order stunned the market, but answered the complaints of thousands of investors who weren’t getting their money back from the firm. The action was based on a fairly detailed investigation by the National Stock Exchange (NSE) which, prima facie, established that KSBL illegally pledged clients’ shares to raise funds. 
 
It did this by hiding facts from the NSE and NSDL by failing to report certain DP (depository participant) accounts and crediting funds raised by pledging clients’ shares to its own bank accounts which were further transferred to a realty company. 
 
Without going into details of how this was done in a digital environment, in a physical world it would mean that KSBL violated the trust of its clients and stole their shares.
 
 
According to the market scuttlebutt, it appears that some investors may not have been entirely unaware of what was going on; but we will come to that later. Karvy’s initial reaction was, interestingly, defiant; probably because it got away unscathed in the IPO scam of 2006 after a SEBI order was set aside by SAT. 
 
When Greed Rules
Coming to investors, sources say that some investors themselves have created the possibility of being cheated by their broker-DPs by allowing their shares to be pledged and earn from them. 
 
They were told how idle shares lying in a demat account could be turned into a source of income, by lending them, especially to make margin payments. They hence allowed their shares to remain in the broker's pool account, to be pledged as a pool. This opens the door to the possibility of brokers misusing the shares. A former SEBI official points out that “this works well when the broker pays interest regularly and the investors have no complaints. However, when the interest stops, many of these investors feign ignorance and play innocent victims.” 
 
Unless they can show that Karvy fudged information and did not send them regular reports, such investors, driven by greed, may end up paying for their foolish and risky behaviour. SEBI also is aware of this practice and had tightened the rules in June, requiring a tri-partite agreement with investors. Those who were party to it would be a different category. The investigation would also show whether banks had done their due diligence and ensured that shares they had lent against were recorded with the depositories. And whether they had sought an undertaking from KSBL that the shares belonged to it and were unencumbered. 
 
However, the bulk of investors may, indeed, be innocent victims; they now have their investment protected and the ability to move their business elsewhere. The episode, however, raises serious questions that need to be addressed quickly. 
 
Are Broker DPs Safe?
A former executive director at SEBI points out that brokers were allowed to become DPs to provide a seamless system and a one-stop service to investors. In practice, though, it has been a constant battle for investors to protect themselves from being cheated by market intermediaries.
 
The first major battle was the misuse of the mandatory PoA that brokers insisted as a requirement for online trading. These used to give brokers sweeping rights to investors’ money and were, often, misused to decimate their investment. Moneylife was part of this long battle all through a decade ago, to clean up the system. 
 
Over time, SEBI has come up with stringent rules to restrict misuse and ensure that investors receive information and alerts through multiple channels about transactions in their account as well as investments. 
 
Brokers are also forced to transfer excess funds available with them back to the client account every quarter. In June, SEBI said that clients’ shares couldn’t be pledged to raise funds after the Allied Financial Services episode. According to Business Standard, another three-dozen brokers are under SEBI’s radar.  
 
And, yet, KSBL with over 234,000 customers, could indulge in such brazen and criminal misappropriation of assets of a large number of investors. This shows that circulars and rules that cast an increasing burden on investors to be forever vigilant are not the answer. 
 
After all, it is SEBI which is relentlessly forcing even long-term investors to dematerialise shares. It has also failed to provide appropriate infrastructure to those who wish to hold physical shares to be able to dematerialise/ rematerialise them as required. 
 
So, the onus of ensuring that shares in DP accounts are safe has to be with the regulator; its inability to keep up with the ingenuity of fraudsters cannot be at investors’ cost. In this context, SEBI’s decision to move quickly and credit shares back to investors’ accounts is a heartening move in the right direction. 
 
(This article has been updated on Wednesday 9.45 with a few additional details)
 
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    COMMENTS

    Bipin Kochar

    5 days ago

    The Karvy case exposes the rot underlying our depository system.

    The pledges against shares are verified and implemented by the depositories.

    If these depositories fail to even validate the legality of the pledge, then they should be held accountable. Once a pledge is made, the depositories have no right to transfer underlying shares without having the pledge removed or declared invalid by an appropriate legal authority (which does not absolve them of the liability to clear the loans granted against the pledge).

    Furthermore, it is shocking that these same depositories allowed the transfer of shares from inactive accounts (of long term investors) to a third party account - SEBI must order any loss suffered due to such illegal transfers must be fully compensated by the depositories.

    N KANITKAR

    1 week ago

    Interesting and scary. What is not understood is how an NBFC or a bank can give loans to a DP who pledges shares not belonging to itself, i.e. retail investor's shares? Secondly, what does the PoA actually mean ? Is it possible for a retail investor to find out this malpractice from information available in public domain?

    REPLY

    VIVEK SHAH

    In Reply to N KANITKAR 6 days ago

    You'll get the answers in my comments below.

    VIVEK SHAH

    1 week ago

    While the current focus is on the broking community it would be prudent of SEBI to investigate PMS players too. The reason being that a lot of PMS players are DPs too and there is a possibility that the investor in PMS is kept in the dark about his actual holdings in his demat account because he/she is given access to the reports generated from their backoffice database and not the live demat accounts in NSDL/CDSL system. For safety reasons I would recommend a PMS customers to once in a while reconcile the security balances shown in the reports generated by the PMS backoffice database with the statements generated from the live NSDL/CDSL system. If a highly regulated intermediary like a Broker can commit such a fraud what can be said about a comparatively less regulated PMS industry.

    Vaibhav Dhoka

    1 week ago

    We in India have Rougue Jurisprudence system where there absolutely no accountibility, system works only for rich and mighty.

    Anil Kumar

    1 week ago

    As I understand with limited legal knowledge - the case throws up 2 contrarian points
    a) 'Holder in Due course' - Wikepedia defines it as - In commercial law, a holder in due course is someone who accepts a negotiable instrument in a value-for-value exchange without reason to doubt its legitimacy. A holder in due course acquires the right to make a claim for the instrument's value against its originator and intermediate holders. (I guess Banks and lenders will argue this line.)
    b) On the other hand - "a person cannot pass on the rights of a stolen property to a purchaser. The stolen property needs to be returned". (SEBI and the Retail account holders will argue this line.)
    If Karvy is unable to pay, someone is going to lose. Let us see which side the law rules.

    REPLY

    Bipin Kochar

    In Reply to Anil Kumar 5 days ago

    The depositories are ultimately responsible in either case as legally they are the custodians and are responsible to record the ownership and transfer of the shares.

    VASANT KULKARNI

    1 week ago

    PLEASE DO NOT STAY THE MATTER!!! ( BY ANY COURT IN INDIA)

    REPLY

    Mohan Krishnan

    In Reply to VASANT KULKARNI 1 week ago

    Very easy for powerful pvt. Banks to hire top lawyers to get verdict from High Court.

    Nakul Kumar Reddy

    1 week ago

    I will do anything for u ,give me clear direction

    Sandeep More

    1 week ago

    The practise of taking the Power of Attorney from the clients forcibly is fairly widespread. When I went to leading Pvt Banks to open a Demat Acct with them, I was told unless I accede to give them POA, my DEMAT ACCT WILL NOT BE OPENED. When I pointed out that it's not mandatory, they requested me to open my Demat Acct eldewhere. Many Pvt Demat Acct providers also refused. At last, I got in touch with a DP who was OK with my not providing POA, that too only when I threatened him with legal consequences. But the majority, esp the Banks have absolutely no fear of the Regulator

    REPLY

    Sucheta Dalal

    In Reply to Sandeep More 1 week ago

    It may be useful for you to read some of the links inside this column to understand issues of POA and demat. Also look up SEBI SCORES and file complaints.

    JOBBY

    In Reply to Sucheta Dalal 3 days ago

    My experience with SCORES tell me it is joke. From the response I received, it looks like it is manned by incompetent people. They behave like a post-office and not a regulator. They cannot comprehend the issue at hand and keep forwarding complaints to unrelated entities. I also wonder if they know the regulations they need to enforce. I had a case closed because the broker did not bother to respond after 4months. Another case, the officer closed case citing exactly opposite of what the regulated entity wrote. Another case I asked for a email so that my response which was longer that their system would accept can be sent, which is not yet provided since 4 months. The regulated entities know their incompetence and don;t hesitate to lie in their response since they know the people enforcing regulation don't know anything about the issue at hand. At the end of the day it an extension of government and people have permanent jobs.

    Sucheta Dalal

    In Reply to JOBBY 3 days ago

    why not write up details? If you notice SEBI was badly rapped in a recent case for doing this. If Moneylife Foundation has a dozen examples, one can take them up jointly. Think about it. Best

    S K Nataraj

    1 week ago

    I commend the action of NSDL in acting very swiftly. They have acted real fast unlike in times like 1999-2000, when they were clearly reluctant to take speedy action to protect their clients money ( shares).

    VINAY RANJAN RAO

    1 week ago

    For you information, Karvy has not transferred shares purchased by clients to their demat account. I had purchased shares of two companies on various dates in September 2019 and this is not reflecting in my demat account. The holding statement sent by the company shows these shares as lying in 'ben' account. Without it being relected in demat account I cannot transfer these shares to a demat account with another broker. There is no response from Karvy to my oral/ written requests. It may be that shares purchased by clients have been also pledged.

    REPLY

    Sucheta Dalal

    In Reply to VINAY RANJAN RAO 1 week ago

    There is no point putting information here sir. You need to file a formal complaint with the stock exchanges and SEBI (SCORES).

    VINAY RANJAN RAO

    In Reply to Sucheta Dalal 1 week ago

    Thank you for the reply. I am taking up with SEBI/SE. I only wanted to highlight that the scope of the Karvy scam extends to withholding credit to demat account of the client for shares purchased. These shares may have been kept in pool account and pledged to banks.

    P S Krishnan

    1 week ago

    The lenders, banks and finance companies were also accomplices to this fraud. How did they accept shares of investors without authorisation. They should lose in this transaction, and rightfully so.

    SURESH NAIR

    1 week ago

    This relief is for investors whose shares were pledged! But what about people like me who have sold shares and are yet to get the money? Sold shares on Oct 16 and Oct 29. I am owed around Rs 5.6 lakhs! What recourse do we have? Who will help us? Contacted Karvy several times and they keep saying that money will be credited to my account within 48 hours but it is never happens!

    REPLY

    Arun Adalja

    In Reply to SURESH NAIR 4 days ago

    Generally money comes within 2 days time and you are not aware of the exchange rules so karvy is not paying you now make complaint with exchange so they may help you.

    Sucheta Dalal

    In Reply to SURESH NAIR 1 week ago

    Again. Have you filed a complaint? Also, Moneylife is one of the few entities to run Moneylife Foundation. We find that most investors dont even make the effort to seek formal redress through official channels. Why keep banging on to Karvy when you need to file formal complaints with NSE, NSDL and SEBI so that they matter can be taken up?

    SURESH NAIR

    In Reply to Sucheta Dalal 1 week ago

    Yes I have filed a complaint with Karvy and NSE. Also with Moneylife Foundation (Legal Help) but yet to get a response from Moneylife!

    Karvy Stock Broking: SAT Asks NSE To Pass Order on Trading Suspension by 6th December
    The Securities Appellate Tribunal (SAT) has reportedly asked Karvy Stock Broking Ltd or Karvy to approach National Stock Exchange (NSE)'s disciplinary committee on revoking the trading suspension. Separately, the Tribunal also asked the Securities and Exchange Board of India (SEBI) to hear Bajaj Finance Ltd, a client of Karvy, and pass an order by 10 December 2019. SAT also ordered suspension of any further transfer of securities that Karvy Stock Broking had pledged with the lenders. Karvy has approached the SAT after NSE, Bombay Stock Exchange (BSE) and Multi Commodity Exchange (MCX) on Monday suspended its trading licence across all segments of equity, cash, commodities and currency on regulatory concerns. 
     
    According to a report from the Mint, after hearing Karvy's representation, NSE's disciplinary committee will pass final order on whether the trading suspension stays or is revoked by 6th December. The petition by Karvy against SEBI would now be heard on 13 December 2019.
     
    In a separate order, the SAT bench of Dr CKG Nair and justice MT Joshi, asked SEBI's whole-time member (WTM) to hear Bajaj Finance and pass an order by 10th December. Bajaj Finance has approached SAT contesting an order passed by SEBI on 22 November 2019 barring trading accounts of Karvy. 
     
    In its contention, Bajaj Finance, represented by senior counsel Janak Dwarkadas, says since  Karvy  violated certain clauses of their loan agreement and withdrew beyond the sanctioned amount, on 20 November 2019, it had issued a loan recall notice to the brokerage seeking refund of its full outstanding loan of about Rs345 crore, including interest and charges. Bajaj Finance was planning to invoke the pledge, however, on 22 November 2019, SEBI prohibited Karvy from transferring securities and the Bajaj group company could not invoke its pledge.
     
    In its order passed on Tuesday, the SAT says, "...we find that the impugned order notes that Karvy had raised funds pledging securities from banks and non-banking finance companies (NBFCs) and therefore was aware that rights of those entities would be impacted by the said order. As such, even if they could not be heard while passing the impugned order at least on their representation they were entitled to be heard...we are of the considered view that the impugned order has prejudiced and adversely affected the rights of the appellant as a bonafide lender." 
     
    Last month, market regulator SEBI found that Karvy Broking had illegally diverted nearly Rs2,000 crore of more than 95,000 clients’ shares to its own accounts. 
     
    Based on a preliminary report from NSE, the WTM of SEBI had issued an ex-parte ad interim order on 22 November 2019 restraining Karvy from taking new clients in respect of its stock broking activities and also prevented the brokerage from using the power of attorney (PoA) given by its clients. Later, on 29th November, the SAT asked SEBI to consider request of Karvy and pass appropriate orders. However, on the same day, SEBI disposed all contentions made by Karvy and barred the brokerage from using PoA of its clients. 
     
    In an email to its clients on Monday, Karvy had said, "All of you must be aware of the fact that the NSE and the BSE have suspended trading by us on all stock exchanges. We have received this communication from the NSE only at 8.27am, in the morning, and were informed that we have been temporarily suspended under rule 13 A (a) of the NSEIL Rules, with effect from 2 December 2019, on account of regulatory concerns. We are yet to receive a show cause notice from them, and we propose to respond to the show cause notice appropriately. The BSE has also sent an intimation to us about the suspension of trading. We are approaching the SAT to intervene." 
     
    Last month, investors across the country complained on social media to the prime minister's office, (PMO), finance ministry and market regulator, SEBI, seeking their payouts.
     
    Reports suggest that Karvy is facing a liquidity crunch due to a number of bad client trades on castor seeds. The Hyderabad-based financial services group is facing liquidity problems as some clients have defaulted on payments after incurring huge losses on trades in castor seed contracts. The payments contagion now seems to have spread to other investors who are complaining that Karvy is not making the payments.
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    COMMENTS

    sudhir apte

    1 week ago

    How is it that company of BF's repute didn't properly scrutinized the security offered by Karvy? Is greed of higher returns getting to them also? Whom should the investors look up to as safe bets? I don't think decision will go in favour of BF. Recovering their money from Karvy is not going to be easy.

    REPLY

    Bipin Kochar

    In Reply to sudhir apte 5 days ago

    The depositories are responsible for verifying and honoring all contracts or pledges.

    Nakul Kumar Reddy

    1 week ago

    Parthasaradhy sir told me that today evening is the dead line ,after that we will do our work .

    Sandeep More

    1 week ago

    All the signatories to the transaction have to be penalised heavily, though personally and sentenced to rigorous imprisonment without handing over the usual adjournments for decades

    Onkarnath Adiga

    1 week ago

    Unbelievable breach of client's trust. Should be dealt with iron hands without any leniency. Advise Karvy to help existing client to transfer securities to some other DPs.

    Nakul Kumar Reddy

    1 week ago

    Suspend right now,useless people
    Notorious criminals ..

    RBI moves NCLT seeking insolvency process against DHFL
    The RBI on Friday filed an application in the National Company Law Tribunal's Mumbai bench for initiation of corporate insolvency resolution process against the cash-strapped Dewan Housing Finance Corporation Ltd (DHFL).
     
    There would be a debt moratorium on DHFL as long as the insolvency process undergoes, an Reserve Bank of India (RBI) statement said.
     
    The apex bank filed the application for initiation of corporate insolvency resolution process against DHFL under several clauses of Section 227 and Section 239 of the Insolvency and Bankruptcy Code, 2016 along with few rules under the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers) Rules, according to the statement.
     
    The move comes a week after the RBI appointed an advisory committee to advise the administrator of the private sector DHFL. On November 20, it had superseded DHFL's board of directors and appointed R. Subramaniakumar as its administrator. 
     
    Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article.
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    COMMENTS

    Dillip Swain

    2 weeks ago

    arrest dhfl management.

    Nakul Kumar Reddy

    2 weeks ago

    File case against them, I will give u full support .
    They want money only .
    File case.

    We are listening!

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