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)
5 years ago
Karvy service has been a pain in the neck right from early 2000. When I found they were not responsive I shifted to another broker in 2003. Another suspicious thing which I noticed was right from 1999 to 2015, I used to get holding statements regularly. However, after 2015, every type of communication from them stepped. They even stopped reminders about DP fees for demat accounts. I have demat accounts of all my family members. But luckily, after shifting to the other broker, I kept only some illiquid stocks in my Karvy demat account. From 2015 till 2019, I spoke to about a dozen employees, sent emails to them, but they never responded. I have no hesitation in labelling them as the worst brokerage in India. The main boss should be jailed since their actions are criminal in nature.
Bipin Kochar
5 years 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.
5 years 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?
Replied to N KANITKAR comment 5 years ago
You'll get the answers in my comments below.
5 years 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
5 years ago
We in India have Rougue Jurisprudence system where there absolutely no accountibility, system works only for rich and mighty.
Anil Kumar
5 years 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.
Bipin Kochar
Replied to Anil Kumar comment 5 years 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.
5 years ago
Mohan Krishnan
Replied to VASANT KULKARNI comment 5 years ago
Very easy for powerful pvt. Banks to hire top lawyers to get verdict from High Court.
Sandeep More
5 years 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
Sucheta Dalal
Replied to Sandeep More comment 5 years 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.
Replied to Sucheta Dalal comment 5 years 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
Replied to JOBBY comment 5 years 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
5 years 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).
5 years 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.
Sucheta Dalal
Replied to VINAY RANJAN RAO comment 5 years ago
There is no point putting information here sir. You need to file a formal complaint with the stock exchanges and SEBI (SCORES).
Replied to Sucheta Dalal comment 5 years 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
5 years 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.
5 years 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!
Arun Adalja
Replied to SURESH NAIR comment 5 years 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
Replied to SURESH NAIR comment 5 years 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?
Replied to Sucheta Dalal comment 5 years 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!
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