SEBI banned Karvy Stock Broking from taking new clients and executing trades on behalf of the existing ones.
Karvy is one of the largest stockbrokers in India with over 2,50,000 clients.
[For the uninitiated, the stockbrokers serve as an intermediary in the stock market. They buy and sell shares (securities) on behalf of the investors. SEBI banned Karvy]
Why was Karvy banned?
Karvy Stockbroking was banned because:
- It used shares of its client as collateral to borrow money from banks. It pledged securities of over 95000 clients worth Rs.2300 crores with 3 banks and one NBFC to raise a loan worth Rs.600 crores.
- It sold clients securities that were pledged to it without using the services of the stock exchange (also known as off-market transfer). It sold pledged client shares via off-market transfer amounting to Rs 228.07 crore in 2019. [The securities that the clients pledge to the broker as collateral, are also known as excess securities.]
- It credited the funds raised to its own bank account instead of the client’s account. (stockbroker account instead of stockbroker client account)
- It diverted the money to fund its real estate business. An investigation by the National Stock exchange (NSE) in August 2019, revealed that Karvy transferred a net amount Rs 1,096 crore to its group company Karvy Realty between April 2016 and October 2019.
- It transferred stocks from the clients to its own Demat account.
In order to hide the above misuse of funds and securities, Karvy is also accused of not reporting the existence of a Demat account (DP account no. 11458979) in the submissions made to NSE from January 2019 to August 2019.
[To appreciate the above- if an investor has to trade in the stock market, he has to make a Demat account with a Depository Participant. Then, the investor gives a power of attorney to the broker to buy and sell shares from the Demat account on his behalf. Karvy misused this power of attorney by pledging its clients’ securities ]
How did SEBI find out about the scam?
The National Stock Exchange (NSE) found several discrepancies in an annual inspection carried out in August 2019.
Also, many of its clients had complained about the money and securities not coming into their accounts.
In June 2019, SEBI had issued a circular that stockbrokers would not be allowed to pledge its clients’ securities for any purpose. The collateral would have to be provided by their own assets. The stockbrokers were given a timeline of 3 months to comply.
But, stockbrokers have clearly found it difficult to follow the orders.
The NSE has appointed EY India Ltd to analyse Karvy’s transactions to ascertain if there was a diversion of funds. Also, the SEBI has directed stock exchanges and depositories to initiate disciplinary action against Karvy.
The SEBI is also investigating other broking firms for similar misappropriations. If this practice turns out to be widespread, it will lead to a serious trust deficit in the relationship between an investor and the broker.
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