Karvy Securities Fraud – Is this the end?

Karvy Securites Fraud

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The Securities and Exchange Board of India (SEBI) imposed a ban on Karvy from executing trades and adding new clients. The ban came after clients filed a mistake of the stock broker’s default on payments with the Prime Minister’s Office (PMO). The finance ministry and SEBI barred Karvy for alleged misuse of the client’s funds of Rs. 2000 crore and then defaulting on the payments of clients of the same amount.

Securities and Exchange Board of India (SEBI) headquarters

In terms of client accounts, Karvy stock broking is one of the largest brokers in the country. According to NSE released the data, as of 31 October, the broker had approximately 2.5 lakh clients. However, despite these strong numbers, the regulator took this rare move and passed the ad-interim. SEBI issued this ex-parte order against the Karvy so as to protect market integrity and save investors from any further loss.

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How the Ban Will Impact Karvy?

The brokerage firm cannot generate funds and create more pledges on client securities in addition to the extent of 2000 crore. “Over the conduct, unauthorized use of the client’s funds creates a serious doubt”, said by SEBI and “also the integrity of KSBL”. This has been one of the largest cases of broker default despite numerous regulations and equity segments.

The client security and money were used by Karvy stockbroking for its own purposes. In the ex-parte order, SEBI directed a forensic audit to be conducted over this default of Rs 2000 crore. Besides, is also directed both the depositories as well as exchanges to initiate disciplinary proceedings against the brokerage firm. The broker, Karvy Stock Broking Limited, is prohibited from taking any more clients for its stockbroking business until the time investigations are complete while NSDL and CDSL will be looking forward to preventing any further misuse of clients’ securities.

The Origin of the Case

NSE received complaints from the investors regarding the irregularities with their Demat accounts on the behalf of the broker. An inspection was carried out in 2019, the report of which showed that Karvy stock broking had transferred the shares from 156 of its clients. It was found that the stockbroker had transferred all the shares in the Demat accounts that were not traded or were dormant during the year.

On this, Karvy stated that its modus was simple. It further added that the shares transferred by the broking house were the ones from the inactive Demat accounts of its clients. Those Demat accounts were controlled by the broking house, the shares of which were then pledged to raise funds with the banks. And, the funds that have been mentioned as used by Karvy for its own purposes are stated to be transferred to its real estate arm, Karvy Realty.

Initial Inspection Report and Action

After its limited purpose inspection conducted on Karvy, the NSE prepared a preliminary report on 19 August. The regulator stated the need for urgent intervention with a justification that the ban was necessary to prevent further misuse of the securities of its clients.

SEBI directed the depositories to monitor the movement of securities from and into the DP account of clients held by KSBL. Besides, they should also ensure that as DP, the client’s operation is not affected. The order noted that the securities lying in the aforesaid DP account belong to the clients who are legitimate securities owners and not to Karvy. So, on these securities, KSBL did not have any legal right to create any sort of pledge and hence, this act is being considered as an act of fraud.

While the SEBI order has put forward the argument that the broker had generated a fund and created a pledge on the securities despite having no legal right, it couldn’t have been observed as a case of fraud if the clients’ securities have been pledged after taking due obligation from each of its clients. However, since KSBL didn’t take any obligation, the issue is considered for the misuse of the client’s securities in an unauthorized manner. And, it is also found that Karvy did not disclose the DP account no. 11458979, named Karvy stock broke Limited (BSE) on purpose.

Karvy Securities Fraud

Further Investigation

On the non-compliances, NSE forwarded a preliminary report to SEBI that covered details of the misuse and pledging of client securities by KSBL. NSE also stated that a detailed report will be submitted soon. KSBL has sold the excess of securities that are not available in the DP account now. The total amount of securities sold amounts to Rs 485 crore till 31 May 2019 through nine related clients. Out of these nine related clients, KSBL also transferred the securities to six clients, a total amount of Rs. 162 crore, till 31 May 2019.

It was observed on subsequent verification that securities worth Rs. 257.08 crore were pledged on the behalf of 4 other clients in addition to the aforesaid nine. Securities worth Rs. 217.85 crore had been recovered by KSBL from four out of nine client accounts. This amount was unpledged during the period of 1 June 2019 to 22 August 2019.

However, from 1 June 2019 to 8 September 2019, KSBL also purchased securities of amount Rs. 228.07 crore from five out of the nine client accounts. To recoup the securities’ shortfall, KSBL had undertaken the purchase or recovery of securities. From 1 April 2016 to 19 October 2019, KSBL transferred the net amount of Rs. 1096 crore to Karvy Realty Private Limited i.e. its group company.

21 days are given to the Karvy stockbroking to file its responses and objection to SEBI. But the period of inspection is limited only to 2019, so the size of the scam is expected to jump.

Karvy’s Response on This

In response to the report on the case of fraud, Karvy has denied its involvement in any misuse of its client’s securities. They said, on behalf of their existing clients as per the instructions, there is no way to prevent them from continuing to transact business for investors’ best interest. Further, the market regulator order is temporary in nature and a permanent one is expected in the near future.

What should existing customers of Karvy do?

If you are currently holding an account with Karvy Stock Broking, it is advisable that you open a new Securities with another broker and transfer all your idle funds in that account. However, given the current circumstances and the immense scrutiny from other depositories to monitor client funds, it could be a very slow process. Hence it is advisable to transfer your idle funds to your own bank account immediately.
Those who are suspecting suspicious activity in their accounts like transfer of their own securities holdings into Karvy’s accounts need to file a complaint with SEBI. You can get started by clicking here

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