Karvy Stock-Broking Scandal

Karvy Stock-Broking Scandal

Introduction:

The story of how Karvy, a stock broker, deceived clients and collected an astounding Rs 1200 crore to invest in real estate, was widely reported in the media. Let’s first review the fundamentals, such as what stock broking is, before delving into the details of the Karvy Stock Broking Scandal, its effects on the Investment Industry, and what transpired before and after. A stockbroker is who? A Demat Account: What Is It? What is a loan against securities, and what is the trading lifecycle?

• Retail investors in India must use a middleman, referred to as a stockbroker or depository participant, to help execute and electronically account for their transactions rather than buying or selling shares directly on the stock exchange.
• Unlike the past, when actual share certificates were produced, electronic accounting takes place in a Demat account. In 1996, the physical certificates were replaced by electronic records of transactions.
• Demat accounts function similarly to bank accounts and are associated with depositories, of which there are only two in India: NSDL (National Securities Depository Limited), which deals with the National Stock Exchange (NSE), and CDSL (Central Depository Securities Limited), which deals with the Bombay Stock Exchange (BSE).
• The Securities and Exchange Board of India Act (SEBI), 1992 governs stockbrokers in India, and brokers are required to register with the Securities and Exchange Board of India.
• Stock broking is a service that allows individual individuals, or institutional investors as well, to purchase and sell shares with the assistance of a stockbroker, an intermediary who charges a commission for their services.
• A stockbroker must sign a Delivery in Slip to register the stocks in a demat account in order to act on behalf of investors following each market transaction. Today, when you create a Demat Account, a Power of Attorney is signed, allowing brokers to act on their own behalf and simplifying the procedure.
• The Securities and Exchange Board of India provides rules that govern the management and regulation of the stock market’s operations as well as those of stockbrokers.

The function of depositories

• Depositories are the organizations that electronically retain securities, such as mutual funds, shares, and debentures, in a form known as a Demat Account.
• Depositories maintain track of daily transactions and are the guardians of the securities.
• Depositories offer a means for transferring money as well as security and liquidity.

Participants in the Depository’s Role

• Investors who wish to purchase or sell shares, debentures, or mutual funds should go via Depository Participants, who function as intermediaries between the depository and its clients.
• To become a Depository Participant, the institution must be certified in accordance with the 2018 SEBI requirements.

Brief Facts of the case:

A methodical money robbery of Rs 2800 cr in form of stocks was committed against investors between April 2016 and October 2019. 

As it began serving as a middleman for individual investors looking to make stock market investments, Karvy Stock Broking Company quickly rose to prominence as one of the most well-known retail brokerage companies. 

Investors began selecting Karvy for their stock transactions and stock conversions to Demat accounts due to its widespread use and rapid expansion. 

Without the investors’ knowledge or approval, the securities they had placed in the company’s confidence were illegally exploited to get many bank loans, while also misusing the attorney’s power they had granted.

These loans are said to have been taken out to finance their real estate business, Karvy Realty.  The stockbroking business did not have the legal authority to interact with the Depository Participant accounts where the securities utilized for the loans were taken from. These accounts were designed exclusively to fulfil any mandatory obligations that customers had to fulfil.

In order to present the shares as securities and obtain financing against them, the company transferred the shares to a different Demat account under the name Karvy Stockbroking BSE. The pilfered money was never disclosed in reports filed with the National Stock Exchange in order to avoid detection.

How was the con carried out?

The brokerage company moved shares from its clients’ inactive demat accounts into its own demat account, Karvy Stock brokerage (BSE), and presented these equities to lenders as its own assets as security for taking out loans.

When and how was it discovered?

Brokers were prohibited from using client securities as collateral for loans to themselves, as per a circular released by markets regulator Sebi on June 20, 2019. This was a long-standing custom in the industry.

Brokers were required by law to separate client money and securities by September 30, 2019, however investors protested to Sebi when KSBL failed to meet this deadline. Sebi then requested that the NSE look into the problem.

What steps did the regulatory bodies take?

KSBL was prohibited from providing brokerage services by an order issued by Sebi on November 22, 2019. The order said that the business had transferred Rs 1096 crore to Karvy Realty, a group entity, between April 2016 and October 2019. Along with working closely with stock exchanges and depository participants (DPs) to swiftly return some of the fraudulently transferred securities to investor accounts, Sebi also urged NSE to perform a thorough forensic examination. The Registrar of Companies (RoC), Hyderabad, was also instructed by the Union Ministry of Corporate Affairs to look into the financial fraud of the Karvy group in January 2020.

How about remuneration for investors?

Soon after the fraud was exposed in December 2019, Sebi collaborated with stock exchanges and DPs to re-integrate the stocks of about 83,000 of the approximately 95,000 KSBL clients who had been the victims of the scam into their individual accounts from Karvy’s demat account.

About 2.4 million KSBL investors with fund balances of up to Rs 30,000 received settlements of Rs 2,300 crore, according to a November 2020 statement from the NSE. As part of attempts to compensate investors, Sebi ordered that in early 2021, KSBL sell off its trading accounts to Axis Securities and it’s demat accounts to IIFL Securities.

Timeline of events:

2019

• November 22 | Exparte order prohibiting Karvy Stock brokerage Ltd (KSBL) from engaging in brokerage services is issued by markets regulator Sebi
• November 26 | C Parthasarathy, CMD of Karvy Group, leaves the board of Karvy Fintech, subsequently rebranding as K-Fin Technologies
• December 2 | In compliance with Sebi’s directives, NSDL and NSE return stocks valued around Rs 2,300 crore belonging to approximately 83,000 KSBL customers to their accounts.
• December 2 | For violating compliance standards, KSBL is suspended by NSE and BSE from all market sectors.
• December 4 | SAT rejects the request by KSBL lenders to retrieve the securities that were returned to clients so that the pledge may be triggered.
• December 14: Sebi denies KSBL lenders relief; December 31: Karvy Group begins corporate restructuring and management reorganization as a damage control measure.
• December 31 | Karvy Group appoints Amitabh Chaturvedi as CEO of the financial services division and begins a corporate restructuring and management reorganization as a damage control measure.

2020

• January | The Karvy Group affairs inquiry is ordered by the Union Ministry of Corporate Affairs (MoCA).
• August 27 In the aftermath of the demat scam, the Telangana High Court has dismissed writ petitions filed by the Karvy Group contesting SFIO & RoC investigations into financial issues.
• November | Approximately 2.4 lakh KSBL investors with fund balances of up to Rs 30,000 get a settlement from NSE worth Rs 2,300 crore.

2021

• February | KB’s trading and demat accounts are auctioned by depositories and stock exchanges to IIFL Securities and Axis Securities, respectively.
• April | IIFL Securities begins to activate the 11 lakh frozen Karvy demat accounts that were held by NSDL and CDSL, with assets under management valued at Rs 3 crore.
• August 19 | Based on an Indosind Bank debt default allegation, C Parthasarathy, the chairman and promoter of the Karvy Group, was detained by the CCS of the Hyderabad police.

What caused the Karvy Scam to occur?

Investors are made aware by the Karvy Scam that their money is not just invested but also at danger, in addition to money kept in banks. It’s not just about what SEBI does to safeguard you as an investor; it’s also about what you do to control the largest cycle—a universe unto itself. It’s a vicious cycle that, if it breaks, could spread like a virus and plunge the entire world into an economic slump. a depression that has the power to transport us back to our ape-human evolutionary history.

The stupidity of those who fall for a scam is what causes them to occur, not the cunning of the scammer. It only occurs when you become careless or put your faith in someone without question. Let’s examine the four main reasons behind the Kary Scam. It took place as:

• By improperly using the Power of Attorney that its clients gave it in order to facilitate transactions, Karvy violated the law in bad faith.
• Clients are given complete access in Power of Attorney without having to connect their Demat Account to the Depositories in order to determine their true account shares.
• Financial institutions have never questioned the legitimacy or authority of the share ownership.
• Since investors never questioned or were aware of the dates for settlement or market operation, Karvy was effective in postponing compensation.

What is Attorney’s Power?

• An instrument known as a Power of Attorney confers legal authority to act on behalf of another party in both financial and non-financial contexts. Consequently, trading tasks are carried out via a Demat account.
• SEBI states that while a power of attorney is not required, investors must continue to sign the Delivery Instruction Slip, which functions similarly to a check, in order to withdraw shares. This is only to make things easier.
• A Demat Power of Attorney ought to be particular, granting Depository Participants no decision-making authority regarding investments and limited to the removal of shares upon sale or the pledge of security to cover the shortfall in margin required for trading derivatives, subject to the requirement that consent be obtained first. By restricting the rights, you protect yourself from becoming a victim of any future disasters.

Guidelines issued by SEBI:

• Payment must be made within a day or in accordance with the market settlement cycle to the shareholder’s Demat account.
• According to SEBI, signing a Power of Attorney (POA) is not required, but if a shareholder does so, he should clearly outline all the powers that the stockbroker is able to execute as well as the duration of the POA’s validity.
• Rather to completing POA, shareholders have the option to sign up for Depositories’ online programs, Speed-e and Easiest, which allow for the online delivery of securities.
• Shareholders must make sure they obtain the Statement of Account from the Stockbroker at least once per quarter and the Contract Notes within 24 hours following trading.
• It is important for shareholders to understand that the securities they give for margin cannot be pledged by your stockbroker in order to raise money.
• If a shareholder chooses a running account, he or she must make sure the stockbroker settles the account on a regular basis, ideally within 90 days (or 30 days if the shareholder has chosen a 30-day settlement).
• Don’t leave money or securities with the stockbroker unutilized. Whenever possible, move the surplus to your savings account.
• Regular account logins are advised for shareholders to ensure that the Demat statements they get from depositories are accurate and that their balances are right.
• Every month, always review the communications you receive from exchanges about the funds and securities balances that the trading member reported. If you see something seems off, let them know right away.
• Always maintain your contact information, such as your email address or mobile number, up to date with your stockbroker. If you are not getting notifications from exchanges or depositories on a regular basis, bring up the issue with the stockbroker or exchange.
• Take prompt action to address any inconsistencies you see in your account or settlements with your stockbroker. If the stockbroker does not answer, follow up with the exchange/depositories.

Implications and Outcome:

Despite the fact that this was a well-established market practice, SEBI issued a circular requesting stockbroking firms that deal in the securities of their clients to avoid from pledging securities in particular.

SEBI set a deadline of September 30, 2019, for sorting the securities. The investors filed a complaint and an inquiry started when Karvy didn’t comply. 

Few things happened as a result: Karvy was banned by SEBI; the company was kicked off of the Bombay Stock Exchange and the National Stock Exchange; the securities were auctioned off; and the Union Ministry of Corporate Affairs was requested to look into possible financial fraud in the company.

Author: Raj Mohan Tiwari, India International University Of Legal Education and Research,Goa