Karvy Scandal Sends Shockwaves Across Domestic Brokerage Industry

The massive scandal of the Hyderabad-based Karvy Stock Broking Limited (KSBL) that came to light in November has yet again highlighted the deep-rooted fraudulent practices in the stock market while prompting banks to take corrective measures in the loans against shares or securities system.

On November 22, the Securities and Exchange Board of India (SEBI) has banned KSBL from continuing its regular operations for misusing money and securities belonging to its investors to fund its real estate arm, Karvy Realty. While the market regulator has pegged the amount swindled to the tune of Rs 2,300 crore, an ongoing forensic audit by EY accountants, recently initiated by the National Stock Exchange (NSE), will put forward the real extent of misappropriation of funds.

SEBI has prima facie found that the KSBL has misused its client’s securities by misusing the Power of Attorney (PoA) given to it by its clients. Therefore, the regulator directed the depositories and stock exchanges to initiate appropriate regulatory proceedings against the brokerage firm. Subsequently, both NSE and BSE banned Karvy from its operations.

SEBI’s directions came in force after, reportedly, numerous clients of Karvy complained to the regulator about money and securities not coming to their trading accounts. In a separate inspection, NSE also found that Karvy was misusing its client’s PoA as the exchange detected that KSBL did not report mandatory submissions to the NSE from January to August 2019.

Influential businessman C Parthasarathy, chairman and one of the founders of the Karvy group, has remained silent over the developments. It is to be noted that Karvy is not new to such controversies.

In 2015, SEBI had barred Karvy from taking up new primary market assignments, including bidding in initial share sales, for one year in a case related to IPO (initial public offer) scam during 2003-2005 period.

In June this year, the Bengaluru police filed criminal cases against top officials of Karvy Stock Broking, Karvy Private Wealth, Karvy Realty and Karvy Capitals when several investors complained that they were cheated to the tune of Rs 4 crore.

When this scam came to light, analysts have openly stated that brokers have been misusing the PoA for years now.

Karvy’s Modus Operandi

According to Karvy’s submissions tob SEBI, KSBL has 12 lakh clients, out of which 3 lakh are active clients. On an average, 20,000 to 25,000 clients transact on a daily basis. KSBL has 900 offices across India.

According to a June SEBI circular, the regulator has categorically restricted all brokerage firms from not pledging the clients securities in order to raise funds. It has also given time till the end of September 2019 for brokers to adhere to the norms, while the stock exchanges, clearing corporations and depositories were tasked to monitor the necessary compliances.

But, it turned out that KSBL was struggling to meet its payment obligations for the last few years and pledging shares has been its core strategy to raise money to fund its sister companies.

In the past few years, SEBI has banned Kassa Finvest Pvt. Ltd, Guiness Securities Ltd, Ficus Securities, BRH Wealth Kreators, Fairwealth Securities and recently, BMA Wealth for similar violations.

Reportedly, BMA Wealth raised amount to the tune of Rs 100 crore by pledging securities of its clients.

Pledging shares or securities is a loan-raising system wherein companies raise money from lenders, taking shares or securities as collateral. In cases of default, the lenders have the right to sell the pledged shares or securities to recover money.

The entities with exposure to Karvy include ICICI Bank (Rs 875 crore), HDFC Bank (Rs 195 crore), IndusInd Bank (Rs 105 crore) and Aditya Birla Finance (Rs 100 crore) among others. However, these were restricted by SEBI from releasing the securities as they failed to provide the loans.

This has prompted the banks and other lenders to relook at all such loans given against securities and tighten norms for future transactions.

Furthermore, the ripples of the scandal have sent shockwaves across the domestic broking industry as brokers fear escalation of compliance costs. Over the years, the number of brokers has been dwindling. From 5,899 in 2014-15, the number of brokers stood at 3,542, down 34%, as of December 31, 2018, shows SEBI data.