Wealth  Management  Services

Why Karvy Stock Broking Had To Change Name To K-Fintech? Was Survival At Stake?

August 24, 2020

In one of the most shocking incidents of this decade, in the month of November, 2019 one of the most reputed and oldest stock broking & financial services company which had 12 lakh clients across the country, mis utilized clients’ funds. Karvy Stock Broking Ltd(KSBL) had allegedly misappropriated money and securities belonging to its investor in order to fund its realty arm through misusing the Power of Attorney given to it by the investors which led to having to cease operations almost immediately causing various hardships to its clientele. The company transferred the shares of its clients to a different account and then pledged shares worth Rs 2300 Crores to get loans from banks and NBFC’s for its realty arm. In fact, things are in such a bad state for Karvy that they have had to change their name to K Fintech to survive in the industry.

How did Karvy Plan accomplish such a misappropriation?

Let me tell you how things should be first. We all know that stockbrokers provide trading platforms to the customer for dealing in equities, debts, mutual funds, commodities and other securities. These big broking houses banks and finance companies provide online trading platforms for executing the above-mentioned options.

The client opens a demat account with the depository through this broking house and in the process gives power of attorney to the broking firm to act on its behalf.

PLEASE NOTE THAT GIVING A POA TO YOUR BROKER IS NOT A MANDATE, IT IS ONLY FOR YOUR CONVENIENCE TO TRADE IN SECURITIES AND MUST BE GIVEN WITH UTMOST CAUTION.

The securities against which payment has been received should be transferred to the demat account of the client with in one working day of the pay-out i.e. within T+1.

Karvy by mis-appropriating the power of attorney given to its by its client transferred the client shares to its pool account and in some cases never transferred the shares to the client’s demat in the first place. It then pledged the shares to raise money and diverted the money to its real estate arm. After numerous complaints received by SEBI from the clients that the money and securities were not coming to their accounts the regulator found that Karvy has allegedly misused client accounts without informing the depository or the stock exchange.

The clients are the legitimate owners of the securities lying in their demat account. The broker has no right to create any pledge on those securities other than if there is a situation to meet the client’s own obligation.

Any regulatory Loopholes?

The regulators have emphasized on better communication and education which would be key in avoiding unwarranted fear and pessimism among the investors. The advisors and brokers should focus on educating the client about then operational efficiency and frameworks of the investment vehicles.

The NSE has asked the investors to keep a regular check on the demat statement and balances received from depositors and if they don’t receive regular messages from the exchange they should contact brokers and the exchanges for the details. Whenever the investor come across any discrepancy in their account or statements then they should immediately contact their brokers and if they are not satisfied with the response, then they should contact the exchanges or complain with the regulator i.e. SEBI via its SCORES platform specially designated towards addressing investor grievances.

Through a circular SEBI has said: “With effect from September 1, 2019, clients’ securities lying with trading members/clearing members… cannot be pledged to banks/NBFCs for raising funds even with authorization by client.” Also, clients’ securities already pledged shall be unpledged by August 31, 2019, and returned to the clients after fulfilment of pay-in obligation.

The circular mentioned that if there is payment default by the client then the broker can hold the securities for up to five days only after that they can sell the security. Now it is no longer possible to pledge client’s share except with the Clearing Corporation of India.

Will Investors Lose Money?

Not only clients of Karvy but other investors are also shocked with this incident and are curious as to are their investments safe with their brokers and what they can do to safeguards the same. After these irregularities came to light SEBI has suspended operations of Karvy Stock Broking, their customers will not be able to do any activity with their demat account, they are advised to open demat account with another broker of their choice and transfer their shares from the Karvy demat account.

Even though Karvy has misused securities of thousand of its investors, industry is of the opinion that there will not be any default as the value of the securities pledged is more than the money taken out by the broker. However, the funds available with Karvy are insufficient and investors may get their money through NSDL insurance or from the Investment Protection Fund which is set up to guard the investors against default by the brokers. The shares and securities have been credited of most of their affected clients and if any discrepancy is seen in their demat holding has been asked to lodge a complaint against Karvy using the SEBI’s scores platform.

Conclusion?

The amount of money misappropriated stands at Rs 2800 crores which has been pledged with banks and NBFC’s. According to the documents available the banks with exposure to Karvy are ICICI Bank (875 crore), HDFC Bank (195 crore), IndusInd Bank (105 crore) and Aditya Birla Finance (100 crore). Banks have requested that they should be given ownership of the shares by invoking pledges, but in that case the investors would be on the losing side, thus SEBI is unlikely to consider this request. Seeing SEBI’s stance, the banks are looking for other options like appealing to the SAT so that their rights are protected.

SEBI has refused any interim relief to Karvy and has imposed restriction in opening new accounts and operating old ones and it is still to be seen what actions will be taken against Karvy considering it’s a case of grave misappropriation of power of attorney. After this case, there is a consensus among the industry experts that mutual funds are much safer options as they have no such issues.

-Siddharth Parekh


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