Stock brokers have been at the receiving end of Securities Exchange Board of India’s regulatory actions lately. Apart from imposing fines and cancelling licences of brokers found bending the rules, SEBI has issued a string of circulars tightening operational controls, and has initiated measures to whittle down their role in markets. But those criticising SEBI for over-regulation need to take note of the findings in its final order on the Karvy Stock Broking case, passed last week.
SEBI’s findings from a NSE inspection report, EY forensic audit and own investigations show that between 2016 and 2019, Karvy Stock Broking raised over ₹3,000 crore by illegally pledging securities in its clients’ accounts. It loaned the money to Karvy Realty and Karvy Capital and when these firms defaulted, left its clients to fend for themselves. To move clients’ securities to proprietary demat accounts, Karvy misused their Powers of Attorney. While pledging clients’ shares to offer margin funding was a common practice in the broking industry until 2019, Karvy pledged even securities of investors who had never availed of margins. The extent of malfeasance is evident from SEBI’s unearthing of over 3.18 lakh investor accounts with fund or security shortfalls in November 2019. Karvy’s top officials, on receiving SEBI’s notices, have indulged in the usual blame-game and claimed ignorance. But this is hardly credible given the number of clients involved and the deliberate concealment of proprietary demat accounts from the exchanges. Given the gravity of the offences, SEBI’s punitive actions do not seem too harsh.
Karvy Stock Broking and promoter C Parthasarathy have been fined ₹13 crore and ₹8 crore, respectively, and barred from the markets for seven years. Other directors have been let off with nominal fines, with a former CEO merely ‘cautioned’. Karvy Realty and Capital have been ordered to refund ₹1,442 crore, with NSE authorised to seize their assets. But rather than go by assurances of exchanges or depositories that ‘a majority’ of investors have received their dues, SEBI needs to follow up and ensure that no investor is left out. Shortfalls must be met out of investor protection coffers.
SEBI has tried to prevent a repeat of this scam through a series of circulars issued since 2019. It has barred pooling of client securities or funds by brokers and mandated segregated accounts. Powers of Attorney have been made optional in broking agreements. Investors have been given a clear line of sight on every pledge/unpledge transaction and funds/securities balances with depositories. Brokers have been barred from offering margin funding using client shares, and asked to use their own capital. Recently, in a move to completely disintermediate stock transactions, SEBI proposed a direct ASBA facility for secondary market investors. But even with all these new rules, there can be no complacency on the part of SEBI or the exchanges that intermediaries will toe the line. That Karvy was able to perpetrate its scam directly under the noses of first-line regulators shows that prompt detection of violations rather than elaborate rules, are key to preventing frauds.