Case Study - Karvy Stock Broking Limited (Part I/IV - Facts)


The developments in the recent case of Karvy Stock Broking Limited (“KSBL”) have been touted as a whole new low in Indian securities markets’ history with fraud. The case involved misappropriation of client securities on a massive scale by KSBL. By being a first in shattering trust-based relationship between a stock broker and its client, it has left lakhs of investors uneasy.


On November 22, 2019, KSBL was barred from accepting new clients. The securities market regulator, Securities and Exchange Board of India (“SEBI”) had prima facie found that KSBL had misappropriated Rs. 1,096 Crore (approx.) by misusing Power of Attorneys (“PoA”) signed by its clients to pledge clients’ securities as collaterals with banks for obtaining loans. KSBL was also found to have diverted the funds to its group entities. This case saw SEBI marking out as well as spelling out the law on misappropriation of securities by brokers and characteristics and scope of PoA.


This article is a Case study on the KSBL. It analyses the law on segregation of securities belonging to the client by the broker and the legal contours of PoAs, as chalked out by SEBI in its recent Orders. It further traces the spillover of the case, attempts at appeals and most importantly, the policy changes proposed and brought about by SEBI.


Facts

KSBL is a stockbroker member of the National Stock Exchange (“NSE”) and registered in said capacity with SEBI. 90,000 individual investors had invested in stocks through KSBL. KSBL is also a Depository Participant (“DP”) of both the National Securities Depository Limited (“NSDL”) and the Central Depository of Securities Limited (“CDSL”).


NSE had conducted a limited purpose inspection on KSBL on August 19, 2019, covering a period of January 01, 2019, onwards. SEBI’s first Order (“Ex-Parte-Ad-Interim Order”) in this matter was based on the findings of this report.


DP Account no. 11468979, named KARVY STOCK BROKING LTD (BSE) was found to have been categorized as a Beneficiary client and opened on December 20, 2000. KSBL had failed to report this account in its filings during the period of NSE investigation.


KSBL was also found to have credited funds raised by pledging securities (which actually belonged to its clients) to 6 of its own bank accounts (“Stock Broker-owned Account”) instead of the Stock Broker-Client Account. Further, these 6 accounts were also not reported to the exchange. Said pledges were given to 1. HDFC Bank Ltd., 2. ICICI Bank Limited, 3. IndusInd Bank Ltd., 4. Axis Bank Limited, and 5. Kotak Mahindra Bank

KSBL sold excess securities (securities not available in the DP account) to the tune of Rs. 485 Crore through 9 related clients[1] till May 31, 2019. Further, it also transferred excess securities to 6 out of these 9 related clients to the tune of Rs. 162 Crore till May 31, 2019. Eventually, it was found that securities worth Rs. 257.08 Crore pledged on behalf of 4 clients out of the aforesaid 9 were unpledged during June 1, 2019 to August 22, 2019.


KSBL had transferred securities worth Rs. 27.8 Crore off-market, from the beneficial owner (“BO”) accounts (“BO Accounts”) of 156 clients who had not executed a single trade with KSBL. Further, securities worth Rs. 116.3 Crore were observed to have been transferred from 291 clients who have not traded with KSBL since June 01, 2019.


“An approximate amount of Rs. 1096 Crore was transferred by KSBL to its group company, Karvy Realty Private Limited from April 01, 2016 to October 19, 2019.”

KSBL also sold excess securities (securities not available in DP Account) to the tune of Rs. 485 Crore through abovementioned 9 related clients till May 31, 2019. Further, it transferred excess securities to 6 out of these 9 related clients to the tune of Rs. 162 Crore till May 31, 2019. On subsequent verification, it was observed that the securities worth Rs. 257.08 Crore pledged on behalf of 4 clients out of the 9, were unpledged during June 1, 2019, to August 22, 2019, and securities worth Rs. 217.85 Crore were recovered by KSBL from 4 out of the 9 client accounts. KSBL had also purchased securities in 5 out of the respective 9 client accounts amounting to Rs. 228.07 Crore during the period from June 01, 2019, to September 08, 2019.


Read Part II (SEBI), Part III (Lender Banks' Case), and Part IV (Policy Developments).

[1] Karvy Consultants Limited, Wizard Insurance Services P Ltd., Zenith Insurance Services Private Limited, Buoyant Insurance services Private Limited, Nova Wealth Management Services Pvt Ltd, Vitalink Wealth Advisory Services Pvt. Ltd., Classic Wealth Management Services Private Ltd., Champion Insurance Services Private Limited, Pelicon Wealth Advisory Services Pvt. Ltd.

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