NSE Suspends Karvy Trading Licence - Reasons & Implications
The National Stock Exchange has declared Karvy Stock Broking as a defaulter for non-compliance with the regulatory provisions of the bourse. In addition, Karvy Stock Broking has been expelled from the membership of the exchange.
The move effective from 23 November 2020, was taken as the broker failed to comply with NSE guidelines.
Under the guidelines, stockbrokers are required to fulfill their obligations and should not involve in any misconduct, or unprofessional conduct among others.
Earlier, Karvy had unauthorizedly transferred securities of clients into its Demat accounts by misusing the PoAs (Power of Attorney) given by its clients.
In November 2019, the market regulator Securities and Exchange Board of India had barred Karvy from taking new brokerage clients after it was found that the brokerage firm had allegedly misused clients' securities to the tune of more than Rs 2,000 crore. The firm misused client collateral for its own trades.
On 22nd November, SEBI issued an interim ex parte order against Karvy Stock Broking Ltd. The order restricted Karvy from taking on new clients. It also directed the two depositories – NSDL and CDSL from honoring instructions given by Karvy. These instructions are given in the ordinary course of events for settlement of trades through a Power of Attorney. The order was issued against Karvy for numerous violations of SEBI norms including the transfer of client shares to itself and pledging of client shares to raise money for itself.
Retail investor clients of Karvy Stock Broking Ltd., which allegedly sold clients’ securities illegally and used the money for its own purposes, may not be able to seek recourse from the National Stock Exchange’s investor protection fund unless the bourse declares the broking outfit to have defaulted. That’s according to JN Gupta, founder and managing director of the proxy advisory firm Stakeholders Empowerment Services. The transaction didn’t take place on the exchange platform so it’s not clear how investors will be compensated in case the payout isn’t completed, he told in an interaction.
The NSE compensates individual investors up to Rs 25 lakh from the investor protection fund in cases of default or if the exchange expels the broker. But that’s dependent on the exchange pronouncing the member in question as a defaulter or expelling him/her. To be sure, Karvy hasn’t defaulted on any trade settlement. It has delayed payout to certain investors who approached the exchange and the SEBI, leading to an interim order from the market regulator. NSE is also conducting a forensic audit of the broking firm.
The process of allowing trading members to perform clearing operations was undertaken to attain certain benefits, but this route has been misused, said Gupta. The broking entity, however, denied the allegation. “We’re of the firm belief that the investments made through owned funds of the group and borrowings other than the pledge of securities were fully compliant with the relevant provisions and directives of the regulator during the period that they were made,” Karvy said in an emailed statement.
It also said it will be providing “detailed explanation and clarifications to SEBI as required”. “There’s no instance where there has been mis-utilisation of client securities.” The market regulator said Karvy’s clients having queries over normal operations of their depository participant accounts may approach the depositories to get their queries addressed.
What Karvy did?
According to the SEBI order, Karvy transferred client securities to itself. The broker also raised money by pledging client securities and transferred this money to its own account. The exact amounts of the various violations are a little unclear. According to the SEBI order a net amount of ₹1096 crores was transferred by Karvy Stock Broking to its group company, Karvy Realty Private Limited. In response to the violations, the SEBI order requires the depositories to monitor the movement of securities into and from the Depository Accounts of the clients of Karvy Stock Broking. However, it also forbids the depositories from honouring instructions of Karvy Stock Broking.
According to a senior executive at one of India’s largest brokers, the SEBI order on Karvy instructions on the basis of client PoAs can prevent existing client trades from being settled. India follows a T+2 cycle which means that client trades executed on Thursday and Friday will come for settlement on Monday and Tuesday respectively. "Sebi directive against Karvy pretty much bars the brokerage firm from executing and settling future trades on client’s behalf. Even the trades that were executed on Friday cannot be settled by Karvy and depositories would need to monitor delivery for settlement of those trades," said Anubhav Ghosh, Partner, Law Point.
In such a scenario, the counterparty is also affected, but there are safeguards in place for them. When the seller is unable to deliver the shares, the exchange initiates an auction to purchase and deliver the shares to the buyer. Penalties are also levied against the defaulting party. As a backstop, the exchanges also have a settlement guarantee fund to ensure that trades are honoured. Futures and Options trades will not be directly affected by the order, but if the broker fails to maintain the margin with the exchange these will be squared off by the exchange, said the aforementioned senior executive. This will ultimately hurt the client who has undertaken the F&O trade in question, he added. Many F&O trades also require cash delivery and hence can get affected.
The Karvy Group has numerous other operations such as commodities broking, wealth management, mutual funds registrar and transfer (RTA) services and central recordkeeping services for NPS. These will not be directly impacted by the broking violations and consequent SEBI order.
What clients can do?
“Clients can open a new Demat account and move the securities that are with the Karvy Demat account to it," said the aforementioned senior executive. “However, this can require a lot of paperwork such as indemnity bonds. Also, since the depositories have been asked to monitor the movement of securities to and from client Demat accounts, this will slow down the process further," he added. If you have idle funds lying in your Karvy brokerage account, transfer these to your own bank account immediately. According to a 2009 SEBI circular all unutilized client funds have to be transferred by the broker concerned to the client’s bank account at least once every 90 days. However, in your case, the 90 days may not have lapsed. If your trades have failed due to the Karvy defaults if your securities have been transferred to Karvy’s own accounts or you notice some other irregularity, file a complaint with SEBI.
It’s time for investors to scrutinize their accounts, according to Anuj Shah, director of Tracom Stock Broking Ltd., ensuring that they have received the required shares or money. “The depository participant, depositories, and the stock exchange have provided enough checks and balances for investors—in the form of transaction information that’s conveyed to investors as mobile alerts, emails, and periodic statements,” he said. “But investors must use them.” Those investors who don’t have open stock positions can immediately seek transfer of securities to a different depository participant, Shah said, adding it’s a one-day process. “And those accounts where the money is involved, investors can ask for payout, so that the money gets transferred to their bank accounts.”
The new SEBI guidelines for handling of client money and securities doesn’t allow for the creation of pool account—or one that pools all money from clients. Brokers are required to segregate securities and money to distinguish client accounts from theirs.
Trading members shouldn’t be allowed to undertake clearing operations. A lot of risk-averse clients already do the simple task of having their Demat account, or depository participant account with a bank-based brokerage while trading with other brokerages, Deven Choksey of KR Choksey said, adding the market regulator should explore having well-capitalized bank custodians do the job of clearing trades and settlement.
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