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Crisis on Karvy Stock Broking Limited regarding the pledge of Investor’s securities.
- Karvy Stock Broking limited according to the SEBI, transferred client’s pledged shares in its account and transferred a stupendous amount of Rs 1,096 crore to its own group company, Karvy Realty Pvt. Ltd, within the time span of April 1, 2016, and October 19, 2019.
- The securities lying in the aforesaid Depository Participant Account (hereinafter referred to as DP account) of KSBL belong to the clients who are the legitimate owners of the pledged securities. Therefore, KSBL did not have any legal right to create a pledge on these securities and generate funds. Even if the client securities were pledged, it should be only for meeting the obligation of the respective clients, which was not observed in this case.
- To prevent Karvy’s lenders to claim on the securities, SEBI used a pre-emptive move, also it further directed the depositories to return the securities as per the statement of one of the depositories. Being under supervision of SEBI and NSE, securities have been transferred from Karvy Stock Broking Limited’s Demat account to the Demat account of clients who have fully paid up. Karvy has around 1.2 million clients out of which 300,000 are active.
- Due to the SEBI’s current directive many high profile investors like Bajaj Finance, ICICI Bank, HDFC Bank and IndusInd bank are expected to knock the doors of securities appellate tribunal (SAT) against the order passed on November 22 by SEBI. The order stated that pledging of securities of the client with lenders as void. Mishandling of securities of the client by Karvy and the respective brokers has provoked SEBI to differentiate and segregate securities of clients from the collaborated pool accounts of the firm. Bajaj finance has already challenged the order and SAT has reserved the order till 3rd December.
- As per the current report by an interim investigation by NSE, securities worth 2300 crore which belongs to more than 94000 clients were transferred to one Demat account of Karvy, this particular practice was undisclosed to the stock exchange and in order to generate group entities funds, fully paid up securities of clients were pledged by Karvy.
What is exactly the basis of the Interim order passed by SEBI on 22nd November 2019?
- The facts of the case depend upon the mishandling of client’s securities by the broker. In the present case, it has been observed that KSBL has misused the power of attorney which was given to them by the clients. KSBL had the possession of securities in a disguised manner for its purposes through self-owned controlled entities. There were numerous transactions in Depository Participant account through which securities have been moved.
- The securities present in the DP account actually belong to the clients who are the true owners of the securities, keeping the above points in mind KSBL did not have any right to pledge these securities in order to raise a loan as these securities could have been pledged only if they were for the benefit of the respective clients.
- Under sections 11(4), 11(1) and 11B read with Section 19 of the SEBI Act, 1992 and Regulation 35 of SEBI (Intermediaries) Regulations, 2008, by way of ex parte ad interim order issued following directions.[1]
- KSBL is prohibited from taking new clients in respect of its stockbroking activities;
- The Depositories NSDL and CDSL, to prevent further misuse of clients’ securities by KSBL, are hereby directed not to act upon any instruction given by KSBL in pursuance of power of attorney given to KSBL by its clients, with immediate effect;
- The Depositories shall monitor the movement of securities into and from the DP (Depository Participant) account of clients of KSBL as DP to ensure that clients operations are not affected;
- The Depositories shall not allow the transfer of securities from DP account no. 11458979, named KARVY STOCK BROKING LTD (BSE) with immediate effect. The transfer of securities from DP account no. 11458979, named KARVY STOCK BROKING LTD (BSE) shall be permitted only to the respective beneficial owner who has paid in full against these securities under supervision of NSE; and
- The Depositories and Stock Exchanges shall initiate appropriate disciplinary regulatory proceedings against the Notice for misuse of client’s fund and securities as per their respective bye-laws, rules and regulations.
Arguments by the lenders i.e. ICICI, HDFC IndusInd Bank and Bajaj finance against NSE and NSDL.
Banks claim that shares kept in Karvy’s account were pledged to raise loan but after the SEBI’s order concerning the transfer of shares to clients, made the banks vulnerable as it was a loss for them. Also, they are against the SEBI’s order which curtailed their right of recovering the loan amount and gave the following arguments-
- HDFC bank has lent around Rs 300 crore from Karvy, which were lent by keeping the pledged securities amounting to Rs 470 crore.
- NSDL wiped off banks security cover by transferring the pledged shares without any compulsion leading to violation of Depositories and Participant Regulations of SEBI.
- Also pledging up to a certain limit may be allowed but over-pledging is prohibited.
- Before cancelling pledge on shares, NSDL did not take the bank’s approval leading to violation of its bylaws and depository rules.
- The overriding effect over all other laws by section 9 and 10 of the Depositories Act –
Securities in depositories to be in fungible form[2].
- All securities held by a depository shall be dematerialized and shall be in a fungible form.
- Nothing contained in sections 153, 153A, 153B, 187B, 187C and 372 of the Companies Act, 1956 (1 of 1956) shall apply to a depository in respect of securities held by it on behalf of the beneficial owners.
Rights of depositories and beneficial owner[3].
- Notwithstanding anything contained in any other law for the time being in force, a depository shall be deemed to be the registered owner to effect the transfer of ownership of security on behalf of a beneficial owner.
- Save as otherwise provided in sub-section (1), the depository being a registered owner shall not have any voting rights or any other rights in respect of securities held by it.
- The beneficial owner shall be entitled to all the rights and benefits and be subjected to all the liabilities in respect of his securities held by a depository.
- Bank’s in the given case acting as beneficial owners should rightfully be indemnified by the NSDL against the loses.
- Passing of ‘ex parte ad interim’ order also holds no water as it can be passed only on the urgent grounds and in the above case, NSDL passed an order directing the transfer of shares to 83,000 Demat accounts without any occurrence of status quo.
- There should be a shred of evidence for prima facie finding of unfair trade practices and manipulative intent. Passing a restraint order which virtually puts a stoppage on right to trade based on the needle of suspicion is harsh and unwarranted,” SAT said.
- An ex-parte interim order may be made when there is an urgency. As held in Liberty Oil Mills & Ors. vs. Union of India & Ors [AIR (1984) SC 1271] the urgency must be infused by a host of circumstances, viz. large scale misuse and attempts to monopolise or corner the market. In the said decision, the Supreme Court further held that the regulatory agency must move quickly to curb further mischief and to take action immediately to instill and restore confidence in the capital market.
Conclusion
Due to the misuse of client’s securities amounting to Rs 2800 crore, Karvy is barred from adding on to new clients as per the latest order by SEBI on 22nd November. National Securities Depository Limited transferred Rs 2013 crore in 90% of the accounts of clients listed with Karvy. Lenders- ICICI Bank, HDFC Bank, IndusInd Bank, Bajaj Finance Ltd have already filed for an appeal in Securities Appellate Tribunal (SAT) and wait for the decision on 12th December 2019. Order by SAT will take into consideration various facts in mind like Due Diligence, Ex Parte order given by SEBI violating principles of natural justice and whether the lenders should be reimbursed for the losses suffered?
[1] As seen at https://www.sebi.gov.in/enforcement/orders/nov-2019/order-dated-november-29-2019-in-respect-of-karvy-stock-broking-limited_45152.html retrieved on 8th December 2019, 3 pm.
[2] As seen on https://www.sebi.gov.in/acts/act03a.pdf retrieved on 9th December 2019, 12:56 pm.
[3] Ibid.
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Very logical position. NSDL should have validated the ownership of the shares in the account before registering the pledge – by registering the pledge,
NSDL has taken responsibility of ensuring that it honor the rights of the lenders to invoke the pledge.
By failing to ask the pledgees to remove the pledge prior to transferring the shares, NSDL has violated it’s own rules –
Hence SEBI should not just order it compensate all impacted parties but also penalize the NSDL management