The Karvy Stock Broking Scandal

Your funds are safe. But here’s what happened and what investors must keep in mind.
By Larissa Fernand |  05-12-19 | 
 
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Larissa Fernand is Website Editor for Morningstar.in. She would like to hear from you and welcomes your feedback.

The Karvy Broking fraud in November pulled the carpet from under everyone’s feet.

Investors are yet to recover from the shock of the Securities and Exchange Board of India (SEBI) unearthing the scandal of Karvy Broking allegedly diverting around Rs 1,200 crores of clients’ shares to its own accounts.

A forensic audit is now underway to look into the illegal fund diversion by Karvy Stock Broking to its real estate arm over the past few years. Karvy Realty allegedly transferred the funds to several other companies. The forensic audit will investigate the end use of the funds as well as the funds trail from Karvy Stock Broking to Karvy Realty and its movement from there.

Bajaj Finance, ICICI Bank, HDFC Bank and IndusInd Bank had moved the Securities Appellate Tribunal (SAT) seeking directions against SEBI and National Securities Depository Ltd (NSDL) for securing shares pledged by Karvy to them.

MANOJ NAGPAL OF Outlook Asia Capital tweeted on this in a very simple way, so I reproduced it below. 

What does Karvy Stock Broking do?

Karvy Stock Broking is a stock broker with 12 lakh clients, each client holding a demat and broking account. Clients can buy/sell stocks through Karvy and the stocks are deposited in the demat account.

When an individual opens a stock broking account, s/he gives a Power of Attorney to the broker to allow them to debit the demat account to effect the transfer of stocks. This is a simple instruction that is convenient for all parties.

What was the fraud committed by Karvy Stock Broking?

Karvy created a demat account (as a client account) in it's own name -  Karvy Stock Broking - Client account. Kept this under wraps and failed to report it to any other entity such as the NSE.

Using the Power of Attorney of the various individuals, stocks/securities were transferred from client accounts to their own account. To put it more simply, when clients bought shares, rather than them being credited to the respective demat accounts, they were directed into their own account.

This is extremely unethical and illegal, and was never the intention of the Power of Attorney being handed to them.

With this, they approached financial players (HDFC Bank, ICICI Bank, Bajaj Finance, IndusInd Bank) and pledged these securities for loans.

The banks and NBFCs did so and handed over the cash to them with the securities as collateral.

NSE, during it's audit, unearthed this money heist and informed SEBI.

What is the impact?

It is estimated that around Rs 2,300 crores worth of shares were pledged and loans taken by Karvy Stock Broking on shares which never belonged to them.

Around 1 lakh individuals/clients are estimated to be impacted. Of this, around 85,000 have got back their shares in their demat accounts thanks to the swift action of SEBI and depositories such as NSDL and CDSL.

The four players - HDFC Bank, ICICI Bank, IndusInd Bank and Bajaj Finance, gave loans based on these securities as collateral; around Rs 340 crores by each. Now that the collateral is no longer there, should Karvy Stock Broking does not pay back, they will lose this money.

What you must note

What happened is an exception. Technically, any broker can do this but most won't do until and unless they want to scam you. The magnitude of this fraud is unprecedented.

What are the safeguards you must follow?

Your Power of Attorney should be a limited - only to execute your transactions. Always access your demat directly with CDSL and NSDL to check your holdings.

Are your mutual funds safe?

Yes. They are just record keepers of mutual funds. They cannot perpetuate such a fraud here. When it comes to mutual funds, the financial transaction is between the investor and the mutual fund, and the bank account from which the money goes and where it must be returned should be the same.

Mutual fund investors need not worry at all.

The National Stock Exchange issued an advisory to clients, which you can read below.

1) Ensure that pay-out of funds/securities is received in your account within 1 working day from the date of pay-out.

2) Be careful while executing the PoA (Power of Attorney) - specify all the rights that the stock broker can exercise and timeframe for which PoA is valid. It may be noted that PoA is not a mandatory requirement as per SEBI / Exchanges.

3) Register for online applications viz Speed-e and Easiest provided by Depositories for online delivery of securities as an alternative to PoA.

4) Ensure that you receive Contract Notes within 24 hours of your trades and Statement of Account at least once in a quarter from your Stock Broker.

5) Please note that securities provided by you towards margin are not permitted to be pledged by your Stock Broker for raising funds.

6) If you have opted for running account, please ensure that the stock broker settles your account regularly and in any case not later than 90 days (or 30 days if you have opted for 30 days settlement).

7) Do not keep funds and securities idle with the Stock Broker.

8) Regularly login into your account to verify balances and verify the demat statement received from depositories for correctness.

9) Check messages sent by Exchanges on a monthly basis regarding funds and securities balances reported by the trading member and immediately raise a concern if you notice a discrepancy.

10) Always keep your contact details viz Mobile number / Email ID updated with the stock broker. You may take up the matter with Stock Broker / Exchange if you are not receiving the messages from Exchange / Depositories regularly.

11) If you observe any discrepancies in your account or settlements, immediately take up the same with your stock broker and if the Stock Broker does not respond, with the Exchange/Depositories.

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Venkat Nagarajan
Dec 7 2019 06:10 PM
Why have there been no arrests so far since these frauds and scams by Karvy Broking are very similar to those perpetrated in the PMC case?
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