The Securities and Exchange Board of India (SEBI) on Friday imposed a 7-year ban on Karvy Stock Broking Ltd (KSBL) and its promoter Comandur Parthasarathy from the securities market. Additionally, they were fined Rs. 21 crores for misappropriating clients' funds by misusing the Power of Attorney provided to them.
KSBL had siphoned off the funds raised by pledging clients' securities to its group firms, Karvy Realty (India) Ltd and Karvy Capital Ltd, according to SEBI's final order in the matter.
In addition to the market restriction, the regulator fined KSBL and promoter/managing director Parthasarathy Rs 13 crore and Rs. 8 crore, respectively.
While Parthasarathy is prohibited from holding the position of director or any other key managerial position in any listed public company or from working with any registered intermediary for a period of ten years, the same prohibition only lasts two years for the two former directors of KSBL, Bhagwan Das Narang and Jyothi Prasad.
The regulator also fined the two then-directors Rs. 5 lahks apiece. The fine must be paid within 45 days.
SEBI also directed Karvy Realty and Karvy Capital to return Rs 1,442.95 crore transferred to them by the brokerage house. They have been asked to return the funds to KSBL within three months, failing which NSE will take control of the assets of the two firms to recover the money. In addition, KSBL, Parthasarathy, Karvy Realty, and Karvy Capital have been directed to cooperate with the NSE in refunding of funds and securities of the clients of KSBL.
In its 88-page order, the market regulator found that KSBL was raising funds by pledging clients' securities and by misusing the Power of Attorney (PoA) granted to it by its clients. Further, the funds by KSBL were being diverted to its group entities thereby violating various provisions of law.
According to the SEBI order, KSBL had sold excess securities (securities not available in the DP account) to the tune of Rs 485 crore through 9 related entities, which were also its clients, till May 2019. Further, KSBL had also transferred excess securities to 6 out of these 9 related entities.
The regulator found that KSBL had raised loans from financial institutions amounting to Rs 2,032.67 crore by September 2019, by pledging shares of its clients as collateral. During this period, the value of securities pledged by KSBL was Rs 2,700 crore.
Here is How The Karvy Saga Unfolded
The case relates to KSBL's massive asset mobilisation drive followed by the raising of huge funds from financial institutions by using the securities mobilised from the clients with a promise to pay them interest. These funds were misappropriated and diverted to KSBL's connected entities, thereby defaulting on its obligations to settle the securities and funds with the clients as per regulatory instructions.
The Karvy demat scam came to light in 2019. Karvy Stock Broking Limited (KSBL) pledged securities of unsuspecting customers from their demat accounts to raise funds from banks and other non-banking financial companies without their knowledge or consent. KSBL had borrowed from HDFC Bank, Axis Bank, IndusInd Bank, Bajaj Finance, Aditya Birla Finance, and others using the securities as collateral.
The outstanding borrowing under the loan against securities (LAS) facility was Rs 789.41 crore in September 2016 and increased to Rs 2,032.67 crore by September 30, 2019. At the same time, the value of securities pledged by KSBL rose from Rs 202 crore on June 30, 2017, to Rs 1,855 crore by March 2018 and further to Rs 2,700 crore by September 2019.
The Watchdog prohibited KSBL from accepting new brokerage clients in November 2019 through an interim order after it was discovered that the company had allegedly misappropriated client securities to the tune of more than Rs 2,000 crore. The exchange's preliminary report was the result of the limited-purpose inspection of KSBL conducted by it on August 19, 2019, covering the period from January 1, 2019, onwards.
The interim order came after NSE forwarded a preliminary report to SEBI on non-compliances observed with respect to pledging or misuse of clients' securities by KSBL. Finally, the directions issued through the interim order were confirmed by SEBI in November 2020.
To investigate the absence of funds and securities discovered during a joint inspection by SEBI, exchanges (NSE and BSE), and depositories (NSDL and CDSL), the NSE recruited Ernst & Young LLP (EY) as a forensic auditor. It was to determine the level of misappropriation of funds and securities as well as other violations committed by it, and also to determine the part played by KSBL's management and directors in the prior wrongdoings.
"It has been adequately exposed by EY in its forensic audit that every day the treasury team of KSBL used to calculate the requirement of funds for its operations in the light of the quantum of trades undertaken during the day. The said calculation used to be forwarded to operation team, which further used to randomly select securities lying in different clients' accounts for placing them under pledge with financial institutions to raise funds through LAS (Loan Against Securities) facility so as to meet the funds requirement," SEBI noted.