Karvy Demat Scam came under public glare in the second half of the year 2019. The regulatory authorities faced a tough time as the embarrassing shortfalls on the part of SEBI’s scope of supervision was the highlight news for the rest of the year. Karvy Stock Broking Ltd (KSBL) is a Hyderabad based stock broking firm who pledged securities lying in the Demat accounts of its clients, without their permission and raised money from multiple banks and financial institutions. This is not the first time that India has witnessed stock market scams. But the Stock broker himself doing the scam has shocked many investors.
To raise a loan from the bank, customers need to submit collateral as security. Higher the amount of loan higher would be the collateral value. This collateral can be stocks also. The investor can pledge the stocks in the bank and raise a loan against it. Just like individuals hold Demat account, brokers have a pool account. The pool account is known as Broker’s Demat Account.
When you buy or sell a share, shares get credited in to your account from the opposite seller or buyer. It first goes into the broker’s pool account and from there it comes to your Demat account. Now, suppose you want to get a loan against your shares. Then, those shares are transferred into the broker’s pool account, and brokers gives it to the banks. Banks issue loans to the broker against the shares submitted to them as collateral. The broker increases the interest rate and passes the money borrowed to the individual whose stocks are submitted. The difference between the two interest rates is the brokers’ profit. Now this is where Karvy Stock Broking Ltd swindled the investors.
Let us understand the Karvy Saga in detail…
Karvy Stock Broking Ltd- Incorporation and Services Provided
Karvy Group was established in the year 1983 and was headed by C. Parthasarathy as Chairman. The group at one time had more than 30,000 employees, spanning 900 offices in about 400 cities and towns. Karvy Group was established in the year 1983 and was headed by C. Parthasarathy as Chairman. The group at one time had more than 30,000 employees, spanning 900 offices in about 400 cities and towns. Karvy Stock Broking Limited is a Non-govt company, incorporated on 30 Mar, 1995. It’s a public unlisted company and is classified as company limited by shares. Company is registered in Hyderabad (Telangana) Registrar Office. Karvy Group is a financial services company in India. It was involved in providing financial services like equity, commodities trading, depository and wealth services and distribution of other financial products. Besides this it also has branches in Bahrain, Dubai, Malaysia, Philippines and the United States.
The Karvy Demat Scam
Karvy Stock Broking Ltd was one of the leading stock brokers in the country with millions of clients. The scam was done by taking advantage of the loopholes present in the system. The first question that comes to our mind is how investors stocks can be pledged in bank without their knowledge ?? The Power of Attorney gives the authority to the brokers. Shares are stored with NSDL and CDSL who are two depositories in India. They work to keep shares safe in the customer’s Demat Account in Electronic form. NSDL and CDSL gives weekly or monthly reports to the account holders about all the transactions done. Here Karvy Stock Broking identified those accounts which were not very active and some of the investors who buy shares do not bother to check the accounts for more than 2 years. Karvy transferred some of the dormant account shares to its own Demat Account named Karvy Stock Broking (BSE) and showed these stocks as its own securities to lenders as collaterals for taking loans.
The company had sold excess securities worth Rs 485 crore through nine related clients till 31 May 2019. They further transferred excess securities worth Rs 162 crore to six of the nine related clients until 31 May 2019. Later, it tried to repurchase the securities worth 228.07 crores to cover up for the shortfall between June – September 2019. An amount of 1096 crore was transferred to its group concern Karvy Realty Private Limited during the period of April 2016 – October 2019.
The Scam Exposed
On June 20, 2019 markets regulator SEBI came out with a circular on handling client securities which said that brokers could not pledge client securities to raise loans for themselves which till then was an established market practice. SEBI had set a deadline of September 30,2019, for brokers to segregate client funds and securities but when Karvy Stock Broking Limited failed to do so by the given deadline, investors complained to SEBI, which then asked NSE to investigate the matter.
The scam then came to light after a limited purpose inspection of KSBL conducted by the NSE in 2019 revealed that KSBL had not revealed a DP account and credited the funds raised by pledging of client securities to 6 of its own bank accounts instead of the stock broker client account. SEBI found out that Karvy had defaulted Rs. 2000 crore of investor funds by pledging the securities holdings of its customers.
Actions Taken By Regulatory Authority
On November 22, 2019, SEBI issued an order banning KSBL from broking services and said the firm had transferred Rs 1096 crore to group company Karvy Reality between April 2016 to October 2019. SEBI also asked NSE to conduct a detailed forensic audit and instructed to quickly transfer some of the illegally transferred securities back in to accounts of investors. In January 2020 the Union Corporate Affairs Ministry also ordered the Registrar of Companies (ROC) Hyderabad to probe Karvy Group Financial Fraud. The Enforcement Directorate attached fresh assets worth Rs 110 crore in connection with the money laundering probe against Karvy Stock Broking. Also the Enforcement Directorate arrested C Parthasarathy Chairman and MD and G Hari Krishna CFO of the Karvy Group for the Rs 2000 crore scam. The ED started money laundering investigation based on the FIR filed by HDFC Bank with CCS Hyderabad Police under various sections of IPC for defrauding HDFC Bank.
In December 2019 soon after the scam to light, SEBI worked with DPs and stock exchanges to transfer securities of nearly 83000 out of the over 95000 scam hit KSBL clients from Karvy’s Demat account back into their respective accounts. In November 2020, NSE said it had settled claims worth Rs 2300 crore to around 2.4 lakh KSBL Investors. SEBI then instructed to auction off KSBL Demat accounts to IIFL Securities and trading accounts were auctioned to Axis Securities in order to compensate the investors.
Nearly three-and-a-half years after the Karvy Stock Broking (KSBL) scam came to light SEBI ordered to ban the stock broking firm as well as its promoter C Parthasarathy from the stock market for seven years. The market regulators also slapped a penalty of Rs 21 Crore a fine of Rs 13 crore on KSBL and Rs 8 crore on Parthasarathy. SEBI has restrained Parthasarathy from holding the post of director, key managerial position or associating himself in any capacity with the listed public company for period of 10 years.
SEBI has also ordered Karvy Reality (India), or KRIL, and Karvy Capital (KCL) to return the nearly Rs 1,443cr . diverted to them to KSBL within a period of three months. If case of failure to return the money, the markets regulator has directed the NSE to take control of KRIL ..
Karvy Scam- Who Should Be Blamed??
The repercussions of the stock market scam is not felt immediately but the extent of damage to the stock market could adversely affect the Indian economy, already reeling a slowdown and also inflationary pressures. Investors are always suggested to invest through trusted brokers who are genuine and will guide to invest properly. But when the Brokers themselves do such fraud , will the investors ever trust the Indian Stock Market ?? Or the Regulators Need to be more vigilant enough to stop the scam happening at the beginning itself. Rs 2300 crore fraud done was hard earned money of the investors.
Banks who lend funds to the Stock brokers are also the funds of the investors who trusted banks for their funds. At the end it is the investor who suffer due to the Fraudsters. Here there are lot of questions which were unanswered as to how the entire scam happened and how the regulators became negligent. SEBI has fined NSE and BSE for their laxity in detecting the fraud and client securities misued by Karvy Brokers.
System will always have a loophole and there are number of fraudsters who have greed for money. The only way to protect the investors from such scams is to have strict laws and punishments for breaking the rules and instructions and a transparent system where audits are conducted on a regular basis to have a check on all the transactions that happen.
Points Investors Should Remember for Demat Accounts
- Ensure payouts for your funds are received within 1 working day of the payout date.
- Do not keep securities idle and dormant. Keep a track of the same frequently as possible.
- Exercise caution when lending the power of attorney to your broker. As per the latest SEBI rules, it is not mandatory to give the power of attorney to your broker.
- Keep changing or updating dematerialized account passwords regularly.
- If you sense something might be wrong, immediately inform the stockbroker and authorities so that quick action can be taken to ensure the safety of your mutual funds.
- Remember to keep your correct contact details like email address and phone number up to date.
- Keep track of SMSes, email newsletters and monthly statements sent by the broker or broking firm.