Karvy Demat Case: How has SEBI Responded?

[Anant Budhraja and Praneeta Tiwari are 5th year BA-LLB (Hons.) students at West Bengal National University of Juridical Sciences]

The Securities and Exchange Board of India (“SEBI”) on April 28, 2023, passed a stringent final order against Karvy Stock Broking Limited (“KSBL”) and its promoter Comandur Parthasarthy, whereby it banned them from accessing the securities market for seven years. Additionally, SEBI also imposed a cumulative penalty of Rs. 21 crores on KSBL and Mr. Parthasarthy for the violation of several provisions of the SEBI Act, 1992 and the Securities Contracts Regulation Act, 1956. This has also been followed up by another recent order passed by SEBI on May 31, 2023, through which it has also cancelled the certificate of registration of KSBL. Such a harsh crackdown upon KSBL is a testament of the SEBI’s resolve to not allow the repeat of the mammoth scam which it alleges was spearheaded by KSBL along with its promoters and allied entities.

In this context, SEBI has done much more than merely adjudicate the culpability of the perpetrators and the magnitude of their involvement with the scam. Rather, SEBI has taken simultaneous steps to eliminate the possibility of stock brokers misusing their clients’ securities for gaining a personal leverage. However, it is essential to analyze the newly introduced measures by SEBI in order to conclusively determine their efficacy over the past four years since the scam was unearthed. Hence, this post would attempt to address that particular issue by examining the regulatory measures introduced by SEBI over the years.


On June 20, 2019, SEBI issued a circular through which it barred the practice of pledging client securities for stock brokers’ personal loans, and hence ordered brokers to segregate client funds and securities by September 2019. As KSBL defaulted in complying with the aforesaid directions, an investigation was triggered by the National Stock Exchange (“NSE”), which informed SEBI of KSBL’s malpractice, wherein they pledged the securities of nearly 95,000 clients and raised approximately Rs. 2,300 crores via loans against shares from different banks such as ICICI Bank, HDFC Bank and Axis Bank, among others. Relying on the NSE’s report, SEBI passed an interim order on November 22, 2019, whereby it prohibited KSBL from taking on any new clients with respect to its stock broking activities and also directed the National Stock Depository Limited (“NSDL”) to allow the transfer of securities from KSBL to the respective clients who had lawfully paid in full against those securities. Subsequently, a string of orders and appeals followed, which ultimately culminated in discerning the culpability of KSBL and thereby prohibiting it from the securities market, as underscored previously.

Analysis of SEBI’s Intervention

As set out in the preceding paragraphs, it is pertinent to note that SEBI acted swiftly in recovering the losses. As on December 2, 2019, NSDL issued a press release notifying the return of nearly Rs. 2,013 crores to approximately 83,000 investors whose shares were illegally pledged by KSBL. Thereafter, SEBI passed a string of orders, circulars and directions, which aimed at curbing the possibility of such a widespread broker scam in the future.

For a start, by way of a circular dated February 25, 2020, SEBI notified that the transfer of securities to the demat account of the trading members (“TMs”) or clearing members (“CMs”) for margin purposes would be prohibited. SEBI also aimed at enhancing transparency by implementing a pledge/re-pledge system, whereby the investors would be provided a complete trail on the status of their pledged securities through brokers, which were then re-pledged through CMs and Clearing Corporations (“CCs”). These changes were ushered in by the SEBI in order to reduce the limitless power exercised by brokers in utilizing the clients’ securities for margin requirements and pledging, without the clients’ knowledge, in order to obtain significant leverage against the same. Also, through a circular dated August 27, 2020, SEBI revised the guidelines for the execution of power of attorney (“PoA”) by the client in favor of the stock broker and/or depository participant (“DP”), such that it made the practice of giving PoA as an optional exercise, which could not be mandated by the stock brokers upon opening of the client account. SEBI further restricted the usage of PoA to only limited circumstances like pledging of securities to meet the margin requirements of the clients, so as to prevent the unfettered misuse of mandatory PoA by brokers like KSBL.

It is essential to underscore that SEBI refined the legal framework surrounding the margin pledge/re-pledge system adopted by TMs and CMs through a circular dated July 20, 2021, whereby it mandated a daily reporting mechanism to be followed by TMs and CMs, in order to provide significant visibility of the client-wise collateral at all levels. SEBI also ensured that a web portal facility is provided by the respective CCs and stock exchanges (“SEs”), such that the clients can easily view and access the information regarding the disaggregated collateral which is reported by the TMs and CMs. Such a monitoring system, which is readily accessible to the investors, can be very effective in safeguarding their securities kept with the brokers, and enabling them to avoid any red flags pertaining to broker defaults. Thereafter, with a view to ensure that the collateral belonging to a client is only used towards the obligations of that client, SEBI in the afore-mentioned circular also issued a direction to that effect, which came into force from May 2, 2022.

Now, despite these regulatory mechanisms in place, SEBI observed that there are significant existing risks related to potential over-reliance on the reporting of the TMs and CMs (collectively, the “members”) regarding the client-wise allocation, along with the threat of misuse of client collateral which is retained by the members and not passed along to the CC. These risks are often heightened in case of stock broker defaults, irrespective of their causation, and hence can negatively impact the usage of clients’ securities by the stock brokers and members, thereby shaking investor confidence in the securities market. Therefore, in order to mitigate the aforesaid risks, SEBI in its consultation paperdated January 17, 2023, proposed the implementation of the UPI-based mandate and block mechanism in the secondary market, such that the clients would be in a position to block their funds in favor of the CC, in their respective bank accounts, in order to indulge in secondary market trading. Through this method, they can easily avoid the difficulty of transferring the securities up front to the members. SEBI has envisaged to achieve the dual objective of eliminating the onerous and potentially risky burden of transferring securities in favor of the brokers and simultaneously allowing the investor to accrue interest on the blocked amount in their bank accounts.

While the above-mentioned measures are welcome in solving the problem of rampant misuse of the investors’ funds, by way of its consultation paper dated February 3, 2023, SEBI cautioned against the looming problem of surplus funds of nearly Rs. 46,000 crores being held with the brokers and CMs as per the last running account settlement data of January 6, 2023. In order to rectify the same, SEBI has proposed the upstreaming of all the investor funds from the stock brokers and CMs to the CCs on a daily basis. Nonetheless, SEBI has allowed the CCs to place the surplus investor funds in very low-risk and liquid overnight money market instruments. It can be observed that such a move might hinder the floating income, in the form of retained surplus funds, which was hitherto enjoyed by the brokers and CMs, but it is a reassuring step towards regaining the investors’ confidence with respect to their securities lodged with the brokers.

In a bid to further tighten the regulatory norms, SEBI through its recent circular dated April 25, 2023 directed all the brokers and CMs to restrain from the practice of pledging their clients’ funds and using that leverage to obtain bank guarantees, effective from May 1, 2023. Further, in case of already created bank guarantees against clients’ funds, SEBI has mandated their winding down till an extended period of September 30, 2023. Along with these directions, SEBI seems persistent to monitor the implementation of this circular as well, by ensuring a compliance certificate to be submitted to the SEs/CCs latest by October 16, 2023, which would play a crucial role in preventing the arbitrary misuse of the clients’ securities held with the brokers.


The catena of orders, circulars, consultation papers and directions issued by SEBI in the aftermath of the Karvy scam are welcome as they pave the way for the investors to regain autonomy over their securities held with the brokers, and restrict the latter from misusing the former’s funds for their own advantage. Nonetheless, it is pertinent to note that the fixing of loopholes in the regulatory system have still yielded nearly 32 broker defaults in the past five years. This brings to fore the burning question as to whether the extensive legal and regulatory mechanism is effectively implemented to address a situation like the Karvy scam. By SEBI’s own admission in the consultation paper of February 3, 2023, a plethora of client funds still remain parked with the brokers, which can lead to destabilizing defaults. Hence, it is the need of the hour that SEBI ensures an effective monitoring and check mechanism to do away with such perpetrators at the very initial stage, so as to avoid heavy losses to investors and simultaneously retain investor confidence in the securities market.

Anant Budhraja & Praneeta Tiwari

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