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.
Background
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.
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.
Conclusion
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
*Karvy scam* Well in my case maruti 48 shares & canara bank 50 shares were illegally pledged as these were purchased around 2019 & I never had a negative balance in my financial ledger. Though my claim was approved, I was not interested in lower price compensation compared with the buying price. Only the initial small amount was transferred through the IMF. What should I do as my present price is much higher now & the dividend of the disputed period is also stuck up in this scam. In my case how can SAT/ NSE/ SEBI release my shares in favour of the lender. What is my fault, why they’re penalising me. To the lender they are not only compensating for the principle amount but also the interest of this period. This is totally unfair for investors and the senior citizens like us. Let’s all collectively protest & call the media, before too late, hope Central Govt will listen to us as the elections are nearby. Waiting for advice from legal experts in the group.