Question 1 : What’s the story of Karvy fraud?

On 22nd Nov ’19, SEBI banned KARVY Stock Broking Limited (KSBL) from accepting any fresh client or executing any fresh transaction on the exchange. This has affected around 2.5 lakhs clients across various branches of KSBL. SEBI’s investigation has unearthed a fraud committed by the senior management at KSBL wherein its clients’ securities have been sold off to the related parties/subsidiary companies, and the proceeds have been given to related parties. In some cases, the DMAT holdings of its clients have been pledged to raise loans for related parties. Exact amount of misappropriation is difficult to ascertain but it can run into a few thousand crores of rupees.

Question 2 : How KARVY could pull this off?

KARVY’s act was unethical and was facilitated by the Power of Attorney given to it by its clients. (Remember that 100-page form that you sign while opening a DMAT & Trading Account, it carries POA as well.) Basically, a POA is like a blank cheque handed over by you to stockbroker to act in good faith.

Question 3 : What could be the motive behind this fraud?

Its difficult to ascertain the exact reasons behind this act. But, for sure, the group businesses like Real Estate and Commodities were not in good shape. Perhaps, big losses there and commitment to stakeholders worked as the trigger behind this.

Question 4 : Will it be contagious and affect other brokers?

There is a general fear among the investors that this could lead to a contagious effect and many more broking house may get impacted. We believe that this is a KSBL specific case, which will not have a contagion effect. There are ample means at the stock exchange level to handle this kind of situation before it becomes contagious. Nevertheless, there can be isolated cases of more brokers found guilty of similar fraud, as the culture gets rotten when a big player like KSBL adopts malpractices. Probably, KSBL would be the isolated big case, and rest (if any) will be relatively smaller. It will be wrong to equate a series of defaults in stockbroking business unlike NBFCs, where the contagion of IL&FS spread to DHFL, ADAG, Essel, etc.

Question 5 : What should be done to prevent similar frauds in the future?

  1. As of today, stockbrokers are not required to disclose related party transactions to the stock exchanges and regulators. There is a big gap here and should be filled up by SEBI.
  2. All brokers, beyond a particular scale, should be mandated to have an independent director on their boards.
  3. Capital Adequacy norms should be brought in, similar to what is maintained for NBFC & banks
  4. Strict disclosures, similar to the MF industry, should be adopted.
  5. KYB (Know Your Broker) norms should be introduced with strict annual compliance.

Question 6 : What should existing clients of Karvy Stock Broking do, right now?

    1. If you are one of those who is not yet affected by KSBL fraud, then move your Trading / Dmat account to some other established broker. Don’t be complacent about it.
  1. If you have been affected by the fraud, then lodge a complaint with SEBI Scores ( website without delay. This is SEBI’s grievance redress system. Don’t expect things to cure up on their own.

By Sameer Rastogi

18 years of experience, PG in Finance and has delivered Wealth Management lectures at IIM Lucknow, IBS Gurgaon and IIPM Delhi. Contributed to various newspapers. Strength – Application of Economic fundamentals to Investment

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