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In the matter of Karvy Stock Broking: The Story So Far

Finsec Law Advisors

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Ex parte ad interim order by SEBI

On November 22, 2019, SEBI had passed an ex parte ad interim order against Karvy Stock Broking Limited (Karvy), wherein Karvy was prima facie found liable for violation of provisions of the SEBI (Stock Brokers and Sub-brokers) Regulations, 1992 along with various circulars issued therein.

As per the Interim Order, the National Stock Exchange (NSE) had forwarded a preliminary inspection report to SEBI requesting it to take actions for Karvy’s non-compliance in relation to pledging and misuse of clients’ securities through one of its depository participant (DP) accounts which was not disclosed by it to the stock exchanges.

Through the Interim Order, SEBI prohibited Karvy from taking new clients and instructed National Securities Depository Limited (NSDL) to not permit any transfer of securities held in the disputed DP account. Further, only transfers to beneficial owners who had paid in full was permitted under the supervision of NSE.

The said findings were upheld by SEBI by way of another order dated November 29, 2019.

Representations by certain lenders

Due to the freeze imposed by NSDL on the said DP Account pursuant to the Interim Order, various financial institutions (Lenders), which had provided loan to Karvy against pledge of securities held in the said account were unable to invoke the pledge and recover the loans. The Lenders made representations to SEBI. However, on account of SEBI’s inaction, the Lenders appealed before the Securities Appeal Tribunal (SAT) stating that they had a valid claim against the securities held in the said DP account and that the Interim Order has invalidated the same. SAT, through its subsequent orders, asked the Lenders to file appropriate representations before SEBI and directed SEBI to consider the same and pass an appropriate order.

Release of securities by NSDL

During the ongoing proceedings before SAT, on December 02, 2019, NSDL issued a press release stating that the securities held in the DP Account had been transferred to the demat accounts of around 82,559 beneficial owners.

Order of SEBI dated December 13, 2019

Pursuant to the directions of SAT, the Lenders filed representations before SEBI seeking restoration of the pledge created in their favour and suspension of any further transfer of the securities held in the DP Account. However, on December 13, 2019, SEBI passed an order rejecting the plea of the Lenders stating that in the absence of any authorisation from Karvy’s clients, the transfer of clients’ securities by Karvy to its own DP account amounted to misappropriation and hence, the pledge created in favour of Lenders was invalid.

According to the said order, though a Power of Attorney (PoA) was executed in favour of Karvy by its clients, the said PoA could have been acted upon only after an order or instruction was received from such clients for trading on the stock exchanges. In the absence of such authorization, the transfer of securities amounted to misuse of the PoA by Karvy. SEBI held that since the securities in the DP Account belonged to Karvy’s clients, the said pledges were unauthorised and invalid, and therefore no rights were created in favour of the Lenders in respect of such securities

Further, it was held that in view of the SEBI circular dated June 20, 2019, which prohibited stock brokers from pledging clients’ securities except for meeting clients’ pay-in obligations, the pledges continued post the said date were invalid. According to SEBI, since the above circular had a direct bearing on the business activities of the Lenders, they were required to take appropriate action in order to ensure compliance with the same. SEBI further observed that the Lenders had failed to verify Karvy’s title over such pledged securities. SEBI further stated that the appropriate regulator, i.e. the Reserve Bank of India, should look into whether the Lenders had exercised proper due diligence prior to sanction of loans in favour of Karvy.

*Finsec Law Advisors is representing few lenders in this matter