In today’s newsletter, we cover the Karvy incident.

Markets

Another scam in the mix?

Since this story allows us to talk a bit about the stockbroking industry and its start cast, we will begin with some formal introductions and who better to start with than the main lead — the stockbroker. A stockbroker, much like your real estate broker facilitates transactions when you want to buy and sell shares of publicly listed companies. And since on most occasions you will have to use a broker to get the job done, they occupy a very special role. Then there’s the stock exchange, where the transactions actually materialise. The broker communicates with the exchange on behalf of the client and the transaction is then executed on the exchange if everything checks out. Currently, we have two major stock exchanges in this country. The Bombay Stock Exchange and the National Stock Exchange. Finally, there is the almighty regulator whose sole responsibility is to maintain order. You break the rules, SEBI will find you and it will punish you. At least, that’s the mandate.

So the story goes that Karvy Stock Broking Ltd, a stockbroker misappropriated shares owned by their clients to fund their real estate arm. And once the National Stock Exchange, the exchange in question here, got wind of this, they wrote to SEBI seeking an intervention. And the regulator complied, passing an order preventing Karvy from adding new clients. Meanwhile, the order also makes it clear that any new instructions issued by the broker to execute transactions (buying and selling shares) on behalf of their clients will no longer be honoured.

But before we delve deep into the issue, a brief on the order itself. This is an ex parte ad interim order, meaning the notice has been issued based on allegations made by the National Stock Exchange without the regulator having heard Karvy’s side of the story. In fact, Karvy will soon be allowed to respond to these allegations in full and there will also be a forensic (a more thorough) analysis on the side. So it’s not a final nail in the coffin.

But the allegations made by NSE are damning.

  1. Karvy used shares owned by their clients as collateral to borrow money and fund their real estate arm
  2. Prima facie a net amount of Rs 1096 crores has been transferred by KSBL (stockbroking arm) to its group company i.e. Karvy Realty Private Limited between from 01 April 2016 to 19 October 2019
  3. They also transferred shares from their clients’ accounts to their own account without using the stock exchange

All these are in direct contravention of rules laid out by the regulator and SEBI has rightfully barred Karvy from executing transactions on behalf of their clients until more clarity emerges. In the meantime, we have about 2.4 lakh Karvy clients who are desperately hoping that they don’t lose money in the process. One look at Twitter and you’ll see hordes of people complaining about unmet obligations and sham transactions. So if you are a client  hoping for more clarity on the matter, we will have to redirect you to Livemint. They have a detailed article on what you can do now to protect your interests.

And that leaves us with one last thing — the fallout. How do you bridge the trust deficit that will inevitably emerge as a result of the Karvy incident? Well, for one, stock brokers need to be more transparent about their business dealings. In what’s traditionally been an opaque industry shrouded in mystery we probably need more communication. Not the kind of communication that’ll simply ask you to buy and sell more shares. No. We need an honest discourse about what is it that brokers are currently doing to protect their client's interests. It doesn’t matter if its a bank. It doesn’t matter if it's an online stockbroker. It doesn’t matter if it's your neighbour from down the street. Ask them what they are doing to safeguard your interests.

And if you don’t get a convincing answer. Maybe its time you look elsewhere.

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