Exchanges under lens for role in Karvy mess
PROBE WIDENS Sebi probing more brokers, why bourses failed to spot lapses
MUMBAI: The markets regulator has expanded its investigation into the Karvy Stock Broking Ltd (KSBL) default episode to include stock exchanges and a dozen broking firms, two people aware of the matter said.
The Securities and Exchange Board of India (Sebi) is trying to find out why exchanges failed to spot the lapses at Karvy, which prevented an early detection of the suspected fraud, and whether more broking firms engage in similar practices, the people cited above said on condition of anonymity.
The regulator is also examining why stock exchanges, which periodically audit brokerages, failed to detect that Karvy had illegally pledged client shares to raise money. In a November 22 order, Sebi said some funds have also been transferred to Karvy group firms.
“Exchanges are required to conduct regular annual inspection of brokers, but in Karvy’s case, they failed to detect instances of misutilisation of client money done by the broking firm at an earlier stage,” said a senior regulatory official, one of the two people cited earlier. “The exchanges are first-line regulators and should be cognizant of any misutilisation of client securities and should have flagged it.”
While the allegedly illegal transactions took place between 2016 and 2019, they were detected much later, between January and August this year, after a limitedpurpose audit by the National Stock Exchange. The audit revealed that Karvy had misused client securities by pledging them
SEBI IS ALSO EXAMINING WHY STOCK EXCHANGES FAILED TO DETECT THAT KARVY HAD ILLEGALLY PLEDGED CLIENT SHARES TO RAISE MONEY
with various lenders without authorization. The total value of these transactions is estimated to be ₹2,000 crore, making it one of the largest defaults by a stock broker in India. Based on its preliminary findings, Sebi on November 22 barred Karvy from signing up new clients or transacting on their behalf.
In December 2018, Sebi asked brokers to standardize their books and records, making it easier for exchanges to inspect and compare broker data.
In January, it directed brokers to report their security balance weekly. After these changes, exchanges began a reconciliation process of matching exchange records with depository records. Depositories were then directed by Sebi to share pledge details with the brokers.
In June, brokers were barred from using client securities to raise funds and asked to wind down existing pledges starting 1 October.
“Auditors of such broker dealers, along with self-regulatory body Finra, are required to give attention to pledges, collaterals, disclosures with respect to related-party transactions, expense sharing agreements, capital contributions and withdrawals, inter-group exposures, and examination of software/compliance tools,” said Sumit Agrawal, founder of RegStreet Law Advisors and a former Sebi official. “In the wake of the recent episode, Sebi may consider stepping up the way stock exchanges or Sebi conducts inspections.”
In a related development, rating agency Icra on Wednesday downgraded two instruments of Karvy Stock Broking on the basis of the recent Sebi order. These are ₹250 crore of long-term line of credit from banks and another ₹300 crore of commercial papers. “The order is expected to impact KSBL’s operations negatively which in turn would affect the debt repayment capacity of KSBL. The rating is based on limited or no updated information on the entity’s performance since the time it was last rated in March 2019,” said Icra.
A Karvy spokesperson said the firm is in the process of making payouts to clients and the first tranche will be done in two weeks.