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Karvy Broker’s Rs. 2000 Cr Default Spooks Dalal Street Amidst Fears Of Similar Defaults By Other Brokers



The default by Karvy Broker has left its clients high and dry and also sent shock waves across Dalal Street that other brokers may be in a similar soup. We must be ready with a contingency plan in case the contagion spreads to other brokers




Karvy was earlier accused by police of cheating hapless investors

The first sign that all is not well with the Karvy group came in June 2019 when a group of hapless investors rushed to the Bengalure police with the complaint that they had been cheated.

Apparently, the top brass of Karvy had promised investors returns of 18-20% and collected large sums of money.

However, when the returns stopped coming and cheques bounced, investors realized they had been taken for a ride.

The police swung into action and filed charges of criminal breach of trust and cheating against Abhijit Bhave, the CEO, and other top officials of the Karvy group.

The present status of the complaints and whether the investors have been able to recover any part of their money is not known.

Change in regime in AP spelt doom for the Karvy group

According to some knowledgeable sources, Karvy Realty bought large tracts of land in Amaravati, the new capital of Andhra Pradesh, in anticipation that Chandra Babu Naidu would storm back into power and they would make a killing.

However, the surprising victory of Y.S. Jagan Reddy upset all plans.

Jagan Mohan Reddy has been on a rampage and is reversing all of Chandrababu Naidu’s major decisions.

This led to the World Bank withdrawing its funding to the Amravati project which torpedoed all business plans.

Even the Lulu group, which is led by Billionaire M. A. Yusuff Ali, revoked its decision to invest Rs. 2200 crore in Andhra Pradesh.





Karvy pledged clients’ securities & took loans for the realty project

A reading of SEBI’s order reveals that Karvy allegedly hatched a devious plan to betray the trust of its clients and misuse their securities.

Apparently, Karvy raised funds by pledging the stocks held in the clients’ demat accounts and used the funds for its own purposes.

“The securities lying in the aforesaid DP account of KSBL, actually belong to the clients which are the legitimate owners of the pledged securities. Therefore, KSBL did not have any legal right to create a pledge on these securities and generate funds,” Ananta Barua, the Hon’ble WTD of SEBI, has observed in a grim tone.

Karvy also appears to have preyed on dormant accounts, where clients have not traded for a long time.

It transferred securities worth Rs. 27.8 Crore, off-market, from the beneficial owner accounts of 156 clients who have not executed a single trade with them.

Further, securities worth Rs. 116.3 Crore were transferred from 291 clients who have not traded with KSBL since June 01, 2019.

Not surprisingly, the funds were used for the ill-fated realty project.

“Prima facie a net amount of Rs. 1096 crores has been transferred by KSBL to its group company i.e. Karvy Realty Private Limited between from 01-April 2016 to 19-October-2019,” SEBI has noted.

Karvy Scam
(Image Credit: ET)

Karvy’s clients are panic-stricken

Naturally, there is a pall of gloom over Dalal Street over the Karvy fiasco with investors worrying about the fate of their hard-earned money.

“This is a reputation loss for the market. Is investors’ portfolio secure with brokers? Whom to trust?” they asked in a mournful tone.

Karvy Default
(Image credit: ET)



Crisis may snowball?

Another worry plaguing Dalal Street is that Karvy may not be an isolated case.

Other brokers are probably also indulging in similar alleged nefarious practices.

In fact, two other brokers named ‘BMA Wealth Creators‘ and ‘Allied Financial Services‘ have already been suspended for alleged nefarious activities.

Also, if Karvy goes down, the ripple effect will be felt by its lenders.





Karvy stays defiant, Denies misuse of clients’ securities

Surprisingly, despite the damning findings in SEBI’s order, Karvy claimed that “there is no instance where there has been misutilisation of client securities”.

It also argued that its action of investing in Karvy Realty is ‘fully compliant’ with SEBI’s regulations.

“There is no instance where there has been misutilisation of client securities. We have a track record of resolving investor complaints, and while we acknowledge delays in handling and resolution of certain cases, to characterise it as misutilisation is a travesty,” it said in a belligerent tone.

“We want to reiterate once again that nowhere in the SEBI order has an amount of Rs 2,000 crore been mentioned, and that this number together with the word default is extremely misleading and damaging to our reputation,” it added.

“There is no ban at all whatsoever, except a restriction on on-boarding new customers for a 21 day period. This is completely false and we will continue to service all our existing customers uninterruptedly,” it emphasized.

Karvy’s clients can still bail out and salvage something

Obviously, there is no merit in Karvy’s clients standing still like a Deer caught in the headlights.

They have to take proactive steps by rushing to the exit door and transfer their securities and funds to another reputed broker.

Neil Borate and Jayshree Upadhyay of Live Mint have explained the precise modus operandi for this in an article.





Zerodha issues soothing assurance and calms nerves

While other brokers have maintained a studied silence over the Karvy fiasco, Zerodha, which is founded by visionary Billionaire Nithin Kamath, has issued a much needed clarification as to the state of their affairs.

“This damning SEBI order against Karvy has come as a shock to everyone in the capital market ecosystem,” Nithin Kamath has rightly acknowledged.

Apparently, earlier, all brokers used to indulge in “margin funding“, i.e. they would pledge the client’s securities with a NBFC and utilize those funds to allow the client to buy stocks on margin.

Brokerages benefitted because they earned higher brokerage and interest income from the transaction.

SEBI realized this mechanism was prone to abuse and banned it in June 2019.

“We have never done margin funding and this regulation does not affect us,” Nithin Kamath has asserted.

He has also pointed out most financial irregularities have debt as the main catalyst.

The compulsion to repay borrowed money induces nefarious activities.

However, Zerodha has zero debt and so is not subject to any pressures.

Nithin Kamath has also clarified that not only does Zerodha not pledge client securities to NBFCs, it does not even keep client securities in its pool account.

All client securities are always in their respective Demats at all times, he has stated.

He has also clarified that Zerodha has never had issues in terms of securities not being credited to clients’ Demat accounts or their being moved out without authorization, or with client fund payouts.

“Our own funds are over 25% of all our client funds put together. This has to be among the highest in the industry in terms of skin in the game, all accrued from organic revenue. Zero external funding or borrowing,” he has added.

“There is no need for concern at Zerodha,” he has stated emphatically and in a soothing manner, bringing much needed solace to all inhabitants of Dalal Street!










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1 Comment
  1. Kamal Garg's Gravatar Kamal Garg
    November 25, 2019 at 11:22 am | Permalink

    I think regulator should take most stringent measures to curb such practices. Every decade, we have one such blow-up at some securities broking firm which derails and demotivates entire investor community.
    Is it a way for 5 trillion dollar economy.
    No way.
    Think about long term serious impact it has created among the investor fraternity.

    Reply

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