Money Money Money: Experts decode the Karvy Broking saga

Take a friend’s house on rent and somehow mortgage it with a bank. Then, in case, you are unable to pay back, the bank will claim ownership of the house because the mortgage lies with it. That, in a nutshell, is the Karvy Stock Broking saga.

Clients have been left wondering what will happen next and the big question now is how important is to understand the nature of the relationship between you the stock investor and your stockbroker.

What are the dos and don'ts? What are the rules of engagement and what are the lessons we, as well as regulators, need to learn from this crisis?

Surabhi Upadhyay spoke to Deepak Shenoy, Founder of Capitalmind.in, Vivek Bajaj, Co-Founder of Stockedge, Bharat Chugh, Partner at L&L Partners, HP Ranina, senior corporate lawyer about these issues in this special episode of Money Money Money.

Vivek Bajaj, Co-Founder of Stockedge said, “Specifically for Karvy you can use the term fraud, but if you see the way financial market, the whole industry has functioned, one critical thing has always been that client asset is always used for the purpose creating margin which eventually is used by the client to trade derivatives in the market. This is a standard practice that has been happening.

Recently, SEBI came out with a circular saying that you cannot use client shares to create collateral for the purpose of giving it to the exchange abd creating money out of that.

"Because of that SEBI circular, these actions have actually happened. There was a deadline which was given to the brokers that if you have created some kind of pledged money around client shares then you need to return it back and there were series of brokers who actually were unable to do it and then the whole thing came out in public.” Bajaj explained.

Deepak Shenoy, founder of Capitalmind.in said, “If you think about what has happened it is actually a systemic issue. What happened is that the exchanges said they won’t deal with brokers. So they transfer shares to broker pool accounts, the brokers are supposed to transfer from their pool accounts into customers' demat accounts."

In 2016, SEBI had wanted to do this within one day. Brokerages had 24 hours to transfer it back to the customers' demat accounts. Many brokers were not doing so and it turns out that they continue their old ways.

"They tell you that you own the shares but the shares sit in their pool account and not in your demat account. Overtime brokers take loans on these pool accounts. They borrow from NBFCs at 12 percent and give it to their customers at 18 percent,” explained Shenoy.

“In case of Karvy, the brokerage decided to give its own entity, Karvy Realty, loans to the tune of Rs 300 crore odd. Basically, the broker has used clients' security to fund itself,” Shenoy said.

Bharat Chugh, Partner at L&L Partners said, “I think most of these power of attorney are traditionally extremely wide where the client is pretty much giving all the authorisation to the broker to deal with the shares and sometimes they also include the power to transfer them further. So the biggest takeaway for client is to ensure that the power of attorney is not wide and it gives very limited rights to the brokers."