Mumbai: The mess at Karvy Stock Broking Ltd seems to be much bigger than first believed. The markets regulator now estimates the misuse of client securities by the broker at 2,800 crore, 40% more than the 2,000 crore it determined earlier, two people with direct knowledge of the matter said.

The misutilization is much larger according to the initial estimates of a forensic audit, Rafique Dada, the senior counsel appearing on behalf of the Securities and Exchange Board of India (Sebi) at the Securities Appellate Tribunal (SAT), said on Friday.

The true extent of the mess at Karvy will be clear only when EY India Ltd, which is conducting a forensic audit on behalf of the National Stock Exchange of India Ltd (NSE), submits its findings. Still, the crisis at Karvy highlights the risks clients face when they entrust their securities with brokerages.

Sebi has alleged that the broker borrowed against clients’ stocks and diverted some of their money to its real estate business.

The misutilization of client securities appears to be around 2,800 crore and all of it has been pledged with banks and non-banking financial companies, said the second person on condition of anonymity.

“It is also likely that amount would increase further but that would emerge only after the forensic analysis is completed," the person said on condition of anonymity.

Banks have 1,415 crore in fund-based exposure to Karvy and some more in non-fund based guarantees, added the person.

The banks with exposure to Karvy, according to charge documents filed with the ministry of corporate affairs, include ICICI Bank ( 875 crore), HDFC Bank ( 195 crore), IndusInd Bank ( 105 crore) and Aditya Birla Finance ( 100 crore).

(Graphic: Sarvesh Kumar Sharma/Mint)
(Graphic: Sarvesh Kumar Sharma/Mint)

On 22 November, Sebi barred Karvy from acquiring new clients and from using power of attorney, thereby barring it from trading on behalf of clients, after the broker allegedly transferred clients’ money for other purposes and indulged in trade not authorized by them.

Banks have been making representations that they should be allowed ownership of these shares as they believe these are legitimate shares, but Sebi is unlikely to consider the request, said the second person.

“If banks get ownership of the shares and invoke the pledges, then it would be the clients who would be on the losing side," the person said. “Right now, it is unclear how much of the bank exposure is based on Karvy’s securities and how much is based on client pledges. If the pledges are invoked on some client securities, then it is the clients who would need to bear huge losses. In that scenario, even investor protection fund would not be enough."

NSE’s guidelines for Investor Protection and Education Fund, used for investors’ awareness and protection of their interests, cap individual payouts in case of default at 25 lakh.

“Considering Sebi’s stance, banks are exploring all legal options including a SAT or a high court appeal. In this scenario, the rights of banks are not being protected," said a third person, who is familiar with the thinking of the banks.

In a late-night order on 29 November, Sebi refused any interim relief to Karvy on usage of power of attorney as it not only feared further misuse but also banks getting ownership of these shares.

“Banks’ ownership of shares would have had the same impact, leaving the clients at a loss," said the second person.

Karvy had moved SAT on Thursday seeking removal of restrictions on the use of power of attorney, as it claimed this was posing hindrances in settling client trades.

On the morning of 29 November, SAT directed Sebi to examine Karvy’s request, which was later rejected.

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