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Top stock exchanges have expelled Karvy Stock Broking Ltd, a year after the markets regulator discovered misuse of client securities at what was once one of India’s leading broking firms. Karvy was also declared a defaulter, meaning it was unable to honour its dues owed to the exchanges.

“All members are hereby informed that Karvy Stock Broking has been expelled from membership of the exchange under rules 1 and 2 of chapter IV of the NSEIL rules and has been declared as a defaulter under provision 1 (a) of chapter XII of exchange bye-laws w.e.f. 23 November 2020, after the close of market hours," National Stock Exchange of India Ltd (NSE) said in a circular issued late on Monday.

“Investors having any outstanding claims against Karvy Stock Broking are advised to file claims with the exchange, if they so desire, within 90 days from the date of issue of this notice," a BSE Ltd notice said on Tuesday.

NSE on 17 September said it settled dues totalling 2,300 crore of about 235,000 Karvy customers. These included investors with a fund balance of up to 30,000.

Any remaining dues owed to investors will be settled by the exchanges from the Investor Protection Fund (IPF).

On 18 November, the Securities and Exchange Board of India (Sebi) asked the exchanges to review their IPF corpus, and NSE was asked to increase the size to 1,500 crore, a nearly threefold increase from 560 crore. The size will increase to 1,200 crore by 26 November, and an additional 300 crore will be maintained to meet any shortfall.

The exchanges did not disclose the size of default by Karvy; however, a regulatory official aware of the matter said it could be 800-1,000 crore.

An interim order by Sebi in November 2019 said Karvy was misusing client securities, pledging them with banks to secure loan facilities towards working capital, thereby creating third-party rights on shares that belonged to clients. The broking firm also sold client securities and transferred the proceeds to its real estate group company. The total misuse of client securities was to the tune of 2,800 crore.

In its interim order, Sebi barred Karvy from taking on new clients, limited its use of power of attorney to existing clients, and directed exchanges to initiate disciplinary proceedings against it.

Sebi on Tuesday also confirmed the directions of its November 2019 order, stating Karvy and its directors violated securities law, as per a forensic audit done by NSE. The audit and final comments were received by Sebi on Monday, it added.

Karvy shall not alienate any of its assets, except with the prior permission of NSE till the investor claims are settled, said Sebi. “Stock exchanges and depositories shall initiate appropriate action against Karvy and its directors, for the violations of their respective bye-laws, as have been found in the forensic audit report received in the matter," Sebi said.

Simultaneously, a member of parliament has written to the markets regulator requesting back-testing of broker defaults in the past decade, and whether these could have been prevented with higher client margins. The letter reviewed by Mint talks about the four big broker defaults to hit India recently - Karvy, Anugrah Stock and Broking, Allied Financial Services and BMA Wealth Creators.

“Sebi needs to carry out a study using back-testing of all broker defaults of the last decade to ascertain if these could have been prevented or averted with higher margins," said Arvind Sawant, member of parliament, in a letter dated 23 November.

Sebi has now mandated collection of upfront margin, client authorization before pledging and peak margin reporting, in an attempt to check misuse of client securities.

Peak margins, which start from 1 December, will involve informing traders and investors at least four times a day about their margin requirements. A trader will be required to have 25% of the peak margin in his account. This will be 50% from 1 March and 75% for the subsequent three months and finally 100% from 1 September 2021.

Brokers sceptical of the move say clients will need to maintain a lot more margin to initiate intra-day trading. Any default in margin could lead to penalties for clients.

Sawant in the letter called this a knee-jerk reaction.

“Sebi needs to make sure that the steps that can be extremely disruptive for the markets have been taken for the right reasons," he said.

ABOUT THE AUTHOR

Jayshree P Upadhyay

Jayshree heads a team of reporters focussing on legal, regulatory, investigative stories. She has worked for over a decade, reporting on financial scams, legal stories and the intersection of corporate and regulatory issues. She is based in Mumbai and has previously worked with Business Standard, Mint, The Morning Context and Bloomberg TV India.
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