Karvy crisis is just what the doctor ordered for Sebi
PremiumHopefully, the Karvy fiasco will result in some tough decisions by the markets regulator
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PremiumIt isn’t that they cannot find the solution. It is that they cannot see the problem," said the English writer G.K. Chesterton. It seems fair to use this description for the Securities and Exchange Board of India (Sebi), which for years, has been trying to protect clients’ funds and securities from unscrupulous brokers. Nearly five years ago, after a number of cases of siphoning by brokers surfaced, this column had said that some rules drafted by Sebi looked good only on paper. The need of the hour was exemplary justice, accompanied with better inspection and surveillance capabilities and, perhaps, even shifting the role of regulating brokers out of stock exchanges.
Nearly five years hence, we have more rules to protect client funds and securities, but we also have a bigger scam. Karvy Stock Broking Ltd coolly pledged clients’ securities and raised funds of about ₹2,800 crore, and reports suggest it even sold some client securities. After a diktat by Sebi to the depositories, most of the securities have been returned to the clients. But the lenders to Karvy are now crying foul and have approached the Securities Appellate Tribunal for relief. The silver lining in all of this mess is that the legal squabble may throw some light on where current regulations and processes fall short.
But only changing rules won’t help; more needs to be done. Hopefully, the Karvy fiasco, as big as it is, will serve as a wake-up call and result in some tough decisions by the markets regulator, and by its bosses.
One of the key lessons from the Karvy crisis is, to use the Sebi chairman’s words, “things that are not allowed by Sebi happen". While this was said in response to Karvy’s suggestion that what it did was within the regulatory framework, the fact remains that market participants often do things that are not allowed.
So, it becomes imperative for Sebi to have greater control and responsibility regarding market surveillance to curb this before things go out of hand. In any case, it’s the regulator that claims to have a state-of-the-art surveillance system that looks at data provided by brokers, exchanges and depositories together. The mismatch in Karvy clients’ actual holdings and what showed up in the system should have been caught by the regulator’s surveillance system.
And if, as news reports suggest, the regulator is unhappy with stock exchanges and their inspection capabilities, Sebi should consider moving this regulatory task either within its doors or to an independent regulatory organization. The buck, after all, stops with Sebi.
The next lesson is that there is no substitute for exemplary justice. The big deterrent for market participants, who consider playing with client funds and securities, is that the punishment in previous such cases was really severe. While it may well be the case that some of Karvy’s clients signed up for products that involved the pledge of securities and leverage—an ongoing forensic audit and the outcome of the case in SAT will throw light on this—the big question is what action Sebi will take against Karvy’s promoters and management if, indeed, there was misappropriation of clients’ assets. If the punitive action stops at a penalty and a suspension of trading licence, it will hardly work as a deterrent for the next in line. In that case, no amount of rules or inspections will help.
The other big lesson for the regulator is that it needs to pull up its socks when it comes to resolution for clients in such cases. Thousands of Karvy’s clients had to go through a harrowing time, because of the way things have played out since the regulator took action against their broker about two weeks ago.
“Sebi can take a leaf out of the US Securities Investor Protection Corp. (SIPC), which takes over operations of brokers that have failed. They do this by appointing a trustee to run the operations of a failed broker, to complete the settlement of pending transactions, among other things. A trustee may also transfer customer accounts to another solvent brokerage firm in what is known as a bulk transfer. Such measures would have helped Karvy’s customers, who are now stuck with a broker who has not been shut down but is not functioning either," says J.R. Varma, professor of finance, IIM Ahmedabad.
In sum, Karvy is a good case study to assess Sebi’s regulatory prowess, and while the regulator will do well to take corrective action for itself, it is also a good opportunity for an outside review of its rule-making, surveillance, adjudication and resolution track record.
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