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Opinion | Karvy crisis an opportunity to tighten norms

The speedy return of shares is the only way to restore systemic credibility

Imagine you are a 76-year-old lady with a Karvy trading and demat account that contains a significant part of your legacy net worth. When you decide to sell shares for an emergency medical need, you find that Karvy is not paying you. Then, you notice that all your shares still reflect in your Karvy demat statement. Your suspicion grows when the payments are further delayed. So, you check the NSDL website and find to your horror that there are no shares in your account. Meanwhile, Karvy reiterates that the shares are very much there and that it is ready and willing to transfer your shares to another broker. The extra condition is that it has stopped printing delivery instruction books and that you need a new book to transfer your shares. But you still go to NSDL’s ombudsman and lodge a complaint. You also lodge a complaint on Sebi’s SCORES. After all this, your morning newspaper still has the brazen chairman of Karvy declaring no impropriety was committed even when the regulator clearly paints Karvy in the wrong.

For retail investors and senior citizens who form a majority of victims in the Karvy scam, these are extraordinary times. It is very easy to view this as a systemic failure. But in reality, this is fiduciary theft. Imagine a bank manager stealing your deposits and pledging them for his own personal loans without your knowledge. This is the equivalent of that. While the matter will be dealt with as per law, this presents an opportunity to tighten regulation and pin accountability. The speedy return of shares is the only way to restore systemic credibility.

From the investor angle, let us analyse some obvious gaps which have been exploited and must be quickly addressed.

First, the time has come to segregate client finances in the clearing stage. Clearing corporations must pay client credits directly into clients’ bank accounts. If clients want to buy shares, they can pay-in separately. This removes stockbrokers from the process of handling clients’ sale proceeds and restrict their role to only settling the purchase pay-in obligations. This will significantly reduce the scope for misappropriation.

The next priority is revisiting the power of attorney authorizations given to stockbrokers. The power of attorney should be limited to settlement needs. The process of all off-market activity in the depository ecosystem must directly include the depositories (NSDL and CDSL). They must be responsible for verifying with clients if they have authorized the execution of moving shares off-market, creating pledges, etc. This eliminates the scope of the stockbroker surreptitiously moving shares and executing pledges, as is believed to be the case now.

The two depositories must be more accountable by complying with better regulatory processes. They seem to be completely caught unawares, even in the light of such high-value pledged transactions executed by a prominent broker in their own related-party books. Bankers must also verify ownership of shares while lending to stockbrokers, realty companies, etc. Clear declarations, consent documentation, and categorical demarcation should be mandatory for shares from a third party under pledge. By clearly identifying the pledge, categorizing them and holding different agencies accountable, we can easily avoid a repeat of such issues. It is important for the RBI and Sebi to act in tandem on this issue.

At one level, one definitely empathizes with regulation. Despite doing so much and constantly working for incremental measures in investor protection, it still faces fiduciary failures regularly and finds itself questioned. The only deterrent against such repetitive crises is to create stronger deterrents, tighten all processes, reduce powers of intermediaries, disintermediate payment systems, and allow clearing corporations to directly empower investors. It may also be time to create a new category of cost-efficient, stand-alone retail custodial service, which will help investors willing to pay a small sum for better security and ease of transaction management. For the investor’s sake, we must decisively fix the fiduciary systems.

Shyam Sekhar is chief ideator and founder, iThought.

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