Sebi Penalises Bse And Nse For Laxity In Karvy Scam

The matter pertains to Karvy unauthorisedly transferring securities worth Rs. 2300 crores of more than 95,000 clients into just one demat account, named Karvy Stock Broking Ltd (BSE). Further these securities were unauthorisedly pledged by thebrokerage firm for itself and its group entities to raise Rs.851.43 crores from 8 banks/ non-banking financial services firms (NBFCs).

Sebi in two separate orders found the exchanges lax in early detection of the misuse of clients’ securities by the brokerage firm. Sebi in its order said that the exchanges followed a ‘casual approach’ while inspecting the broker in the previous years.

The orders also lay bare how Karvy exploited the gaps in information reconciliation by market infrastructure institutes (MIIs).

MIIs include exchange and depositories.

The demat account used by Karvy to affect the large-scale transfer of investors’ securities was supposedly tagged as a BSE margin account.

“BSE did not examine this account at all, leading to a gap in supervision which allowed KSBL (Karvy) to continue pledging client securities through this account,” Sebi said in its 64 page order against BSE.

“It escaped scrutiny by BSE on 2 counts – first one being failure to check nomenclature of account by BSE and secondly, failure to scrutinize the alerts on off-market transfers pertaining to this account shared by NSDL with BSE,” Sebi order added.

This particular account escaped NSE’s scrutiny since it was a BSE tagged account.

“NSE reasonably believed that the onus was not upon it to conduct an inspection and examination of the same, in view of the manner in which responsibilities were apportioned in practice,” Sebi order against NSE said quoting the exchange.

As per the Sebi order BSE had carried out a full-fledged inspection on Karvy for FY 2016-17.

In the same year, BSE had received an email from the regulator highlighting a complaint against Karvy for breaching the networth norms. Karvy had been investing in group companies through both debt and equity. Karvy has a very high debt of Rs.1000 crores debt on very low equity bases. This debt ideally should have made Karvy’s net worth negative.

NSE in the same fiscal had found Karvy funding substantial amounts (Corporate Guarantee amounting to ₹1,917 Crores) to the group company not involved in any securities business resulting into negative networth of ₹79.75 Crores of KSBL. It was also observed by NSE that the value of corporate guarantee issued was higher than its total balance sheet value of ₹1338.21 crores as on 31-03-2016

During the full-fledged inspection BSE did not flag the negative net worth concerns, Sebi said in the order.

“It is necessary to appreciate that Noticee (BSE) performs the role of a frontline regulator and its obligation to conduct inspection of brokers cannot be merely checklist based, particularly when a red flag was highlighted to it by Sebi and Noticee was aware of imposition of penalty on KSBL (Karvy) by NSE. However, from the inspection report of 2016-17 and from the submission of the Noticee, I find that the inspection was carried out in a routine and mechanical manner, without taking into consideration reference from Sebi and findings of NSE,” the Sebi order against BSE said.

Against NSE, Sebi said that exchange needed to have taken proactive action since there were serious findings by NSE relating to KSBL funding substantial amounts to the group company.

“KSBL (Karvy) was successfully able to evade detection of client security pledging because it misinformed NSE that the account was margin account of the other exchange and did not pertain to NSE transactions. Accepting the claim of KSBL at face value that the account was a BSE margin account also shows lack of reasonable due diligence on the part NSE in ensuring required compliance,” Sebi said in the 89-page order against NSE.

“The standard of due diligence for the Noticee (NSE) has to be seen in the context of its function as first level regulator and the onerous responsibility cast upon it to provide a safe and reliable infrastructure for trading in securities,” said Sebi.