The latest ones to now join this fraud train are share broking firms, the focus so far has been on the banks which has now shifted to share brokers
India’s banks and NBFCs have been found to be infected with giant frauds and misuse of funds, such that the banking system continues to be crisis-ridden. The bankruptcy of banks (who have been nursed under the PCA by the RBI) and their giant shocking NPAs bear loud testimony to utter misuse of funds by those who were entrusted with public money.
The latest ones to now join this fraud train are share broking firms if the focus so far has been on the malpractices and misconduct of banks, NBFCs and their borrowers, it has now shifted to share brokers, who have blatantly misused client funds, which has now been revealed.
It all started with the BSE and the NSE conducting inspection of the books and records of share brokers, to verify their compliance with the SEBI regulations, particularly in the matter of keeping client funds and securities in separate and distinct accounts, different from those of the share broker.
The inspection by the BSE and the NSE found a rampant and open violation of these SEBI norms by the share broker. They were found to have not kept client money and shares in separate accounts. The brokers were found to have misused the power of attorney taken from their clients and in a most unauthorized and fraudulent manner, they pledged shares of clients with banks and financial institutions and raised money against these shares, which did not belong to them. This was quietly done without the consent of their clients, particularly in dormant accounts with low frequency of transactions, of unsuspecting clients who trusted brokers have thus been cheated.
The money illegally raised in this manner by the brokers was then used by them for share trading, margin lending, derivatives trading, and speculation and was also diverted into activities like real estate. And to make it easier to misuse and pledge client shares in this fraudulent manner, they often did not deposit the shares bought by clients into their individual Demat accounts and instead kept them in a common pool with them for such misuse.
They often funded their own clients, which built false trading volumes, giving lucrative income to brokers, by way of interest and brokerage too. The total amount fraudulently raised by brokers in this manner is over Rs.10000 crores and many brokers have misused the funds in such a manner that they are in no position to repay the loans raised and release their client securities from the pledge.
The biggest misuse of client shares has been reported to be by Karvy, which is among the top ten share brokers of India, with almost 2.5 lakh clients, which it services through 900 offices, employing over 30000 persons. It has misused client shares, by pledging them without client consent and has raised Rs.2000 crores, of which almost Rs.1100 crores has been siphoned and diverted into its real estate business, since 2016.
Such loans have been raised from banks, NBFCs and institutions, who did not bother to check that the shares pledged with them as security, do not belong to Karvy. This was found out during the course of inspection of Karvy by NSE, which promptly informed SEBI. NSE was alarmed and it also appointed EY to conduct a forensic audit of the affairs of Karvy.
The fact is that SEBI has been aware of these shady illegal practices of sharebrokers. In June 2019 it cracked the whip and directed all share brokers to set their house in order, by returning shares belonging to clients and also completely separately each client’s fund and shares from its own, by 30-09-19.
The fact is that many brokers have not been able to comply with SEBI’s order, indicating that they have either misused the funds or have incurred losses in their share market transactions, such that they are unable to return the shares and funds of their clients.
Based on the NSE inspection report, SEBI has quickly passed an interim order, to protect public interest awaiting the forensic audit report of EY. It was in effect prohibited Karvy from undertaking share transactions for clients on the stock markets, apart from instructing depositories to not transfer any shares at the instructions of Karvy, even if it holds a client’s POA. Karvy can thus conduct share market transactions for itself, but not for its client. Interestingly Karvy denies any such wrongdoing and says that all is well.
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While this is a most serious issue and SEBI will need to heavily punish the delinquent brokers, it will yet need to handle the matter sensitively by giving them time to square off these transactions, or else all hell will break loose in the share markets.
Although SEBI has announced new regulations to prevent any such fraudulent misuse by brokers, it will yet need to avoid an overkill of heavy-handed regulation, or else the capital markets will go into a coma.
In meanwhile Karvy faces severe loss of trust, its credit rating has been downgraded and its clients will need to shift to new brokers, not just due to loss of trust, but also due to SEBIs order, which bans Karvy from undertaking these transactions for its clients.
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