- Wealth PMS
We’ve recently had a podcast about this (Click here to read) But there’s more to it, and here’s a deeper take on it.
The recent Karvy Stock Broking Limited (KSBL) episode means: Can we trust the stock brokers? Times were different when Harshad Mehta and Ketan Parekh scams happened. After that SEBI has tried to continuously append the existing laws and try to plug loopholes. Even with all the regulations in place, SEBI has hardly any mechanism to detect early warning signs from fraudulent brokers.
In cases of Karvy, the story is not yet out. It is a case of taking out money by pledging client’s securities. So how did Karvy manage to do it without getting caught by SEBI? Before getting to know how, we need to understand certain terminologies associated with the broking business.
You don’t own shares in “physical” form anymore. There used to be share certificates. Printed on heavy paper. Now, it’s all electronic, and the records are in electronic India-wide depositories.
In India there are two depositories viz National Security Depository Limited (NSDL) and Central Depository Services Limited (CDSL). These two depositories are responsible for maintaining the security holdings – stocks, bonds, mutual funds and what not. For instance you have two different brokers and both of them are mapped to NSDL, then you can directly view all you holding at NSDL. Typically all your securities which are paid in full will be reflecting at NSDL post 2 days of buy. In case of sells, It will reflect immediately next day. In most cases NSDL or CDSL sends a SMS when securities are sold, so you are aware.
Most stock brokers will have a pool account. The pool account consists the securities of clients with the following criteria.
Trading and clearing members are two separate entities. In Indian context most brokers perform the dual functionality of trading/clearing member. Trading members are the one responsible for execution of trades for clients and clearing members are the one who settle the trades. In case of Karvy it is both trading/clearing member.
Power of Attorney:
All the brokers nowadays take power of attorney of client while onboarding. Power of attorney helps brokers in moving your securities from your demat to pool account and vice-versa. In absence of a power of attorney each transaction must be manually signed by client (through a depository instruction slip) and given to depository or exchange to move the securities in and out. If you are unable to submit the signed slip within one day of your trade then default happens. If you don’t give a power of attorney, most online brokers won’t allow you to sell.
There have been lot of regulations by SEBI for broking business. In Karvy’s it was found to be a breach of regulations and misreporting of accounts. The whole story centres around misuse of pool account and pledging of client shares. How did Karvy manage to pull this off goes as below:
SEBI after seeing the preliminary report from NSE has issued certain set of guidelines which restricts Karvy in doing furthermore damage. The order has below restrictions for Karvy.
So effectively no new client enrolment will happen for Karvy until further orders. It needs to cater to current set of clients entangling the mesh.
As Karvy earlier had power of attorney of clients to transfer securities. Karvy had the authority to ask depositories to move client securities to whichever account according to their will. The current order puts a blanket ban and has asked NSDL and CDSL not to take any request of security transfers from Karvy.
So the clients need to request for security transfers in NSDL or CDSL. Even with clients request depositories need to evaluate individual request. As in some cases client might have signed the depository transfer form and might have given it to Karvy, which might be misused in these cases.
For clients whose securities are not reflecting in their NSDL statement and are part of the above said pool account, their securities have been blocked from trading. If the client has bought those securities on margin or has only partially paid for those securities, then client needs to pay in full to release the securities and transfer into their depository. If its already fully paid, then client can send a request to NSDL/CDSL to release the security.
Not all the clients at Karvy are affected by this ban by SEBI. However intraday trades and margin trades have been limited at Karvy and no one knows till when it persist.
Its better to shift your account with some other broker may be Zerodha, Upstocks, HDFC, ICICI etc. Before that you need to check whether your security holding are part of pool or in your demat account.
If your account is at NSDL (see your account details at Karvy),
If your account is at CDSL.
Note: You can do this with any broker. If you suspect your broker is keeping securities at the pool account, please follow the above steps.
You may also receive a monthly e-CAS (common account statement) at your mail address from NSDL/CDSL. The PDF is password protected. Follow the instructions in mail to open the document, and cross check your holdings.
Now, the below steps:
With Karvy under SEBI tangles, most of us might have second thoughts on the brokers. The preferential way of thinking is lets go for brokers managed by banks like HDFC or ICICI etc rather than going for online brokers (discount brokers). These brokers are managed by banks, so banks cannot do such shady stuff. We trust broking business with banks at the same level of our deposits at banks. This is blatantly untrue.
Even banks can be a mess. If you look at NSE’s broker reports – the biggest broker is Zerodha who has 0.02% of complaints with only one arbitration case (out of more than 10 lakh clients). HDFC Securities has 2 arbitration cases, and ICICI Securities has 3. (All this is info for April 2019 to October 2019)
Plus, have you ever tried recovering money from a bank? It’s next to impossible – they will go to any extent to ensure they don’t pay. No SEBI action is ever strict against banks because RBI will get into the issue of jurisdiction. There is no guarantee that a bank run broker won’t try to fraud you – and, because they now have full access to your bank account, they can take any amount they want, without you knowing! They have that power of attorney and mandate. We don’t think that’s the right choice.
(Btw, ICICI Securities does do margin funding also, with over 340 cr. in margin funding as of last year’s annual report. These funds are also via pledging of customer securities, and while I don’t think there will be a problem, you have to understand that you have no control over such things. In comparison, a discount broker like Zerodha does not do margin funding yet, and have stated that they will only do it in the future with the more strict recent regulations that segregate special accounts for such purpose)
Why is it complicated to know if the broker has credited your demat account? If a security is bought by a customer, and that security does not hit the customer’s demat account within two days, there are easy ways to know:
You have to work at edge cases like “auction” notices for short delivery etc. but this can be done through tech.
Apart from these a number of checks can be done during share pledges, and you’ll detect a lot more fraud. Unfortunately, we don’t want to really detect this kind of fraud because too many big people will fail. However, the only way to clean up the system is to have big people fail, and ensure it’s a deterrent going forward. Let’s hope the Karvy mess teaches us the right lessons.