Karvy fallout: Sebi plans tighter norms to protect mutual fund investors

Regulator proposes discontinuing of pooled accounts, to protect investors

The case of wrongful share pledging by Karvy Stock Broking has led the Securities and Exchange Board of India (Sebi) to consider bringing in tighter norms. This is to protect mutual fund (MF) investors from falling prey to any such misuse of their investments.
 
In a consultation paper issued on Monday, the regulator pointed out the scope for misuse of investments when MF transactions were executed by intermediaries such as brokers and digital platforms provided by MF distributors and investment advisors.
 
In the case of brokers, Sebi observed: “Units and funds move in an aggregate manner from the broker’s account to the registrar and transfer agents, and the asset management company’s account. In such cases, once pooling happens at an intermediary level, the traceability of funds/investor details is lost to AMCs and RTAs (registrar and share transfer agents).”
 
Further, there could be issues when MF investors redeem their investments. MFs are relieved of their obligation towards payments given that the credit of units happens to brokers. Therefore, any investor grievance is taken up by the exchange and arbitration mechanism.
 
Without naming, the Sebi paper alluded to the Karvy case and said instances had come to light where the client’s funds or securities were diverted or mis-utilised by the trading member towards margin obligations, settlement of its own obligations, or for raising loans against clients’ securities.
 
On digital platforms, the note said that MFs, again, didn’t have sight of the source of funds received through such platforms. Further, distributors were not expected to handle clients’ funds and securities. Even during physical application, there were blind spots as distributors were not allowed to receive cheques in their names but in favour of the MF. Investment advisors were also required to provide non-binding services.
 
“Routing of funds and units through them may lead to potential misuse of funds and units,” the Sebi paper said. To plug these gaps, the market watchdog has proposed discontinuing pooling of units by all platforms. In FY19, Rs 53,679 crore worth of transactions —close to 50 per cent of the total MF transactions — were through the pooled route.
 
Exchanges will have to facilitate a more direct interface between clients and the clearing corporation, bypassing intermediaries such as brokers, under this new proposed framework.
 
“For transactions on exchange platforms through the stock broker, exchanges shall put a necessary system in place to ensure the pay-in is directly received by the recognised clearing corporation from the investor’s bank account, and pay-out is directly made to the investor’s bank account from a recognised clearing corporation’s account,” the paper said.
 
“In the same manner, for subscription and redemption, units are directly credited into and debited from the investor account respectively,” it added.
 
For transactions outside exchanges, AMCs will have to put systems in place to ensure subscription and redemption of units take place without any pooling of accounts.
 
On November 22, Sebi had passed an interim order against Karvy Stock Broking, barring it from taking any new clients on allegations that it had wrongfully pledged client securities to raise debt for its own requirements.

The case of wrongful share pledging by Karvy Stock Broking has led the Securities and Exchange Board of India (Sebi) to consider bringing in tighter norms. This is to protect mutual fund (MF) investors from falling prey to any such misuse of their investments.

In a consultation paper issued on Monday, the regulator pointed out the scope for misuse of investments when MF transactions were executed by intermediaries such as brokers and digital platforms provided by MF distributors and investment advisors.

In the case of brokers, Sebi observed: “Units and funds move in an aggregate manner from the broker’s account to the registrar and transfer agents, and the asset management company’s account. In such cases, once pooling happens at an intermediary level, the traceability of funds/investor details is lost to AMCs and RTAs (registrar and share transfer agents).”

Further, there could be issues when MF investors redeem their investments. MFs are relieved of their obligation towards payments given that the credit of units happens to brokers. Therefore, any investor grievance is taken up by the exchange and arbitration mechanism.

Without naming, the Sebi paper alluded to the Karvy case and said instances had come to light where the client’s funds or securities were diverted or mis-utilised by the trading member towards margin obligations, settlement of its own obligations, or for raising loans against clients’ securities.

On digital platforms, the note said that MFs, again, didn’t have sight of the source of funds received through such platforms. Further, distributors were not expected to handle clients’ funds and securities. Even during physical application, there were blind spots as distributors were not allowed to receive cheques in their names but in favour of the MF. Investment advisors were also required to provide non-binding services.

“Routing of funds and units through them may lead to potential misuse of funds and units,” the Sebi paper said. To plug these gaps, the market watchdog has proposed discontinuing pooling of units by all platforms. In FY19, Rs 53,679 crore worth of transactions —close to 50 per cent of the total MF transactions — were through the pooled route.

Exchanges will have to facilitate a more direct interface between clients and the clearing corporation, bypassing intermediaries such as brokers, under this new proposed framework.

“For transactions on exchange platforms through the stock broker, exchanges shall put a necessary system in place to ensure the pay-in is directly received by the recognised clearing corporation from the investor’s bank account, and pay-out is directly made to the investor’s bank account from a recognised clearing corporation’s account,” the paper said.

“In the same manner, for subscription and redemption, units are directly credited into and debited from the investor account respectively,” it added.

For transactions outside exchanges, AMCs will have to put systems in place to ensure subscription and redemption of units take place without any pooling of accounts.

On November 22, Sebi had passed an interim order against Karvy Stock Broking, barring it from taking any new clients on allegations that it had wrongfully pledged client securities to raise debt for its own requirements.