Karvy Stock Broking scandal: Sebi unlikely to provide relief to lenders

The Securities and Exchange Board of India (Sebi) is unlikely to provide any relief to the four embattled financial institutions that had lent to Karvy Stock Broking, which, in turn, had placed client securities as collateral.

Following the directions of the Securities Appellate Tribunal (SAT), Sebi last week gave a hearing to HDFC Bank, ICICI Bank, IndusInd Bank, and Bajaj Finance in the matter involving transferring securities that were unlawfully pledged from the accounts of Karvy’s clients. Sources said the regulator was likely to hold the lenders accountable for failing to do due diligence on the ownership of the securities that Karvy had pledged. 

SAT has directed Sebi to pass an order on the matter by December 12. Sebi’s circular in June had said clients’ securities that were pledged must be unpledged and returned to them. The regulator’s stand has been that “since the lenders had never questioned Karvy on the ownership of the pledged shares and the rightful owners, they should be held responsible for this negligence”, said a person with knowledge of the matter.

“There is a mechanism prescribed on advancing loans to stockbrokers. It requires foolproof verification of underlying collateral offered by borrowers. A large financial institution is expected to have a proactive approach by checking from depositories about the shares being offered by brokers for pledge and whom they belong to,” he said. In case a client defaults on payment, brokers could hold the securities for up to five days, after which they could liquidate them in the market and recover the dues.

The rule was to come into effect by August 31 but its enforcement was postponed by another month and brokers were given time till September 30. The provision means brokers are obliged to revoke the pledge by October 1. Sources said Sebi had taken a firm stand that lenders who gave loans against shares had taken cognizance of the circular and, in the light of that, verified all collateral. Karvy allegedly raised over Rs 600 crore by illegally pledging securities belonging to 95,000 of its clients worth more than Rs 2,300 crore. Karvy used the securities to generate funds for group entities, including its real estate subsidiary.

Karvy did not disclose the depository participant account to either the exchanges or depositories, said another person in know.