Sebi penalises NSE, BSE for laxity in Karvy Stock Broking case

Brokerage misused securities worth Rs 2,300 crore belonging to more than 95,000 clients, says regulator

The Securities and Exchange Board of India (Sebi) has slapped a penalty of Rs 3 crore on the BSE and Rs 2 crore on the National Stock Exchange (NSE) for “laxity” in detecting misconduct by Karvy Stock Broking (KSBL).

The Hyderabad-based broking outfit misused securities worth Rs 2,300 crore belonging to over 95,000 clients through unauthorised pledging. These funds were used by the brokerage and its group entities to raise Rs 851 crore from eight banks.

This marks a rare instance where the regulator has charged stock exchanges –considered to be the first-level regulators – for the misconduct of a broker.

The market regulator found several lapses on the part of BSE and NSE that allowed KSBL to misuse securities belonging to its clients. Lapses in monitoring and failure in detecting wrongful tagging of demat accounts allowed KSBL to move client shares from one demat account to another without generating any alerts, Sebi has said.

“The scale of misuse by KSBL points to the loss to investors which can potentially be caused when irregular conduct is not detected in a timely manner,” Sebi said in two separate orders.

Wrongful tagging of accounts

The Sebi order against BSE and NSE reveals how KSBL played both exchanges. The brokerage used a demat account opened with the National Securities Depository (NSDL) to transfer securities worth Rs 2,300 crore in an unauthorised manner. Such a large transfer of securities escaped regulatory glare as it was not properly tagged. In its communication to NSE, KSBL said the account was BSE-tagged and it was reported to the respective exchange. As a result, NSE allegedly thought it didn’t need to examine this further. On the other hand, “BSE did not examine this account at all, leading to a gap in supervision which allowed KSBL to continue pledging client securities through this account,” says the Sebi order.

The regulator said if the proper nomenclature of the account was ensured, it would have resulted in the removal of the misleading BSE-tag on the account. The account then would have been treated as a proprietary account, which would have raised alerts during transfer of shares from client accounts. This would have helped in early detection of the fraud.

Client dues recovered

In 2019, Sebi had passed an ex-parte ad-interim order against KSBL, when the unauthorised pledging issue came to light. Efforts taken by Sebi, depositories, and exchanges helped KSBL’s clients recover their dues. In December 2019, NSDL had said securities were returned to 82,559 clients from the KSBL demat account. In November 2020, NSE had said funds and securities worth Rs 2,300 crore belonging to about 235,000 investors of KSBL were settled.

Rules changed

Following the KSBL debacle, Sebi had changed norms around pledging of shares to prevent their misuse by brokerage. The regulator did away with the concept of power of attorney, which earlier allowed brokerages gain access to client securities.