This article is written by Zohra Mistry.

Introduction

I was shocked in the month of November when instead of “No Shave November” selfies, the media was full of how Karvy as a Stock Broker duped investors and raised a whopping Rs 1200 crore to divert into its real estate. Before dwelling into what was Karvy Stock Broking Scandal and its impact on the Investment Industry, what happened after and before that, let’s first understand the basics like What is Stock Broking? Who is a Stockbroker? What is a Demat Account? What is the lifecycle of Trading and What is Loan against Securities?

• In India, a retail investor cannot directly buy or sell shares on the Stock Exchange, they need an intermediary known as Depository participants/Stockbroker who assists to execute the transactions and have them electronically accounted for. 
• The electronic accounting happens in Demat Account unlike in ancient times where Physical Share Certificate was issued but in 1996 these physical certificates were replaced to electronically record the transactions.
• The Demat Account is like bank account and is linked to the Depositories who acts as the custodian of shares and in India, we only have two depositories: NSDL(National Securities Depository Limited; deals with “National Stock Exchange” (NSE)) and CDSL (Central Depository Securities Limited; deals with Bombay Stock Exchange (BSE)).
• In India, Stockbrokers are governed by the Securities and Exchange Board of India Act (SEBI), 1992 and brokers must register with the Securities and Exchange Board of India.
• Stock Broking is a service which enables retail or for that matter institutional investors to buy and sell securities with the help of an intermediator called Stockbroker who in exchange for his service charges a fee called Commission.
• For Stockbroker to work on behalf of investors after every market transaction he needs to sign Delivery in Slip to register the stocks in Demat. To make this process hassle-free in today’s world when you open a Demat Account, a Power of Attorney is signed which enables brokers to act independently.
• All the workings of the stock market and for that matter stockbrokers are managed and regulated by the guidelines provided by the Securities and Exchange Board of India.

Role of Depositories

• Depositories are the institutions that hold the securities which include shares, debentures and mutual funds electronically in the dematerialize form called Demat Account.
• Depositories are the safe keeper of the securities and record everyday transactions.
• Depositories provide security and liquidity, and offer a fund transfer system.

Role of Depository Participants

• A depository interacts with customers with the help of agents called as Depository Participants i.e. if the investors want to buy or sell shares, debentures and mutual funds it should be done through them.
• In order to be a Depository Participant, the institution should obtain certification as per the  SEBI regulations laid down in 2018.

What is a Demat Account?

• A Demat account is like a Bank’s Saving Account in function. A bank account is used to store money from paper currency to electronic money in the same way in a Demat Account the physical shares are converted into electronic form which is known as Dematerialization.
• In order to open a Demat Account, similar to how we approach a Bank for opening the account, we approach Depository Participants; they take proof of identity to open this account and then they become intermediaries for transacting in stock markets.

What is the Power of Attorney?

• A Power of Attorney is a legal document that gives authority to act for another person in matters relating to both financial and non-financial matters. Thus, in case of Demat account, it is used to carry out trading functions.
• As per SEBI, Power of Attorney is not mandatory but if it’s not available, investors need to keep signing the Delivery Instruction Slip similar to a Cheque for withdrawing shares. This is just to ease the process.
• Power of Attorney for Demat should be a specific one that doesn’t give Depository Participants the right to make investment decisions and is used only to withdraw shares when sold or pledge security in order to cover the margins shortfall for trading derivatives with a clause to take a consent before doing so. By limiting the rights, you save yourself from falling prey to any kind of future mishaps.

Lifecycle of Trading

Loan against Security

We in our daily life need money for our various needs and these needs sometimes cannot be fulfilled with the income that we earn. We then seek assistance through a Financial Institution called as Banks. These Banks lend us money for a charge known as Interest against a security known as Collateral. The Collateral can be in the form of any tangible asset like property or intangible asset like Securities in Demat Account.

This could best be explained with our day to day hearing of a loan known as House Loan. When you take the house loan, the house that you purchased is mortgaged with the bank until you fulfill your obligation to pay back. Thus, the house is collateral and in loan against security, the house is replaced with securities in dematerialized form to create a margin for loan.

Thus, Loan against security in simple terms refers to pledging the security with the bank as collateral for the money that will be lent by the bank. The money will be lent only on the shares available in the Demat Account.

Karvy Stock Broking Scam

Now, as we have understood the basics, we will understand in detail what Karvy as Stockbroker did that caused a scam of around Rs. 1200 Crore.

Karvy is one of the biggest stockbroking firms and has millions of clients who it serves. These clients instruct Karvy on a day – to – day basis to execute their market transactions. Karvy needs a Depository Participants account to execute these transactions after which these are transferred to Client’s Account. To enable Stockbroker here Karvy to seamlessly carry out these transactions, Client had signed a Power of Attorney authorizing Karvy to do the process. Karvy took undue advantage of this situation opening another Demat Account in its own name and transferred all the securities in its fake account using the Power of Attorney and delaying the payout to clients citing the reason of technical glitches.

Once the securities were transferred to its fake account under the name of Karvy, Karvy approached various financial institutions to raise money and in turn utilised these amounts for its real estate business named Karvy Realty.

Using this unethical method Karvy raised around 1200 crores, when some clients complained about the delayed payouts to SEBI, a forensic audit was carried out by SEBI wherein the issue of fund diversion by Karvy came in light where it acted in bad faith. Karvy’s license was cancelled and it was ordered that all the shares pledged with Financial Institutions be returned to the Clients of Karvy. Till now 90% of the shares are transferred and the Demat with Karvy was to be closed and securities to be transferred to the new account.

Why did the Karvy Scam happen?

Karvy Scam is an eye-opener to the Investors that not only money in banks is at risk, but money invested is also risked. It’s not what SEBI does to protect you as a Regulator, it’s also about what you do as investors to manage the biggest cycle, a world in its own self. It’s a vicious cycle, if gone from hand will be like the virus that can engulf the whole world into economic depression. A depression that can bring back the time when we evolved from apes to humans.

Scams doesn’t happen because the fraudster is smart but because of the ignorance of people getting duped. It only happens when you forget to be vigilant or place trust blindly. Let us understand in four pointers why the Kary Scam happened. It happened as:

• Karvy acted in bad faith by mis-utilising the Power of Attorney granted to it by Clients for ease of transactions.
• Clients granted full access in Power of Attorney without linking their Demat Account to the Depositories to know their actual shares in the account.
• Financial institutions never questioned the authority or authenticity on the ownership of the shares.
• Karvy was successful in delaying payouts as investors never doubt or made themselves aware of the deadlines for settlement or market functioning.

What did SEBI do after the scam?

Once this scam in light, SEBI issued 11 points guidelines which are as follows:

1. Pay-out to be received in the Shareholder’s Demat account within 1 day or according to the market settlement cycle.
2. As per SEBI, execution of Power of Attorney(POA) is not mandatory but if a shareholder is executing it, he should carefully specify all the rights that the stockbroker can exercise and timeframe for which POA is valid.
3. Instead of executing POA, shareholders can register for online applications viz Speed-e and Easiest which is provided by Depositories for online delivery of securities.
4. Shareholders need to ensure that he/she receives the Contract Notes within 24 hours of trades and Statement of Account at least once in a quarter from the Stockbroker.
5. Shareholders should be cognizant of the fact that the securities provided by them towards margin are not permitted to be pledged by your Stockbroker for raising funds.
6. If a Shareholder has opted for a running account, he should ensure that the stockbroker settles his/her account regularly and not later than 90 days (or 30 days if you have opted for 30 days settlement).
7. Do not keep funds and securities idle with the Stockbroker. Always transfer the excess to your savings account.
8. Shareholders should regularly login in to their account to verify balances and Demat statements received from depositories for correctness. 
9. Always check messages received from exchanges on a monthly basis regarding funds and securities balances reported by the trading member and immediately raise a concern if you notice a discrepancy.
10. Always keep your contact details namely Mobile number/ Email ID updated with the stockbroker and take up the matter with Stockbroker/ Exchange if you are not receiving the messages from Exchange/ Depositories regularly.
11. If you observe any discrepancies in your account or settlements, immediately take up the same with your stockbroker and if the Stockbroker does not respond, with the Exchange/Depositories.

What you should do as an Investor?

• Be proactive in checking whether the Demat account is handled carefully or not.
• Be vigilant.
• Don’t just sign any documents without understanding the reason for it.
• If you have multiple Demat accounts or single, do make sure you are registered with the Depositories.
• Make sure you keep yourself well informed about the Market and its settlement.
• Don’t leave excess amount in Demat, always have it transferred to the Saving Bank.
• Always shout when in Doubt.

Just like you call your Phone Banker or Bank Branches to inquire about your savings account balances, update your passbook regularly and you keep yourself awake to see no fraudulent transactions happen. Treat your Demat Account as well in the same manner.

So, to conclude I would say don’t be a learned fool who just does things as they ought to be done. Do verify the documents that you sign, ask if any amends or legal changes can be made in the documents that are specified mandatory. Ask a field expert for help when you are in doubt. I don’t say all Depository Participants are frauds, but no fraudster will say I am a Fraud. Being cautious, taking preventive measures to avoid losses, knowing your rights and obligation doesn’t make you over smart. It’s always wise to be smart. 

• Do link your Demat Accounts to Depositories.
• Do frequently check your Demat Account.
• Do raise it in case of Discrepancy.
• Don’t panic and be worthy Investors. 

Let me share with you my  3 D’s principle that I follow when it comes to managing the trading account, it goes as follow:

• Divert excess amount to savings accounts.
• Divulge to Regulators for delayed payouts.
• Drop in to your Demat Account to see the balance.

---

LawSikho has created a telegram group for exchanging legal knowledge, referrals and various opportunities. You can click on this link and join: