It’s turning out to be a season of misery for India’s financial sector. The unfolding events at Punjab and Maharashtra Co-operative Bank, Dewan Housing Finance Corporation and Karvy Stock Broking have all combined to knock the confidence out of investors and depositors alike.
The latest one – the Karvy episode – allegedly reveals promoters of a smart kind who skilfully skirted rules, avoided the system and showed no qualms in breaking the trust which is very core to any relationship in the financial world.
What happens if they are caught in the act? The repercussions are bound to reverberate across many adjacent businesses. In this instance, Karvy was found by market regulator SEBI to be pledging the shares of its clients sans their knowledge.
The alleged modus operandi was simple. Karvy liberally used – rather misused – the power of attorney (PoA) obtained from its clients. Karvy employed the PoA to transfer the shares of its clients to its related entities who thereafter pledged them with banks for raising fresh funds. The company allegedly had an unreported DP (depository participant) account to facilitate, rather hide, the misuse of client shares to satiate its thirst for funds. Rules make it mandatory for a depository to notify the exchanges all its DP accounts. This unreported DP account was used as a conduit for its share pledge exercise.
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According to SEBI, an investigation by the National Stock Exchange found Karvy to be indulging in an act not permitted by rules. The misuse that the NSE probe discovered and reported was shocking. For, Karvy had reportedly transferred the securities of clients received in pay out from the pool account to this specific demat account. (These should have gone to the clients’ demat account, in fact). Not only that. Some fully-paid clients’ shares existing in their demat accounts too were allegedly transferred to this unreported demat account.
Following the NSE report, the SEBI barred Karvy from taking any new clients in respect of its broking activities. Depositories such as NSDL and CDSL were told not to act upon any instruction from Karvy. They were also instructed not to allow transfer any shares from the unreported account.
This has, naturally, put Karvy’s clients and banks in a fix. Client, who were taken for a ride by Karvy, aren’t quite sure of their shares. Banks, too, must be worried about their loans to Karvy.
If sources are to go by, some other depository participants are also under the lens of the market regulator for Karvy-like wrong-doings. The Karvy imbroglio, nevertheless, has raised a host of issues. Is it wise to let an outfit which is largely driven by promoters who have diverse business interests into the DP (depository participant) field?
It also begs the question: Do we need to erect a Chinese wall in the DP arena? Is it prudent to bring in a rule-based mechanism to quarantine multiple-activities of a DP? Even as further investigations are on, the discoveries in Karvy and the interim action of SEBI in their wake are bound to trigger a chorus of noise for a re-look at the governance rule for DPs.
That Karvy had chosen to execute the PoA given by clients for “off market transactions” gives a clue or two to the enormity of the wrong-doing. The SEBI action, in the meanwhile, has put a question mark on not only the clients’ money but also the loans given by banks against pledging of these shares by Karvy (by misusing the PoA). Are banks guilty in lending to Karvy? Sources do give benefit of doubt to them.
Sometime ago, there was a proposal to tag the stocks. It was, however, a different matter that it never fructified. Tagging stocks, it is argued, would help stake-holders in the entire chain to track the legal owners of shares. The authorities will now do well to create a mechanism that pictures the rightful owner of a stock.
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The Karvy fallout also seeks a rethinking on whether being ‘big’ is a sign of quality or trust. Being a small company is not a disqualification but automatically sparks more suspicion than their larger counterparts. Ultimately though, big or small, it is the practicing value system that sets the two apart.
The happenings at Karvy may bring in opportunities for others in the near-term. Where the public money is involved, trust becomes a key concern of investors. They will invest their trust in ethical players. In the wake of episodes such as Punjab and Maharashtra Co-operative Bank, Dewan Housing and Karvy, this aspect will weigh more on their minds. It is against this backdrop that quiet outfits like MSE FSL, a 20-year-old subsidiary of MSE (erstwhile Madras Stock Exchange) and similar others are now gearing up to approach the Karvy issue. They now seek to give the old adage “small is beautiful” a new meaning by asserting “small is safe”.
Ethics and safety are two sides of a coin in a business relationship. The recent instances of unsolicited pain heaped on unsuspecting depositors/investors will increasingly demand the need for fostering the two in the financial sector. Raters themselves may be under cloud.
Yet, the unfolding events suggest that DP space could also be well served with a mandatory rating. Karvy must have given the market regulator a new insight into the DP world. This at a time when the regulator has plenty on hand at the moment.
K.T. Jagannathan is a senior business journalist.