The purported misuse of client trust by Karvy, a stockbroking firm, to raise funds for itself has shown all players in the entire chain – from stock exchanges to depositories and banks – in a bad light.
Karvy was allegedly pledging the shares of clients using the power of attorney given by them to raise money for itself. Post the discovery of the alleged fraud, the Securities and Exchange Board of India, the depositories and exchanges have placed a ban on Karvy.
Their reactionary action has managed to somewhat stem the agony of the firm’s retail clients. But still, the whole episode has raised several questions on the failure of these institutions to spot the malaise early. How did Karvy manage to hoodwink all of them to carry on a clandestine activity?
Not surprisingly, these shenanigans have raised the pitch for refreshing the regulatory framework, especially relating to stockbroking and depository participants.
Much water has flown under the bridge since India’s regional stock exchanges passed into the pages of history and the National Stock Exchange and Bombay Stock Exchanges became the de facto kings. Member-brokers of the regional exchanges have either turned members of the NSE and BSE or have become sub-brokers or authorised persons of existing members.
Watch: Karvy Broking Scandal Explained: Unethical Pledging of Client Securities?
The broking business also has undergone a major metamorphosis. Today, it has problems aplenty. An uncertain market, discount practices, online trading and a maze of rules and the like have all posed a challenge of their own. In the bargain, it has given rise to avoidable practices. All these have combined to put the present regulatory framework at a risk.
The current framework, it is argued, is under increasing stress, what with one too many players in the field. Given this, a view is gaining increasing ground that the existing regulatory and supervision mechanism needs to be revisited sooner than later. If consolidation is seen as the cure for many ills in the banking industry, why not this course be adopted in the broking arena as well? After all, consolidation gives a player the required bandwidth to absorb rising costs in an increasingly compliance-driven era.
The Karvy case indeed reiterates the need to conduct a ‘fit and proper test’ on all broking houses. Like non-banking finance companies, brokerage houses too be categorised based on their membership with exchanges and ranked according to their service offer. If the discounting in the automobile industry is bad, nil brokerage in the stock business too is undesirable and must be banned as it has the potential to trigger not-so-healthy practices.
Since the Karvy episode is allegedly caused by promoter-induced shenanigans, it is time the responsibility was fixed by forcing them to have a minimum holding in the company. At the same time, the management and owners should be kept at a distance by having a majority of directors who aren’t loyal to the promoters on the board of the company. Simultaneously, adequate financial barrier in terms of a minimum net worth could help keep the non-serious players out of the field. From a client-protection angle, it will be well served if only public limited companies are allowed in the business.
While enforcing strict restrictions on off-market deals, the authorities will do well to encourage via suitable mechanism to force institutional business through the members of the stock exchanges. Market is extremely dynamic. And, it requires a proactive regulatory and supervisory regime. Karvy has indeed exposed an inadequate and under-equipped system.