2019 (12) TMI 477 - AT - SEBI

Pledging/misuse of client securities by the stock broker - violations of the Securities Laws - HELD THAT - The securities lying in the aforesaid DP account actually belong to the clients which are the legitimate owners of the securities. Therefore, KSBL did not have any legal right to create any kind of pledge on these securities. Even if the client securities were pledged, it should have only been for meeting the obligation of the respective clients which was not observed in this case. Considering the issue of misuse of clients securities by KSBL in unauthorized manner, for its own use and purposely not disclosing the DP account no. 11458979, named KARVY STOCK BROKING LTD (BSE) to the Exchanges in their reporting create a serious doubt on the conduct and integrity of KSBL. The acts of KSBL are prima facie in violation of Stock Broker Regulations, SEBI circular no. SMD/SED/CIR/93/23321 dated November 18, 1993, SEBI Circular No. MRD/DOP/SE/Cir 11/2008 dated April 17, 2008, SEBI Circular No. SEBI/HO/MIRSD/MIRSD2/CIR/P/2016/95 dated September 26, 2016, SEBI Circular No. SEBI/HO/MRD/DP/CIR/P/2016/13 dated December 16, 2016, SEBI Circular No. CIR/MRD/DP/54/2017 dated June 13, 2017, SEBI Circular No. CIR/HO/MIRSD/MIRSD2/CIR/P/2017/64 dated June 22, 2017 and Circular No. CIR/HO/MIRSD/DOP/CIR/P/2019 dated June 20, 2019, as discussed above. Therefore, there is need for urgent regulatory intervention to prevent further misuse of clients securities. In exercise of powers conferred upon me under Sections 11(1), 11(4) and 11B read with Section 19 of the SEBI Act, 1992 and Regulation 35 of SEBI (Intermediaries) Regulations, 2008, by way of this ex parte ad interim order, pending forensic audit, hereby issue the following directions (i) KSBL is prohibited from taking new clients in respect of its stock broking activities; (ii) The Depositories i.e. NSDL and CDSL, in order to prevent further misuse of clients securities by KSBL, are hereby directed not to act upon any instruction given by KSBL in pursuance of power of attorney given to KSBL by its clients, with immediate effect; (iii) The Depositories shall monitor the movement of securities into and from the DP account of clients of KSBL as DP to ensure that clients operations are not affected; (iv) The Depositories shall not allow transfer of securities from DP account no. 11458979, named KARVY STOCK BROKING LTD (BSE) with immediate effect. The transfer of securities from DP account no. 11458979, named KARVY STOCK BROKING LTD (BSE) shall be permitted only to the respective beneficial owner who has paid in full against these securities, under supervision of NSE; and (v) The Depositories and Stock Exchanges shall initiate appropriate disciplinary regulatory proceedings against the Noticee for misuse of clients funds and securities as per their respective bye laws, rules and regulations;

Issues Involved:
1. Non-reporting of DP account and misuse of client securities.
2. Unauthorized pledging of client securities and misappropriation of funds.
3. Violation of SEBI regulations and circulars.
4. Transfer of securities without client authorization.
5. Transfer of funds to group company.
6. Need for regulatory intervention and preventive measures.

Detailed Analysis:

1. Non-reporting of DP account and misuse of client securities:

KSBL did not report the DP account no. 11458979, named KARVY STOCK BROKING LTD (BSE) in the filings made by it from January 2019 to August 2019. This account was categorized as Beneficiary Client and opened on December 20, 2000. The securities in this account actually belong to the clients, and KSBL had no legal right to create a pledge on these securities. KSBL credited funds raised by pledging client securities to its own bank accounts instead of the "Stock Broker-Client Account" and did not report these accounts to the Exchange as required under SEBI Circular No. SEBI/HO/MIRSD/MIRSD2/CIR/P/2016/95 dated September 26, 2016.

2. Unauthorized pledging of client securities and misappropriation of funds:

KSBL sold excess securities to the tune of ?485 Crore through 9 related clients and transferred excess securities worth ?162 Crore to 6 out of these 9 related clients. Upon verification, it was observed that securities worth ?257.08 Crore were unpledged and securities worth ?217.85 Crore were recovered by KSBL from 4 client accounts. KSBL also purchased securities amounting to ?228.07 Crore to recoup the securities shortfall. This action violated SEBI circulars and Clauses A (1) & (3) of the code of conduct prescribed for Stock Brokers under Regulation 9 of SEBI (Stock Brokers & Sub Brokers) Regulations, 1992.

3. Violation of SEBI regulations and circulars:

KSBL's actions were in violation of multiple SEBI circulars, including SEBI Circular No. SMD/SED/CIR/93/23321 dated November 18, 1993, SEBI Circular No. MRD/DOP/SE/Cir – 11/2008 dated April 17, 2008, and SEBI Circular No. SEBI/HO/MIRSD/MIRSD2/CIR/P/2016/95 dated September 26, 2016. These circulars mandate the separation of client securities from the broker's own securities, proper reporting, and the prohibition of using client collateral for purposes other than meeting the respective client’s margin requirements/pay-ins.

4. Transfer of securities without client authorization:

KSBL transferred securities worth ?27.8 Crore off-market from the beneficial owner accounts of 156 clients who had not executed a single trade with them. Additionally, securities worth ?116.3 Crore were transferred from 291 clients who had not traded with KSBL since June 01, 2019. This was done without client authorization, violating SEBI regulations.

5. Transfer of funds to group company:

KSBL transferred a net amount of ?1096 Crores to its group company, Karvy Realty Private Limited, between April 01, 2016, and October 19, 2019. This transfer of funds was a misuse of client securities and funds, highlighting serious misconduct and lack of integrity.

6. Need for regulatory intervention and preventive measures:

To prevent further misuse of clients’ securities, SEBI issued an ex parte ad interim order prohibiting KSBL from taking new clients in respect of its stock broking activities. The Depositories (NSDL and CDSL) were directed not to act upon any instruction given by KSBL in pursuance of power of attorney given to KSBL by its clients. The Depositories were also instructed to monitor the movement of securities into and from the DP account of clients of KSBL and not allow the transfer of securities from DP account no. 11458979. The transfer of securities from this account was permitted only to the respective beneficial owner who has paid in full against these securities, under the supervision of NSE. Additionally, the Depositories and Stock Exchanges were directed to initiate appropriate disciplinary regulatory proceedings against KSBL for misuse of clients’ funds and securities.

Conclusion:

The findings recorded in this order are based on the prima facie examination of facts and prima facie violation of securities law. The present order has been passed under disciplinary proceedings against KSBL for the prima facie violations of the Securities Laws. KSBL may file its objections/reply within twenty-one days from the date of receipt of this Order. This order shall come into force with immediate effect.

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