2020 (1) TMI 679 - Board - SEBI

Pledging of securities of unpaid clients required taking of explicit authorization by the stock broker from each such client and in respect of each such pledging - HELD THAT - PoA given by the client to the broker can be used for the purpose of pledging in favour of the stock broker, only for the purposes of meeting the margin requirements. The authorization claimed under said PoA by the Representor is not the explicit authorization of the client, as referred to under SEBI circular dated September 26, 2016 and of which record is also required to be maintained by the stock broker of all such authorisations. Representor, in para 18 (e) of its representation dated December 19, 2019 has prayed that in respect of partly/unpaid clients, KSBL be directed to issue five days notice to the clients or the Representor be allowed to issue 5 days notice to clients to enable the clients to redeem the pledged shares by making payment of the corresponding outstanding indebtedness, failing which the Representor be permitted to invoke the pledge on shares. If the Representor is able to show proof of authorization in respect of securities having value of ₹ 13.69 crores belonging to unpaid clients, such securities can be released to the Representor after following the above procedure under supervision of NSEIL.

Summary

Issues Involved:

1. Misuse of client securities by Karvy Stock Broking Ltd. (KSBL).
2. Validity of pledges created by KSBL.
3. SEBI's directions and interim orders.
4. Representation by Axis Bank Limited.
5. Legal implications of pledging client securities.
6. Compliance with SEBI circulars.
7. Rights of fully paid versus partly/unpaid clients.
8. Authorization for pledging securities.
9. Procedural directions for resolving the dispute.

Detailed Analysis:

1. Misuse of Client Securities by Karvy Stock Broking Ltd. (KSBL):
The judgment highlights that KSBL misused client securities by pledging them to generate funds without legal rights, violating SEBI circulars and guidelines. The SEBI interim order dated November 22, 2019, mandated immediate actions to protect investor interests, leading to the freezing of certain client securities.

2. Validity of Pledges Created by KSBL:
The Representor (Axis Bank Limited) argued that the pledges created under the impugned demat account were valid as per the SEBI circular dated September 26, 2016, and not invalidated by the SEBI circular dated June 20, 2019. However, SEBI found that pledging securities of fully paid clients without their explicit authorization is invalid and amounts to misappropriation.

3. SEBI's Directions and Interim Orders:
The SEBI interim order directed depositories to ensure that the transfer of securities from the KSBL account is permitted only to the respective beneficial owners. The order also mandated maintaining the status quo regarding the securities in the impugned demat account.

4. Representation by Axis Bank Limited:
Axis Bank Limited filed an appeal and made representations to SEBI, seeking clarity and relief regarding the pledged securities. The Hon'ble SAT directed SEBI to hear the appellant and other relevant entities and pass appropriate directions.

5. Legal Implications of Pledging Client Securities:
The judgment underscores that pledging securities of fully paid clients without their authorization does not convey any title to the pledgee. Such actions are deemed invalid and amount to misappropriation. The court referenced the ABN Amro Bank case, emphasizing that wrongful pledging cannot be recognized as valid for conveying title.

6. Compliance with SEBI Circulars:
SEBI circulars dated September 26, 2016, and June 20, 2019, were pivotal in determining the validity of the pledges. The latter circular prohibited pledging of client securities and mandated unpledging existing pledges by October 1, 2019. Axis Bank claimed compliance with these circulars by requesting KSBL to unpledge the securities.

7. Rights of Fully Paid Versus Partly/Unpaid Clients:
The judgment differentiates between fully paid and partly/unpaid clients. Fully paid clients' securities cannot be pledged without their explicit authorization. In contrast, securities of partly/unpaid clients could be pledged if explicit authorization was obtained, and records maintained.

8. Authorization for Pledging Securities:
The Representor argued that the Power of Attorney (PoA) given by clients was sufficient authorization for pledging. However, SEBI clarified that PoA could only be used for meeting margin requirements and not for general pledging, as per the SEBI circular dated April 23, 2010.

9. Procedural Directions for Resolving the Dispute:
SEBI directed that if Axis Bank could provide proof of authorization for pledging securities of unpaid clients, those securities could be released to the bank following a specified procedure under the supervision of NSEIL. This included issuing a five-day notice to clients to redeem the pledged shares by paying the outstanding indebtedness.

Conclusion:
The representation by Axis Bank Limited was disposed of in accordance with the findings and directions provided, ensuring compliance with SEBI regulations and protecting investor interests.