Coming down heavily on National Securities Depositaries Ltd (NSDL) and the Securities and Exchange Board of India (SEBI) for transferring, without any authority of law, fungible shares pledged by Karvy Stock Broking Ltd with four banks and one non-banking finance company (NBFC), the securities appellate tribunal (SAT) directed SEBI, National Stock Exchange (NSE) and NSDL to restore the pledge which was made in favour of these lenders within four weeks. Axis Bank, ICICI Bank, HDFC Bank, IndusInd Bank and Bajaj Finance Ltd have filed appeals against two orders passed by SEBI rejecting representation from the lenders.
In an order, the SAT bench of justice Tarun Agarwala (presiding officer) and Meera Swarup (technical member) says, "In our view, if SEBI, NSE and NSDL were of the opinion that the pledge was wrongly created by Karvy as it included clients securities who had no debit balance then the appropriate remedy for SEBI or to the depository was that the depository should file an application before the national company law tribunal (NCLT) for rectification of its register. This process was not done and like a highway robber, NSDL, through illegal directions from SEBI, transferred the pledged shares (which were fungible) to the clients of Karvy, whose action was without any authority of law."
"Thus, in our view, the action of the respondents in not allowing the appellants to revoke the pledge under the Depositories Act and in removing the pledged shares without the appellant's consent was wholly illegal and without any authority of law. The shares so removed and transferred by NSDL under the directions of SEBI are liable to be restituted," the bench says.
As an alternative to restore pledged shares, the Tribunal directed SEBI, NSE and NSDL to compensate Axis Bank, ICICI Bank, HDFC Bank, IndusInd Bank and Bajaj Finance with the value of the underlined securities pledged in their favour along with interest at 10%pa (per annum) within four weeks.
The appeals filed by Axis Bank, ICICI Bank, HDFC Bank, IndusInd Bank and Bajaj Finance are against the SEBI order, where their representations were rejected under similar circumstances.
These lenders advanced loans against securities pledged by Karvy. Since Karvy defaulted, they wanted to invoke the pledge. However, before that, SEBI passed an ex-parte ad interim order on 22 September 2019 directing the depositories not to allow the transfer of securities from the depository participant (DP) account.
According to the lenders, the securities pledged by Karvy were from a DP account. They filed appeals before SAT seeking relief to invoke the pledge following the default committed by Karvy. Their appeals were disposed of with SAT directing them to make a representation. The lenders made representations before SEBI which were rejected.
While disposing the appeals on 17 December 2019, the tribunal directed the parties to maintain the status quo regarding the securities in DP account no19502787.
As a result of the interim order, the pledged shares are still intact and have not been encashed. On the other hand, even though the shares were pledged in favour of the lenders, NSDL issued a press release on 2 December 2019.
In the release, NSDL says, "As per the directions of SEBI and under the supervision of NSE, securities have been transferred from the demat account IN300394-11458979 named Karvy Stock Broking Ltd (BSE) to the demat accounts of respective clients who have paid in full against these securities. The number of such clients who have received securities is 82,559."
SAT says, "NSDL, without revoking or cancelling the pledge in accordance with the Depositories Act and the DP Regulations 1996, transferred the pledged shares to the clients of the broker."
In the course of its business, Axis Bank has been extending overdraft facilities against shares to Karvy from time to time. This overdraft facility was according to an agreement under which a total sum of Rs100 crore had been disbursed. As of 7 December 2019, an aggregate amount of Rs80.64 crore, along with interest, was due from Karvy.
The overdraft facility was secured by shares pledged by Karvy from its demat account having client ID – 19502787, which was named 'KSBL – client account – NSE-CM'. The shares pledged under the overdraft facility agreement were of clients of Karvy, who had debit balances with the stockbroker. According to Axis Bank, the pledge was in compliance with the SEBI circulars issued from time to time, namely, the circular on 26 September 2016.
Later, in a circular on 30 June 2019, SEBI issued directions to the participants in the securities market, stock exchanges, clearing corporations, depositories, trading members, clearing members and depository participants, requiring all clients' securities, which were pledged earlier under the earlier circulars, to be either unpledged or returned to the clients upon fulfilment of pay in obligation or disposed of after giving five days’ notice to the clients. Such unpledging of the clients' shares was to be done by 31 August 2019 which was subsequently extended to 30 September 2019.
Axis Bank communicated with Karvy about clearing the outstanding and with SEBI about the status. In a letter on 3 October 2019, Axis Bank informed SEBI that the broker had requested three months' time to clear the outstanding amount.
While all this was happening, SEBI's whole-time member (WTM) issued an ex-parte ad interim order on 2 November 2019 against Karvy, alleging that the broker had misused its clients' securities. The ex-parte ad interim order found that Karvy did not report DP account no11458979 named Karvy Stock Broking Ltd to the stock exchange in which clients’ securities were pledged. Further, Karvy credited the funds raised by pledging clients’ securities to six of its own bank accounts instead of crediting it in the stock broker–client account and did not report the six bank accounts to the stock exchange.
The WTM further prima facie found that the securities in the DP account no11458979 belonged to the clients who are legitimate owners of the pledged securities.
The WTM directed that the depositories will not transfer securities from DP account no11458979 named Karvy Stock Broking Ltd (BSE).
Pursuant to the ex-parte ad interim order passed by the SEBI WTM, NSDL issued a communication intimating the lenders that the clients’ securities that Karvy pledged would remain in a state of abeyance.
On 29 November 2019, the WTM rejected Karvy's request on an application seeking flexibility in using a power of attorney (PoA) issued by its clients. On 3 December 2019, Axis Bank invoked the pledge through NSDL and filed an appeal challenging NSDL's 23 November 2019 order of NSDL before SAT. While disposing of the appeal, the tribunal directed Axis Bank to make an appropriate representation to SEBI which would be decided.
Accordingly, a representation was made praying that the ex-parte ad interim order passed by the WTM on 22 November 2019 was not applicable and that Axis Bank should be allowed to invoke the pledge on account of the default made by Karvy.
The representation of Axis Bank was rejected by an order on 14 January 2020 passed by the SEBI WTM, holding that the shares pledged by Karvy were invalid and, therefore, could not be invoked by Axis Bank.
In November 2019, SEBI banned KSBL over client defaults worth Rs2,000 crore. The brokerage house was prohibited from taking on new clients and executing trades for existing customers.
This followed an investigation by NSE, which found that Karvy had allegedly sold client stocks pledged with it through associated entities. The regulator had told depositories not to act upon any instructions by KSBL based on powers of attorney given to the brokerage house in order to prevent further misuse of client securities.
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