Market regulator Securities and Exchange Board of India (SEBI) has imposed a penalty of Rs1.9 crore on four former key officials of Karvy Stock Broking Ltd (KSBL) for several violations, including non-segregation of clients' funds and securities, misappropriation of clients' securities and diverting proceeds to group companies and illegally pledging credit clients' securities with banks and non-banking finance companies (NBFCs).
Those penalised by SEBI include: KSBL's former chief financial officer (CFO) Krishna Hari G (Rs1 core penalty), ex-compliance officer Srikrishna Gurazada (Rs30 lakh), former head for back office operations P Srinivasa Raju (Rs40 lakh) and V Mahesh (Rs20 lakh), chief executive officer (CEO) of Karvy Data Management Services Ltd.
In an order issued last week, Prasanta Mahapatra, adjudicating officer (AO) of SEBI, says, "I note that the noticees were acting as key employees of KSBL when the violations were committed, due to which lakhs of investors have suffered. As a matter of fact, even after more than three years since the interim order, the funds and securities of clients of KSBL have not been settled, further amplifying the gravity of the situation."
In March 2019, the National Stock Exchange (NSE) inspected KSBL for FY18-19. During the inspection, KSBL declared that it had pledged around Rs65 crore as of 31 August 2018 with banks and NBFCs, against which an overdraft of Rs32.28 crore was raised. Based on the submissions made by KSBL, it was observed by NSE that the broker had raised excess funds amounting to Rs90,835 for nine clients, i.e., the clients did not have any obligation which warranted such funds to be raised by KSBL.
NSE also conducted a limited-purpose inspection of KSBL. After NSE's preliminary inspection report on 22 November 2019, SEBI passed an ex-parte interim order to appoint Ernst & Young LLP (EY) as forensic auditor to review KSBL between 1 April 2016 and 30 September 2019. After EY submitted its forensic audit report (FAR), SEBI, on 24 November 2020, confirmed the directions issued in the interim order. On 23 November 2020, NSE expelled KSBP from its membership and declared the broker as a defaulter.
In its FAR, EY found that KSBL had an outstanding loan against securities (LAS) facility of Rs789.41 crore in September 2016 with an overall borrowing of Rs1,051.36 crore. KSBL's borrowing increased to Rs2.032.67 crore on 30 September 2019 from Rs1,051.36 crore on 30 September 2016.
Pledging of securities by KSBL was increased substantially to Rs1,855 crore by 31 March 2018 from Rs202 crore (value of securities as of 30 June 2017). It was increased further to Rs2,700 crore by 30 September 2019, FAR says.
FAR observed that, as of 5 September 2019, at least 75% of the total quantity in client holding was pledged by KSBL even when the clients had a credit balance on that date. Further, 58% of clients holding at least 52% of the value of securities that were pledged did not trade for more than one month.
FAR also noted that out of additional borrowings of Rs1,531.90 crore between 1 April 2019 and 30 September 2019, Rs1,228.36 crore was given by KSBL as loans, advances or investments in group companies. It included Rs428.36 crore as advances for investment in subsidiaries and Rs800 crore towards loans and receivables from subsidiaries.
FAR observed that a net amount of about Rs1,120 crore was transferred from KSBL to its various group companies. NSE also identified that KSBL had a shortfall of funds to the tune of Rs402 crore and securities (valuation) to the tune of Rs157 crore as of 17 November 2020.
SEBI then decided to initiate adjudication proceedings against key persons of KSBL, who allegedly contributed or colluded with the broker in its wrongdoings.
In response to SEBI's show-cause notice (SCN), Krishna Hari, former CFO of KSBL, submitted that the broker's books were maintained in a separate software application 'Pragnya' which was used for generating trial balance that was given to the corporate finance and accounts team for incorporating in financial books.
However, SEBI observed that the demarcation being emphasised by the CFO is not supported by any evidence and that, after working for close to two decades with KSBL, it is expected that he would at least have some documentation regarding the separation of responsibilities between corporate finance and accounts department and stock broking division which would add credence to his claim.
The market regulator noted that KSBL's ex-compliance officer Srikrishna Gurazada was involved in the borrowing of clients' securities outside of stock exchanges' lending and borrowing mechanism and further pledging such clients' securities, as opposed to his claim of merely being a person who was involved in product development. "As he (Mr Gurazada) was reporting directly to the CEO…it was his duty to examine the legality of such process and stop any act contrary to the provisions of law," the SEBI AO says.
P Srinivasa Raju, head of back office operations of KSBL, argued that he did not have the power to pledge clients' securities without the approval of the management. However, SEBI clarified that there is no allegation that such illegal pledging was being done without the approval of KSBL's management.
"Rather, the allegation is that he was aiding and abetting the management in illegal pledging of clients' securities to raise funds, which were later diverted to group companies of KSBL," the market regulator says, adding that even if he did not have the power to approve, he had an obligation to report such patent illegal activities to SEBI, which he failed to carry out.
SEBI asked all the four former key officials of KSBL to remit the penalty amount within 45 days.
