SEBI order on Karvy: A dilemma for the banks

PALAK SHAH | | Updated on: Dec 06, 2021


Allowing third-party share pledges to continue a mistake of banks even after SEBI discontinued it this year.

SEBI’s order against Karvy has now put banks and finance companies, who lent money to the broker against pledged shares, in a fix.

These banks and finance companies are not in position to off-load pledge shares as SEBI has instructed NSDL and CDSL to not allow the transfer of securities from Karvy’s demat, unless it is to the ultimate beneficiary of the shares, who has paid the money in full. Such an order has further complicated the matter as the shares, even if it is lying in the demat account of Karvy, were pledged in favour of lenders.

Effectively, the order has put NSDL, CDSL and the banks in a dilemma on the issue of allowing off-loading of pledge shares, sources in the know told BusinessLine .

Also read:Karvy mess: Who is to blame?

Executives of large private banks and finance companies met SEBI this week to sort out the issue of pledge shares, but there seems no immediate solution in sight, the sources said. In fact, a leading finance company has decided to stop giving loans to brokers against pledged shares, sources said.

Pledging of shares

Pledging of shares is a unique model in capital markets to avail finance. Under this system, the charge on the shares lying in a broker’s demat account is made in the favour of the lender. This means that even though the shares are in the demat account of the broker, the lender has a right to sell them at the click of a button. This is simply known as invoking of the pledge.

However, SEBI on Friday directed NSDL and CDSL, the two depositories holding all the demat accounts in India, to allow transfer of shares in Karvy’s demat account only to their ultimate beneficiaries.

Also read:Karvy case: How can investors protect themselves?

The mistake that lenders committed was that they did not check if the shares lying in Karvy’s account were its own or its clients. Legal experts said that it has now come to light that Karvy had pledged shares of several clients to lenders, and they (lenders) could invite legal hassle if they sell them. It is to be noted that pledging of clients’ shares was allowed until August, when SEBI put curbs on it.

Karvy still said that it had managed to recover pledge shares worth around Rs 600 crore from a bank. Yet, it is believed there is huge amount of pledge shares pending with other lenders, including large private banks.

What did the SEBI order say?

“The Depositories (NSDL, CDSL) 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 the securities, under supervision of NSE; and the Depositories and Stock Exchanges shall in initiate appropriate disciplinary regulatory proceedings against the Noticee for misuse of clients’ funds and securities as per their respective bye laws, rules and regulations,” SEBI order said.

The NSE is now conducting a forensic audit of Karvy and the broker has got 21 days time to represent to SEBI.

Published on November 27, 2019
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