Karvy Case: SEBI Denies Relief To Lenders

The Securities and Exchange Board of India denied relief to a group of lenders and directed them to approach a civil court to seek recourse against Karvy Stock Broking Ltd. and recover the money lent against pledged shares.

“The pledge created by Karvy Stock Broking of the securities owned by its clients, was unauthorized, and in law, not treated as a valid pledge,” the market regulator said in the order posted on its website.

On Dec. 4, the Securities Appellate Tribunal had directed the banks and financial institutions to approach the market regulator to secure shares pledged to them by Karvy. This after HDFC Bank Ltd., ICICI Bank Ltd., IndusInd Bank Ltd. and Bajaj Finance Ltd. moved the appellate tribunal against National Securities Depository Ltd., National Stock Exchange of India Ltd. and SEBI for transfer of pledged shares to beneficial owners pursuant to the market regulator’s Nov. 22 order. As a relief, the banks had sought a ‘status quo ante’ against Karvy, which would restore their position as it was before SEBI’s order.

In its Nov. 22 order, SEBI had barred Karvy from taking on new customers for allegedly having unauthorisedly pledged client shares to raise funds from these lenders for its own use. The shares have since been transferred from the broker’s pool account to client accounts.

Lenders’ Arguments

Bajaj Finance had sanctioned a loan of Rs 345 crore to Karvy, while ICICI Bank and HDFC Bank had extended loan facilities of Rs 700 crore and Rs 350 crore respectively.

The lenders had made the following prayers with the market regulator:

• Bajaj Finance: SEBI must set aside its Nov. 22 order and restore the pledge in its favour. Alternatively, the market regulator must direct NSDL to indemnify it for the losses arising due to transfer of pledged shares.
• ICICI Bank contended that it had a claim over the pledged shares and therefore pled for restoration of the pledge in its favor.
• HDFC Bank sought partial vacation of SEBI’s order and reversal of NSDL’s move to transfer the shares to the beneficial owner’s demat accounts.

SEBI’s Observations

The market regulator, however dismissed the lenders’ pleas and denied relief to them on the following grounds:

• Karvy was not authorised to pledge securities which were fully paid by its clients. Therefore the transfer and pledging of such securities by Karvy amounted to misappropriation of clients’ securities. As a result, the pledge created by Karvy cannot be treated as valid.
• Karvy could not have pledged clients’ securities as such pledging is prohibited by the Depositories Act. The pledge was thus unauthorized.
• Securities in Karvy’s demat account with the stock exchanges were not reflected in its balance sheet as an investment or holding in securities. A prudent lender must refer to a borrower’s balance sheet for ascertaining its financial position before extending a loan.
• Banks and financial institutions did not verify Karvy’s title over the pledged securities and solely relied on the representations made by the brokerage firm.

Experts BloombergQuint spoke with earlier had anticipated this outcome. Lenders will have to take Karvy to court for breach of contract to recover the amounts, and SEBI cannot settle the dispute between banks and Karvy, they had said.