Karvy Crisis: Securities Appellate Tribunal Reserves Order In Pledged Shares Case

The Securities Appellate Tribunal reserved its order in appeals filed by three banks seeking to secure shares pledged to them by Karvy Stock Broking Ltd.

HDFC Bank Ltd., ICICI Bank Ltd. and IndusInd Bank Ltd. moved the appellate tribunal against National Securities Depository Ltd., National Stock Exchange and Securities and Exchange Board of India for transfer of pledged shares to beneficial owners.

The market regulator had passed an order on Nov. 22 barring Karvy from taking on new customers and dealing with their money for allegedly selling clients’ securities and using funds for its own purposes. The regulator had also restrained transfer of securities from Karvy’s depository participation account with immediate effect, except to those beneficial owners who had made full payments for the securities.

Banks claimed that certain shares in Karvy’s DP account were pledged to them and therefore, SEBI’s order, which allowed transfer of shares to beneficial owners was contrary to law and curtailed their chances of recovering the amounts extended as loan to Karvy. NSDL transferred shares without their consent, thus causing loss of pledged shares which cannot be recovered back immediately. Therefore, banks have sought a ‘status quo ante’ against Karvy, which would restore their position as it was before SEBI’s order.

Initially, Bajaj Finance Ltd. had moved SAT seeking quashing of SEBI’s order on similar grounds. Karvy has a total outstanding obligation exceeding Rs 344 crore towards Bajaj Finance. To this, SAT passed an order directing the non-bank lender to approach SEBI’s whole-time member for seeking relief and granted a suspension on further transfer of shares from Karvy’s account.

Here are the key arguments made by the banks in their case against NSDL and NSE:

HDFC Bank’s Arguments

Gaurav Joshi, counsel arguing on behalf of HDFC Bank, made the following arguments:

• HDFC Bank has dues exceeding Rs 300 crore from Karvy, which were lent against pledged securities valued at Rs 470 crore.
• NSDL transferred pledged shares despite any compulsion or urgency, thus wiping off the bank’s security cover. It violated SEBI’s Depositories and Participant Regulations by unilaterally marking the accounts as settled.
• Demat shares are fungible in nature and hence, tracing and recovering them from the markets after their transfer to the beneficiary accounts would be a complex process.
• NSDL violated its own byelaws and depository rules as it did not seek bank’s prior consent or concurrence as a pledgee before cancelling pledge on the shares.
• While the law allows pledging of securities, it prohibits wrong or over-pledging.

ICICI Bank’s Arguments

Sandeep Parekh, counsel arguing on behalf of ICICI Bank, sought indemnification from NSDL against losses arising on the pledged shares on following grounds:

• Section 9 and 10 of the Depositories Act says that a depository is the registered owner of shares for effect of transferring ownership. It holds the shares on behalf of beneficial owners. These sections have an overriding effect over all other laws.
• The law requires a depository to indemnify beneficial owners in case of negligence. ICICI Bank along with other banks was the beneficial owner as it had fractional ownership of the pledged shares. Therefore, NSDL must indemnify them against the impending losses.
• The market regulator failed to inspect Karvy’s books while NSE failed to detect the mismatch between client and broker’s positions despite the law requiring it to do so on a monthly basis.

IndusInd Bank’s Arguments

Counsel for IndusInd Bank made the following arguments:

• A regulator issues an ‘ex parte ad interim’ order only on urgent grounds for grant of status quo to prevent an irreversible act. However, NSDL pushed shares to 83,000 demat accounts despite a status quo.
• SEBI undermined its own regulations by acting contrary to the depository rules on pledged shares.
• Law clearly requires consent of pledgee before taking any action on pledged shares. However, no such consent from IndusInd bank was obtained by NSDL.

SEBI And NSDL’s Rebuttal

Rafique Dada, counsel for SEBI, rebutted the allegations on the following grounds:

• Banks failed to check the ownership and position of shares pledged by Karvy, despite working with the brokerage firm for more than a decade.
• Being a pledgee, banks cannot claim a higher position or more rights than Karvy over the shares.
• Reversing the transfers made to more than 83,000 demat accounts and checking bona fide status of each account would consume a lot of time.

Somasekhar Sundaresan, counsel for NSDL, made the following arguments in depository’s defense:

• NSDL is merely a record keeper of the shares in the markets.
• Fraud vitiates all solemn acts and therefore, NSDL doesn’t owe any liability to the banks.

Venkatesh Dhond, counsel for NSE, informed the tribunal that transfer was effectuated only after ascertaining that beneficiaries had paid for the securities in full.