A Framework For The Resolution Of Stock Broking Firms
Brokers watch their screens during trading hours inside a dealing room at a bank in Mumbai, India. (Photographer: Abhijit Bhatlekar/Bloomberg News)

A Framework For The Resolution Of Stock Broking Firms

BloombergQuintOpinion

The developments over the last week regarding Karvy highlight the urgent need for an operational framework for the resolution of stock-broking firms and the smooth portability of positions in India. Almost two weeks back, the SEBI issued an order imposing various restrictions on Karvy Stock Broking Ltd., but did not shut down the stockbroker.

The order also froze the securities lying in the name of the stockbroker on the ground that these securities actually belonged to the broker’s clients. Subsequently, these securities were transferred to the names of around 80,000 clients who had fully paid for the shares. Since the broker had pledged these securities with various bank and non-bank lenders, these creditors appealed to the Securities Appellate Tribunal which observed today that “a lot of water has flown under the bridge”, and it is not possible to reverse what has already been done.

In this blog post, I will, however, focus on the problems faced by the clients of Karvy. In its appeal to the SAT, Karvy complained that because of the SEBI restrictions it was unable to execute the instructions given by its clients (especially online clients) on the basis of the power of attorney that is normally used in these cases. On a direction from SAT, SEBI examined this matter but refused to make any concession, and stated that clients were free to issue paper transfer instructions or to fax them. Meanwhile, on Monday, the stock exchange “temporarily” suspended Karvy from its membership, and yesterday the SAT has refused to entertain an appeal against this action.

Clients are now stuck with a broker who has not been shut down or liquidated but is not functioning anymore.

It is not acceptable to say that the 1.2 million clients of Karvy can individually initiate the paperwork to move their trading accounts to another broker. Contrast this with how the SIPC does this in the United States:

Shortly after the commencement of a liquidation proceeding, a SIPA trustee may transfer customer accounts to another solvent brokerage firm in what is called a “bulk transfer.” The bulk transfer can occur without the consent or participation of any customer, and may result in customers getting access to their property in a few days or weeks.

It is also instructive to see how this process worked in the case of MF Global which is in many ways similar to the Karvy episode. The SIPC stated that in the MF Global case:

SIPC initiated the liquidation proceeding within hours of being notified by the SEC

The same day (Oct. 31, 2011), there was a court order appointing a trustee to run MF Global:

ORDERED that … the SIPA Trustee, as appointed herein, is authorized to operate the business of MF Global Inc. to: (a) conduct business in the ordinary course until 6:00 p.m. on November 3, 2011, including without limitation, the purchase and sale of securities … and obtaining credit and incurring debt in relation thereto; (b) complete settlements of pending transactions, and to take other necessary and appropriate actions to implement the foregoing, in such accounts until 6:00 p.m. on November 7, 2011; and (c) take other action as necessary and appropriate for the orderly transfer of customer accounts and related property.

Within two days (Nov. 2, 2011), the first set of bulk transfers covering about 50,000 accounts began.

There is an urgent need to create a statutory and regulatory structure to do all this in India, but I suspect that at a crunch, the regulators may be able to achieve some of these goals using existing statutes and by stretching the powers that they already have to protect the interests of investors. The even more urgent need in my view is to create the operational capability to implement this on the ground. It should not take more than a week to just put a brokerage firm into limbo.

Also read: NSE Lists Dos And Don’ts To Protect Investors’ Shares Amid Karvy Matter

Jayanth Varma is professor of Finance and Accounting at IIM Ahmedabad. This article was originally published on his blog.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.

BQ Install

Bloomberg Quint

Add BloombergQuint App to Home screen.