What was the Karvy demat scam?

Hyderabad-based Karvy Group flagship Karvy Stock Broking (KSBL)

pledged securities lying in the demat accounts of its clients, without
their permission, to raise funds from multiple banks and financial
institutions. These funds were then diverted into other Karvy group
companies like Karvy Realty.

What was the magnitude of the scam?

Initial estimates showed that KSBL pledged securities of over 95,000
clients illegally and raised over Rs 2,300 crore via loans against shares
(LAS) from multiple lenders like HDFC Bank, ICICI Bank, IndusInd
Bank, Axis Bank, Bajaj Finance, Aditya Birla Finance.

How was the scam done?

The broking firm transferred shares from the demat accounts of its
clients, which were not active, into its demat account named Karvy
Stock Broking (BSE) and showed these stocks as its own securities to
lenders as collateral for taking loans.

How and when was it unearthed?

On June 20, 2019, markets regulator Sebi came out with a circular on
handling client securities which said that brokers could not pledge
client securities to raise loans for themselves, which till then was an
established market practice. Sebi had set a deadline of September 30,
2019, for brokers to segregate client funds and securities but when
KSBL failed to do so by the given deadline, investors complained to
Sebi, which then asked NSE to investigate the matter
What was the action taken by regulatory agencies?
On November 22, 2019, Sebi issued an order banning KSBL from
broking services and said the firm had transferred Rs 1096 crore to
group company Karvy Realty between April 2016 to October 2019. Sebi
also asked NSE to conduct a detailed forensic audit while working
closely with depository participants (DPs) and stock exchanges to
quickly transfer some of the illegally transferred securities back into
the accounts of investors. In January 2020, the Union corporate affairs
ministry also ordered the Registrar of Companies (RoC), Hyderabad, to
probe Karvy group financial fraud.
What about investor compensation?
In December 2019, soon after the scam came to light, Sebi worked
with DPs and stock exchanges to transfer securities of nearly 83,000
out of the over 95,000 scam-hit KSBL clients from Karvy’s demat
account back into their respective accounts.
In November 2020, NSE said it had settled claims worth Rs 2,300 crore
to around 2.4 lakh KSBL investors with fund balances of up to Rs
30,000. In early 2021, under directions from Sebi, KSBL’s demat
accounts were auctioned off to IIFL Securities and its trading accounts
were auctioned to Axis Securities as part of efforts to compensate
investors.
Tracking the scam

2019
November 22 | Markets regulator Sebi issues exparte order banning
Karvy Stock Broking Ltd (KSBL) from broking activities
November 26 | Karvy Group CMD C Parthasarathy resigns from board
of Karvy Fintech, which later rechristens itself as K-Fin Technologies
December 2 | Under Sebi’s directions NSDL and NSE transfer securities
worth around Rs 2,300 crore of nearly 83,000 clients of KSBL back into
their accounts
December 2 | NSE & BSE suspend KSBL from all market segments for
violation of compliance norms
December 4 | SAT turns down KSBL lenders plea to get back the
securities that were transferred back to clients so that pledge can be
invoked
December 14 | Sebi refuses relief to KSBL lenders
December 31 | Karvy Group kicks of corporate rejig and management
reshuffle as damage control exercise; brings in Amitabh Chaturvedi as
CEO of financial services business

2020
January | Union ministry of corporate affairs (MoCA) orders probe into
Karvy Group affairs
August | Telangana high court dismisses writ petitions filed by Karvy
Group challenging SFIO & RoC probes into financial affairs in wake of
demat scam
November | NSE settles claims worth Rs 2,300 crore to around 2.4 lakh
KSBL investors with fund balances of up to Rs 30,000
2021
February | Depositories and stock exchanges auction KSBL’s demat
and trading accounts to IIFL Securities and Axis Securities, respectively
April | IIFL Securities starts activation of 11 lakh frozen Karvy demat
accounts with assets under management worth Rs 3 crore that were
held by NSDL and CDSL
August 19 | Karvy group chairman and promoter C Parthasarathy
arrested by CCS of Hyderabad police based on loan default complaint
by IndusInd Bank

Clues
1) Karvy group secretly pledged securities lying in the demat
accounts of its clients

2) Over Rs 2,300 crore raised by Karvy via loans against shares (LAS)
from multiple lenders like HDFC Bank, ICICI Bank, IndusInd
Bank, Axis Bank, Bajaj Finance, Aditya Birla Finance.

3) New SEBI rule implemented stating brokers could not pledge

client securities to raise loans for themselves, which till then was
an established market practice, giving a deadline of September
30, 2019, for brokers to segregate client funds and securities

4) Markets regulator Sebi issues exparte order banning Karvy Stock

Broking Ltd (KSBL) from broking activities

5) Union ministry of corporate affairs (MoCA) orders a probe into

Karvy Group affairs. Telangana high court dismisses writ
petitions filed by Karvy Group challenging SFIO & RoC probes
into financial affairs in wake of demat scam

6) Under Sebi’s directions NSDL and NSE transfer securities worth

around Rs 2,300 crore of nearly 83,000 clients of KSBL back into
their accounts
7) Depositories and stock exchanges auction KSBL’s demat and
trading accounts to IIFL Securities and Axis Securities,
 respectively. IIFL Securities starts activation of 11 lakh frozen
Karvy demat accounts with assets under management worth Rs
3 crore that were held by NSDL and CDSL

8) Karvy group chairman and promoter C Parthasarathy arrested

by CCS of Hyderabad police based on loan default complaint by
IndusInd Bank

Questions
1. As SEBI, how wud u prevent this?
2. What steps would you take as banks that got duped?
3. As investors, how would you avoid or comprehend these situations?