Banks begin fact check on pledged securities

Mumbai: As a fallout of the Karvy episode, banks have started sending out letters to brokers to verify whether pledged securities belonged to them or to clients.

According to sources, many banks have started relooking at the documentation and other risk management measures required to ensure that the loan against pledged shares is not misused, like in the case of Karvy.

Some banks are even considering reducing exposure to smaller brokers.

Lenders have turned cautious after Sebi banned Karvy for misusing client securities.

Markets regulator Sebi is also considering tightening the rules to prevent misuse of client funds and securities by brokerages.

During a study of such market practices, the Sebi had found that clients were compelled to issue irrevocable power of attorneys (PoAs), which gave broker/s the right to open and close accounts and trade on client's accounts without consent. In most cases, brokers were not even offering services unless clients gave PoAs.

Karvy is accused of misusing client securities worth Rs 2,800 crore to secure loan facilities from lenders towards working capital by abusing POAs. The brokerage also sold off client securities and transferred the proceeds to its real estate group company.

Following the Sebi directive to transfer securities only to beneficial owners, the National Securities Depository Ltd on December 2 transferred shares worth Rs 2,013 crore into the accounts of 83,862 Karvy clients, which is almost 90 per cent of the affected clients.

Four lenders had approached the Securities Appellate Tribunal (SAT) saying the shares were pledged with them and therefore they had the right over these shares.

On December 4, the SAT ruled that reversing these transfers was untenable, leaving the lenders with no securities to invoke the pledge.

ICICI Bank, HDFC Bank and Indusind Bank had contended that many of these securities had been used to borrow money from them and had pleaded with the tribunal to either get back the securities back to them or put them in an escrow account to protect their funds.

BSE and NSE had suspended Karvy Stock Broking Ltd's trading licence for all segments due to non-compliance with exchange and securities markets rules.

Besides NSE and the BSE, Multi Commodity Exchange (MCX) and MSEI have also suspended the licence of the brokerage firm.

This action follows the 22 November Sebi order which had in its preliminary findings held that the brokerage firm had misused client securities and used it for other purposes. Karvy had sold clients securities and the proceeds were transferred to related party businesses, such as Karvy Realty Ltd.