Order in the matter of Karvy Stock Broking Ltd.

WTM/AB/MIRSD/MIRSD-SEC-4/26927/2023-24 SECURITIES AND EXCHANGE BOARD OF INDIA ORDER UNDER SECTION 12(3) OF THE SECURITIES AND EXCHANGE BOARD OF INDIA ACT, 1992 READ WITH REGULATION 27 OF SECURITIES AND EXCHANGE BOARD OF INDIA (INTERMEDIARIES) REGULATIONS, 2008. IN RESPECT OF NOTICEE SEBI REGISTRATION NO. KARVY STOCK BROKING LTD INZ000172733

IN THE MATTER OF KARVY STOCK BROKING LTD.

BACKGROUND

1. Karvy Stock Broking Ltd. (“KSBL/ Noticee”) was a registered member of the National Stock Exchange of India Ltd. (“NSE”) and BSE Ltd. (“BSE”) with SEBI Registration No. INZ000172733. KSBL is also a SEBI registered Depository Participant (“DP”), having registration number IN–DP–CDSL–175–2015 and was a DP of NSDL and CDSL.

2. SEBI had received a preliminary report (“NSE–IR”) dated November 22, 2019, from NSE, containing its observations of the inspection of KSBL. It was inter alia observed in the NSE–IR that KSBL was raising funds by pledging client securities and diverting the funds so raised to related entities. Based on the observations made in the NSE–IR, SEBI, by way of an Ex Parte-Ad-Interim Order No. WTM/AB/SEBI/MIRSD/HO/35/2019 dated November 22, 2019 (“Interim Order”), pending completion of forensic audit initiated by NSE, issued the following directions:– “i. KSBL is prohibited from taking new clients in respect of its stock broking activities;

Order in the matter of Karvy Stock Broking Ltd. 1 / 18 (ii) The Depositories i.e. NSDL and CDSL, in order to prevent further misuse of clients’ securities by KSBL, are hereby directed not to act upon any instruction given by KSBL in pursuance of power of attorney given to KSBL by its clients, with immediate effect; (iii) The Depositories shall monitor the movement of securities into and from the DP account of clients of KSBL as DP to ensure that clients’ operations are not affected; (iv) The Depositories shall not allow transfer of securities from DP account no. 11458979, named KARVY STOCK BROKING LTD (BSE) with immediate effect. The transfer of securities from DP account no. 11458979, named KARVY STOCK BROKING LTD (BSE) shall be permitted only to the respective beneficial owner who has paid in full against these securities, under supervision of NSE;” 3. Thereafter, vide an Order No. WTM/AB/SEBI/MIRSD/HO/17/2020 dated November 24, 2020 (“Confirmatory Order”), the directions issued vide the Interim Order were confirmed against the Noticee.

4. Just prior to the passing of the Confirmatory Order, NSE submitted a Forensic Audit Report (“FAR”) dated January 9, 2020, along with its observations, to SEBI on November 23, 2020. The period covered under the FAR was from April 1, 2016 to October 19, 2019. The major findings of the FAR are listed below:– (a) Non–segregation of funds and securities of clients; (b) Misappropriation of clients’ securities and diversion of proceeds to Group Companies; (c) Misreporting/non–reporting of data under enhanced supervision to NSE; (d) Non–reporting of the DP account no. IN300394–11458979, named KARVY STOCK BROKING LTD–BSE to exchanges; (e) Pledging of credit clients’ securities with Bank/ NBFCs; (f) Funding to clients having debit balances by providing further exposure; and (g) Non–settlement of funds and securities of the clients. Order in the matter of Karvy Stock Broking Ltd. 2 / 18

5. Based on the aforementioned prima facie findings in the FAR and SEBI’s own investigation, a Show Cause Notice dated January 29, 2021 (“SCN”), was issued to the Noticee inter alia alleging that it had mis-utilised clients’ funds and securities. Subsequently, a Final Order in the matter was passed on April 28, 2023, wherein it was held that the charges alleged against the Noticee in the SCN stood established.

6. Simultaneously with the above mentioned proceedings, SEBI had initiated enquiry proceedings against the Noticee under Chapter V of the SEBI (Intermediaries) Regulations, 2008 (“Intermediaries Regulations”). Accordingly, a Designated Authority (“DA”) was appointed to enquire into whether the alleged violations by the Noticee warranted suspension or cancellation of the Certificate of Registration granted by SEBI or any other action provided in Chapter V of the Intermediaries Regulation. On completion of the proceedings, the DA submitted a report dated April 29, 2022 (“DA Report”) recommending that the Certificate of Registration granted to the Noticee be cancelled.

7. Pursuant to this, a post enquiry SCN (“P–SCN”) dated May 27, 2022, was issued to the Noticee, under Regulation 27(1) of the Intermediaries Regulations, to show cause as to why action, as recommended by the DA or any other action as considered appropriate by the Designated Member (“DM”) should not be taken against the Noticee. A copy of the DA Report was also forwarded along with the P–SCN, and the Noticee was advised to file its reply, if any, within 21 days from the date of receipt of the said SCN.

8. The P–SCN was served on the Noticee at the address available on record with SEBI. The Noticee, however, did not submit any reply to the SCN. Subsequently, the Noticee was provided with an opportunity of personal hearing on August 23, 2022, which was later rescheduled to November 4, 2022, by SEBI, on account of administrative exigencies. The Noticee, in reply, vide an e– mail dated November 2, 2022, sought an adjournment of the hearing and additional time for submitting its reply to the P–SCN, primarily citing the ill health Order in the matter of Karvy Stock Broking Ltd. 3 / 18 of its Managing Director (“MD”), Mr. C Parthasarathy. The request made on behalf of the Noticee was accepted, and a fresh date of hearing was granted on November 22, 2022. The Noticee, however, again sought an adjournment, citing health issues faced by its MD. Considering the same, a fresh date of hearing was granted to the Noticee on December 6, 2022. In response, the Noticee vide an e–mail dated December 6, 2022, once again sought an adjournment. Vide this reply, in addition to citing the ill health of its MD, the Noticee also stated that it was in the process of changing its legal counsel and sought an opportunity to inspect the documents relied upon by SEBI in the P–SCN. Accordingly, SEBI granted the Noticee an opportunity to inspect the documents on December 20, 2022. The Noticee vide an e–mail dated December 21, 2022, stated that it was unable to undertake the inspection on the date granted by SEBI on account of unavailability of its counsel due to the ongoing court holidays. Accordingly, the Noticee requested that a new date after January 15, 2023, be granted for undertaking the inspection. In response, SEBI informed the Noticee that a new date for inspecting the documents is being provided on February 6, 2023. The Noticee was also granted an opportunity of personal hearing on February 14, 2023. I, however, note from the records that the Noticee failed to undertake the inspection and also did not appear for the hearing on the scheduled date.

9. I note that in these proceedings, the Noticee has neither provided a reply to the allegations made in the P–SCN nor availed the opportunity of hearing granted to it. I note that sufficient opportunities were provided to the Noticee to reply to the P–SCN and also to appear for a hearing. Having regard to the aforesaid, I am of the view that the principles of natural justice have been duly followed in the matter. In such circumstances, the allegations in the P–SCN against the Noticee are taken up for consideration, on the basis of the material available on record.

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CONSIDERATION

10. I have considered the FAR, the DA Report, the P–SCN issued to the Noticee and other material available on record. I shall now proceed to deal with the violations alleged in the P–SCN in seriatim.

FUNDS RAISED BY PLEDGING CLIENT SECURITIES

11. It is noted from the records that in September 2016, KSBL had an outstanding LAS facility of Rs. 789.41 Crore, and its total borrowings amounted to Rs. 1,051.36 Crore. The borrowings of KSBL further increased to Rs. 2,032.67 Crore as of September 30, 2019. I note from the FAR that the treasury team of KSBL regularly shared the monthly borrowings obtained through different credit facilities with the Chief Financial Officer (“CFO”) and the operational team of the Noticee. Further, the list of securities that were identified for pledging in order to obtain Loans against Securities (“LAS”) was also shared. I note that forensic audit had undertaken a sample fund trail exercise to determine how the money borrowed through LAS facilities, where securities of clients were pledged, was utilised and it was observed that in the sample 25 instances that were analysed, an amount of Rs. 257.38 Crore was transferred to Karvy Realty India Ltd. (“KRIL”). A few of the said instances are given in the Table below:

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12. It is also noted that there was a wide variance between the value of securities pledged by KSBL with banks/ NBFCs between April 1, 2016 and December 17, 2019, and the investments held by it, as disclosed in its audited financial statements, during the same period. The details of the same are given in the chart below:

13. It can be noted from the above that there was a significant rise in pledging, starting from Rs. 202 Crore in the first quarter of the financial year 2018 (QE June 2017) and reaching Rs. 1,855 Crore in the fourth quarter of the same financial year (QE March 2018). The value of pledged securities remained within the range of Rs. 1,800 to Rs. 2,000 Crore until the first quarter of the financial year 2020 (QE June 2019). Subsequently, it increased to approximately Rs. 2,700 Crore by the second quarter of the financial year 2020 (QE September 2019).

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14. I note from the FAR that securities of clients who had no negative balance (i.e., zero or credit balances) were also pledged by the Noticee. These securities, I note, were transferred to KSBL margin/beneficiary accounts without obtaining consent from the clients. Furthermore, KSBL also did not follow the stock lending and borrowing mechanism to borrow stocks from clients. The findings in the FAR in this regard are given in the Table below:

TABLE 1 NO. OF DAYS SINCE LAST NO. OF CLIENTS HAVING CREDIT VALUE OF SECURITIES PLEDGED TRADE DATE BALANCE AS ON SEPTEMBER 5, 2019 (RS. IN CRORE) <=30 35,532 480 31 TO < =90 24,138 248 91 TO <=180 13,113 94 181 TO <=360 10,254 102 361 TO <=720 3,001 60 > 720 294 30 TOTAL 86,332 1,014

15. It is important to note that through a Circular No. MRD/DOP/SE/Cir–11/2008 dated April 17, 2008 (“Circular dated April 17, 2008”), SEBI had specified that client collateral/ securities should only be used to meet the client’s margin requirements or pay–in obligations. Additionally, in Circular No. CIR/HO/MIRSD/DOP/CIR/P/2019/75 dated June 20, 2019 (“Circular dated June 20, 2019”), SEBI reiterated that client securities received as collateral should only be utilised to fulfil the respective client’s margin requirement by depositing them with stock exchanges, clearing corporations, or clearing houses. Further, vide the Circular dated June 20, 2019, SEBI mandated that trading members/ clearing members are prohibited from pledging client securities held in “client collateral account,” “client margin trading securities account,” and “client unpaid securities account” to banks/ NBFCs for raising funds, even with client authorisation, after September 30, 2019. This restriction is in accordance with Rules 8(1)(f) and 8(3)(f) of the Securities Contracts (Regulation) Rules, 1957, as it prohibits fund–based activities by trading members/ clearing members.

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16. It is, however, observed that KSBL had pledged client securities amounting to Rs. 2,700 Crore beyond September 30, 2019, which is a violation of the provisions stated in Circular dated June 20, 2019. Further KSBL, by pledging the securities of the clients in the manner described above and continuing to do so even after a specific direction by SEBI prohibiting such pledging of securities of clients has violated the Circular dated June 20, 2019 read with Circular bearing no. SEBI/HG/MIRSD/DOP/CIR/P/2019/95 dated August 29, 2019, and Circular dated April 17, 2008.

NON–SETTLEMENT OF CLIENTS’ FUNDS AND SECURITIES BY KSBL

17. It is noted from the records that as on November 22, 2019, KSBL had not settled funds to the extent of Rs. 527.18 Crore and securities worth Rs. 2,862.05 Crore, which were returnable to its clients. The details of such unsettled funds and securities are as follows: TABLE 2 PARTICULARS NUMBER OF VALUE OF FUNDS VALUE OF SECURITIES CLIENTS (IN RS. AND CRORE) (IN RS. AND CRORE) CLIENTS WITH ONLY SECURITIES 47,502 – 317.81 CLIENTS WITH ONLY FUNDS 1,37,232 217.16 – CLIENTS WITH BOTH FUNDS & SECURITIES 1,34,099 310.02 2,544.24 TOTAL 3,18,833 527.18 2,862.05

18. As per the SEBI Circular bearing No. MIRSD/SE/Cir–19/2009 and dated December 3, 2009 (“Circular dated December 3, 2009”), the actual settlement of funds and securities shall be done by the broker, at least once in a calendar quarter or month, depending on the preference of the client, in case of running accounts. In all other cases, the funds and securities have to be settled within 24 hours of receiving the payout. I note from the records that amounts provided in Table 2 were not settled by the Noticee within the time period provided under the SEBI circular dated December 3, 2009, and therefore, I hold that such actions of the Noticee were in contravention of the provisions of the said Circular.

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TRANSFER OF FUNDS TO RELATED ENTITIES

19. It is noted from the audited financials of KSBL as of March 31, 2019, and the unaudited financials as of September 30, 2019, that the loans taken from banks/ NBFCs by KSBL had increased from Rs. 500.77 Crore to Rs. 2,032.67 Crore during this period. Details of the borrowings of the KSBL during this period are given in the Table below: TABLE 3 FIGURES IN RS. AND CRORE PARTICULARS MARCH 31, 2019 SEPTEMBER 30, 2019 LOAN AGAINST SECURITIES 26.11 786.93 OTHER BORROWINGS 474.66 1,245.74 TOTAL 500.77 2,032.67

20. It is noted that out of the additional borrowings of Rs. 1,531.90 Crore, during the period April 1, 2019 to September 30, 2019, Rs. 1,228.36 Crore was given as loan/ advances/ investments to Group Companies (Rs.428.36 Crore was given as advances for investment in subsidiaries and Rs. 800 Crore was given towards loans/ receivables from subsidiaries).

21. The FAR also records, based on an analysis of the total inflow/ outflow between KSBL and its Group Entities, that an net amount of approximately INR 1,120 Crore was transferred from KSBL to its various Group Companies from FY 2017 till October 19, 2019, details of which are given in the Table below: TABLE 4 FIGURES IN RS. AND CRORE – INFLOW / (OUTFLOWS) GROUP COMPANY NAME FY 2016-17 FY 2017-18 FY 2018-19 FY 2019-20 TOTAL KARVY REALTY INDIA LTD. (86.63) (235.49) (109.74) (662.33) (1,094.19) KARVY CAPITAL LTD. (164.80) (70.82) (144.69) 31.55 (348.76) KARVY FOREX & CURRENCY PVT. LTD. (5.67) 0.01 0.51 0.24 (4.92) KARVY MIDDLE EAST LLC - (2.17) - - (2.17) KARVY INVESTMENT ADVISORY SERVICES LTD. 0.01 (0.75) - - (0.74)

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TABLE 4 FIGURES IN RS. AND CRORE – INFLOW / (OUTFLOWS) GROUP COMPANY NAME FY 2016-17 FY 2017-18 FY 2018-19 FY 2019-20 TOTAL KARVY INC (0.33) - - - (0.33) KARVY RENEWABLE ENERGY PROJECTS LTD. - - (0.20) 0.01 (0.19) KARVY ASIA PACIFIC PTE LTD. - (0.05) - - (0.05) KARVY INSURANCE REPOSITORY LTD. 0.01 - 0.01 0.01 0.04 KARVY INVESTOR SERVICES LTD. (0.53) 0.63 0.46 0.34 0.89 KARVY HOLDINGS LTD. 15.82 (1.04) 22.06 (35.85) 0.98 KARVY PRIVATE WEALTH LLC DUBAI 0.19 0.60 0.20 0.01 1.00 KARVY COMTRADE LTD. 3.84 4.17 3.56 1.46 13.03 KARVY CONSULTANTS LTD. 7.90 31.67 11.48 0.27 51.31 KARVY FINANCIAL SERVICES LTD. (25.74) 59.48 56.66 (1.33) 89.07 KARVY DATA MANAGEMENT SERVICES LTD. 22.27 37.86 167.48 (54.00) 173.61 (KDMSL) TOTAL (233.67) (175.90) 7.78 (719.62) (1,121.41)

22. Further, I note that a sample fund trail exercise was undertaken by the Forensic Auditor of the bank statements of KSBL, and it was observed that there were transactions from the bank accounts earmarked as ‘client bank accounts’ by KSBL to the ‘own bank accounts’ of KSBL. It was also noted that such funds were, in turn transferred to the Group Companies of KSBL. A few instances of such transfer are given below:

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23. In view of the aforesaid observations, I hold that the Noticee, by way of transferring the funds/ securities from client accounts to other accounts/ own account, had mis–utilized the collaterals/ securities of its clients for purposes other than those mentioned in SEBI Circular No. SMD/SED/CIR/93/23321 dated November 18, 1993 (“Circular dated November 18, 1993”). Order in the matter of Karvy Stock Broking Ltd. 11 / 18

NON–COOPERATION WITH THE FORENSIC AUDITOR

24. I note from the records that KSBL had failed to cooperate with the Forensic Auditor in the proper assessment of the assets and liabilities of the member towards clients. The Noticee being a SEBI registered intermediary is obligated to provide the data as sought by SEBI/ stock exchanges either by itself or through its appointed auditor. The list of pending information/ clarifications sought by the Forensic Auditor which were not provided by KSBL is provided below:

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25. Such conduct by the Noticee, I note, is not in compliance with the Code of Conduct specified for stock brokers under Clauses A(1), A(2), A(3), A(4) and A(5) of the Code of Conduct specified under Schedule II read with Regulation 9(f) of the SEBI(Stock Broker) Regulations, 1992.

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NON-REPORTING OF BANK ACCOUNTS AND DP ACCOUNTS

26. I note from the records that KSBL had not reported six own bank accounts (stock broker-own accounts) to stock exchanges as required under the Circular dated September 26, 2016. It is also noted from the FAR that KSBL had credited funds raised by pledging client securities to these six own bank accounts. The details of these accounts are given in the Table below:

TABLE 7 S. NO. BANK NAME BANK ACCOUNT NO. 1. HDFC BANK LTD. 210130000134 2. ICICI BANK LTD. 405034104 3. INDUSIND BANK LTD. 606014011496 4. AXIS BANK LTD. 916030054913843 5. KOTAK MAHINDRA BANK LTD. 11210382 6. HDFC BANK LTD. 00210140000014

27. It is also noted that KSBL had failed to furnish to the exchanges details of its DP Account No. IN300394–11458979, which was opened on December 20, 2000. The said DP account was classified as a beneficiary client account. Such non– furnishing of details of bank accounts and DP accounts, I hold, is in contravention of the provisions of the SEBI Circular bearing No. SEBI/HO/MIRSD/ MIRSD2/CIR//P/2016/95 and dated September 26, 2016 (“Circular dated September 26, 2016”).

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GRANTING FURTHER EXPOSURE TO DEBIT BALANCE CLIENTS

28. I note that NSE had undertaken a sample analysis of the funding provided to KSBL’s top 25 debit balance clients, and it was noted that KSBL had provided funding for 13 of the said 25 clients. The details of the funds advanced are tabulated below:

TABLE 8 S. CLIENT CODE CLIENT NAME HIGHEST FUNDED LOWEST FUNDED AVERAGE FUNDED NO. AMOUNT (IN RS.) AMOUNT (IN RS.) AMOUNT (IN RS.) 1 306615 VIJAY CHIMANDAS JHAMMANI 7,16,13,653 1,57,53,186 5,78,56,707 2 306621 NEETA VIJAY KUMAR JHAMNANI 18,30,87,604 1,90,712 5,08,19,347 3 307413 KANCHAN MANDHANA 26,90,748 18,03,428 21,84,780 4 316V0255 VINOD KUMAR PODDAR 2,19,07,577 40,20,935 1,37,14,554 5 A020002 CLASSIC WEALTH MANAGEMENT 35,82,18,078 45,55,808 12,13,05,782 SERVICES PRIVATE LTD. 6 A020004 ZENITH INSURANCE SERVICES 38,30,47,860 6,30,41,430 23,84,45,773 PRIVATE LTD. 7 A020005 BUOYANT INSURANCE SERVICES 24,22,04,594 77,41,874 7,37,75,491 PRIVATE LTD. 8 A0200098 PELICAN WEALTH ADVISORY 10,37,25,546 10,93,022 4,46,24,384 SERVICES PRIVATE LTD. 9 A020091 WIZARD INSURANCE SERVICES P 27,13,98,170 2,78,43,084 8,23,80,412 LTD. 10 A45073048 NISHANT SINGH 30,57,50,586 6,05,43,452 24,70,66,683 11 A45073052 PANKAJ DOBHAL 2,35,18,028 97,41,196 1,84,27,493 12 HBH5691 VITALINK WEALTH ADVISORY 34,33,18,880 9,14,317 8,69,77,560 SERVICES PRIVATE LTD. 13 KM10004549 DEVENDRA KUMAR SHARMA 9,71,84,983 49,38,901 3,56,61,690

29. I note that the Noticee, by funding the positions of these clients, has compromised its risk management procedures and contravened the provisions of the Circular dated September 26, 2016.

30. I shall now proceed to consider the directions that should be issued against the Noticee that would be commensurate with the violations established in this Order in the matter of Karvy Stock Broking Ltd. 17 / 18

Order. A stock broker plays a critical role in the securities market as it acts as an interface for retail investors and is therefore required to maintain high standards of integrity and fairness in the conduct of its business dealings and uphold the trust reposed by investors who hold their funds and securities with it. As a regulator of the capital markets, SEBI has the duty to safeguard the interest of investors and ensure that their rights are protected. I also note that the Noticee has been declared a defaulter and expelled by BSE on November 24, 2020, and by NSE on November 23, 2020. Given the above, I am inclined to accept the recommendation in the DA Report that the Certificate of Registration granted to the Noticee, be cancelled.

DIRECTIONS

31. In view of the aforesaid observations and findings, I, in exercise of the powers conferred upon me under Section 12(3) read with Section 19 of the SEBI Act, 1992 and Regulation 27 of the Intermediaries Regulations, hereby cancel the Certificate of Registration of Karvy Stock Broking Ltd. (INZ000172733).

32. Irrespective of the cancellation of the Certificate of Registration, the Noticee shall continue to be liable for anything done or omitted to be done as a Stock Broker and continue to be responsible for payment of outstanding fees and dues, if any, payable to SEBI.

33. This Order shall come into force with immediate effect.

34. A copy of this Order shall be served upon the Noticee and all recognised Stock Exchanges for information and necessary action.

Place: Mumbai ASHWANI BHATIA Date: May 31, 2023 WHOLE TIME MEMBER SECURITIES AND EXCHANGE BOARD OF INDIA Order in the matter of Karvy Stock Broking Ltd. 18 / 18