Karvy’s Scam of 2800 Crore | Case Study on Karvy fraud

On 23rd Nov 2020, the top 2 stocks changes of India i.e. NSE and BSE have terminated the stockbroking membership of Karvy. Karvy was also declared a defaulter which means it was not able to pay the due it owed to the stock exchanges.

In this article, I have covered this story that recently made a big headline and impacted a lot of investors all over India. Karvy made a fraud of around 2,800 Cr which resulted in its termination as a stockbroker.

So let's investigate Karvy’s fraud case:

Before I explain the fraud, you should know a bit more about the company:

• Karvy Group was established in 1983 and the group has around 30,000 customers with 900 offices present in 400 cities and towns all over India.
• So basically Karvy group has got multiple subsidiaries in various businesses under the finance domain.
• Some of its subsidiaries include:
• Karvy Stock Broking Limited which is the broking arm of Karvy group and provides equity broking service along with other services like wealth management services, portfolio management services, etc.
• Karvy Comtrade is for commodity broking.
• Karvy Financial Services Ltd which is an NBFC i.e. Non-Banking Financial Service company.
• Karvy Realty Limited which is the real estate arm of Karvy group, etc.

Now that you understand the various businesses of Karvy, it would be easy to understand the fraud.

So basically, Karvy did 2 frauds:

• 1st, it misused its client shares and pledged them with banks to get loans.
• 2nd, Karvy also sold its client shares and transferred the proceeds to its real estate group company.
• The total misuse of client securities was to the tune of ₹2,800 crore.

Now, you would be confused about how could Karvy Stock Broking Limited sell its client's shares or pledge them for loan?

To understand this, you should know that Karvy stock broking limited had around 12 lakh clients. Each client was holding demat as well as a broking account. So broking account is used to buy and sell the shares. Now, when you buy the shares, you need to store them somewhere. And that’s where you need a demat account to store the shares.

Now, when an individual opens a stockbroking account, he/she gives a “Power of Attorney” to the broker that gives the authorization to debit your shares from your demat account whenever you sell your shares. This is very important to understand. “Power of attorney” means that you allow your broker to debit the shares from your demat account when you sell them.

So basically, Karya created a demat account in its own name and used the power of attorney to transfer stocks from clients account to its own demat account.

Then Karvy went to financial companies like Bajaj Finance, HDFC bank, etc. and pledged those stocks to secure the loan. Please remember that the stocks did not belong to Karvy. They belonged to its client. But banks and NBFCs had no clue about it. So the banks and NBFCs handed over the cash to Karvy against the stocks as collateral. 

The four players - HDFC Bank, ICICI Bank, IndusInd Bank and Bajaj Finance, gave loans of Rs 340 crore each based on these securities as collateral.

Now NSE, during its audit, identified this scam and informed SEBI.

The estimated misuse of securities was in the tune of around 2800 Crore. So Karvy pledged around Rs 2800 crore worth of shares to secure the loan. Please note that these shares never belonged to Karvy. These were their client’s shares.

After the scam was identified, Karvy was asked to pay back the money to its clients but Karvy defaulted in payments. The default is in the range of Rs 800-1,000 Crore. As a result, Karvy’s stock broking membership was terminated by NSE and BSE. 

As per the latest news, NSE has paid Rs 2,300 Crore to its 2.35 lakh investors who have stocks and money stuck with Karvy Broking Lmt. Some of the money was paid from the Investor Protection Fund with the stock exchange.

While such scams certainly shatter the trust between the investor and the broker, investors should be very careful with their investment. For example, investors should only open accounts with trusted brokers in the country. Moreover, do not keep too much idle cash in your trading account. Finally, keep a track of your investments and carefully read the emails and messages from your stock broker.

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PS: If you want to learn every aspect of fundamental analysis of stock and other important concepts of personal finance, you can explore my video course on "Everything about money management".