Law Enforcement Branch Unearths Karvy Stock Broking Assets SEBI Has Failed To Uncover Since 2019

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On March 8, 2022, Hyderabad Enforcement Department (DE) issued a Provisional Seizure Order under the Prevention of Money Laundering Act (PMLA) against C Parthasarathy, Founder of Entity Group Karvy, his sons Adiraj Parthasarathy and Rajat Parthasarathy, and the following key group entities: Karvy Stock Broking Ltd (KSBL), Karvy Realty (India) Ltd (KRL), Karvy Financial Services Ltd (KFSL), Karvy Data Management Services Ltd( KDMS), Karvy Consultants Ltd (KCL), M /s Adhirajat Commercial Enterprises Pvt Ltd, Adhirajat Holdings and Compar Estates and Agencies Pvt Ltd.

The order follows an extremely detailed and meticulous investigation which is said to have also taken into account the findings of investigations by the National Stock Exchange (NSE) and the Serious Fraud Investigation Office (SFIO). In the process, the investigative agency identified dozens of companies, subsidiaries and front companies of the group and estimated the value of assets held by Karvy’s founder, his family and group entities at Rs1,984.84 crore (See table).

More than 52 people were interviewed, including the five key officials arrested along with founding chairman C Parthasarathy and still imprisoned, the chief executive officer (CEO), the chief financial officer (CFO) and the company secretary and chief compliance officer. Their revelations and confessions allowed investigators to create flow charts of how investor funds were diverted by KSBL to create a layering effect and then diverted in many ways. Karvy had raised the funds by illegally pledging the shares of 250,000 investors by transferring them to a demat account which was not disclosed to the stock exchange or the regulator.

Here is the history documented by the ED order, in a nutshell. KSBL had been in business for 30 years and had always borrowed funds for working capital, margin financing and extending credit to investors on their shares held by it. The problem arose after 2013-2014, when he began diverting funds raised by illegally pledging client shares to a collection of insurance brokerage firms within the Karvy Group. These companies used the embezzled money as margin funds to trade massively in their own accounts and suffered huge losses that needed to be covered. KFSL, a non-banking financial services entity, had accumulated losses and accumulated non-performing assets (NPAs) over the years. C Parthasarathy tried to split it after it boosted its valuation by injecting illegally borrowed money. This only led to further losses.

Money was also diverted to family members who received lavish salaries and expenses without doing any work. Curiously, only C Parthasarathy was arrested while his family was only interrogated. For many, it is a reminder of how Ramalinga Raju’s confession in Satyam Computers had protected the rest of the family.

The ED alleges that the entire Karvy fraud was run by a ‘cabal’ of key executives who called themselves ‘the Parthasarathy Secretariat Section’ and had control of the back office. The seizure order, however, documents Mr Parthasarathy’s claim that his officials kept him in the dark about business losses.

Compiling a series of complaints and first information reports (FIRs) filed by lenders, investors and others, ED estimates fraud by KSBL at Rs1,922.42 crore, broken down as follows:

Even allowing for a fanciful overstatement and the fact that significant value would be unrecoverable in a defunct band, the ED investigation shows that a significant sum could have been recovered with prompt regulatory action.

This raises serious questions about why our powerful capital market regulator, armed with powers to search, seize, plunder and even arrest people, has not made similar discoveries or decided to seize the properties of Karvy even a year after his interim. Ordered of November 22, 2019.

Investor protection is the primary task of the Securities and Exchange Board of India (SEBI), even before market regulation. Unlike stock exchanges, SEBI has been empowered by law to do whatever it takes. Yet SEBI’s track record shows it doesn’t go beyond ordering forensic audits, whether it’s a big broker default like Karvy, the roommate scam (Colo ) of 2015 or questionable disclosures by listed entities.

The contrast becomes stark when looking through the ED Seizure Order served on 30 entities, including the Parthsarathy family (with sons Rajat and Adhiraj Parthasarathy), prominent family businesses (M/s Adhirajat Commercial Enterprises Pvt Ltd, Compar Estates and Agencies Pvt Ltd and Adhirajat Holdings), the main subsidiaries (mentioned above) and the group of fictitious companies originally registered as insurance brokers, but used to divert and overlay funds and to stock market transactions. These fictitious companies, at the heart of the fraud, are: Advanced Financial Services, Buoyant Insurance Services Pvt Ltd, Champion Insurance Services, Classic Wealth Management Services, First Mercantile Wealth Advisory Services, Pelican Wealth Advisory Services, Nova Consultants, Vitalink Wealth Advisory Services, Ultimate Insurance Services Pvt Ltd, Wizard Insurance Services Pvt Ltd, Zenith Insurance Services Pvt Ltd, Citadel Wealth Advisory Services, Suranj Consultancy Services and Nova Wealth Management Services.

Five key lenders – HDFC Bank, ICICI Bank, Axis Bank, Aditya Birla Finance and Bajaj Finance who provided loans against properties to KSBL – are also included in the notice. The ED order shows that KSBL’s head office – Karvy Millennium (estimated value Rs 65.67 crore) – has been pledged to Aditya Birla Finance and Karvy House in Banjara Hills (estimated value Rs 25.47 crore) has been pledged to Axis Bank, while a series of flats, valued at over Rs13 crore, have been pledged to HDFC Bank. The attachment documents dozens of other claims, lenders and assets, based on the FIRs each filed.

While all of the ED charges will be heavily argued by the group, which already has several proceedings in different forums, the main conclusion of the ED, in my opinion, is the number of entities that have been spawned by each of the main entities of the Karvy group to create layers and camouflage the flow of funds for market operations and real estate investments.

Here is an overview of the subsidiaries of each key entity. The ED notes that brokerage firm KSBL alone had 15 subsidiary entities listed in the table below.

2. Karvy Consultants had nine subsidiaries:

3. KDMSL, the valuable data management company, had seven entities which were also used to embezzle funds.

4. Then there were nine family businesses owned by C Parthasarathy.

5. There is also a list of 17 front companies launched by the Karvy Group, which include eight entities mentioned in the SEBI orders which partly overlap with the 14 insurance brokerage entities used for market operations, and a few others, such as Blue Planet Housing Infrastructure, Heartlands Infrastructure and Meteor Infrastructure & Projects, which were clearly for the real estate game.

Unfortunately, all of this is cold comfort to investors, as ED stock doesn’t get them one step closer to getting their own money back from Karvy. Timely action by the market regulator may, however, have provided them with better terms.

For the record, SEBI only did two things for the benefit of Karvy’s investors. The first, on December 2, 2019, when he ordered the National Securities Depository Ltd (NSDL) to return the shares illegally misappropriated by KSBL (via an undisclosed demat account) to the investors who were their rightful owners. This saved more than 82,000 investors (of about 90,000 whose shares were pledged) from being frozen and caught up in endless litigation by lenders (Read: Karvy default: For once, SEBI is moving quickly to protect the interests of retail investors). For a whole year after that, SEBI did nothing, while Karvy founder C Parthasarathy repeatedly bought time from the Stock Exchange and the regulator with the promise of bringing in at least Rs 1,000 crore in selling KDMS. It was only at the end of November 2020, that NSE finally expelled KSBL (NSE evicts stock brokerage from Karvy; Declares it by default), making it the largest default broker on the Exchange.
In April 2022, SEBI imposed a small fine of Rs 3 crore on the Bombay Stock Exchange (BSE) and Rs 2 crore on NSE, for their “laxity” in failing to detect the fraudulent transfer and sale of 2,300 Rs crores of shares owned by over 95,000 investors. Curiously, in mid-November 2020, NSE issued a statement stating that “Funds and securities of approximately Rs 2,300 crore belonging to approximately 2.35,000 investors have been settled so far with concentrated efforts on the regulation of small investors. Investors with fund balances up to Rs30,000 owed by Karvy Stock Broking have been colonized.”
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