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Stock Broker Goes Bust: How Can Investors Safeguard Their Equity Investments?

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Karvy Stock Broking Ltd. (KSBL), once ranked among the top stock broking firms in India, was declared a defaulter by SEBI and expelled from the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). The final order confirmed the ban on Karvy Stock Broking Ltd. (KSBL) from taking on new clients a year after passing an interim order, wherein it had imposed a ban on KSBL for misusing clients’ securities.

National Stock Exchange of India Ltd (NSE) issued a Monday circular informing Karvy Stock Broking Ltd. has been expelled from the exchange’s membership and declared as a defaulter w.e.f. 23rd November 2020, after the closure of the market.

What went wrong with Karvy Stock Broking?

As per the interim order SEBI issued in November 2019, the market regulator said Karvy Stock Broking was misusing the PoAs (power of attorney) given by its clients, pledging them with banks to secure loan facilities towards working capital. SEBI’s order also stated that Karvy Stock Broking had sold a client’s securities and transferred the gains to the tune of ₹2,000 crores to its real estate arm.

The entire episode has left a section of investors worried about such instances happening again, with many investors asking questions like:

  • How do I safeguard my equity investments?
  • What will happen to my assets if my stockbroker becomes bankrupt?

With a proactive SEBI implementing various rules and regulations to safeguard the interests of investors, the potential for fraud has considerably reduced compared to the past. However, as an investor, you must be cautious as unscrupulous brokers may always find ways to exploit loopholes in the system. Read more about the 1992 stock market scam here.

How can investors safeguard their equity investments?

  • Constantly update your mobile number and email ID with the depository.
  • Monitor each SMS or email statement the depositories send after every direct equity investment in the Demat account. If you notice any unauthorized debits or credits in your Demat, contact your DP for clarification.
  • Ask your stock broker for a ledger balance and holding statement every 90 days.
  • Don’t keep excess money in your broking account. Instead, transfer the funds back to your bank account if you don’t intend to make any investments immediately.
  • Check your Demat balance regularly through NSDL/CDSL website or mobile application.

The steps mentioned above will help an investor to safeguard equity investments to a great extent. However, the biggest question asked by investors is, “What will happen to my investments if my stockbroker becomes bankrupt?”

When a stockbroker becomes bankrupt or shuts down a business, there is nothing for an investor to worry about as the stocks are held in his Demat account with the CDSL or NSDL.

However, the most significant cause of concern for an investor would be unutilized funds lying in his trading account when a stock broker goes out of business. Under a directive from SEBI, exchanges have set up an Investor Protection Fund (IPF) to address this problem. Today, the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) have an IPF corpus of Rs. 784 crores and Rs. 594 crores, respectively.

The SEBI model bye-laws on Investor Protection Fund states that “The IPF may provide compensation against a genuine and bonafide claim made by any client, who has either not received the securities bought from a trading member for which the payment has already been made by such client to the trading member there against or has not received the payment for the securities sold and delivered to the trading member or has not received any amount or securities which is/are legitimately due to such client from the trading member, who is either declared a defaulter or expelled by the Exchange or where the trading member, through whom such client has dealt, is unable to get the securities rectified or replaced for the reason that the introducing trading member at the Exchange is either declared a defaulter or expelled by the Exchange, under the relevant Rules, Bye-laws and Regulations of the Exchange”.

So, where a stockbroker goes bankrupt or out of business, clients can claim money from stock exchanges once the broker is officially declared a defaulter, subject to a maximum amount of Rs. 25 lakhs. Market regulator SEBI has put in place several safeguards like strict financial disclosures and regular audits for stockbrokers to protect the interests of equity investors. However, those looking to circumvent the system for quick gains through fraud may always look for ways to do so.

As an investor, always review your investment holdings and balances and file timely complaints in case of any lapses. Remember, “Caution is the mother of safety”.

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