The problem is that there is never just one cockroach in the kitchen! If Karvy Stock Brokers screwed up, so will some others. Sure, many stock brokers will be taking defensive action given how SEBI has dealt with Karvy. That said, more Karvy like issues cannot be ruled out.

What Karvy Stock Brokers Did?

1. When clients buy or sell stocks (or other securities); or take position in F&O market, they must either bring in the cash needed to do such trades, or they can pledge their shares (or other securities) to their brokers who will extend them the margin needed to do such trades.
2. Pledged shares serve as security for the broker. In case the client does not bring in the required cash or suffers a loss on the position, the broker can sell these pledged shares to recover the margin money extended to the client.
3. After extending the margin money, Karvy took client’s pledged securities to its own account, raised loans against these pledged securities and transferred the loan money to a group company (which is into real estate!)
4. In reality, Karvy or any other stock broker could actually use the POA given by clients to pledge any of their demat holdings. In this case however it appears that Karvy only transferred shares / securities that were already pledged by clients against which Karvy had extended margin money. Still not allowed!

What should you do as an investor?

Given that SEBI has already banned Karvy from taking new clients and has imposed restrictions on Karvy from dealing with client’s demat holdings, it actually makes Karvy one of the safer brokers. In reality, almost all stock brokers indulge in similar practices. How do you think zero brokerage/ discount brokers are surviving?

That said, never deal with people who indulge in corrupt practices, and this sure was a corrupt practice. Karvy broke investors trust and should be punished for this. Here’s what you should do if you are worried about your demat holdings at Karvy or any other Stock Brokers:

1. Transfer from Karvy to another account: Open another demat account. Once you have 2 demat accounts, ask your new broker to give you a copy of the Client Master Record (CMR). Take this CMR to Karvy’s office and fill up a form to transfer existing stock holdings or close account and transfer existing stock holdings to the new demat account. There is no capital gains or any other tax implication of doing this. Please do not sell your holding, you don’t have to.

I have 3 demat accounts (yes you can have as many as you want). One is with ICICI Securities for my long term holdings. It give me a net worth statement with utmost ease which is needed at many places. The other is with Motilal Oswal which I primarily use for trading. I never rely on any discount brokers. To me, that is a disaster waiting to happen.

2. Margin shares – No matter which broker you use, check your shares lying in margin account from time to time. Brokers pledge your shares to give you margin for excessive buying both in cash and Futures and Options segment, without your asking for the same. Even after you bring in clear balance (cash) to fulfil the margin shortfall, almost no broker automatically releases your pledged shares immediately. You must ask them to do the same. So make it a point that whenever you buy for more than the cash available in your account, you check the pledged shares immediately after you fulfil the shortfall in margin obligation.
3. Avoid Discount Brokers: Unless you are a trader who does not hold anything in the demat account, why will you use a discount broker? From network failures to bad support teams to a potential fraud, discount brokers are most suspect to all, however you may look at it. Please do not find justifications otherwise.
4. Statements and contact details: Make sure that your phone, email and address is captured correctly on all your accounts. Also make sure that you are receiving your Consolidated Account Statement (CAS) from either CDSL or NSDL every quarter. You should all be getting a CAS from NSDL / CDSL so long as you have an active demat account. This statement will consolidate all your mutual fund and stock holdings across various demat accounts in one statement.

Educate yourself & use a Financial Advisor: It is a mystery to me why investors still fall for repeat frauds. A bigger mystery is why investors are not using the services of a dedicated financial advisor. These days top advisors will work with you for very little fee. It always helps to have them by your side. Give them a quick call before doing something that you are not sure of. There are various ways in which you can hire a financial advisor. I work on fee only model, I sell regular plans, charge percentage of AUM all of which you can decide. So call me if you need to talk.

Also Read: Best Stock Brokers in India (Note: Brokerage rates have fallen substantially from the date of the linked article).

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Rajat Sharma

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