SAT Allows Lenders To Use Pledged Shares In Karvy Stock Broking Case

The Securities Appellate Tribunal has invalidated two orders of SEBI, which restrained some lenders from undoing the pledge on shares held by Karvy Stock Broking Ltd.

The order on Wednesday came on appeals by the financial firms that sought to invoke the pledge after Karvy defaulted on the loans extended to it. The SAT gave permission to Axis Bank Ltd., HDFC Bank Ltd., ICICI Bank Ltd., IndusInd Bank Ltd. and Bajaj Finance Ltd. to use the shares that were pledged in its favour under the rules of the Depositories Act and DP Regulations.

The tribunal instructed the Securities and Exchange Board of India, the National Stock Exchange and the National Securities Depository Ltd. to reinstate the pledge made in favour of the appellants within four weeks. On failure to do so, they must compensate the appellants for the value of the securities pledged along with a 10% interest per year within the same timeframe.

Karvy was barred from taking on new clients via an interim order in 2019. After a four-year investigation, Karvy, its managing director and independent directors were barred from the securities market.

The hearing was on five appeals against two orders of the market regulator, which denied the representation of these lenders to access securities pledged with them.

The SAT's observation emphasised that the circulars issued by SEBI were directed solely at the managing directors of recognised stock exchanges and depositories, not at banks or the appellants involved in this case.

The circulars aimed at enhancing supervision of stockbrokers and depository participants. The SAT observed that clause 2.5 of a 2016 circular outlined that a stockbroker could exercise a lien on clients' securities based on its indebtedness, subject to explicit authorisation. Pledges could only occur through the depository system in compliance.

It said a significant shift occurred with Clause 2(c) of a circular dated June 22, 2017, that removed the requirement for explicit authorisation before pledging. This meant that a stockbroker could pledge a client's security if the client had a debit balance in its ledger without the need for explicit authorisation.

When someone is given a legal right to certain property through a valid pledge, that right becomes attached to the property, according to the SAT.

The right cannot be ignored or used to sell or distribute the property in order to pay off the debts or obligations of the person who originally owned the property. So, once a valid pledge is in place, the property cannot be sold or distributed to settle the broker's debts, it said.

The SAT pointed out that if SEBI, the NSE or the NSDL think that the pledge was wrongly created by Karvy, they should have followed the appropriate legal process by filing an application before the National Company Law Tribunal for correction. It pulled up the NSDL for unlawfully transferring the pledged shares to Karvy's clients without proper legal authority.