Within a few hours of the alleged Karvy scam breaking out this weekend, I got a text from my brother with just one worried question:
“Will this impact my different mutual fund investments for whom Karvy is the RTA (Registrar & Transfer Agent)?”
Now, in case you aren’t aware - RTAs are companies that process various MF related transactions (redemption, subscription, transfer, etc) made by the investor.
They also perform various backend functions like accounting, sending investor statements, etc., as shown in the illustration above. To learn more about this & the investments ecosystem, check out this guide
I wrote earlier.
Interestingly, my brother’s concerns were also justified since Karvy is the largest RTA in India. They serve 23 of the 46 registered Mutual Fund houses, and have an approx. 80% market share of MF folio accounts together with CAMS (another RTA).
So over the weekend, I dug deeper into the entire affair in order to understand what was happening, and determine whether the scam engulfing Karvy Financial Services (the brokerage firm) would have any impact on Karvy, the RTA. Here’s a summary:
Part 1: The Scandal
- On 22nd Nov, SEBI passed an order on Karvy Stock Broking Ltd., framing it as an “urgent regulatory intervention to prevent further misuse of clients’ securities”
- In the order, Karvy is alleged to have misused its power of attorney that is usually given by clients so that brokers can place trades on their behalf
- While the allegations cover different instances of misuse of this power, the gist is that they pledged securities of clients on their own (allegedly, without the client asking for it)
- The funds resulting from the pledged shares were then credited to Karvy’s own accounts (and of entities related to them), rather than that of the client
- More than ₹1,000 crores have been allegedly moved around in such a concealed manner
- These irregularities were actually uncovered by the National Stock Exchange (NSE) in one of their audits on the brokerage - and the SEBI order is entirely based on this
- Amongst other things, the order bans Karvy from adding new clients & taking any actions on behalf of existing clients
- Karvy Stock Broking Ltd. has issued a soft response on their website, but have 21 days to officially counter these allegations by writing to SEBI.
Part 2: The Impact on Karvy, the RTA
- The RTA registered with SEBI is Karvy Fintech Pvt. Ltd., which is a separate legal entity from Karvy Stock Broking Ltd.
- While the Karvy Group still has a stake in this separate company, its main shareholder is the private equity firm General Atlantic, which had invested in the company in 2018.
- Unlike the stock brokerage firm, which directly handles money & securities for clients, whereas Karvy Fintech the RTA does not handle MF investor money or shares
- The actual shares & money of MF investors is with the Mutual Fund houses, or with designated custodians - not the RTA.
- Since the RTA only performs operational, accounting, and other back-end functions for MF houses, any fallout from this scandal or impact on Karvy Fintech will still not negatively impact the funds of MF investors
In the end, I was relieved to learn that this scandal won’t spillover to MF investors - but it has still impacted thousands of retail investors & ignited negative sentiments around the overall investments industry.
It also highlighted to me that currently, it’s not possible for retail investors to choose which RTA, custodian, depository, etc. you want to work with. This is done by the MF house or brokerage you want to work with.
While having larger businesses negotiate better deals (hopefully) for their clients is great, I feel that investors should still have the ability to choose/change if they wish to.
Opening this up will not only increase transparency, but the increased flexibility might even improve competition in an industry that’s practically functioning as a duopoly at the moment.
-Vikas Bardia, CFA