Mutual fund commissions stop for sub-brokers of Karvy Stock Broking

In November 2020, SEBI said KSB could not transfer any of its assets till its investors’ claims were settled.

The sub-brokers of Karvy Stock Broking (KSB) have stopped receiving the mutual fund commissions over the last three-four months, putting them under financial strain, even though the broker has been receiving commissions for the mutual fund (MF) schemes sold through its sub-broker network.

This is the inadvertent result of capital market regulator Securities and Exchange Board of India's (SEBI) action against KSB on account of a scandal that had got uncovered in 2019, where it was found that KSB had pledged securities of its clients and borrowed money against their knowledge. In the meantime, fund houses are not able to directly give commissions to sub-brokers, without a no-objection certificate (NOC) from KSB.

“Fund houses are in contract with KSB to pay the commissions. Therefore, ideally KSB should tell us that out of their commissions, we should pay a particular amount directly to sub-brokers. KSB has not yet given us any NOC. SEBI should also agree to this as it should not seem that we are violating their account freeze order,” said an executive of a fund house.

The problem

In November 2020, SEBI said KSB could not transfer any of its assets till its investors’ claims were settled. The broker was charged by SEBI for borrowing funds from banks and non-bank financial companies, by placing stocks that belonged to its clients as collateral. 

However, in addition to being a stockbroker, KSB is also a mutual fund (MF) distributor. And it enrolls individuals as its sub-brokers for selling MFs and other financial products. When fund houses pay commission, they pay directly to KSB, who after deducting their share, pass the rest to its sub-brokers.

MF executives say while SEBI has barred KSB from stockbroking business after this case, its order has not found it unfit to carry out the MF distribution business.

“Due to this lack of clarity, fund houses have been paying commissions to KSB,” said another executive of a fund house.

KSB in its response said, “There was a delay in between but we are making up for all of them.”

Hoping for SEBI and AMFI to step in

The sub-brokers have written to SEBI and the Association of Mutual Funds in India (AMFI, the MF industry’s trade body) to help with their commission payouts. In one such letter written to AMFI, which is reviewed by Moneycontrol, a sub-broker has said SEBI should unfreeze Karvy’s bank accounts to clear the payments of sub-broker commissions that have been held back.

It is understood that AMFI has been following up with SEBI and Karvy to find a way out.

The MF assets handled by KSB’s sub-broking network could be more than Rs 1,000 crore, industry sources suggest. AMFI data shows that KSB had average MF assets worth Rs 10,346 crore in the financial year 2019-2020 and earned Rs 66.55 crore in commissions, putting it among the leading national distributors (NDs) in the country.

Waiving off the need for an NOC

Some sub-brokers are trying to get the assets shifted to their own names, asking KSB to give NOCs, which they can show to fund houses.

These sub-brokers say they can use the guidelines laid down by AMFI for transferring MF assets. They say if SEBI and AMFI waive off the need for an NOC in Karvy’s case, the underlying assets (investors’ monies) - and commissions- can be transferred to the names of individual sub-brokers.

Sub-brokers say that while this could take care of their future commissions, it may not be enough to release past commissions earned that are still stuck in KSB’s frozen bank accounts.

The Karvy stockbroking scandal

KSB was barred by Sebi for taking any new clients in November 2019, on allegations that it had borrowed funds against its clients’ equity investments.

It was revealed that securities worth Rs 2,300 crore belonging to over 95,000 clients, were pledged with various banks and non-bank financial companies as collateral.

The country’s two leading stock exchanges -- NSE and BSE -- cancelled the broking membership of KSB last year in November.

Both NSE and BSE declared the broking firm as a defaulter for not complying with the regulations of the exchanges.