On November 30, 2022, SEBI suspended the PMS license of Karvy Stock Broking Limited (Karvy) for one month.
If you go into disbelief after reading this, I won’t hold it against you. That is the news. While Karvy’s PMS license is suspended, there is no penalty levied on for the non-compliance of the SEBI (Portfolio Managers) Regulations, 1993 as per the SEBI order.
SEBI conducted an inspection on Karvy’s business for the period from April 1, 2018 to March 31, 2019. SEBI also covered the period from December 05, 2019 to December 13, 2019 and had major findings in that period.
An interesting point to note here is that the non-compliance was observed with respect to the SEBI (Portfolio Managers) Regulations, 1993 and not the PMS Regulations, 2020 since the inspection period was FY 2018-2019.
The SEBI order was comprehensive and has some important notes.
Let us see where the organisation erred.
#1 – Appointment of Principal Officer
As per the PMS Regulations, 1993, the principal officer needs to have either professional qualification OR an experience of at least ten years in related activities in the securities market.
SEBI observed that Mr. Vikas Rajpal was appointed as Principal Officer with effect from April 16, 2019. He did not fulfil the qualification requirements when he was appointed as he had experience of around 7.5 years only.
He was given the position of Principal Officer as a temporary arrangement till Mr. Sachin Mittal was appointed as Principal Officer in June, 2020, subsequently.
What is expected from a SEBI registered Portfolio Manager:
The portfolio manager has to ensure that the Principal Officer complies with the applicable qualification (and now certification too) requirements at the time of appointment as well as at all times. There is no provision for relaxation of this requirement even if the Principal Officer is appointed on a temporary basis.
#2 – Contents of Disclosure Document
a. Contrary provisions in its Disclosure Document
Disclosure Document (DD) is one of the very important documents given to a client.
SEBI observed that the information about the deduction of the placement fee mentioned in two different sections in the Disclosure Document was contrary to each other.
In one of the sections in the DD, it was mentioned that the placement fee shall be deducted upfront from the Client’s portfolio on receiving the investment and in other section it mentioned that the placement fee will be deducted at the end of each calendar quarter till completion of one year of receiving corpus.
Karvy mentioned that there was a change in the manner the placement fee was charged after FY 2016-17 and the change was inadvertently not carried out in the sections of the DD. However, this was noted by SEBI as “misguiding the clients w.r.t the payment they have to make”
b. Disclosure about penalties, pending litigations, etc.
The DD should contain details of penalties, pending litigation or proceedings, findings of inspection or investigations for which action may have been taken or initiated by any regulatory authority.
Also the latest disclosure document should be placed on the website of the portfolio manager.
SEBI observed that the information about the penalties, litigations, proceedings etc. was missing in Karvy’s DD on the website.
Karvy contested that the DD was given as hard copies to the clients and the said details were mentioned in the copies.
What is expected from a SEBI registered Portfolio Manager:
A portfolio manager needs to observe high standards of integrity and fairness in all its dealings, and that investors and clients should be given true and adequate information. It has to be careful in updating the information in the DD as well as in the client agreements. It has to ensure that there is no mismatch or contradictions in the information provided to the clients through various sources.
An updated copy of the disclosure document should be placed on the website of the portfolio manager at all times.
#3 – Contents of Model Portfolio Management Agreement
a. Outsourcing of core activities
As per SEBI Circular CIR/MIRSD/24/2011 dated December 15, 2011 intermediaries registered with SEBI cannot outsource their core business activities and compliance functions.
In Karvy’s case, the Model Portfolio Management Agreement signed by the clients states that “For the purpose of discharging any of the duties, obligations and functions (whether under this agreement or under the above mentioned Letter of Authority), of the Portfolio Manager……….. the Portfolio Manager is empowered to delegate the performance of its duties, discretions, obligations, any of powers and authorities hereunder to such sub-delegates and pay fee/ consultancy charges that may be charged to the client’s account.”
While Karvy did not outsource its core activities, SEBI interpreted that the clause in the Model Portfolio Management Agreement establishes that Karvy has a provision to outsource any of its activities including its core activities.
However, SEBI concluded that there was no non-compliance of PMS Regulations, 1993 or SEBI Circular CIR/MIRSD/24/2011 dated December 15, 2011 since Karvy did not outsource its core activities.
b. Termination of agreement
In Karvy’s case the Client may at any time terminate this Agreement by giving not less than 30 days prior written notice however the portfolio manager may terminate the agreement any time.
SEBI observed that there is a lack of uniformity and this is not in the interest of clients.
What is expected from a SEBI registered Portfolio Manager:
Again, one has to be really careful while drafting the portfolio management agreement and avoid any clauses and provisions which can be taken as violation of the applicable regulations and circulars.
SEBI places a lot of importance on maintaining high standards of integrity and fairness on part of the portfolio manager in all its dealings with clients.
#4 – Open position in respect of allocation of securities
The portfolio manager cannot keep any open position in respect of allocation of sales or purchases effected in a day
SEBI observed that Karvy had kept open positions in respect of allocation of sales or purchases effected in a day from the transaction statement of the pool securities account.
What is expected from a SEBI registered Portfolio Manager:
The portfolio manager cannot keep any open position in respect of allocation of securities. Unintentional and inadvertent error on the part of the Portfolio manager is not accepted by SEBI and considered as this being not in the interest of investors and posed a risk to investors.
#5 – Deficiencies made in the auditors’ report
A portfolio manager has to take steps to rectify the deficiencies mentioned in the auditor’s report, within two months from the date of such report.
SEBI observed in the Internal Audit reports that there was an observation on certain amounts that were pending un-reconciled in the pool bank account of Karvy.
Karvy replied that the unreconciled items were due to operational reasons, viz. non-identification of individual clients to whom such balances pertained. However, it was later decided by Karvy that amounts be transferred pro rata to the accounts of all clients belonging to the particular schemes. However, the same was not done.
What is expected from a SEBI registered Portfolio Manager:
There cannot be unreconciled differences lying in the books of a portfolio manager for a long time, except for reasons beyond the control of a portfolio manager. Timely and corrective action should be taken by the portfolio manager.
#6 – Appointment of compliance officer
A portfolio manager is required to appoint a compliance officer who will be responsible for monitoring the compliance of the SEBI Act, 1992, the rules and regulations, notifications, guidelines, instructions, etc. and also for redressal of investor grievances.
SEBI observed that Karvy appointed Mr. Vikas Rajpal as Principal Officer as well as the Compliance Officer, which was not accepted by SEBI.
What is expected from a SEBI registered Portfolio Manager:
PMS Regulations, 2020 clearly mention that the role of compliance officer shall not be assigned to the principal officer. Hence a principal officer needs to be a separate person.
In view of the violations and non-compliance, SEBI suspended Karvy’s certificate of registration for a month, with immediate effect.
What does suspension of the certificate of registration mean for Karvy?
It means Karvy will not be able to conduct fresh business under the PMS license for a month, i.e., it cannot onboard new clients during suspension. However, it will be allowed to service its existing clients.
One can argue if SEBI’s order and action against Karvy sets a precedent for the future too. I would be wary of saying that.
Karvy’s submission to SEBI included the fact that it does not have active operations since November 2019 and it is in the process of surrendering its certificate of registration as portfolio manager.
That could be the reason for this soft order without any monetary penalties. One can’t say what could be different if it was any other entity.
Having said that, Karvy is a big player in the securities market and any action by SEBI affects the reputation of an intermediary.
So, get periodic internal audits done (though not a mandatory requirement under the new regulations) so that the non-compliances can be known and rectified in time.
A stitch in time, saves nine 😊
And as I always maintain, the cost of compliance is small in comparison to the cost of non-compliance.
If you are looking to get an internal audit or the corporate governance audit done, please write to me at kruti@cskruti.com.
Kruti
One of my Friend wants to float a PMS in form of a pvt Ltd company where clients would be onboarded and they would be introducing capital in form of ledger balance with broker account and securities held by the client. And by pledging these securities, margin will be provided by the broker and the PMS will be managing funds and executing trades in client account through strategies in options (99.99% options writing). Through these activities, returns will be generated in client account and the PMS will charge management fee and performance fee. Is this service covered under PMS? If No, which category my friend can register these services with SEBI?
Hi Aayush, in PMS, portfolio manager cannot leverage the portfolio of its clients for investment in derivatives. Hence it is not recommended to register a PMS for this activity. Has your friend considered registering a category III AIF?