InvestorQ : I have a question as to whether the Karvy case will impact my mutual fund investments since Karvy is also a large mutual fund registrar. Are my MF units safe?
shrinidhi Rajan made post

I have a question as to whether the Karvy case will impact my mutual fund investments since Karvy is also a large mutual fund registrar. Are my MF units safe?

Riya Dwivedi answered.
9 months ago

You have raised a very valid question but that is not do with the issue of Karvy being the registrar but more to do with the ethical use of the broker pool account. Investing using the broker pool account is very common when it comes to mutual funds and it does open the entire system to frauds like the one perpetrated by Karvy. Here is what you need to know about.

· You will recollect that a few days back, SEBI released a discussion paper with the title, “Usage of pool accounts in Mutual Fund Transactions”. In the aftermath of the Karvy scam, this paper by the SEBI has sent alarm bells ringing through a number of mutual fund intermediaries who sell mutual funds to investors. That is because, while the goal is to make investor money safer and less liable to diversion, it may end up killing the goose that lays the golden eggs in the process.

· This move, if it happens, could not only hit the old age brokers but also the much younger Fintech companies that have been relying on the marriage of technology and client expansion to reach out to a large mass of mutual fund investors. If the paper is seriously followed up with, it could end up banning a practice that is common among the new generation of Fintech companies. Remember that most of the Fintech MF distributors and advisors are heavily promoting app-based mutual fund investing.

· The effort of the regulator is clearly the direct fallout of the Karvy affair. In India, all aspects of dealing with money and savings are difficult enough as it is. If investors have to worry that the intermediary (being the broker or advisor) could take possession of their investments or money, it could be a huge loss of faith in the integrity of the system. In fact, it was seen in the Karvy case that such assets were pledged and also sold in some instances.

· The shares were transferred from the clients’ depository accounts, sold off and the proceeds transferred to Karvy’s real estate business. This is possible in equity investing because almost all stockbrokers operate with a power of attorney over the investors’ shares. But it is not too difficult to replicate such a situation in the mutual funds business as there is a window of time when neither the investor nor the AMC has control over the funds and it is entirely in the hands of the broker or the intermediary. That is the point of risk that SEBI is wary of.

SEBI’s view is that there is absolutely no need for this kind of an arrangement in the case of mutual funds, which deal with small savings. When you invest in mutual funds the money should go directly to the actual scheme of the fund company. The same logic should hold in the event of redemption too. Perhaps, the custody approach using clearing corporations could be the answer.