Aftermath of Karvy Stock Broking fraud: Are your mutual fund investments safe?

By Dhirendra Kumar

Are my investments safe? This is the first question any investor asks. If you ask an expert, then logically it must be answered by a counter question, “Safe from what?”

When you make any investment, there are different threats to its safety. Broadly, they might fit into two categories. One, its inherent investment value may decline. Two, someone else, who is not authorised to do so, may liquidate it and run away with the money. Savers who invest in equities or equity-backed mutual funds (MFs) are generally prepared for the first type of threat. That’s part and parcel of returns-versus-risks spectrum that one signs up for when investing in equity.

The second type of threat is different. It’s a crime. One would expect that such threats would not materialise at all, or at a very marginal scale. However, as the experience of Karvy Stock Broking shows, that expectation is not realistic. From what Sebi’s investigation shows, it appears the stockbroking firm (or persons within it) pulled off an elaborate heist. One could call such a fraud unprecedented— this kind of fraud has never been done before on such a scale. However, smaller brokers may have done similar things.

We can sense that frauds using digital transactions are increasing. For example, the impression is digital pilferage from bank accounts is happening on a large scale. We all seem to know of more than one such case within one’s circle of acquaintances. Similarly, the Paytm know-your-customer (KYC) scam is widespread enough for the company to be making considerable effort to warn people not to fall for these frauds.

Many people feel sieged by frauds they do not understand and therefore, cannot guard against. In the physical world, we all know how to buy and use a stronger lock. In the world of digital transactions, you can’t be confident that you know how to prevent yourself from being robbed. In fact, you cannot be confident that you have not already been robbed and you just don’t know it yet!

From the savers’ and investors’ perspective, a natural question that arises is whether mutual fund investments may be vulnerable to a Karvy kind of scam. As the scandal shows, what your broker tells you about your stock holdings could well be fictional. Does it mean that for your fund holdings, you should also worry that some intermediary is going to take possession of your funds, sell them off and appropriate the proceeds? According to the Sebi investigation, that is what Karvy Stock Broking did with several hundred crore rupees worth of shares belonging to clients. The shares were transferred from the clients’ depository accounts, sold and the proceeds transferred to Karvy’s real estate business.

Also read: Karvy demat scandal: How to keep an eye on your broker

I’m not going to stick my neck out and say that no fraud of any kind is possible with mutual funds, but this kind of a thing can pretty much be ruled out. In stock investing, the stockbroker is an actual intermediary. In mutual funds, there may be a sales intermediary, but the financial transaction is between you and the fund—not the fund company but the specific scheme in which you have invested. Not just that, the bank account from which the money goes to the fund and the one to which it comes back must be the same. The fund holding must also be in the same name as the account. Essentially, there is no intermediary in the transaction itself.

The structure is much simpler than stocks. Mutual funds are much more suited to the consumer kind of hands-off investor who does not have the wherewithal to mount 24-hour vigilance that other types of investment transactions require.


(The author is CEO, Value Research)