NSEL Scam

National Spot Exchange Limited (NSEL), the first Electronic Commodity spot exchange of India, was incorporated in May 2005. NSEL was a subsidiary of 63 moons technologies limited, then known as Financial Technologies India Limited (FTIL) which was founded by Jignesh Shah.

The then Prime Minister’s vision to create a single market across the country for both manufactured and agricultural produce was the reason for NSEL to be conceived.

NSEL commenced its operations in October 2008. Its operations included providing an electronic platform to undertake spot trading of commodities. The then Managing Director of NSEL, Anjani Sinha announced that the NSEL had launched gold, mini gold, silver and cotton contracts, and more commodities were to launched in every following week.

The case came into light when NSEL made a payment default on the orders of the Forwards Market Commission (FMC) to stop launching any fresh contracts. This led the Exchange to abruptly shut down in July 2013.

According to the rules of FMC, the ‘SPOT’ contracts needed to be settled within 11 days. In other words, the entire transaction including delivery of the commodities as well as transfer of money should be settled in 11 days. Thereby, keeping the transaction as ‘Spot’ and not a ‘Forward Contract’.

What exactly happened?

NSEL supposed to make just T+2 contracts which were spot in nature. But NSEL did not abide by the guidelines. They designed multiple contracts such as T+25 or T+36 contracts. These contracts were forward contracts and NSEL was not authorised to make such contracts. But they did and no one stopped them.

NSEL made paired contracts and termed them as Arbitrage contracts. Investors assumed the arbitrage to be guaranteed as NSEL as an exchange stood guarantee. The brokers sold such arbitrage contracts to the customers where they could Buy the T+2 contracts and sell the T+25 contracts.

A long term contract usually has a higher price as compared to a short term contract. Thus the T+25 days contract was priced higher than the T+2 contracts. Thus the pattern of contract for the customers was that they purchased the T+2 contracts and sold the T+25 contracts. Now on the second day, they took the delivery of the commodities and stored them in the NSEL warehouse. Further on the 25th day they provided delivery of those commodities to whom they had sold the T+25 contracts. The price difference produced almost 15-18% net return to the investor after deducting storage charges, VAT, etc.

This went on for two years resulting in NSEL to generate high revenues. The number of customers to escalate to around 15000, who put in at least INR 2 lakhs, in order to earn higher returns.

Now the issue that arose was that these contracts were always executed in pairs. None of the investor was allowed to take just one side of the contract i.e. either purchase or sell. The brokers reported to have sold the pair contracts in the format of purchase on the near side while sell on the far side.

What stopped them?

Exemption was provided to spot exchanges like NSEL and NCDEX by the Forwards Market commission (FMC), for one day carry forward facility. Although, the day limit was not specified in the law, the rule stated that the contract should not surpass the 11 day trade settlement.

The Ministry of Corporate Affairs issued a show cause notice dated April 27, 2012, to NSEL for certain clarifications regarding the trades. Further on the orders on the Department of Consumer Affairs (DCA), NSEL suspended trading in all but its E-Series contracts as on 31st July 2013. NSEL would not launch any new contracts and the existing contracts were needed to be settled on the due date.

As seen earlier, there were investors who had purchased commodities on the T+2 contracts. These investors expected that after 25 days their sell contract would actuate and they would be paid back money from the sell contract.

According to Anjani Sinha, the MD, there were 40 live contracts out of the 86 contracts they launched in various commodities which had settlement period of over 11 days.

This resulted in the INR 5600 crore settlement crises in July 2013.

In August the FMC ordered Financial Technologies India Limited to appoint a reputed Forensic auditor firm to establish the creditability of the Books of accounts authenticate the commodity stock it had in the warehouses with the records. It was also in news that FTIL in a draft audit report suggested system and process improvements in some of NSEL’s departments.

Choksi and Choksi was the audit firm who was provided with the assignment of NSEL. In the audit report, they had provided a clean chit regarding the E-series contracts on NSEL. The FMC gave a No Objection Certificate for the E-Series settlement. Thus 40,000 genuine claimants of E-Series received benefit.

The audit report which came down heavily on NSEL stated that the NSEL had no mechanism to monitor the activities of the custodians in respect of quality, quantity or verification of underlying stock except for the two audit conducted in the past in December 2012 and March 2013. In many cases the collateral was just inadequate or just missing leading to the settlement crises.

In October 2013, Amit Mukherjee (Former Vice- President, Business development NSEL) was the first to be arrested by the Economic Offenses Wing (EOW) of Mumbai Police. Further arrests were of Jay Bahukhandi (Former Assistant Vice President, NSEL) and Anjani Sinha (Former Chief executive of NSEL).

Who were actually opposite the investors?

Opposite to the investors i.e. who were supposed to sell the contracts of T+2 and purchase the contracts of T+25 were revealed quite later. In reality they were just 24 who used the paired contracts pattern to raise money easily.

One of these 24 was Nilesh Patel, the Managing Director of NK Proteins Limited, supposedly the first borrower in the NSEL Scam. He was arrested by EOW in October but subsequently got out on bail.  Raised funds under the garb of the contract without depositing any collateral in the warehouses. The amount earned by NK Proteins due to the above contracts were utilised for expansion purposes and a castor oil joint venture with Adani group. It had deployed around 333 crore of the investor’s money it earned into the joint venture contract.

Some of the other defaulted borrowers who were also arrested include – Arun Sharma (Lotus Refineries), Surinder Gupta (PD Agro), Indrajit Namdhari (Namdhari Foods), Kailash Aggarwal (Ark Imports), Narayanam Nageswara Rao (NCS Sugar), B V H Prasad (Juggernaut Projects), Varun Gupta (Vimladevi Agrotech), Chandra Mohan Singhal (Vimladevi Agrotech), Ghantakameshwar Rao (Spin-cot Textiles)and Prashant Boorugu (Metcore Steel & Alloys).

What about the Brokers?

In November 2016, on the orders of the Ministry of Corporate Affairs, the Serious Fraud Investigation Office (SFIO) conducted investigations for the alleged irregularities in the NSEL Scam. SFIO is a multidisciplinary organisation which is involved in detecting white collar crimes. It recently submitted a report to the government stating that all the 148 member brokers of NSEL had earned ‘Unlawful Gains’ while their clients had to suffer ‘illegal Losses’.

SFIO wanted the Securities and exchange Board of India (SEBI) to put the commodity broker houses or their promoters or their directors through the ‘Fiat and Proper test’. SFIO also suggested the government to begin the ‘Winding Up Process’ of the 148 broker firms as they had been conducting business in a fraudulent manner.

The brokers had been accused for indulging in manipulation of client KYCs large scale modification of client codes on multiple deals as well as infusion of unaccounted money via their NBFCs. They made false representations of assured and risk free returns to clients.

Accused of the alleged role in the NSEL Scam of about INR 5600 crores, Criminal proceedings were initiated by SEBI against about 300 brokers.

Show cause notices were dispensed by SEBI to top 5 broker firms namely Anand Rathi commodities, India Infoline Commodities (IIFL), Geofin Comtrade, Motilal Oswal Commodities and Phiilip Commodities. The charges issued were mis-selling of NSEL contracts as they promised assured returns without ensuring delivery. Further they were also issued second show cause notices when SEBI was not satisfied with their explanations offered on the mis-selling allegation. SEBI said that these broker firms seemed to have a close association with the paired contracts and NSEL as they facilitated the paired transactions for their clients.

Nearly two years after it issued the show cause notices, Market regulator SEBI, Motilal Oswal and IIFL Commodities as ‘Not Fit and Proper’ and they shall cease to act as a commodity derivatives broker. In the orders uploaded by SEBI on its website, Motilal Oswal and IIFL had a close connotation with NSEL and allowed themselves to become a part of the network.

“Thus…the notice is not a fit and proper person to be granted registration to operate as a commodity derivatives broker,”

said the SEBI order.

SEBI also ordered that the clients of Motilal Oswal and IIFL Commodities need to withdraw or transfer the securities held by them with the broker within 45 days at no additional cost.

Motilal Oswal in a statement said that they too were the victim of the scam like thousands of other investors. They also claimed to have its own group investment of around INR 57.8 crores due from NSEL on the date of default. They would explore legal options as they were aggrieved by the order and also the order would not have any impact on the overall business of the company.

India Infoline Commodities Limited did not have any outstanding dues from NSEL, but would also explore legal options being aggrieved by the order.

In case of IIFL only 0.06% of its total business is in commodity trading and a 326 crore exposure to NSEL. While Motilal Oswal had a 263 crore exposure to NSEL.

Both the companies are likely to appeal the directions in the Securities Appellate Tribunal (SAT), according to the officials of the two firms.

The next to be declared as ‘Not Fit and Proper’ were Geofin Comtrade (Formerly known as Geojit Comtrade) and Anand Rathi Commodities (ARCL) by SEBI on 26th February 2019.

According to a report, Geofin Comtrade had an exposure of about INR 290 crores while ARCL had an exposure of INR 591 crores against NSEL.

Phillip Commodities India was the latest and fifth broker that SEBI declared as ‘Not Fit and Proper’.

The clients of Phillip Commodities, Geofin Comtrade and Anand rathi Commodities were given the same order to withdraw their funds or securities within 45 days. If they failed to do so the broker would transfer it within 30 days thereafter.

SEBI said that even though the broker firms were yet to be established in court, it is justified to keep a person in doubtful reputation out of the market rather than having the risk of market to get affected.

Fear looms around the other broker firms named by various investigating agencies as similar actions would be taken for their alleged involvement in   the NSEL Scam.

Author
Vhabiz Lala
Volunteer – Equity Research & Valuation (M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

Connect with Vhahbiz on LinkedIn

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