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NSEL Fiasco: What Happens Next?

Published on Tue, Sep 03,2013 | 13:27, Updated at Tue, Sep 03 at 13:27Source : 

By: Tejesh Chitlangi, Partner, IC Legal

Chennai Express has broken all box office records and has made tons of money for its stakeholders. On the other hand, we have the derailed NSEL Express, which has broken the scam records earlier held in the names of some of the legendary market manipulators and as a result lost the investor money, which does not seem to retrieve.  

The fallout of National Spot Exchange Limited (NSEL) needs no detailed explanations as a lot has been written about it. Investors are unable to get their money back as NSEL has failed to honour the proposed payment schedule as a result of the defaults committed by the borrowers. The three major causes of the current crisis are outlined below:

(1) Government, FMC Inaction and FC(R)A Violations - A long silence and inaction by the Government (Ministry of Consumer Affairs) resulted in the trading of forward contracts on a spot exchange for a good long period.

The Forward Markets Commission (FMC) too did not take onus to regulate/prohibit the forward contracts traded on a spot exchange despite it being empowered and duty-bound under section 4 of the Forward Contracts (Regulation) Act, 1952 to regulate such forward market activities. 

(2) Failure of the Board, Management and Promoters – Permitting settlement of contracts beyond 11 days (upto 25 and 35 days), allowing short sales on a spot exchange, non verification of the actual commodities lying in the godowns, allowing NSEL to run like a ponzi scheme are all the reasons for which the board, management and promoters of NSEL can be held responsible for. 

(3) Lack of diligence by the Brokers – The brokers crying foul not only facilitated the investors to trade in the illegal forward contracts but also marketed the products as fully secured investments garnering handsome returns. The illegality of the product and in-sufficiency of underlying commodities should have attracted their attention.

Having said that, the real issue now is what happens next as the exchange on expected lines has defaulted in making scheduled pay outs to the investors. A loan has been availed by NSEL from the promoter as a temporary measure to avoid another default on the second weekly payment obligation but may not serve the purpose as settlement obligation will recur every week and such loans may not be availed on subsequent occasions. This Article contemplates the next line of action from a legal-regulatory perspective which the Regulators, NSEL, stock exchanges and Investors are likely to pursue. It also discusses the way forward for NSEL's promoter - Financial Technologies (also a promoter of MCX, MCX-SX, and certain foreign exchanges) and the directors of NSEL, some of whom also are on the boards of MCX, MCX-SX and certain foreign exchanges.

The issues are discussed below under relevant heads:

Possible defences by NSEL

NSEL under its bye-laws is bound to utilise the Settlement Guarantee Fund (SGF) to repay the dues of the investors but the amount lying there is grossly inadequate. Interestingly, due to a “Limitation of Liability” clause (bye-law 12.14), NSEL's liability to repay under its bye-laws in such eventualities may be limited to the amounts lying in the SGF. However, as the disputed contracts were in essence void, such NSEL claims may get countered. Apparently, as per the reporting formats available on the FMC website, the spot exchanges have to report their activities to FMC on weekly, fortnightly and quarterly basis. Hence, NSEL (if has reported) may take a defence that the Government, FMC despite of being aware of the exchange activities, earlier never prohibited them but only sought explanations to which it had provided them satisfactory responses.

Eligibility of Promoters and Board Members under Cloud

Financial Technologies (FT) is the holding company of NSEL, also promotes and holds 26% shareholding in MCX, 33.86% of MCX-SX (including warrants on a fully diluted basis) and is in turn promoted by Mr. Jignesh Shah who individually and in joint names holds 18.08% in FT as on June 30, 2013. Mr. Shah is the vice-chairman on the boards of NSEL, MCX and MCX-SX. Similarly Mr. Joseph Massey is the director on boards of all three entities listed above. Mr. Shreekant Javalgekar is a director on the boards of NSEL and MCX.

FMC as a next step may revoke the fit and proper status of the NSEL’s board members (as they have already been warned) and promoters if the payment defaults continue. This will have cascading effect as the individuals listed above may no more be eligible to sit on the board of MCX due to a recent FMC directive of May 17, 2013 enlisting fit and proper criteria. Furthermore, they may also not be eligible to sit on the board of MCX-SX due to SEBI fit and proper requirements. FT may also be directed by FMC and SEBI to give away its promoter tag of NSEL, MCX and MCX-SX and divest its shareholding in these respective companies. In this regard, eligibility of FT to promote and some of the above mentioned individuals to sit as directors on some of the foreign exchanges (as per their website) in Singapore, Dubai, Mauritius, Africa and Bahrain may also come under cloud as FT and aforesaid individuals will have to pass the eligibility tests under the local laws and their regulators.

Compliances under Equity Listing Agreement

Under Clause 36 of the Equity Listing Agreement, a listed company is required to immediately inform the stock exchange of all the events, which can have a bearing on the performance/operations of the company and also disclose if there is any price sensitive information. Whether such disclosures got triggered and were timely made by Financial Technologies (a NSE and BSE listed company) is for stock exchanges to examine. This is in view of the fact that NSEL is a material subsidiary of FT from which FT derived substantial revenues, and the knowledge of contracts in question being in violation of law and the resultant bubble seem to be known to various market participants for a long time, much before the Government's first formal direction on July 12 asking NSEL to not launch new contracts came.

Legal Options

NSEL post utilising the commodities in the godowns (which are inadequate), is likely to pursue appropriate legal remedies against the defaulters including police complaints (NSEL has already complained to EOW) and explore other legal actions including winding up operations of the defaulting entities. Investors are likely to file police complaints and law suits (legal proceedings may to some extent be avoided as would otherwise results in delay as matter would become sub judice) against the Management, Board and the promoters of NSEL holding them personally liable to repay. SEBI may examine the roles of the stock brokers if their client monies have been channelized through commodity broking arms in the illegal contracts without proper diligence. FMC and the Government are also likely to take suitable actions against the management, board and the promoters of NSEL, as discussed earlier.


What's in a Name? The Shakespeare’s quote was followed seriously by NSEL as the spot exchange functioned like a forward exchange. NSEL’s website in the 'About Us' link still proudly states that its state-of-the-art technology facilitates risk free and hassle free purchase and sale of various commodities. No comments here.

The regulators should ensure that NSEL does not end up becoming another Sahara, whereby investors keep lurking for their dues. The regulators and enforcement agencies have a point to prove and can set a precedent by acting swiftly and sensibly.


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