#Debriefed: NSEL’s tryst with the Judiciary

On 24 July this year, it was reported that the a special court would be set up to hear all cases relating to the National Spot Exchange Limited (NSEL). The same news report also stated that Economic Affairs Secretary, Shaktikanta Das, held a review of the action taken in the NSEL scam (Scam)..The genesis of the Scam.In May of 2005, NSEL was incorporated as a Joint Venture (JV) between Financial Technologies of India Ltd. (FTIL) and the National Agricultural Cooperative Marketing Federation of India (NAFED).Under the JV agreement, FTIL would hold 99.99% in NSEL..In 2008, NSEL commenced operations, providing an electronic trading platform for spot trading of commodities such as bullion, agricultural produce, metals etc. As a commodity exchange, NSEL acted as a platform for commodity spot trading wherein one could buy goods by paying cash on the ‘spot’. This was facilitated by online trading thereby making transacting convenient and anonymous..Back then, commodity trading was regulated by the Forward Market Commission (FMC). However, in 2015, the FMC was merged with the Securities Exchange Board of India (SEBI)..The exemption.Under the Forward Contracts Regulation Act, 1952 (FCRA), a forward contract is one which is either settled after a period of eleven days or where there is no actual delivery of goods. Through a government notification issued in 2007, NSEL was granted an exemption for all one-day duration contracts (spot contracts) under Section 27 of the FCRA which meant NSEL was allowed to offer one-day forward contracts provided that members would not resort to short sales and that outstanding positions at the end of the trading day would result in delivery..However, the FMC found that NSEL allowed trading on its platform without verifying whether the seller had stocks, in effect allowing short sales by members..Thus, the investors actually sold commodities without proof of underlying stock and entered into buyback arrangements. These investors entered into buyback arrangements by ‘purchasing’ spot contracts and ‘selling’ the same commodity to stockists after 25 to 35 day periods ignoring the FCRA, which would result in an annual arbitrage gain of nearly 15%..None of this was permitted, and the exemption notification was unsurprisingly withdrawn in October 2014..In between the exemption and withdrawal notification, an innocuous looking notification was issued by the FMC in July 2013..This notification restricted NSEL from making fresh contracts available, as they were likely to be in contravention of the FCRA. Naturally, investor sentiment was marked by deep panic, as a result of which nearly 13,000 investors withdrew from the exchange. This effectively stopped the wheel of roll-over trades, thereby inhibiting NSEL from raising fresh funds to repay old investors..The bubble had burst. A bubble that was then estimated to be 5,600 crore in size..Legal proceedings & Multiple agencies.Following agencies are involved in investigation of the Scam, with the progress being monitored by Department of Economic Affairs, Ministry of Finance:.Economic Offences Wing (EOW) of Mumbai Police.The EOW has invoked provisions of the Maharashtra Protection of Interest of Depositors (in Financial Establishments) Act, 1999, augmented the number of Designated Courts and made several arrest in this regard since the Scam broke out..It filed a 9,600 page charge sheet in January 2014 with the names of the primary accused. In this regard, so far, 831 properties worth Rs. 7,063 crore have been attached, out of which, properties worth Rs. 6,115 have been notified..Out of these, properties worth Rs.2,000 crore are FTIL’s assets. FTIL, however, opposed this move and the Bombay High Court, has allowed disbursement of employees’ salary and other statutory expenses out of the attached properties..Enforcement Directorate.The Enforcement Directorate has initiated a money-laundering probe before the designated special court i.e. City Civil Court and Additional Sessions Judge, Greater Bombay under the Prevention of Money Laundering Act, 2002 (PMLA)..The probe against NSEL and 67 other accused includes Jignesh Shah, the alleged mastermind, who after spending nearly one month in judicial custody was recently granted bail..SEBI.Following SEBI’s merger with the FMC in September 2015, SEBI recently commenced a forensic audit of the top six brokers which have the highest exposure to NSEL. The audit is being conducted for two years preceding July 2013, which is when trading on NSEL was halted..Financial Intelligence Unit- India (FIU- IND).The FIU-IND passed an order in November 2015 under Section 13 of the PMLA imposing a penalty of Rs. 1.66 crore on the NSEL for non-compliance of the PMLA. Obviously, NSEL has appealed before the designated Appellate Authority under the PMLA..Ministry of Corporate Affairs (MCA).The MCA had issued a final order for merger/amalgamation of NSEL with FTIL under Section 396 of the Companies Act, 1956. This is the first time this section has been invoked by the Government for a forced merger between two private companies. If actualised, such a merger would force NSEL’s liabilities on FTIL and make FTIL a party to the ongoing litigation..FTIL, obviously, has vehemently opposed this merger and the Bombay High Court has restrained the Government from notifying the final Order dated 12 Feb 2016 in the Official Gazette. The matter is currently pending before the Bombay High Court..DEA meetings.The DEA has been conducting regular meetings to review the action taken by various investigative/enforcement agencies. The latest meeting i.e. the twelfth meeting in this regard was held on 24 July, wherein it was, inter alia, stated that a designated Judge of the City civil Court and Additional Sessions Judge, Greater Bombay has been nominated to try various cases arising out of the NSEL payment crisis..The Lawyers.Noted lawyers involved in the proceedings include Abad Ponda,who is representing Jignesh Shah before the designated special court and, FTIL before the EOW..In the merger case, senior counsel Abhishek Manu Singhvi and Virag Tulzapurkar have appeared for NSEL, while Janak Dwarkadas appeared for FTIL..The Future.Following the Harshad Mehta Scam, the government in 1992 had enacted the Special Court (Trial of Offences relating to Transactions in Securities) Act to set-up special courts, mostly with the objective of recovering huge sums of money lost by banks and restoration of public confidence in the financial system..What the Harshad Mehta Scam also brought to light were the various regulatory loopholes which needed immediate attention of the government. Among other reforms, the government prompted the government to force the state-owned banks and institutions to set up the National Stock Exchange..However, even after two decades, the case continues..In the Scam too, out of the Rs. 5,574 crore due to investors, NSEL distributed Rs. 304.50 crore to small investors in September 2013, which still leaves a sum of nearly Rs. 5,269 crore yet to be distributed. As provided above, there is a multiplicity of proceedings in this matter and many opposing interests, which is causing a delay in the process..Given the snaillike approach in the Harshad Mehta Scam, one can only imagine when (and if) the investors will recover their money..Last edited at 8:05 PM on 16 August, 2015