New Delhi/Mumbai:

he government on Tuesday ordered the merger of National Spot Exchange Ltd (NSEL) with its parent Financial Technologies (India) Ltd or FTIL, despite the best efforts of Jignesh Shah, the promoter of both, to protect his flagship from the fallout of fraud at the spot exchange.

It isn’t clear how the merger will resolve the fraud, which has left many investors unpaid, especially because the amount owed to them does not appear on NSEL’s books as a liability.

The merger will also affect minority shareholders of FTIL, in which Shah and his associates own about 45%.

The merger was recommended by commodity market regulator Forward Markets Commission (FMC) and was also a long-standing demand of investors affected by the fraud at NSEL.

In a draft order issued on 21 October, the government said it decided to merge the two entities in public interest, forcing the latter to assume all the liabilities of the commodities bourse and also making it a party to all the contracts and agreements entered into by NSEL. FTIL owns 99.99% of NSEL, on which trading was suspended after the 5,574.35 fraud came to light in July 2013.

“... the Central government is satisfied that to leverage combined assets, capital and reserves, achieve economy of scale, efficient administration, gainful settlement of rights and liabilities of stakeholders and creditors and to consolidate businesses, ensure co-ordination in policy, it is essential, in the public interest that Financial Technologies India Ltd. and the National Spot Exchange Ltd. should be amalgamated into a single company," said the 21-page draft order issued by the ministry of corporate affairs (MCA).

The merger is being done under Section 396 of the Companies Act.

“A draft order in this behalf has been issued. All due procedures in this regard shall be followed. The members of the two companies, its creditors may provide suggestions/objections within a period of 60 days," the ministry added.

FTIL shares plunged 20% to 169.65 on the BSE on a day the benchmark Sensex gained 0.55% to 26,575.65.

“The Company is taking appropriate steps in the matter in consultation with the legal counsel of the Company," FTIL said in a note to BSE on Tuesday.

FTIL has opposed the idea of merging NSEL with itself. Last month, in a letter to the stock exchanges, FTIL said that under the Companies Act, the government can merge two companies only if such a union is essential in public interest.

“The interest of the 13,000 clients of the brokers who traded on NSEL platform for higher returns cannot be termed as ‘public interest’ when 66% of the entire outstanding amount is being claimed by just 6% of the trading clients," FTIL said in its letter.

According to the order, all the equity shares held by FTIL in NSEL will be cancelled. For accounting purposes, the merger will be effected from 31 March 2014 and all transactions thereafter would be pooled into a common account. The amalgamation will also make FTIL a party to all the contracts, deeds, bonds and agreements of which NSEL was a part of.

More importantly, any suit, prosecution, appeal or other legal proceedings which may be required to be filed against NSEL will now be filed against FTIL.

In other words, FTIL will have to take over all assets and liabilities of NSEL as of 31 March and also the full responsibility of all transactions thereafter.

P.R. Ramesh, one of the advocates advising FTIL, says that according to the order, pending liabilities of NSEL after the attachment and sale of assets of defaulters will be shifted to FTIL.

“The government wants to lift the corporate veil and the order will be tested on both, moral and legal obligations, of FTIL in the matter. The matter is still sub-judice but the government has gone ahead with the order," he added.

According to corporate dabatase Capitaline, FTIL’s standalone cash and bank balance was 119.19 crore for the financial year ended 31 March 2014.

FTIL saw its net profit falling by nearly 14% in the financial year ended 31 March 2014, though the quarter ended 30 June 2014 saw net profit rise by 58% to 128.25 crore when compared with the same quarter a year ago.

R.S. Loona, former executive director (legal) of Securities and Exchange Board of India (Sebi), said the final order has to stand the test of the courts, which will decide on the public interest aspect.

“It can be safely said that the matter will land in court. I don’t think that the court would want to interfere right now as MCA has given (FTIL and its investors) two months to file objections. Finally, it will all boil down to whether public interest of FTIL or NSEL will prevail in the court."

Meanwhile, the economic offences wing (EOW) of the Mumbai police on Tuesday said it had attached assets around 6,000 crore in connection with the NSEL fraud. Rajvardhan Sinha, additional commissioner of police (EOW), said that the merger of NSEL with FTIL won’t affect the police investigation.

The order marks the end of NSEL, which was incorporated in May 2005 and started functioning as a spot exchange in 2008.

“Subject to the other provisions of this Order, and clause (aa) of sub-section (4) of section 396 of The Companies Act 1956... National Spot Exchange Ltd. shall stand dissolved," the MCA order said.

The ministry’s move was welcomed by affected investors

“This is a fantastic move. It strengthens our hopes of recovery of money that has been trapped in the NSEL crisis. It also deters other companies from committing such acts through subsidiaries," said Arun Dalmia, one of the investors in NSEL.

A second investor, Ketan Shah, said discussions with the government had been going on for the last two months. “We are relieved at this development. This is a very important move and a key development to push forth the recovery of our money," said Shah.

On 18 August, FMC wrote to MCA to consider merging FTIL with NSEL “in public interest so that the human/financial resources of FTIL are also directed towards facilitating speedy recovery of dues from the defaulters at NSEL". The letter is available on the FMC website.

FMC was of the view that the manpower and financial strength of NSEL had been depleted and so it was “financially and physically incapable of effecting any substantial recovery from the defaulting members".

The fraud at NSEL came to light on 31 July 2013 when the exchange suspended trading in all but its e-series contracts. These, too, were suspended a week later. The suspension may have been prompted by an instruction from the ministry of consumer affairs to the exchange asking it not to offer futures contracts. A spot exchange isn’t supposed to do so, but NSEL was doing that.

NSEL tried to implement the change, but because its appeal was to investors and members who were not interested in spot trades, it eventually had to suspend all trading.

It later emerged that all trading on NSEL happened in paired contracts, with investors, through brokers, buying a spot contract and selling a futures one for the same commodity.

The entities selling on spot and buying futures were planters or processors and members of the exchange.

It turned out there were only 24 of them, and they used the paired contracts as a way to raise easy money.

Subsequent investigations highlighted the involvement of promoters. On 14 August last year, NSEL proposed a payout plan, but it has been unable to stick to the schedule and has not made a single successful payout ever since.

Khushboo Narayan in Mumbai contributed to this story.

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