Home / Market / Stock-market-news /  MCX-SX special audit finds norms were breached

New Delhi: Initial findings of a special audit being conducted on the MCX Stock Exchange (MCX-SX) have revealed violations of corporate governance norms, and instances of one-sided, related-party transactions and conflicts of interest similar to those unearthed at Multi Commodity Exchange of India Ltd (MCX), said two people familiar with the findings.

Both MCX-SX and MCX are affiliates of the Financial Technologies (India) Ltd (FTIL), founded by entrepreneur Jignesh Shah, who was arrested this month with former MCX chief executive Shreekant Javalgekar in connection with a 5,574.34 crore payments crisis at National Spot Exchange Ltd (NSEL), another entity of the group.

Preliminary findings of the audit of MCX-SX highlighted the instances of related-party transactions similar to those found at the MCX, and also a breach of corporate governance norms, said one of the two people cited above.

“The findings suggest that MCX-SX entered into heavily one-sided related-party agreements with several entities, including FTIL. Many of these related-party contracts were detrimental to the interest and benefits of MCX-SX as they favoured the second parties and not MCX-SX."

The findings could spell more trouble for FTIL, which has been at the centre of multiple investigations by regulators and law enforcement agencies since the crisis at NSEL surfaced at the end of July last year. Mint has not reviewed a copy of the initial report of the special audit.

“If the findings are related to corporate governance and operational deficiencies, then it may have an impact on the daily operations. Members would move away if the credibility of the exchange is affected," said Rajnikant Patel, a former managing director and chief executive officer of Bombay Stock Exchange (BSE).

FTIL holds a 99.99% stake in NSEL and 26% in MCX. FTIL and MCX each hold 5% equity in MCX-SX, along with convertible warrants.

The Mumbai-based chartered accountant Kalyaniwalla and Mistry is conducting the audit ordered by the newly appointed board of MCX-SX on the direction of markets regulator Securities and Exchange Board of India (Sebi).

The audit covers related-party transactions, risk management practices and corporate governance standards followed at the exchange.

Kalyaniwalla and Mistry has submitted its preliminary findings to the top management of MCX-SX. The final report will be prepared and presented before the board next month, said the first person.

Replying to an e-mail by Mint on the special audit, an MCX-SX spokesperson said, “The audit is comprehensive in nature. Our board has decided to conduct this audit to build confidence."

“The audit is in progress and as a part of this process, various notes are being exchanged between us and the appointed auditor. Since the report is not ready we would not be taking it up for discussion in the next board meeting," the exchange’s spokesperson said.

The exchange hasn’t officially disclosed date of the meeting as yet.

The special audit of MCX-SX follows the forensic audit of MCX, which was done at the behest of commodities market regulator the Forward Markets Commission (FMC) after the crisis at NSEL surfaced.

The audit of MCX conducted by PricewaterhouseCoopers (PwC), whose findings were put out on the exchanges last month, revealed a number of related-party transactions and failure to comply with corporate governance norms.

The audit had also observed that FTIL continued to have significant control over running of MCX under its previous management and board of directors even after it became a listed exchange in 2012.

“Sebi had asked for a forensic audit of MCX-SX, covering the similar parameters that were followed by PwC in case of MCX. The review period for the special audit is from the inception date of the stock exchange till date. The audit report is expected to be given to Sebi in the next few weeks," said the second of the two officials cited above.

Among several instances of allegedly unfair related-party transactions, the forensic audit has found that MCX-SX signed unreasonably expensive technology contracts with FTIL.

High priced contracts for use of FTIL software for the exchange’s front-end trading and clearing systems were signed, even though similar trading software was available at lower prices in the market, the first person said.

Such one-sided contracts could be the reason that MCX-SX had incurred higher operational costs over several years since its inception in 2008.

According to MCX-SX’s annual reports, the stock exchange incurred losses of 2.92 crore, 57.80 crore and 56.21 crore during the fiscal years 2012, 2011 and 2010 respectively, while it made a net profit of 21.42 crore in fiscal year 2013. However, MCX-SX’s technology cost increased to 41.37 crore in fiscal year 2013 from 32.65 crore in fiscal year 2012, 17.38 crore in fiscal 2011 and 18.57 crore during fiscal 2010.

MCX-SX has been audited by an auditor appointed by the Comptroller and Auditor General of India (CAG) for the past four years, and Sebi too has been “inspecting our exchange as part of the yearly renewal process," the MCX-SX spokesperson said in response to a query from Mint.

“Hence, we would like to reassure all stakeholders about the robustness of the processes followed by the exchange and the trading platform that the exchange has to offer," the spokesperson added.

In reply to an e-mail from Mint on Wednesday evening seeking comment on the findings, an FTIL spokesperson said the company could only respond on Thursday.

The initial findings of the audit has also questioned whether an “arm’s length" distance had been maintained between MCX-SX and FTIL.

An arm’s length transaction is one in which both parties are acting in their own interest without any duress.

Business decisions of MCX-SX were influenced by FTIL even if they went against the interest of MCX-SX, the findings showed.

“Since several directors were common to both the FTIL and MCX-SX boards, on many occasions, the business decisions were taken and related party contracts were agreed upon keeping FTIL’s interest as the first priority," said the first person cited above.

The scope of the special audit of MCX-SX’s past dealings is over and above the work of the exchange’s statutory auditor Chaturvedi and Shah, appointed by CAG, said both the persons.

“The scope of the audit done by a statutory auditor and a forensic or a special auditor is quite different," said Amarjeet Chopra, former president of the Institute of Chartered Accountants of India (ICAI).

“In the context of related parties, a statutory auditor will go by the disclosures made by the company secretary. A forensic auditor can go beyond this. A statutory auditor can be held negligent only if he has not disclosed related party transactions even after proper disclosures made by the company secretary," he added.

After the final report on special audit is approved by the MCX-SX board, it will be submitted to Sebi for an examination.

Ashish Rukhaiyar contributed to this story.


Anirudh Laskar

Anirudh Laskar is a senior editor at Mint, with 17 years of experience. He has reported on significant corporate matters including large mergers and acquisitions, India's emerging e-commerce sector and regulatory issues in the financial services industry. Based out of Mint’s Mumbai bureau, Anirudh has worked with Business Standard and The Telegraph before joining Mint in 2009.
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