Blackstone, Sheth brothers to oppose NSEL merger order

Mumbai: Blackstone Group Lp and the Sheth brothers—the two largest minority shareholders in Financial Technologies (India) Ltd (FTIL)—plan to challenge a government order that the company merge with its fraud-hit subsidiary National Spot Exchange Ltd (NSEL), three people familiar with the matter said.

The investors are exploring options and likely to move in consonance in the next few days in opposing the draft order that the government said was in “public interest”. The order sought to transfer all liabilities of the commodities bourse to FTIL, the flagship company of entrepreneur Jignesh Shah.

“We will move in the next few days but we are trying to understand what will be the best way—public, legal, private,” said one of the three persons cited above. All three spoke on condition of anonymity.

The 21 October order sought to make FTIL, which owns 99.99% of NSEL, a party to all the contracts and agreements entered into by the exchange, on which trading was suspended after the ₹ 5,574.35 crore fraud came to light in July 2013, initially as a payments crisis. The order gave FTIL and NSEL two months to file objections.

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.

“Shareholders are exploring options to counter the move to merge NSEL and FTIL not on the basis of responsibility standpoint, but the validity of such a move in terms of judicious corporate practices. Lawyers are examining various options to oppose this move as it is against established practices,” said a second person.

Blackstone Group holds a 7.02% stake in FTIL. Ravi Sheth, managing director of Greatship (India) Ltd, and his brother Bharat Sheth together hold 8.1% on the company. Greatship is an offshore services provider to energy companies.

Promoter Jignesh Shah directly and indirectly holds a total of 45.63% in FTIL.

An email sent to Blackstone Group and FTIL hadn’t been answered as of press time on Tuesday.

The merger of FTIL and NSEL has been proposed under Section 396 of the Companies Act that empowers the government to order such a union when it is deemed to be in public interest. This is the first time the government invoked the provision in a case involving non-state entities.

Shares of FTIL have fallen 13% since 20 October, wiping out ₹ 129 crore in market capitalization for shareholders. On Tuesday, the shares fell 1.47% to close at ₹ 184.15 while the BSE’s benchmark Sensex rose 0.48% to 26,880.82 points.

Shareholders of FTIL say the government does not have a strong enough case to invoke Section 396.

“I think government did a mistake by invoking Section 396. If they merge NSEL with FTIL on the grounds of public interest, then there are many other matters where a merger should have been already initiated,” said the third person.

FTIL has opposed the proposed merger of NSEL with itself.

“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 a letter to the stock exchanges last month.

Some analysts have opposed the government move on grounds that the government was forcing a parent company to take on the liability of a subsidiary, thereby ignoring the fact the subsidiary had been formed as a separate entity so that the parent’s liability is limited to the extent of its investment in the firm.

The concept of limited liability will come into the picture only if the aggrieved party moves court against the final order, said R.S. Loona, former executive director (legal) at the Securities and Exchange Board of India.

“The government may go ahead and merge the companies citing ‘public interest’ but if the order is challenged in court then the issue of limited liability will be tested. The court would not want to interfere right now as MCA (ministry of corporate affairs) has given FTIL and NSEL two months to file objections,” he says.

Loona cited the example of special purpose vehicles (SPVs) that companies form for specific projects, to explain the limited liability concept.

“The whole objective of promoting SPV is that parent company is not subjected to risk obligations of the SPV. FTIL may be the single-largest shareholder of NSEL but why it should be exposed to liability of a separate legal entity?” Loona said.

Meanwhile, in a separate development, FTIL is considering filing a caveat before the Chennai bench of the Company Law Board against the possibility of a forced change in the management of the company after its merger with NSEL, said the third person quoted above.

A change in management was suggested by FMC in a letter to MCA on 18 August. On Monday, The Indian Express reported that the government was considering the suggestion.

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.n@livemint.com

Ashish K. Mishra & PR Sanjai contributed to this story.