Photo: Abhijit Bhatlekar/Mint
Photo: Abhijit Bhatlekar/Mint

Order violates fundamental principles of rule of law

The problem with the order merging scam-tainted NSEL with its parent FTIL is that it lays the blame on all FTIL shareholders

The government’s decision to merge National Spot Exchange Ltd (NSEL) with parent company Financial Technologies (India) Ltd (FTIL) is ill-advised. By doing so, the government is effectively laying the blame of the NSEL scam on all shareholders of FTIL, even though only a few of them were involved with the spot exchange.

Here’s the main problem: the government is forcing a parent company to take on the liability of a subsidiary company, ignoring the fact the subsidiary was formed as a separate entity precisely so that the parent company’s liability is limited to the extent of its investment in the firm.

According to an expert in finance and corporate governance, if the government proceeds with the forced merger, it will appear the country doesn’t respect the rule of law. The expert added that it will set a bad precedent.

Consider a scenario where the insurance subsidiary of a bank goes bust, and the government uses the same provision in the Companies Act to force a merger between the insurance arm and the bank. Will the Reserve Bank of India just sit tight? Will the government cite, like it has in the NSEL case, that public interest is at stake, since it involves the funds of investors and customers of the insurance company? Naturally, the central bank will shoot back that greater public interest is involved in protecting the bank and the funds of its depositors.

Similarly, who’s to say that the dues of investors in NSEL’s products serve a greater public interest than the interests of FTIL’s minority shareholders? An argument is being made by NSEL investors that about 85% of FTIL’s shares are held by a few large shareholders and the over 55,000 other shareholders hold less than 15% in the company. But can it be concluded that the interests of these small shareholders don’t matter?

The Forward Markets Commission (FMC), which initiated the merger proposal, said in a communication to the ministry of corporate affairs (MCA) that minority shareholders of FTIL should have realized that equity investments carry inherent investment risk. The reasoning is that since they enjoyed benefits such as a higher dividend and capital appreciation when NSEL was doing well, they must now also bear the risks associated with the acts of omission and commission of the holding company. But according to the laws of the land, the risks associated with such acts by the holding company are limited to the extent of capital invested.

Another reason provided by FMC is that Mumbai Police has filed a charge sheet against Jignesh Shah, the founder of FTIL, which means there is prima facie evidence regarding Shah’s culpability in the matter. Here, the assumption seems to be that Shah and FTIL are one and the same. Why should FTIL’s minority shareholders suffer for Shah’s alleged misdemeanours? Of course, as an aside, it can be said they have already paid the price—FTIL shares have fallen by over 60% since the NSEL scam came to light. But it’s another matter for the government to force the entire company and its shareholders to take on the liabilities of one errant subsidiary. If Shah is found to be culpable, he should be made to bear the brunt.

It must be noted here that the 5,600 crore or so due to NSEL’s investors isn’t listed as a liability on NSEL’s books. As of now, at least as far as the books of accounts go, they are liabilities owed by the exchange’s defaulting members. So it won’t be passed on to FTIL’s books either through the merger. How, then, will the merger benefit anyone? FMC’s case, which, of course MCA has bought into, is that since NSEL’s manpower and financial strength has depleted in the past year, it isn’t able to perform its task of recovery effectively. The hope is that with FTIL’s resources, things should move more quickly on this front.

Those are high hopes indeed. What the government should have done was perhaps act on FMC’s second recommendation, which was to replace FTIL’s management. That way, it could get FTIL and NSEL to cooperate in the work of recovery.

Of course, all this is not to say that NSEL’s investors shouldn’t be paid back their dues. But two wrongs don’t make a right. If the government is keen on the recovery of the dues of NSEL investors, it must act tough against NSEL’s management, the FTIL directors who were involved in the running of the spot exchange, including Shah, as well as the defaulting companies who owe the exchange large sums of money.

Considering that FTIL has a large institutional shareholder in Blackstone Group Lp, which owns 7% in the company, it won’t be surprising if some minority shareholders rally together and move the courts against the government’s proposed move. They are likely to say that any liability should be fixed on Shah, rather than the entire company. From a publicity perspective, this is an outcome India could well do without.

As it is, the DLF Ltd order by Securities and Exchange Board of India has left many investors in India’s equity markets sour. While Sebi’s investigations revealed misconduct by the company’s management, it also penalized the company by banning it from raising capital. DLF shares fell sharply after the order, resulting in a double whammy for investors—apart from grappling with the fact that they had been cheated in terms of disclosures, they also witnessed a drop in the value of their shares.

In both the FTIL and DLF cases, fundamental principles about corporate limited liability, the rights of minority shareholders and property rights appear to have been violated. Unless corrected, they may well deal a blow to investor sentiment. It will very probably now be up to the courts to uphold these basic rules.