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Mumbai: The Forward Markets Commission (FMC) has accused the promoters and directors of National Spot Exchange Ltd (NSEL) of complicity in the cheating of investors.

While questioning their “fit and proper" status, the commodities market regulator has pressed, in a 40-page show-cause notice, multiple charges against NSEL directors, including Jignesh Shah, for allegedly perpetrating the 5,600 crore settlement fraud and conspiring to cheat investors intentionally.

Mint has reviewed a copy of the show-cause notice.

According to the show-cause notice served on NSEL’s promoters and directors, despite repeated warnings from the spot exchange’s internal auditors and continuing defaults by the exchange’s borrowers, its board continued to lure investors with assured return schemes. They also helped defaulting members secure credit from banks by providing corporate guarantees.

The internal audit report of NSEL for six months between April and September 2011, by Mukesh P. Shah and Co., had observed that even though the exchange did not have the licence to operate as a non-banking finance company, it was exposing itself to a higher risk of credit default by funding transactions without any security.

“Such a callous approach and conduct on the part of an entity that called itself an exchange and ...boasts of a reputed listed company like FTIL as the controlling holding company... is highly reprehensible and makes an explicit portrayal of dishonesty and lack of integrity whose actions were driven by vested self interest without any regard for their duty towards thousands of investors…," the notice said.

Financial Technologies India Ltd (FTIL), promoted by Jignesh Shah, is the holding company of NSEL.

The notice suggested that NSEL’s former managing director Anjani Sinha’s 11 September affidavit claiming that the promoters and directors of NSEL were not aware of and responsible for the crisis is not correct.

An NSEL spokesperson said, “FMC has given a two week time to reply to the notice and we cannot comment on it now."

According to two persons familiar with the development, who asked not to be identified, NSEL has appointed Naik Naik & Co. as its lawyer to draft responses to the show-cause notice.

The settlement crisis at NSEL came to light on 31 July, when the exchange abruptly suspended trading in all but its e-series contracts (these were suspended a week later). The closure may have been prompted by an instruction from FMC to the exchange asking it not to offer futures contracts (which a spot exchange isn’t supposed to, but NSEL was).

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. All trading on NSEL, it later emerged, happened in paired contracts, with investors, through brokers, buying a spot contract and selling a futures one for the same commodity. They pocketed the difference—around 18%.

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.

When the trading was suspended, the investors were left holding contracts that the members couldn’t buy because they didn’t have the money to do so. On 14 August, NSEL proposed a payout plan, but it has been unable to stick to the schedule or even make one complete payout.

FMC, which has been recently authorized to monitor the settlement process of NSEL, blamed the exchange’s board for deliberately allowing its members (or borrowers) to increase their exposure sharply despite the government’s show-cause notice to it in April 2012.

It quoted Sinha as stating on 13 September that the exposure of the borrowing members went up from 2,009 crore to 6,762 crore between 30 March and 30 June.

In April 2012, the ministry of consumer affairs sent a show-cause notice to NSEL pointing out several of the issues that are responsible for the current settlement crisis—including contracts not being backed by adequate stocks in warehouses.

The FMC show-cause notice said that instead of taking action against defaulting members, NSEL's directors provided corporate guarantee to banks such as HDFC Bank Ltd and financial companies such as Karvy Financial Services Ltd (KFSL), for providing credit facilities to some buyer members including N.K. Proteins and Aastha Minmet (India) Pvt Ltd.

“….blanket approval was being taken from the board of directors for providing guarantee in favour of HDFC Bank up to 175 crore and for guarantee in favour of KFSL up to 100 crore….This clearly shows the connivance between the buyers/management and the board of directors," the notice said.

According to the regulator, the directors ignored repeated defaults by members such as N.K. Proteins, a company promoted by the son-in-law of former NSEL chairman Shankarlal Guru, and Lotus Refineries Pvt. Ltd, since 2011 and instead of debarring such defaulters, actually exempted them from margin payments and facilitated loans to them from banks by extending corporate guarantees

FMC also charged the boards of NSEL and FTIL with keeping quiet despite being aware of misuse of NSEL’s margin money account. Citing the findings by NSEL’s forensic auditor, the show-cause notice said, “The funds of the initial margin account were utilized for meeting the exchange obligation for defaulting members and financial obligations of the other business operations.. On 28 March 2013, 236.5 crore was withdrawn from the settlement fund in order to fund NSEL’s own business overdraft account."

FMC refuted all claims made by the NSEL board earlier that they were not aware of the developments at the exchange and thus could not be held responsible for the crisis.

The FMC also charged Multi Commodity Exchange of India Ltd (MCX), another FTIL group company, with allowing Indian Bullion Market Association (IBMA) to trade on MCX in violation of existing norms. In a letter dated 6 September, Shreekant Javalgekar, managing director and CEO of MCX, admitted to the fault saying, “We firmly believe that the omission to trace IBMA trading in the capacity of a client ought not have occurred...We regret for the aforesaid non-compliance for the year from 2012 onwards that has taken place and we sincerely request the Hon’ble commission to take a lenient view and condone the unintentional non-compliance of the guidelines."

To strengthen its argument that the NSEL board was fully aware of illegitimate paired trades, absence of commodities for physical delivery and other wrongdoings, the regulator explained how some of the key management personnel (KMP) quit the NSEL board when they discovered that buyer members were defaulting and the board was silent about it.

“…Buyers with poor credentials had been introduced over the last four years ... and the default had started in 2011-12 itself. It is also observed that all key management personnel (except Jignesh Shah and Anjani Sinha) have ceased to be KMPs since year 2011-12 when the default had started, indicating that such KMPs may be aware of the irregularities on NSEL. Shah also ceased to be KMP in the year 2012-13 for which no reason has been given, which is ostensibly meant to distance himself from NSEL when things had (gone) totally out of control," said FMC’s show-cause notice.

Among other things, FMC also found that NSEL did not insist upon ownership of goods before allowing its members to place the sale order in violation of norms on prohibition of “short sale" on spot exchanges.

Incidentally, forensic auditors have found that NSEL’s management information systems were incapable of indicating the actual commodity stocks supporting the trades. “These are not isolated cases of poor governance but a deliberate ploy by a technology-driven parent company (FTIL) to facilitate these wrong doings with full knowledge of directors and the holding companies," the notice said.

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