NSEL Scam: UPA’s Handling Of The Issue Needs To Be Probed

In January, the Ministry of Corporate Affairs (MCA) gave permission to the Serious Fraud Investigation Office (SFIO) to prosecute 71 persons and companies in the 2013 Rs 5,600 crore National Spot Exchange Limited (NSEL) scam.

Among those against whom action will be taken are 63 Moons, the parent company of the defunct NSEL, its founder Jignesh Shah and its former officials Joseph Massey and Shashidhar Kotiyan. The last two have since been arrested by Maharashtra Economic Offences Wing (EOW) police.

The SFIO has also initiated steps to wind up the Indian Bullion Market Association, a subsidiary firm of NSEL, and Juggernaut Projects, one of the prime defaulters in the scam.

The EOW that had handled the case since the scam broke out, on its part, is looking at various legal options against some brokers, estimated to be 150, who were allegedly involved in the scam.

The SFIO has concluded that at least 148 broker companies have made “unlawful gains” in the scam and asked SEBI, the market regulator, to put these companies through a “fit and proper” test. This means they could be barred from trading on either stock exchanges or commodity exchanges if they do not respond to SEBI’s test satisfactorily.

Motilal Oswal Commodities Brokers Pvt Ltd, Geofin Comtrade Ltd, India Infoline Commodities Ltd and Anand Rathi Commodities Ltd are some of the firms found to have made the “unlawful gains”. Prosecution of some auditing firms, which closed their eyes to these irregularities, has also been sanctioned.

The SFIO, which had probed the NSEL scam thoroughly since 2016 after it was asked to look into one of India’s sensational market scams by Ministry of Corporate Affairs, has also unearthed some hawala transactions that took place in the garb of spot commodities trading.

On its part, the broking community has opposed the actions, alleging witch-hunt by the investigating agencies. As the law enforcement agencies continue to unravel the scam and with EOW filing chargesheets against the accused in a local Mumbai court, there are a few unanswered questions in the whole episode.

The questions relate to what happened between NSEL and the then government headed by Manmohan Singh.

One is not sure if the SFIO was mandated to look into this or the EOW has looked at it closely. The surprise is that there are a few gaps in the scam that need to be plugged. Let’s look at what the scam was all about.

The NSEL was set up to launch spot trading in farm produce electronically. Spot trading of agricultural products falls under the purview of the states.

The objective of launching spot trading electronically in agricultural produce was a noble one - to help farmers sell their wares to buyers across the country at a remunerative price. The objective was also to defeat trader cartels that operate in regional agricultural markets to beat down farm produce prices.

When states control spot trading in regional agricultural markets, how could a similar trade, though electronically, be allowed across the nation? The Centre then came up with a solution to overcome this problem.

It issued a Gazette notification on 5 June 2007 allowing one-day forward contracts on NSEL. The notification was issued amending the Forward Contracts (Regulation) Act 1952, exempting all one-day contracts on NSEL from the Act. However, the NSEL was subject to regulation of local markets where such electronic trading took place.

The amendment helped NSEL to go live on 15 October 2008. But its operations were restricted to only the states where the Agricultural Produce Marketing Committee (APMC) Act had been amended. Thus, NSEL spot market was launched only in Gujarat, Rajasthan, Maharashtra, Odisha, Madhya Pradesh and Karnataka - the states that had amended APMC Act.

There were some loopholes in allowing NSEL launch spot trading in these states. One, no regulations were in place for the NSEL to operate. Thus, the Centre had no control on whatever happened at the spot exchange.

Two, the states, too, couldn’t control since the NSEL was launched by a notification by the Centre. This created total confusion since no one was clear if it was the Centre or the state that would regulate the exchange.

However, as an afterthought the Centre came up with another notification on 6 February 2012 that said that when sought for, all information on trading would be furnished to the Centre or the Forward Markets Commission (FMC), which supervised the functioning of commodity futures exchange.

This, again, had only provisions for asking details of trading and not taking any action, in case of any irregularity. Since it was spot trading, the FMC couldn’t act. These loopholes came in handy for the unscrupulous elements to indulge in irregularities. At one point of time, the daily turnover at NSEL touched Rs 600 crore. How?

Three years before the scam broke out in 2013, some members of a regional commodity exchange in Kolkata complained to then FMC Chairman B C Khatua that NSEL trading went beyond spot transactions. Khatua said he would look into it. Nothing was heard from him thereafter.

What happened was that NSEL began to offer contracts that could be settled between 25 and 40 days when actually the law stipulated that trading should be settled by 5 pm every day.

NSEL in a way got greedy. In an effort to bring more people to its spot trading, it tried to rope in processors and unwary investors.

NSEL extended nearly 40 days credit to these processors with money being got from the unwary and unsuspecting investors. The system operated thus:

Suppose, if a processor needed to buy, for example, 100 tonnes of castorseed, he would be asked to sell the produce that he did not have to an investor at, say, Rs 1,000 a tonne.

Thus the processor gets the money required to buy stocks, guaranteed by a warehouse receipt. The investor, in turn, was promised by processor that he would buy it back at a higher price that will take care of the interest that the investor would have earned if he had invested elsewhere.

Thus, while buying 100 tonnes of castorseed at Rs 1,000 a tonne, the processor would sign a deal to buy it back at, say, Rs 1,012.50 after a month. NSEL stood guarantee for the trade with the investor holding the warehouse receipts of the stock sold to the processor.

This sort of trading was, per se, unlawful. This was, in a way, forward trading that began to affect other exchanges which were doing proper commodities trading.

Also, such trading distorted the market with prices being determined by factors other than the fundamentals like demand and supply. NSEL and its brokers used this process to rope in many investors, promising them attractive returns, as high as 25 per cent per annum. SFIO, in its probe, found out that 83 per cent of NSEL’s total clientele was not aware of the nuances of commodity trading.

This led to chaos in NSEL trading. In one case, bundles of straws were shown as stocks for wool in a Punjab town, while in some other cases warehouse receipts were got ready without any stocks.

All these resulted in the dues to investors rising to Rs 5,600 crore by July 2013 when the then government woke up to the reality.

The Manmohan Singh government had sensed something amiss with NSEL in 2012 and issued a show cause notice. Nothing happened after that until 9 July 2013, when the then Food and Consumer Affairs (FCA) Minister K V Thomas issued a statement that the Centre will take action against NSEL for violating spot trading rules.

On 15 July, the FMC directed NSEL to stop launching any contract until further orders. These developments came even as a panic-struck NSEL sought permission from the Centre to launch T+10 contract which means a trade could be settled within 11 days.

The permission was not given but the damage was done with NSEL halting trading from 31 July 2013 as it was cornered from all sides.

In these developments, there are a few things that haven’t got answers yet. Unfortunately, neither of the EOW or the SFIO have not got any mandate to look into what happened on the other side, where government officials were supposed to monitor the happenings.

It would would worthwhile to know the answers to the following:

• Traders had complained about irregularities in NSEL operations in 2013 with the then FMC commissioner. Why didn’t he act on the complaint or what did he find out after the complaint was lodged?
• In 2012, the FCA ministry issued a show cause notice to NSEL. Why did the ministry not give any deadline to NSEL to put its house in order?
• Why did officials in the ministry not follow up for a year on the issue?
• When the ministry had issued the show cause notice, why were state governments not alerted on the issue?
• When the Centre came up with a notification to allow spot trading by NSEL electronically, why did it not have any clause to regulate it and ensure everything would be legal and in order?
• Why didn’t the government of the day then ensure that there would be at least one regulator to supervise the functioning of the NSEL spot market?
• Why was even the second amendment in 2012 too a half-baked one?

There might have been a hidden political hand behind these developments. The handling of the issue by the Manmohan Singh government needs to be probed deeper in view of the above questions.

The hurried notification of 2008, the additional amendment in 2012, a silent show cause notice the same year and the FMC’s inaction for nearly three years and the NSEL are all lessons to be learnt by the government and its officials.

It would only be worthwhile if the investigations into the 2013 NSEL scam can go deeper into the administrative lapses rather than just confining to the fraud committed by a select few.