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Volume-3, Issue-10, Nov-2013
ISSN 2230-7850
Playing With The Trust
( A Study Of Payment Crisis At Nsel )
Abstract: Investment is the process where individuals (retail and institutional) park their savings into some
securities or funds most important is RISK OF DEFAULT.
Here comes the question of INVESTOR PROTECTION. What if a borrower defaults payment? In such a
case the investors are protected by Securities and Exchange Board of India. SEBI has issued SEBI (INVESTORS
PROTECTION) guidelines in the year 2000 and these guidelines are amended from time to time in order to protect
the shareholders and investors from unfair and fraudulent trade practices. But if any exchange is not regulated by
SEBI then it is the bonafide investors who suffer. The same happened in case of National Spot Exchange Limited
where more than 13000 investors invested their money. The money of these investors is now in the pocket of
24borrowers/owners of businesses. This article will throw some lights on the NSEL payment scam. We will
encounter the causes of the scam and try to find out some ways to protect the investors from such kind of fiascos in
future.
Keywords:National Spot Exchange, NSEL, State Agriculture Marketing Board, MCX, FCRA
INTRODUCTION
National spot exchange (NSEL) is a commodity
exchange in India, and is a joint venture of Financial
Technologies (India) ltd. (FTIL) and National Agricultural
cooperative Marketing Federation of India (NAFED).
National Spot Exchange commenced its live trading
operation in different commodities on Wednesday, 15
October 2008. National spot exchange stated mission is to
develop a common Indian Market by setting up a nationwide
electronic spot market and providing state of art trading,
delivery and settlement facilities in various
commodities.For first time in India, National spot
Exchange has introduced E-series products in commodities.
Retail investors can trade and invest in commodities like they
invest in equities. Investor who wish to purchase E-Gold
units are required to open their beneficiary account with
NSEL empanelled Depository Participant (DPs) and
disclose their client ids and DP ids to their respective
members to enable them to transfer the units to the respective
client's accounts. The following chart shows the total
turnover of NSEL from October 2008 to August 2013.
NSEL is the premier spot exchange for trading of
commodities with a 99 per cent share of the market and deals
in agri commodities and metals. It has 817 members with
over 56,000 trader work stations across the country and in
2012-13 it turned over RS 2.95 lakh crore
REGULATORY FRAMEWORK OF NSEL
NSEL commenced operations pursuant to the
Gazette notification dated June 5, 2007 which was issued by
Ministry of consumer affairs, Food and Public distribution,
Government of India, allowing it to conduct trading in
commodities. Subsequently government has issued office
order dated February 06, 2012 to appoint FMC as monitoring
agency to overview the functioning of National Spot
Exchange. In compliance with the condition of the Gazette
Notification NSEL submits relevant reports, returns and
information to FMC.
In addition, NSEL obtains license from State
Governments under respective state APMC Acts, where it
intends to launch Farmers contract for agricultural
Premlata , Monika Saini And Renu Yadav , Playing With The Trust ( A Study Of Payment Crisis At Nsel ) Indian Streams
Research Journal Vol-3, Issue-10 (Nov 2013): Online & Print
Premlata , Monika Saini And Renu Yadav
Assistant Professor Gargi College University Of Delhi
Research Scholar Department Of Commerce Delhi School Of Economics University Of Delhi
Assistant Professor Kamla Nehru College University Of Delhi
.
commodities.
OBJECTIVE OF THE STUDY
The aim of this research paper is to see in details the
background and history of National Spot Exchange Limited.
How it was started and how it flourished over a period of time
and from where it took the shape of a fiasco and who all are
people behind this scam. Whether it is the promoters and the
directors who are responsible for the loss of investors or is it
the loophole which exists in the regulations and governing
bodies. We have tried to find out the reasons of failure of
NSEL. We have also given some suggestive measures which
could have been taken to stop such a scam and how these
frauds can be stopped in future also.
THEORITICAL BACKGROUND OF NSEL SCAM
Looking back, when the NSEL commenced
operations in October 2008, it started as an exchange to
facilitate commodity producers to find buyers for their
products. Spot exchanges normally offer T+2 or T+3
deliveries. Any buy or sell transaction should be settled
within a few days. If you purchased on the exchange, you
paid your dues in two or three days and took delivery the next
day of whatever you had bought whether castorseed or wool.
But as that didn't bring volumes to the exchange and
trading was relatively thin, sometime in 2010, according to
market reports, Jignesh Shah introduced forward contracts
that could be executed over 30-45 days. In other words, the
settlement cycle was given another dimension. Now there
were two settlement cycles for the same castor seed: a three-
day cycle and a, say, thirty day-one.
But there was a crucial difference in the NSEL's
price-discovery mechanism. The 45-day forward contract,
for instance, of all commodities was always higher than a
three-day forward contract. Says Shankar Raman, Head -
Investment Products & Advisory Services, Centrum Wealth
Management: The prices were so funny that all the time
there was a 15-18% forward gap. There will always be a
carrying cost, but a fixed 15-18% is unheard off. That
changed the fortunes of the NSEL and volumes perked up.
Average monthly trading volumes shot up from Rs 1000
crore to Rs 28,000 crore till May 2013. Financial
Technologies derived 57% of its profits from NSEL. The
higher the trading turnover, the higher the revenues an
exchange makes.
The table given below shows how different parties
made money by using different loopholes available to them.
A typical broker sales pitch:
NSEL scam / NSEL fraud is a 5600 Crore Rs (About
US$ 0.9 Billion) fraud which came out in the public domain
after the Ltd failed to pay out its
investors in commodity pair contracts after 31 July 2013. It
was subsequently found out that the most of underlying
commodities never existed and buying and selling of
commodities like Steel, Paddy, Sugar, Ferrochrome etc. was
being conducted only on paper. The pair trades in various
commodities were offered in one day forward contracts of
T+2 and T+2(sometimes even T + 35) payment terms
(bought and sold at the same time). This offered an arbitrage
opportunity of about 12-15% P/A. Investors who honored
their T+2 payment obligation found that the National Spot
Exchange neither had money nor commodities to honor their
T+25 obligations to investors. About 24 borrowers were
given the funds by NSEL without any underlying commodity
deposited by them. One of the borrowers who have taken
away around 1000 Crores is NK protein Ltd which is owned
by the son-in-law of ex-chairmanShri. Shankarlal Guru.
About 15000 investors along with public sector units like
and PEC are also affected.One crucial difference that
everybody overlooked was that these contracts should have
been guaranteed by goods in the warehouses. Nobody
seemed to verify whether the goods actually existed or not.
Brokers started giving out contract notes to hundreds of
investors backed against just one warehouse receipt (you
can't split a receipt). The warehouse receipt acted as title to
the stock. The broker was taking a risk on the warehouse
receipt. Nobody verified the warehouse receipt or whether
goods were actually at the warehouse. Some warehouse
receipts are said to be authentic as some genuine producers
wanted to finance their working capital till their goods were
sold. But as nobody verified the warehouse receipts more
commodity traders started producing warehouse receipts
against which they received easy funding. Some may have
used this money for financing their business, but the rest is
anybody's guess. Borrowers paid around 12-18% per annum
as they were selling-long dated contracts and buying higher
priced spot contracts. They rolled-over their positions as
nobody asked for collateral or their investments back. As
they repeated the cycle, in the end, the whole thing ballooned
into a huge un-checked financing scheme for commodity
traders. The following table shows the structure of a trade in
NSEL.
National Spot Exchange
MMTC
2
Playing With The Trust ( A Study Of Payment Crisis At Nsel )
Who made money and how
The Exchange
Revenues through charging a transaction cost as a percentage of turnover. The more the
turnover, the higher the earning.
The Broker
Brokerage fees of 2-3% on the gross amount invested. A typical AUM of Rs 100 crore nets
the broker Rs 1-3 crore per annum.
The Investor
Earned 1-1.5% a month buy short-term contracts at lower price and selling long-dated
contracts at higher price. Pocketed the difference.
The Trader
Bought long-dated contracts at higher price and sold short-date contract at a lower price and
a paid a net difference of 1-1.5%. In the process received easy funding at a very low cost.

Commodity Duration Lot Size Days (Approx) Investment Yield*
Castor Seed T+3 & T+36 300 bags 52 Rs 10 lakh 16%
Castor Oil T+5 & T+30 10 MT 38 days Rs 10 lakh 15%
Paddy T+2 & T+25 300 bags 35 days Rs 3-4 lakh 14%
Steel T+2 & T+25 10 MT 35 days Rs 5-6 lakh 14%

.
Since February last year the Forward Markets
Commission (FMC) started monitoring what was happening.
The NSEL was not regulated as a commodities exchange
under the FMC as it obtained a waiver from the Consumer
Affairs Ministry from the Forward Contracts Regulation Act.
Forward trades were banned by the Forward Markets
Commission in NSEL as the exchange was not authorised to
do so. As investors could not trade in these long-dated
contracts on the NSEL ever again, the arbitrage game that
everybody played closed down overnight.
The Fallout
Ever since, the FMC sent a letter to NSEL to stop
carry forward trades in July, the exchange and its promoters
were in a denial. Queries from media on the lack of stocks
and probable default were met with strong denials. Even
before the July 31st statement by NSEL to stop the forward
trades, the markets was abuzz that NSEL was heading for
trouble and some traders will not be able to meet their
commitments. Investors and their brokers are especially
bitter about the way NSEL and its promoters Jignesh Shah
informed everyone that all commitments will be met by the
exchange and the traders.
EFFECTS OF THE FRAUD
1.The share prices of its promoter company FTIL have
crashed by 60-70% resulting in massive erosion in market
cap.
2.The share prices of sister company (Multi
Commodity Exchange Ltd)also took a massive beating.
Finally pushed by court directive the Forward Markets
Commission has asked the promoters of NSEL why their 'fit
and proper' status to run exchanges in India should not be
revoked. Once this is done the promoters FTIL-Jignesh Shah
will not be able to run any exchange in India.
3.Jignesh Shah and Joseph Massey on 9/10/13 had to resign
from the board of MCX-SX stock Exchange. As a fallout of
this fraud Jignesh Shah was compelled to resign from MCX
on 31/10/13
EVENTS AND TRENDS IN NSEL BEFORE THE
PAYMENT CRISIS
After establishing NSEL as an successful
commodity exchange, its promoters took various steps to
grow the business of this exchange. Different policies were
adopted for the welfare of society, employees and
environment. But after the payment crisis one might think
that all these policies were formulated for self interest rather
MCX
than the interest of the society. A few of these policies are
mentioned as follows:
(1.)Policy on Computer Donation to NGOs Policy
(November 15th 2009)
National Spot Exchange Limited is committed for
the overall development and wellbeing of its stakeholder as
well as the society in which it exists. This Computer
Donation Policy is a step forward by National Spot Exchange
Limited with an objective of giving the underprivileged/
disadvantaged a chance to be well versed with technology.
Under this policy, National Spot Exchange Limited
will donate those computers which will be declared obsolete
by System Admin. The revenue generated through the
buyback policy of these computers is around Rs.3, 000/ per
computer resulting in a total of Rs 3 lac for 100 computers,
which is the budget that will be set aside for Computer
Donation each year.
(2.) Environment Policy(November 15th 2007)
National Spot Exchange Limited is committed to
provide healthy and safe work environment to all its
employees and carry out environment friendly business at all
its offices. In line with these goals, National Spot Exchange
Limited has published this Environmental Policy. This
policy aims at setting higher standards, reducing pollution by
minimizing the waste generation and recycling obsolete IT
hardware.
(3.) Health and Safety Policy (August 6th 2007)
National Spot Exchange Limited will provide its
employees with a safe and healthy workplace in compliance
with all applicable laws and regulations. Consistent with
these obligations, the Company will provide safe standards
of health and safety in the working environment. This is
consistent with our commitment to corporate citizenship,
social responsibility and sustainability. The Company's goals
are to provide products and services that are safe and
environmentally sound throughout their lifecycles, conduct
our operations in an environmentally responsible manner,
and create health and safe work practices and work
environments that enable National Spot Exchange Limited
employees to work free of injury and in a wholesome
environment.
(4.)HIV/AIDS POLICY(August 6th 2007)
The HIV/AIDS pandemic has become a matter of
serious concern in all the countries around the world as it has
affected every possible section of the population. National
Spot Exchange Limited (hereafter referred to the
company) believes in having healthy work environment for
its employees which is free from any discrimination. This
HIV / AIDS Policy is formulated in the interest of both the
employer and the employees to contribute towards the noble
cause. This policy is applicable to all the employees of
National Spot Exchange Limited across India.
(5.)CSO/TRAINING POLICY (November 15th 2007 )
There is a huge market demand for trained
professionals in the field of commodity markets. National
3
Structure of the trade
For investor
Buy a lower priced T+2 contract
Sell a higher priced T+35 contract
For trader
Sell a lower priced T+2 contract
Buy a higher priced T+35 contract
Contract
T+2
Money moves from investor to trader
Stock moves from trader to investor

T+35
Money moves from trader to investor
Stock moves from investor to trader


Playing With The Trust ( A Study Of Payment Crisis At Nsel )
.
Spot Exchange Limited is part of the Financial Technologies
Group. This Group is determined to provide equal
opportunities to the economically disadvantaged/weaker
sections with the belief and understanding of inclusive and
healthy growth in the society. Keeping in view the objective
and belief on this noble cause, Financial Technologies Group
has taken up many CSO initiatives and many more are in
thoughts.
This policy for Training is formulated in the interest
of both the society as well as an extension of the
organization's belief & value in reaching out to the society in
a meaningful way.
(6.) Employee Volunteerism Policy(November 15th 2007)
National Spot Exchange Limited is committed for
the overall social development of the under privileged and
marginalized sections of the society. Employee volunteerism
policy gives opportunity to its employees to get directly
involved in serving the society through various
activities/donations. This involvement also gives employees
a sense of pride for the company they work with. A corporate
community outreach program showcases the commitment of
National Spot Exchange Limited and will result in increased
levels of employee satisfaction.
The above information has been collected from the
NSEL website. As per this information NSEL has built good
reputation by establishing some policies for the benefits of
society, employees and environment. If any investor reads
these details from the website of NSEL he/she will definitely
be impressed by such initiatives. Nobody would think about
such a crisis before investing in NSEL.
STEP BY STEP INSIDE STORY SO FAR
For three years from June 2007 when it received
permission from the Ministry of Consumer Affairs to
commence spot trading in commodities, the National Spot
Exchange Ltd (NSEL) struggled to attract market
participants. Then, sometime in the latter part of 2010, the
exchange, emboldened by the absence of strict regulatory
oversight, expanded its operations to include 'novel
products'.Punters joined in steadily to take advantage of the
new 'services' NSEL offered, which included paired
contracts of T+2/T+25. Despite whispers of unauthorized
deals, including those struck for the above paired contracts,
punters felt safe to do business because of the lack of
regulation. It was only after February 6, 2012, when the
Government notified the Forward Markets Commission as
the designated agency on behalf of the ministry that things
started to move. The FMC found glaring anomalies in NSEL
operations. Here is how it all happened:
February 6, 2012: FMC named as the designated
agency for spot markets (Consumer Affairs Ministry
notification S.O 228 (E)). Armed with this power, FMC asks
for trade data from spot exchanges in prescribed format.
Analysis of NSEL trade data reveals that:
(a) 55 contracts offered for trade are with settlement period
exceeding 11 days, which violates FCRA, 1952
(b) Condition of 'no short sale allowed by the exchange
members' is breached.
FMC writes to the Ministry of Consumer Affairs, saying
NSEL not fulfilling the two conditions of permission under
which it was set up.
April 27, 2012: The ministry issues a show-cause
notice to the exchange regarding violation of conditions
(vide Letter no. 12/3/003-IT). NSEL submits its reply to the
ministry (vide its Letter dated May 29, 2012).
August 2, 2012: Responding to a request on May 31
from the ministry for its comments, FMC after a thorough
study of NSEL's reply points out that:
(a) The exchange does not insist on ownership of goods
before allowing members to sell and that transactions not
backed by ownership of physical goods violate the 'no short
sale' condition;
(b) Contracts in which settlement period goes beyond 11
days are forward contracts (known as NTSD non-
transferable specific delivery contracts), which are within
FCRA ambit.
Meanwhile, tremendous amount of political
pressure is brought on the Ministry of Consumer Affairs not
to precipitate the matter but settle amicably. Lobbying at
different levels within the bureaucracy gets rampant. At the
highest levels in the ministry, it was felt that NSEL's
operations were indefensible, but caution was preferred to
knee-jerk government intervention that could potentially
dent market confidence. Even as policymakers weighed
options, the exchange's business continued.
December 2012: It is noticed that NSEL's Web site
cites FMC as one of the regulators of the spot exchange (the
others being State Agriculture Marketing Board and
Warehouse Development Regulatory Authority).
February 14, 2013: NSEL confirms modification of
content after FMC objects to the incorrect use of its name as
regulator of spot exchange.
April 29, 2013: A query from the ministry (Letter
12/3/2003-IT) as to the nature and quantum of penalties
levied in the event of FCRA violation leads the FMC to point
out on May 13 that it has no such powers; says penalties are
imposed by courts only on conviction for violation of the
provisions.
July 10, 2013: Consumer Affairs Secretary holds
meeting with spot exchanges (NSEL and NCDEX Spot
Exchange). The ministry seeks an undertaking from NSEL
that: (a) no further/fresh contracts will be launched until
further instructions; and (b) all existing contracts will be
settled on the due dates.
July 22, 2013: NSEL submits an undertaking
saying, We undertake not to launch any further/fresh
contracts in new commodities and/or not in places till further
instructions from concerned authority. It also promises to
undertake that we shall settle all the contracts traded on the
exchange on their respective 'settlement due dates' as per
contract specification notified by the exchange.
July 31, 2013: NSEL announces that trading in all
contracts, except e-series contracts, stands suspended until
further notice; that delivery and settlement of all pending
contracts will be merged with immediate effect; and to defer
it for a period of 15 days. The crisis comes to a head.
4
Playing With The Trust ( A Study Of Payment Crisis At Nsel )
.
August 8,2013:- It is noticed that, NSEL would take 8
months to settle the dues of all investors who are to receive
payments, aggregating about Rs 5600 crore, and pay about
3% of all outstanding dues every week starting August 20.
NSEL reported that it would take 30 weeks for
payment settlement, and would also pay about 5% of all the
dues each week.
August 14, 2013:- NSEL released a schedule of
plan for payouts over the next 30weeks. The payouts were to
be made every Tuesday, starting from 20 August. For 20
weeks, NSEL has to pay amount of RS 174.72 crore and
thereafter it has to pay 86.02 crore till next 10 weeks and the
remaining Rs 124.71 crore would be settled in the 31 week
which fall after 11 march 2014.
September 16,2013:- NSEL investors want seize
assets of promoter firm FTIL(Financial Technology India
Ltd. to safeguard the interest of investors.
Sachin Pilot, Minister of Corporate Affair ministry,
said that non-compliance with regulation and provisions of
the Co. Act in the NSEL will not be tolerated any more.
September 19,2013:-NSEL investors approach the
police after the exchange had defaulted on the 5th
consecutive pay-out to its investors and members.
October 1,2013:- The Economic offence wing of
the Mumbai Police froze bank Accounts of crisis-ridden
NSEL, which said the action prevents the exchange from
making a schedule payment of RS 174.72 crore to investors.
October 8,2013:- Since the issuing of summons
last week, around 13 directors of defaulting companies have
presented themselves before EOW. Out of these, at least six
people, named as directors, were found to be employed
clerks or peons with the companies.
NSEL made payment as follows:-
REVIEW OF LITERATURE
In this section of the research article we will review
the existing literature on National SpotExchange and on the
payment crisis of NSEL.
According to an article in Business Today
AnjaniSinha has claimed that structured and transparent
Electronic Spot Market will reduce the cost of intermediation
and thereby increase the farmer's realization of prices
without increasing the price paid by consumers. According
to him, such physicalmarkets already exist, but in an
unorganized form. An electronic spotmarket is not a new
market.However, the gap between the pricepaid by the
consumer and farmer's price realization is huge, thanks to
marketing inefficiencies in the current set-up. But such a gap
can besubstantially reduced through anorganized pan-India
electronic spot market, he said. He also added that all
contracts will be compulsory delivery contracts. The
position outstanding at end of day must result in delivery.
The seller will be required to deliver goods in
NSELwarehouses specified in each contract, where quality
will be tested against the specified parameters.
In another article titled Jignesh Shah's financial
Ecosystem it was mentioned that Jignesh Shah is dead
serious about his unique model for financial inclusion. Our
objective is to empower the masses and enable them to utilize
our services at an affordable price, stressed the Chairman &
CEO of the FT Group. FT's strategy is based on driving
financial inclusion by reaching out to the bottom of the
pyramid as this will drive future business, added
SanjeevPatkar, Director (Research), Dolat Capital, who has
been tracking the company since 2003.
The article mentioned at the end that can Shah pull
off his grandgame plan of building an international and a
uniquefinancialecosystem? Aside from regulatoryuncer
tainties, other risks in his model include the willingness of
non-urban consumers to adopt and adapt to his technology;
also, analysts point out that scaling up the warehousing
business may prove tricky as FTpenetrates deeper upcountry.
Yet, Shah's entrepreneurial endeavors just wouldn't be the
same without the risk element. What's more, the risk-to
reward equation has worked well inhis favourso far.
JatinPanvcholi (2013) has pointed out that NSEL
was permitted trading in forward contracts without looking
into the need for physical backing of stock as required in spot
trade. And this resulted into a ticking time bomb and around
Rs. 6000 crore invested by 13000 investors found its way to a
group of borrowers and most of whom have defaulted. The
author said that the members/brokers of the exchange
assured investors that the investments were risk free as there
was a collateral stock of commodities in warehouses across
India. The funds invested were then channeled by the brokers
to borrowers and owners of businesses who spent these funds
in their own operations.
According to the author many small investors in
India think and believe that the word exchange means
government and they presume financial strength and
credibility. That is not the case in reality. Though the
Government of India gave an approval to the NSEL for
trading, the same government suspended trading of all
contracts including the e-series at the NSEL in the first week
of August. In his article the author has pointed out flaws in
the Government of India's regulatory framework and lack of
stringent law to prevent these types of crisis.
Mahesh Nayak (2013) has said that money raisedat
the NSEL may have been directedto other investment
channels suchas real estate or gold. But with boththese
markets depressed, it proveddifficult to quickly liquidate
assetsand return the money. And this resulted into default.
Brokers were trading with anexchange which was
governmentlicensed and a legal entity. Thereforeit is the
NSEL's responsibility to payoff investors whose money is
stuck.The exchange is the counter-guaranteeparty among
buyers and sellersfor a trade, says C.J. George,Managing
5
Type of payment Date Amount Due
(crore)
Amount Paid
(crore)
Outstanding due
(crore)
1 20 august,2013 174.72 92 80.72
2 27 august,2013 174.72 11.90 150.82
3 3 September, 2013 174.72 11.45 161.27
4 10 September, 2013 172.72 7.77 165.00
5 17 September, 2013 174.72 4.58 168.14
6 24 September,2013 174.72 11.28 151.72
7 1 october, 2013 174.72 0 174.72
8 8 October, 2013 174.72 2.85 171.57
9 15 october, 2013 174.72 28.34 144.38
10 22 October, 2013 174.72 0.3 142.72
11 29 October, 2013 174.72 29 145.72
12 5 November,2013 174.72 11 163.72

Playing With The Trust ( A Study Of Payment Crisis At Nsel )
.
Director of GeojitBNPParibas Financial Services.
The author said that Jignesh Shah was aware of all
this otherwise he would himself make a presentation to the
Ministry of consumer affairs and FMC. For a while everyone
made money but no one complained. In fiscal year 2012/13,
the NSEL recorded a net profit of `127 crore, accounting for
56 per cent of the consolidated profit of FT, compared with
10 per cent in the previous financial year.
In his another article titled saving his own skinthe
author Mahesh Nayaksaid that NSEL had paid investors just
about Rs. 297.5 crore against a commitment to pay Rs. 522
crore. But of this too, the bulk, Rs. 177.23 crore, has been
sourced as a bridge loan from the NSEL's promoter Financial
Technologies (FT).
Swiss-based audit firm SGS Stocks foundso far are
only about15 per cent of the declaredamount against which
transactionstook place on the NSEL. Sources say theaudited
warehouses were expected to have stocks worth Rs. 2,200
crore, but the recovered stocks are worth only Rs. 300 crore.
According to the author there is another unanswered
question- the mysterious depletion of the NSEL'ssettlement
guarantee fund (SGF) after tradingwas stopped. It was earlier
stated to be Rs. 800crore; it is now Rs. 60 crore.
The author has mentioned some unanswered
questions which are as follows.
1)Regulations clearly state that in a spot market contracts
have to be settled in 11 days. How could the NSEL run its
controversial product, which allowed delivery time of up to
45 days, without government approval?
2) Why did the NSEL change its auditor in 2012/13?
3) How did the settlement guarantee fund suddenly reduce
after trading stopped on the NSEL? To whom were payments
made?
4)Why the warehouses did issues receipts without verifying
the value of the commodities or checking for collateral?
5)Did the NSEL conducta thorough 'KnowYour Customer'
checkof the processors? If not, why not?
6) When the government suspected fraudulent practices at
the NSEL in mid-2012, why did it not take immediate action?
According to George Iype (Managing Director and
CEO of Commodity Online Group) thousands of investors
have lost their precious money when the National Spot
Exchange Limited (NSEL) defaulted on payments in August.
The Rs 5,600/- crore payment crisis has turned into a major
scam. It is now touted as the biggest financial scandal in
India, overtaking the earlier stock market scams perpetuated
by Harshad Mehta and Ketan Parekh in the last two decades.
NSEL top brass including its MD and CEO AnjaniSinha has
been arrested and put into jail. Various investigating agencies
including the Economic Offences Wing and Enforcement
Directorate are on the trial to recover the lost money.
The NSEL crisis has wiped out hundreds of crores
of rupees from the investing community. The money that
investors put in with brokers and NSEL in good faith has
changed hands to reach real estate developers, mall builders,
middle men and racketeers. It is three months since the
financial scam has come to light; but the government has not
done anything worthwhile to recover the investors' money.
The events that have unraveled in the wake of the
NSEL scandal are proof that lack of regulation, government
inaction, manipulation in trading, lack of knowledge and
last, not the least, greed can ruin the hard-earned savings of
investors. Core to the NSEL mess is systemic failures on
several fronts. NSEL operated on a regulatory vacuum. The
government approved the existence of a commodities spot
exchange without assigning a regular to manage it. The
NSEL management made its own rules and regulations and
started the now-defunct novel method of spot trading in
commodities on an exchange platform. Brokers, investors
and clients who were lured by the 'amazing' returns of 12 to
20 per cent that the NSEL spot trading platform offered put
their money in the safe hands of an exchange. In India, there
was never any major incident wherein investors distrusted a
stock or a commodities exchange approved by the
government. The commodity trading scam is an eye opener
to a series of flaws that continue to haunt the financial and
trading services sector in India.
People are these days paranoid of investing in spot
and futures markets in commodities thanks to the NSEL
scam, high margins on trading and depleting profits thanks to
the commodities transaction tax. Globally, commodity
trading, especially in hot commodities like metals, crude oil
and bullion is bigger than stock market transactions. It is high
time the government in India took some speedy and effective
measures to restore the confidence of people investing in
commodities.
In the last six years, there have been efforts to
amend the Forwards Contracts (Regulation) Act, 1952, in an
attempt give more autonomy to FMC. But for one reason or
the other, the amendment to better regulate and cleanse the
commodities market is still hanging fire. Thanks to these
lacunae from the part of the Indian government, commodity
futures trading have turned out to be a game of speculation.
The NSEL scam has frightened investors who now fear that
the margin money they put into trade in the commodity
futures market could also vanish.
In the wake of the NSEL scam, there is an urgent
need to pass the FCRA bill in the Parliament and turn the
commodity futures market vibrant like the equity market in
India.
POSSIBLE CAUSES OF THE NSEL DEBACLE
Before a bubble bursts one cannot tell that such a
thing is going to happen in future. But once the bubble gets
bursted it is easy to pin point the reasons of the burst. In this
section of our research article we have also shown the
possible causes of failure is one of the grooming commodity
exchange of India.( National Spot Exchange Limited)
1) No physical stocks in the warehouses: Transactions
without having physical stock is like carrying out the
badlatrading which was stopped in India in 1993. After
searching 62 warehouses, it was found that at least 17
warehouses are bogus and remaining warehouses contain
some goods but not in a substantial quantity.
2) Wrong Minutes and Meeting: The Board meeting were
not conducted in a proper manner. The minutes of the
meeting would be signed by board members who had not
even attended the meetings, and even these were prepared by
6
Playing With The Trust ( A Study Of Payment Crisis At Nsel )
.
people who were not authorized to do so. EOW found that
minutes of meeting were "cooked up".
3) Lack ofregulations: There are a few difficult questions
for the government. Why was the NSELallowed to thrive in a
legal vacuum since2008? How could the existing laws ofthe
FMC grant an exemption to NSEL toallow one-day forward
contracts (asagainst spot trading)
The exchange collected a margin of 10% apart from
having the security of the underlying stock. Also, the
exchange is expected to facilitate short sales, but it is
believed that stockists were allowed to sell the commodity on
a T+2 basis without actually depositing the commodity in the
warehouse. Also, there were doubts about storage and quality
of physical goods in the warehouse.
4) Financial engineering :Vivek Gupta, director, research,
Capital Via Global Research, says, "The whole process turns
out to be financial engineering where the NSEL was acting as
a finance company, the investor was investing in
commodities and processors were getting finance from
investors, enticing them through higher risk free returns
mentioned on the website of the NSEL."
5) Involvement of punters: Many of punters involved in
trading as they thought there is no specific rule who govern it.
so, many of them used its loophole.
LESSONS LEARNT
The first lesson from the NSEL crisis is that if
someone promises easy money, there must be something
wrong somewhere. Investors must seek complete clarity
when any product promises to give high returns for very long
periods.
The other lesson is that while investing in an
instrument that is offering such returns, the risk on the
counterparty has to be evaluated. While the average investor
may not understand the minute details, one thing that was
under question in this particular crisis was the size of the
Trade Guarantee Fund versus the volumes being reported.
STEPS TAKEN BY FMC AND MINISTRY OF
CORPORATE AFFAIRS (TILL DATE)
1.Grant Thorton Forensic Audit
At the behest of the forward Markets Commission
NSEL asked Grant Thornton to conduct a forensic audit of
the books of NSEL. The report though not complete and with
insufficient cooperation from NSEL does bring out some
glaring irregularities on the basis of which the FMC has
served a show cause notice to the promoters of NSEL about
their 'fit and proper' status to run exchanges.
The report pointed out:
i.There are still wide differences between the books of NSEL
and those of most borrowers.
ii.AnjaniSinha wrote an internal email to stop using IBMA
for rigging MCX prices and to use SNP Designs P Ltd (His
wife ShaliniSinha's company) to conduct proprietary
speculative trades on the exchange. Grant Thornton has also
been asked to conduct a forensic audit of MCX. Subsequent
to a court petition by investors of NSEL, FMC has been
directed by Mumbai High Court to conduct a forensic audit
of E-series bullion contracts of NSEL.
2.Steps by Indian government
The Indian government which took some half-
hearted measures in the beginning swung into action when
the matter reached the courts and the Parliament. The income
tax department surveyed all the 24 defaulters who owe Rs
5,600 crore to the investors. But investors like Dharnidharka
say it's a case of too little, too late.
3.Role of Ministry of Consumer Affairs
In a show cause notice based on data provided by
dated 27/4/12 the
Ministry of Consumer Affairs had asked NSEL that why
proceedings should not start against NSEL as it was
conducting illegal trades and there was no mechanism to
verify commodity stocks. However till 12 July 2013 there
was no action from the Ministry which allowed the scam
amount to balloon to 5600 Crore Rupees. It is believed that a
lot of political maneuvering was done to keep this in
abeyance which cost the investors their hard-earned money.
Surprisingly the finance ministry and the committee headed
by ShriArvindMayaram tried to wash their hands off the
crisis saying it was an 'unregulated exchange' and HNIs
(High Net-worth Individuals) invested with open eyes. This
is in spite of the fact that the FMC was the designated agency
to supervise NSEL from early 2012 and FMC was aware of
'NBFC like activities' going on at NSEL.
4.EOW police Action
The EOW (Economic Offences Wing)of Mumbai
police is currently investigating this fraud and there have
been many raids with an FIR (First Information Report)
being filed against the directors of National Spot Exchange
Ltd and directors of their promoters Financial Technologies
India Ltd along with some brokers. Regulator the Forward
Markets Commission is looking into the issue. Amit
Mukherjee, Assistant Vice-President (Business
Development), NSEL, was arrested on 9/10/13 by the EOW
wing of Mumbai police. This is the first arrest in the NSEL
fraud. The economic offences wing (EOW) of Mumbai
Police arrested Jai Bahukhandi, former assistant vice-
president of NSEL on 10/10/13. This is the second arrest in
this sordid saga of fraud, deceit,complicity of corrupt
bureaucrats and apathy of the government.Ex CEO and MD
AnjaniSinha was arrested by EOW of Mumbai police on
17/10/13. EOW has invoked MPID (Maharashtra protection
of investor's deposit) act under which it can attach properties
of the accused.
The biggest borrower from NSEL Nilesh Patel of
NK proteins Ltd was arrested on 22/10/13 by EOW wing of
Mumbai police. It is being made out that the FT server which
housed sensitive data had crashed just after the scam broke
out. The EOW has retrieved the mirror server from
Bangalore and forensic tests are being conducted. An FIR
was registered in the case on September 30 by the EOW
against top NSEL executives (including Jignesh Shah and
Joseph Massey). They have been charged with cheating,
forgery, breach of trust and criminal conspiracy, etc.
5.Attachment of properties
Around twenty-five immovable assets of
Forward Markets Commission (India)
7
Playing With The Trust ( A Study Of Payment Crisis At Nsel )
.
borrowing companies spread across the country will be
attached in the first phase, said an officer at the Economic
Offence Wing of Mumbai Police.The officer said the value of
the 100 shortlisted properties was sufficient to recover Rs
5,600 crore, which the crippled exchange promoted by the
Financial Technologies group of Jignesh Shah, owes to over
13,000 investors and 148 members/brokers.
The EOW has invoked the `Maharashtra Protection
of Interest of Depositors Act' in the case, which empowers
them to attach immovable assets of the accused.The
investigators will later start the process of attaching the
properties of promoters, directors and others. The probe so
far has also suggested that money has been routed outside the
country by some companies and this is a clear case of money
laundering, the officer said.Some of the largest borrowers of
NSEL include Mohan India, NK Proteins, Laxmi Group,
MSR Food Processing and Swastik Group.
The police have arrested four persons so far
AnjaniSinha, former CEO of NSEL; Nilesh Patel, managing
director of NK Proteins; Amit Mukherjee, a former AVP of
the exchange and Jay Bahukhundi, another ex-AVP of
NSEL.
Persons arrested ( NSEL)
October 9,2013:- The Economic offences wing of
Mumbai police on Wednesday made its first arrest in the
National Spot Exchange Limited. Amit Mukherjee, Vice
president, Business Development was arrested on 8
october,2013. He is accused of introducing almost all of the
defaulting companies and receiving kickbacks from them.
October 10,2013:-The Economic offences wing
(EOW) of Mumbai Police on Thursday arrested Jai
Bahukhandi, assistant vice president in charge of
warehousing at National spot exchange limited. He accused
of making false stock statements.
October 17,2013:- The Economic offence wing
(EOW) of Mumbai Police on Thursday arrested
AnjaniSinha, former managing director and CEO of the
Exchange.
October 22,2013:- The Economic offence wing of
the Mumbai police on Tuesday arrested NK Proteins
Managing Director Nilesh Patel for his alleged role in the Rs
5600 crore. He was arrested for doing synchronised trades at
NSEL.
FINDINGS AND SUGGESTION
We have found the following wrong doings at NSEL.
It was offering 25-34-day contracts for commodity trading
while a maximum of 11 days are allowed.
Warehouse receipts of commodity stocks were being issued
without warehouses actually having stocks.
Independent investigations have shown benami investors
and owners of warehouses.
NSEL has to pay back Rs 5,600 crore of investor money, has
already defaulted twice.
Jignesh Shah may face the brunt and be held responsible. But
can't discount his high contacts for now.
The fact is that there is no particular body to
regulate spot commodity trading and there is total ambiguity
about the guidelines and rules under which it is supposed to
function. Even the FMC, which is the regulator of forward
trading in India, has no teeth or powers to take corrective or
punitive action. Says former NCDEX chairman P.H. Ravi-
kumar, One of the reasons for this scam is that the exchange,
the warehouse and the clearing agency as well as the futures
exchange were all owned by the same party. This should have
come to the notice of the authorities.The Ministry, which
ensures compliance of entities with the Companies Act, is
soon expected to receive the inspection report on the records
of NSEL, Financial Technologies (India) Ltd and
MCX.Ministry would be looking at whether NSEL and other
entities violated companies law.
In 2007, the government exempted NSEL from all
regulatory control and allowed it to function freely. There is
a vast scale of illegalities going on. The 2007 notification
itself is illegal as the law doesn't give the government the
power to change rules, says an expert who has been rallying
against NSEL's irregularities. What also added to the
ambiguity was the fact that spot markets are a state
subject.Complicating matters is the fact that many SEBI and
FMC officials now work in MCX; some MCX officials have
also found their way into SEBI. In fact, Paul Joseph, who
signed the 2007 order exempting NSEL from regulator's
purview, is now a principal advisor with MCX. There was
also least interference from the ministry with officials rarely
attending NSEL meetings, allowing Shah a free hand. For
instance, he introduced practices like gold trading till
midnight, which led to speculative practices and increased its
turnover dramatically. It also increased NSEL's exposure in
metals and non-agro commodities. According to sources, 80
per cent of NSEL's activity was in non-agricultural
commodities
In 2004-05, the government had appointed
consultancy firm KPMG to do a study on whether the FMC
should merge with SEBI. They had recommended the
merger; but the then consumer affairs (and agriculture)
MinisterSharadPawar shelved it. Now with Chidambaram
back at North Block and the ministry of consumer affairs
having a less powerful head in T.K. Thomas, the NSEL scam
has provided the finance ministry solid ground to go for the
kill.
For, even as two government committees look into
this matter, some key questions remain unanswered: where
has the money actually gone, how were NSEL buyers and
sellers getting 15 per cent returns, and how were brokers
involved in a spot exchange meant only for buyers and
sellers? Explains agricultural expert Devinder Sharma,
Spot exchanges were set up to ensure that physical
commodities would be traded and there would be no
speculation. But the government and the ecosystem was
pushing a market-determined price through speculation
which has led to this situation. This also defeated the
purpose of discovering prices.
While there's a lot of anger at the moment, in a
country where commissions and investigations rarely bear
fruit, the outcome can be predictable. That is the concern.
Last year, the government had promised a CBI inquiry into a
scandal involving trading in Guar seeds. Does anyone
remember what happened?
8
Playing With The Trust ( A Study Of Payment Crisis At Nsel )
.
The Investors Forum has written to consulting firm
Ernst & Young's (EY's) global head, seeking
for their losses in the Rs 5,600-crore National Spot Exchange
.
This is the latest move in the investors' campaign
against the auditors and consultants of NSEL, following the
registration of criminal complaints with the Mumbai Police's
economic offences wing and with the Union ministry of
corporate affairs. The campaign has gained strength after
reports said the ArvindMayaram panel, appointed by the
central government to probe the crisis, made a reference to
shoddy due diligence by the auditors.
In a letter dated October 31, addressed to Mark
Weinberger, the firm's US-based chairman, the Forum said:
"We are firmly of the view that EY is equally responsible for
the loss caused to these hapless investors, by their acts of
conveniently omitting crucialand damaging facts about the
business practices employed by the promoters of NSEL.
Therefore, it is also the liability of EY to compensate the
aggrieved investors, now that the bubble has burst."
Investors have pointed to some incorrect assertions by EY's
financial risk services, in a report titled 'Risk-based review of
commodity financing business.
The September 2012 report, commissioned by
GeojitComtrade, a broker which traded on NSEL, pointed to
various risks and suggested measures to Geojit.An EY
spokesperson said, We categorically deny any allegations
of wrongdoing and collusion. These allegations are incorrect
and out of context. We are confident of the quality of our
work and confirm that the report prepared by Ernst & Young
Pvt Ltd (now Ernst & Young LLP) on commodities financing
in India articulates the regulatory environment and clearly
explains the key risks associated with the commodities
financing business in India. The report must be read in
totality, to gain a complete view of our assessment and
recommendations thereof. We are bound by our
confidentiality agreement with our client and are, therefore,
unable to provide any further comments.
NSEL
compensation
payment crisis
Investors also took exception to the fact that an EY
associate was the statutory auditor of NSEL in the year
immediately preceding the risk assessment report. To this,
the EY spokesperson said, Ernst & Young LLP and SV
Ghatalia and Associates (SVGA) LLP are independent firms.
The above-mentioned advisory report on commodities
financing in India has no relationship whatsoever with the
statutory audit of NSEL done by SVGA. Further, the
advisory report on commodities financing was issued in
September 2012, during the financial year 2012-2013, and
SVGA was not the statutory auditor of NSEL's financial
statements for that year. A copy of the report commissioned
by Geojit, reviewed by Business Standard, showed one of the
actionable items recommended by EY was Regular audit by
Geojit of the warehoused commodities. It said any
additional cost incurred for this should be passed on to the
investor.
It also pointed to several regulatory risks and rated
these high. But investors say the report gave some
misleading assertions while detailing the exchange's
infrastructure under the head 'assessment of NSEL
Infrastructure and set-up'. Under this, the EY report said all
NSEL warehouses were accredited under the central
warehousing regulator, WDRA. However, none of the
warehouses were registered with WDRA. The EY report to
Geojit , however, pointed to absence of enforcement
agencies for compliance of WDRA. It added that there was
a contingent financial risk on account of potential for
fraud.
Second, under the parameter of risk management
, the report said there was daily mark to market of open
positions. Margin call issued in case of breach of predefined
limits. It is clear from recent forensic audits and the show
cause notices issued by the Forward Markets Commission
(Business Standard has reviewed these) that the exchange, in
fact, did not implement any mark to market mechanism
(revluation of assets based on current values) on the trades.
Further, under the head 'clearing and settlement mechanism'
EY stated there was limited counterparty risk for the
company (Geojit) on account of robust risk management
framework adopted by the exchange for clearing and
settlement of trades. NSEL investors point out that NSEL
did not have proper risk management. The showcause notice
issued by FMC said, In practice, NSEL had not adopted
adequate risk management measures and also compromised
on its actual implementation. EY seems to have prepared
the risk assessment for the limited use of Geojit's business
and based on terms of reference given to it. Many of the
assessments in the EY report were based on the framework of
rules, bylaws and circulars put out by NSEL. The report did
not do physical checks on whether these rules and laws were
actually followed or implemented by the exchange or not.
CONCLUSION
If someone promises easy money, there must be
something wrong somewhere. Investors must seek complete
clarity when any product promises to give high returns for
very long periods.
A commodity spot exchange is neither allowed to
offer forward contracts nor settle contracts beyond 11 days
9
QUERYING EYS RISK ASSESSMENT
NSEL investors seek compensation for their losses
from EY global chairman and CEO
EY Report to Geojit has certain assertions, which
have been challenged subsequently
Report based on publicly available statements and
legal framework put out by NSEL
Report also highlights several regulatory risks on
paired trades and rates these as high
However, the report commissioned by Geojit was
not addressed to investors

Playing With The Trust ( A Study Of Payment Crisis At Nsel )
.
(T+11). However, the NSEL was doing both. The
Department of Consumer Affairs, after a few warnings, sent
a notice in July. This triggered panic among traders, many of
who rushed to close their positions. The exchange, as a result,
had to defer settlements.
The NSEL scandal along with the imposition of the
commodities transaction tax has resulted in a steep fall in the
commodity futures trading volumes in India. Finance
Minister P Chidambaram imposed a 0.01% tax on the trading
of non-agriculture commodity derivatives from July 1. This
has affected the trading volume of gold, silver and other
metals in India's leading futures exchange, Multi-
Commodity Exchange (MCX). MCX is a sister of company
of NSEL, both of which are promoted by Financial
Technologies India Limited.
One of the fundamental flaws in theIndian legal
system is that we wait for a scam to happen before we frame a
law. This is more of a reactive rather than a proactive
approach. Unfortunately, we do not have the luxury of time
nor doesIndia have unlimited options. The Government of
India has failed to createeffective legislation for the
efficientoperation of commodities and forward market.
Now the biggest question arises here is who will
bear the loss of Rs 5,574.31 crore? The only option now
seems to be for the government to use the taxpayers' money
for a bailout. But then the question is, why should taxpayers'
money be used to finance scams? Some psychologists may
blame the NSEL debacle on the delusions and madness of
investing crowds, which may not be totally untrue.
However,the absence of a regulatory mechanism, poor
financial literacy and the lack of integrity of highly educated
and qualified finance and law professionals are certainly at
the cornerstone of this crisis. With an insufficient legal
framework and a lack of tough legislation, it should not
surprise us if some other financial scam surfaces soon. Indian
financial markets are evolving and are prone to irregularities,
lack of transparency and a close nexus between fraudsters
masking themselves as entrepreneurs and corrupt politicians.
Which hidden scam is going to unfold next?
REFERENCES
Bureau, E. E. (2012, October 16). ED quizzes Sinha; Shah,
Massey seek more time from FMC. The Indian Express .
BUREAU, E. E. (2013, October 14). Enforcement
Directorate registers FIR against NSEL promoters, directors.
The Indian Express .
Bureau, E. E. (2013, October 22). NSEL crisis: NK Proteins
MD Nilesh Patel arrested. The Indian Express .
Chandrashekhar, G. ( 2013, August 08). How the NSEL
crisis unfoldeded. THE HINDU .
India, P. t. (2013, August 26). NSEL defaulters barred from
trading in stock market. The Indian Express .
India, P. T. (2013, November 05). NSEL defaults again; pays
Rs. 11 cr against Rs. 174.72 cr. The Indian Express .
JOSHI, S. P. (2007, September 23). MCX is Spot on.
Business Today .
Mengle, G. S. (2013, October 23). Arrested NSEL officials
forged documents: EOW. The Indian ExpressMengle, G. S.
(2013, October 17). EOW grills former NSEL MD Anjani
Sinha, arrests later. The Indian Express .
Mengle, G. S. (2013, October 12). Mumbai EOW carrying
out forensic audit of NSEL. The Indian Express .
NAYAK, M. (2013). In a Spot. Business Today , 12-14.
NAYAK, M. (2013). Saving His Own Skin. Business today .
Network, T. N. (2013, August 08). NSEL seeks 8 months to
settle dues. TIMES OF INDIA .
network, T. n. (2013, August 08). Shah, NSEL must clear air
on money trail. Times of India .
(2013). NSEL fails to pay investors for ninth time. New
Delhi: The Indian Express.
Pancholi, J. (september 14, 2013). NSEL Debacle. Economic
& Political Weekly .
Sahgal, S. G. (2013, November 01). The NSEL Saga. The
Economic Times .
Sarin, R. (2013, October 09). MCA expands scope of NSEL
probe;70 firms under scanner. The Indian Express .
SERVICE, E. N. (2013, October 09). NSEL crisis: EOW
arrests firm's vice president AMit Mukherjee. The Indian
Express .
Service, E. N. (2013, October 25). NSEL crisis: Jignesh Shah
quizzed for 6 hrs by police. The Indian Express .
Service, E. N. (2013, October 08). NSEL crisis: Jignesh
Shah, Massey appear before EOW. The Indian Express .
Service, E. N. (2013, October 21). Probe reveals NSEL board
'orchestrated' meetings. Express News Service .
srinivasan, R. (2013, August 04). An Exchange in Spot. THE
HINDU .
VERMA, V. (2009). Jignesh Shah's FINANCIAL
ECOSYSTEM. Business Today .
WIKIPEDIA
www.nationalspotexchange.com
10
Playing With The Trust ( A Study Of Payment Crisis At Nsel )
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