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Why has Sebi taken action against 5 commodity brokers

NSEL was hit by a Rs 5,600 crore payment default fraud in 2013 when the exchange failed to repay 13,000 investors. Here's what happened.

NSEL was hit by a Rs 5,600 crore payment default fraud in 2013 when the exchange failed to repay 13,000 investors. (File)

On November 29, the Securities and Exchange Board of India (Sebi) banned five commodity brokers from obtaining fresh registrations as commodity brokers for their alleged involvement in the National Spot Exchange Ltd (NSEL) scam.

While Motilal Oswal Commodities Broker and Phillip Commodities India are banned for three months, the regulator barred Anand Rathi Commodities, Geofin Comtrade and India Infoline Commodities for six months from making fresh applications seeking registration as they did not meet the ‘fit and proper’ person criteria for their alleged role in mis-selling NSEL contracts by promising assured returns without ensuring delivery.

NSEL was hit by a Rs 5,600 crore payment default fraud in 2013 when the exchange failed to repay 13,000 investors.

NSEL scam

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In September 2009, NSEL, promoted by Jignesh Shah-led FTIL, introduced on its platform the concept of ‘paired contracts’, which involved two simultaneous transactions being undertaken at the same time with the same counterparty – one being a purchase transaction (settling at T+2 or T+3) and the other being a sale transaction (settling at T+25 or T+36), at different prices on the platform of NSEL. The transactions were structured in a manner that buyers of the short duration contract always ended up making profits. Investors were allegedly lured into investing in these contracts by these five brokers.

Later, the Ministry of Consumer Affairs (MCA) found that NSEL had not made it mandatory for the seller to actually deposit goods in the warehouse before he took a short position through a member of the exchange. The exchange had no stock check facility which validated the member position. Also, it was observed that the contracts made available by NSEL were for periods exceeding 11 days.

MCA later directed NSEL not to launch any fresh contracts and that all the existing contracts should be settled on the due dates. NSEL faced the problem of settling Rs 5,600 crore dues to 148 brokers after it suspended trade on the government direction. Various agencies, led by Forward Market Commission (FMC), ordered multiple investigations and its top officials were booked on charges of fraud.

The matter

After FMC was merged with market regulator Sebi, all the five entities applied to Sebi, seeking registration as commodity derivatives brokers in December 2015. These applications, however, were rejected by Sebi in 2019, on the grounds that these entities did not meet the ‘fit and proper person’ criteria under Schedule II of the SEBI (Intermediaries Regulations) 2008 (Intermediaries Regulations). The ‘fit and proper person’ criteria is a requirement that has to be satisfied by any intermediary at the time of registration with SEBI and also through the time it holds a valid registration with SEBI.

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While passing the order, Sebi had said that the ‘paired contracts’ traded on the NSEL platform were in the nature of financing transactions and were also held to be violative of the provisions for Forward Contracts (Regulation) Act, 1952 (FCRA). These entities were also closely connected with NSEL. The five brokers appealed against the Sebi order to the Securities Appellate Tribunal (SAT), which in June 2022 set aside the Sebi’s order and asked the market regulator to decide the matter afresh.

Sebi’s action

After considering the matter again, the Sebi’s Whole Time Member Ashwani Bhatia in the November 29, 2022 order wrote, “There is no doubt that such ‘paired contracts’ were, in fact, financing transactions which are distinct from the sale and purchase transactions in commodities and were, thus, in breach of both the exemptions granted to NSEL and the FCRA.”

These contracts were being projected as an alternative to fixed deposits. “There were enough red flags for a reasonable person to come to conclude that what was being offered as paired contracts on NSEL were not spot contracts in commodities,” Bhatia wrote in the order.

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He further said after reviewing all the material on record, it is concluded that the five entities, presumably driven by their desire to earn brokerages, provided a platform for clients to access a product which raised serious questions on their ability to conduct proper and effective due diligence regarding the product itself.

First published on: 02-12-2022 at 16:07 IST
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