Sebi to seek police report before deciding on action against brokers

Capital markets regulator to decide on brokers suspected of selling NSEL contracts as investment vehicles

The capital markets regulator will seek a report from Mumbai police’s economic offences wing (EOW) to decide whether it needs to act against brokers who may have engaged in mis-selling contracts in the National Spot Exchange Ltd (NSEL) scam, two persons familiar with the development said.

After procuring a report from the police wing, the Securities and Exchange Board of India (Sebi) will examine whether some brokers indeed violated regulations, the two persons said on condition of anonymity.

Some brokers are suspected to have sold NSEL contracts as investment vehicles. Around 200 brokers are alleged to have sold NSEL products by promising an assured return to investors.

Trading was halted on NSEL in July 2013 after a Rs.5,574 crore settlement scam surfaced at the commodities bourse, which is 99.99% owned by Financial Technologies India Ltd (FTIL). This month, the ministry of corporate affairs (MCA) ordered a merger between FTIL and NSEL

“To initiate action on the allegations against brokers that were selling NSEL contracts, (Sebi) needs additional evidence. To gather this information Sebi will seek a copy of the audit conducted by EOW on these brokers,” said one of the persons cited above.

The regulator will examine the brokers to determine whether they complied with the ‘fit and proper’ criteria ply their trade, the second person said.

In September 2015, the Forward Markets Commission (FMC) was merged with Sebi, bringing the commodity exchanges and participants in the commodity derivatives market under Sebi’s jurisdiction.

Sebi is now trying to streamline rules between the equity markets and commodity markets to ensure continuity of regulations.

As per existing rules for brokers and intermediaries, Sebi assesses brokers and intermediaries to ensure they match the ‘fit and proper’ criteria.

The regulator can take action against an intermediary for violation of Fraud and Unfair Trade Practices Regulations (FUTP) if it finds the conduct of a broker questionable.

The EoW has been investigating the role of brokers in the NSEL scam ever since it came to light in 2013. In March 2015, three brokerage officials were arrested in connection with the scam and later released.

The executives were Amit Rathi, managing director of Anand Rathi Financial Services Ltd; C.P. Krishnan, whole-time director of Geofin Comtrade Ltd; and Chintan Modi, vice-president of India Infoline Commodities Ltd.

Mint reported on 5 March that the three brokerage executives were arrested on charges of cheating, forgery, criminal conspiracy and misappropriation.

Soon after the arrests the three brokerages issued statements saying that they were cooperating with investigating agencies and would continue to do so.

The arrests had followed a forensic audit of brokerages that were trading on NSEL. Business Standard reported on 3 November 2015 that the EOW may conduct a second forensic audit of these brokerages.

“FMC regulations did not have specific guidelines for brokers and were governed by exchange bye-laws. However Sebi has stringent regulations namely FUTP and broker regulations under which it can take action against the registered brokers,” said Parag Bhide, senior associate at the law firm Advaya Legal.

“In this case Sebi may either need to conduct forensic investigation on its own and/or seek reports from agencies like EOW, and Central Bureau of Investigation (CBI),” he said.

Advaya Legal represented Lotus Refineries, named as a defaulting member of NSEL, in the past. It is no longer representing any of the parties involved in the NSEL case.

While Sebi is looking into the role of brokers, it may find it difficult to take action against defaulting members, said another person familiar with Sebi’s processes.

On 12 February, the finance ministry said it had asked Sebi to take action against defaulting NSEL members. A day later, the government issued a final order clearing the merger of NSEL with FTIL. The merger is now subject to the approval of the Bombay high court.

“Sebi has taken cognizance of the finance ministry’s directive to act on the NSEL defaulting members. However, the merger order between Sebi and FMC had kept spot exchanges outside its purview and majority of the defaulting members operate in spot exchange market,” said the person quoted above.

Agreeing with Sebi’s stance, Tejesh Chitlangi, a partner at law firm IC Legal says that Sebi regulations currently do not allow for action against the trading members.

“Sebi doesn’t have jurisdiction over trading members. However, if Sebi wants to act against these members the applicable Section is 11B of Sebi Act under which Sebi has wide ranging powers to act in wider interest of market. It is likely that if Sebi takes action against these members Sebi’s jurisdiction would be challenged,” said Chitlangi.

NSEL, through circulars in September 2013, declared 22 trading members as defaulters for failure to pay their dues.

NSEL investors, however, say that Sebi can take action against defaulting members to recover money under violation of collective investment scheme (CIS) regulations.

“FMC was given the power to recover funds as per the Gazette notification on 6 August 2013, and with the former commodity futures market regulator merged with Sebi, the unified regulator automatically has jurisdiction for search and seizure in this matter to recover funds,” said Ketan Shah, president, NSEL Investors’ Action Group (NIAG).

Through the gazette notification, the government imposed additional conditions on NSEL to protect the interests of commodity market participants.

“Settlement of all outstanding one-day forward contracts at NSEL shall be done under the supervision of FMC and any order or direction issued by the FMC in this regard shall be binding upon the NSEL and any person, intermediary or warehouse connected with the NSEL, and for this purpose, the FMC is authorized to take such measures, as it deems fit,” the notification said.

Ht Mint, New Delhi, 24th February 2016