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Who was responsible for the NSEL scandal — the exchange, its members, brokers or investors?
After investigation of the exchange’s role and that of the defaulting members, the needle of suspicion has now turned to the brokers — intermediaries who actually sold NSEL contracts to investors. With officials from the top brokerages arrested, here’s what we can glean from market players and investors, on the brokers’ role in the affair.
It may have useful takeaways for investors on other commodity platforms.
Assured returns Some NSEL investors say that they were lured onto the spot exchange because they were given very detailed return calculations by their brokers.
Vivek Ram, affected by the NSEL scam, explains that when he traded on the exchange, his broker sent him regular updates on impending trading opportunities — specifying the ‘buy’ and ‘sell’ price and returns as well.
One such example was of paddy basmati of pusa variety 1121. The broker’s mail said the amount of investment required from the client was ₹4,49,165.98, with a buy price at ₹3,048.2 and sell price at ₹3,119.5. He was also told that the profit on this trade would be ₹7,798, translating into a return of 12.95 per cent.
“When I got these mails, if I had the funds in my bank account then I agreed to the trade and after five minutes I got a confirmation from broker that it was executed. I transferred funds to the broker a/c on pay-in day. Since the mail had all details I never bothered to see the buy price and sell price, I just looked at the investment amount, the yield promised and my bank balance at that time.”
Two learnings here. One, when trading on any exchange platform, don’t go by quotes provided to you, do your own fact checking on the exchange. Two, there is nothing called a ‘risk-free’ return. It is only because investors didn’t question brokers on how they managed the assured return that it became easy for all involved in the racket to defraud them.
Incidentally, most of these contracts were offered as wealth management solutions. But the Forward Markets Commission doesn’t allow brokers to offer portfolio management services in commodities!
Unregulated exchange The key reason why NSEL’s contracts were suspended by the FMC, precipitating this crisis was that the exchange wasn’t regulated by anyone. Investors on the exchange went by broker assurances and were also taken in by entities such as the NAFED which traded on the exchange. After the scam came to light, it was found that, not only was the exchange outside the ambit of FMC, it had not even maintained an adequate Settlement Guarantee Fund to cover any defaults.
In the stock markets, there is a robust risk management system in place with SEBI mandating what should constitute an SGF and the amount that needs to be contributed towards it. Prior to NSEL, we don’t know if the commodity bourses had made SGF details public. But the MCX now declares details of its SGF in the Investor Relations section on its website. So, if anyone now offers you a new financial product, ask him about how counter-party risks are guaranteed.
Manipulation of client code While making the recent arrests, the Economic Offences Wing alleged that brokers acting as intermediaries on the exchange modified client codes — that is, they used the trading accounts of some clients without their consent to put through trades. Such modifications have allegedly occurred three lakh times!
Nagappan Valliappan, President, Securities and Timeshare Owners Welfare Association, says this indicates that there has been no surveillance mechanism or they deliberately overlooked it.
“We hear that there have been instances of client code modifications at the back office when the actual trade on the exchange’s platform happened in the name of someone else. It may have been with the intention to show profits to some clients to lure them in.”
You, the investor, cannot have checks and balances against client code changes. But insist on contract notes being mailed to you after every trade and obtain copies of the ledger periodically. This will prevent your trading account from being misused by the broker.
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