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The Central Bureau of Investigation, or CBI, stirred a hornet's nest two weeks ago when it moved on two cases related to two companies promoted by Jignesh Shah's Financial Technologies. It filed a first information report, or FIR, in the widely investigated case of National Spot Exchange in which investors, mostly high net worth individuals, are said to have lost Rs 5,574 crore. Shah has been named in this FIR. Another was a preliminary enquiry against CB Bhave, the former chairman of the Securities and Exchange Board of India, or Sebi, and KM Abraham, former Sebi member, in relation to MCX-SX, the stock exchange of Financial Technologies. While many saw the FIR on the National Spot Exchange case coming, it was the preliminary enquiry against Bhave (a former bureaucrat) and Abraham (a serving bureaucrat from the Kerala cadre), who are considered men of high integrity, that surprised everyone - more so because Bhave and his team at Sebi had declared Shah and Financial Technologies not "fit and proper" to set up a stock exchange. Their stand was well known; and that's what shocked people about the preliminary enquiry.
Bhave has strongly opposed the enquiry and has said that if CBI fails to come up with evidence against him, it should tender an apology. Others too have lent their strong support to the former Sebi chief. HDFC Chairman Deepak Parekh said the move was "creating fear psychosis for public officers" and the probe against such "upright" officers would further vitiate the decision-making environment in the country. Congress leader Jairam Ramesh called it "shocking and appalling" and said "some larger forces" seemed at work: "This fishing expedition by CBI is detrimental to decision-making in public domain... All decision-making will come to a halt this way," Finance Minister P Chidambaram told The Indian Express: "I have been briefed on the case. I don't think the entire facts are yet before CBI." For its part, CBI has indicated that it will not buckle under pressure. "It is too early to think of closure in this matter," CBI Director Ranjit Sinha told Business Standard.
Since the case is six years old and has generated a lot of heat, it is worthwhile to find out what had actually happened in those days. Venkat R Chary, the former chairman of Multi Commodity Exchange, or MCX, anchored by Financial Technologies, says: "When the Reserve Bank of India, or RBI, first set up a joint committee of Sebi and its officials for working out the modalities for exchange-traded currency derivatives in early 2008, MCX was of the opinion that commodity traders need to have a natural hedge for currency risks and a commodity derivative regulator should also be a part of the joint committee (so that exchanges regulated by it can also offer the product)." However, this suggestion was not accepted and the decision was taken that only stock exchanges will be allowed to offer trading in currency derivatives.
Troubled start
This decision of RBI gave birth to MCX-SX. Sebi, according to a regulatory official, "was in those days of the opinion that there was a need to impart competition in securities trading because one exchange (the National Stock Exchange) had a virtual monopoly and the other exchanges were not able to compete. Hence, Sebi gave permission to MCX and Financial Technologies to set up the stock exchange in 2008." However, prior to that, in mid-2007, MCX was investigated by the income-tax department but nothing incriminating was found against it. According to Chary, MCX had fully cooperated with the income-tax department and "it is a well-known fact now that they found nothing adverse against MCX".
"Then director general of (the) income-tax (department) told me that they had not found anything adverse against MCX or Financial Technologies. He, however, told me he could not give anything in writing to me," says Chary, a former bureaucrat. "That incident was another proof that our competitors may have misguided the income-tax department by feeding it false information. After my meeting with the director general, I wrote to the consumer affairs (the administrative ministry) secretary to inform him of what transpired in my meeting and to place the facts on record." With this clean chit, when Financial Technologies wanted to take stakes in two regional exchanges which were in the process of demutualising themselves, Sebi agreed. The finance ministry, however, wrote to Sebi that MCX was being investigated and hence not "fit and proper" to hold shares in any stock exchange. Sebi, which is always mindful of its status as an independent regulator, replied saying that "a mere raid is not a reason for declaring someone not fit."
So was there an attempt by rivals to checkmate Financial Technologies? Chary has alleged that a senior finance ministry officer had recommended in December 2007 that state-owned Life Insurance Corporation and Nabard reduce their stake in NCDEX (a private exchange that competed with MCX) from 15 per cent to 5 or 6 per cent each in favour of the National Stock Exchange in order to help NSE "steer NCDEX to compete better with MCX".
According to Chary, he wrote to the Central Vigilance Commission, the anti-corruption wing of CBI, the finance ministry and even the prime minister's office but to no avail. Chidambaram has said that MCX and Financial Technologies were initially allowed currency trading and not equity trading. However, securities market professionals and even regulatory officials are not buying this argument. According to a senior executive with a stock exchange, "A stock exchange is a wider term and equity is only one of its segments, though it is a glamourous segment." He prefers anonymity because CBI is investigating the matter. "Bhave, the then Sebi chairman, had told us, 'Remember, you are recognised as a stock exchange. Do not deny yourself the right to be in all segments that a stock exchange can be in,'" says Chary.
A new start
MCX-SX, the stock exchange, started functioning in late 2008, when the global financial crisis had just begun. The permission was granted on the condition that the promoters of the stock exchange, who owned 100 per cent stake, would reduce their holding to 5 per cent within a year to comply with the Sebi norms.
But, the company could only partly dilute its equity and was given one more year to complete the restructuring. However, "when Financial Technologies restructured the capital base by cancelling the shares held by it and MCX, the rift with Sebi seems to have begun," recollects a veteran capital market observer. What really happened? In a departure from what is normally done to lower a promoter's stake, Financial Technologies and MCX brought down their stake not by bringing in new investors but by converting their shares into warrants without voting rights and dividends. While the capital of other investors was retained, Sebi felt that the warrants allowed the promoters to hold substantial economic interest in the exchange even after they had lowered their stake.
In September 2010, Sebi gave another extension to Financial Technologies to restructure. However, in three months, Financial Technologies was declared not "fit and proper" by Sebi. This was challenged by Financial Technologies and ultimately when the Supreme Court ruled in the company's favour, Sebi had to grant permission to the stock exchange for equity trading also.
MCX-SX begun trading in equity in early 2013. However, had this competition been introduced five years ago, the exchange scene in the country could have been different. The regulatory official quoted earlier says that, "MCX-SX when permitted to launch equity segment couldn't do much now as the time for it had lapsed a few years ago." MCX-SX originally wanted to start equity trading in 2009 to compete with NSE, but that did not materialise. Though MCX-SX had cleared this hurdle and equity trading on MCX-SX was inaugurated on February 9, 2013, more trouble was brewing for Financial Technologies - something that would seriously impact its cash flows.
First, on February 28, 2013, in the budget for 2013-14, commodity transaction tax on non-farm commodities was introduced. In this space, MCX had most of the volumes. So, it was the first to be affected by this tax. Later, on 25 April, RBI issued a guideline asking overseas corporate bodies with Indian investments to take its permission for offering any equity or equity-related product in the overseas market. As a result, the exchange set up by Financial Technologies in Bahrain offering rupee-dollar futures lost most of its volumes. The National Spot Exchange default in July 2013 was the final nail in the coffin.
Settlement talk with NSEL investors at stake
While the fate of MCX-SX depends on the probe by CBI, the promoters of the stock exchange are facing challenges of their own. One of its promoters, MCX, is facing pressure from the Forward Market Commission, the regulator for trading in commodities derivatives in the country, to ensure that the stake of its anchor investor, Financial Technologies which also happens to be a promoter in the MCX stock exchange, is reduced from 26 per cent to 2 per cent in accordance with the law.
Financial Technologies, meanwhile, has declared its intention to exit all stock exchanges, including MCX and MCX-SX.
There is also a turf war raging at Financial Technologies. Some of its closest supporters, Ravi Sheth and Bharat Sheth, who hold nearly 8 per cent stake each along with private equity firm Blackstone, have joined hands to oust the company's group chief executive and promoter, Jignesh Shah.
They are also building pressure on Shah to sell stake to a particular company (sources say it is Tech Mahindra) when it goes for stake dilution. Financial Technologies has said that it wants to bring in a strategic investor with 26 per cent stake and the decision on who to sell the stake to will be taken by a high- level committee.
Many fear the cross currents playing out at the company could derail the settlement talk with National Spot Exchange investors which is in the final stage. Shah has offered to pay 20 per cent, or Rs 1100 crore, of the Rs 5,574 crore the exchange owes to its investors. Ravi Sheth and Bharat Sheth, have said they will oppose the deal when it comes for approval to the Financial Technologies board.
