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Commentary

Brokers Were Definitely Guilty in NSEL Fiasco Also: Reader

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An alert reader of Capital Mind has called me out on my post that brokers could have been innocent. No chance, he says, and he explains:

I was reading your article on The NSEL Scandal/Scam where you observed that the arbitrage was believable I disagree and wanted to bring to your notice certain facts regarding this issue. I had participated in this market but stopped after I observed the following.

1) In a normal arbitrage (like the yes bank example)  each leg of the trade is actually separate brought together only by the simultaneous execution. However in NSEL One HAD to execute both buy/sell transactions together. It was not possible to execute just one side of the trade. In fact you could not just randomly fireup the terminal and execute these trades. The Brokers would coordinate with the exchange (on the phone) and the exchange would release contracts accordingly.

2) The Fact that there were only one or two counter parties for each commodity was well known to the brokers. In fact they were well aware that the exchange was being used as a irregular financing mechanism. Further almost all the volume in the exchange were these paired trade/arbitrage. There was very little or no actual trading happening.

3) There was no formal settlement mechanism where warehouse receipts were formally exchanged between the broker and the exchange. In some cases they would email you an excel sheet with a list of warehouse receipt numbers. You did not have to mail anything back. The Exchange would adjust the receipts on its own. Even if you wanted it was not possible to get the actual receipt.

4) Most brokerages did not advocate this scheme to their Private Wealth Clients (I mean the real HNI’s not the garden variety 25 Lakhs plus clients) however they were freely pushing the product through their boiler rooms. If the brokerages truly believed in the product why would they not push it to their most valuable clients this was after all the ultimate treasury management tool.

5) Important issues such as VAT etc were ignored by the exchange/brokers.

6) EACH and EVERY broker who called me regarding this assured me that they had thoroughly researched the scheme and in fact most claimed that their own audit teams regularly visited the various gowdowns etc etc.

7) NOT one broker told me that the exchange was not regulated.

In my opinion the brokers  definitely guilty of failing their fiduciary responsibility and ignoring red flags just so they they can get their brokerage. They have very aggressively pushed the product.While I do not know this as a fact I would guess that the brokerage being offered in this market would be quite a bit higher than brokerage in the NSE/BSE.

regards

All the bold is done by me.

Forget everything else and just focus on Point  No. 1. If the concept was that two trades had to be put together simultaneously, it wasn’t an exchange by any standard! Any broker worth his salt would have known there’s something wrong here.

I think the #1 problem is with the NSEL exchange, it’s management, it’s board and it’s promoters.

But that doesn’t mean there weren’t #2 and #3 guilty parties. Brokers, if they had done the above, were definitely guilty of, at the very least, not acting in the fidiciary benefit of their clients. This is even worse than ULIP misselling, though some insurance agents come very close.

There are more – the auditors, the defaulters, the FMC (when it ignored this), the government ministries, and yes, even the investors. (The reader above understood that it was possibly a scam. How many others didn’t care?)

We have to enforce action against the #1 guilty party.

But we also must address #2 and #3, even though some will say it is poetic justice that many of these very brokers have lost substantial sums of money. It is imperative though, that we do not allow them to pass their losses to their customers.

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