CASE STUDY -NATIONAL SPOT EXCHANGE LIMITED

 

 

Author

CS Deepak P. Singh

 

 

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As you are aware that the management of a company is supposed to work in the best interest of the shareholders, however in practice it may pursue its own agenda and that leads to the agency conflicts. Since corporates are legal entities and managed by natural persons and they collectively called Board of Directors. The BOD is supposed to work for betterment of company and the owners i.e., shareholders, but in some time, they indulge in such activities which are against their duties and responsibilities. They are under common law considered as agent and trustee of the assets of the company. Sometimes conflict often results in management adopting illegal and unethical practices to boot revenue and profits and window dressing of financial results to mislead general public and the shareholders, by showing that company is growing day by day, this way they hide actual financial position of the company. The Auditors of the company are also involved in this type of activities.

This type of malpractices occurs due to lack of Corporate Governance in the company and some big companies were victims of these malpractices. Such as Enron, WorldCom, Xerox, Lucent Technologies and of course in India Satyam Computers Limited, The National Spot Exchange Limited.

The nature of problem reported in above companies are inflated profits and understatement of losses and liabilities by using unconsolidated Special Purpose Vehicle. Inflated profits by classifying operating expenses as Capital Expenditure leading to over statement of profits and assets of the company in the financial statement.

In Xerox the management has inflated reported profits by recognizing future receipts as current income by changing Accounting Policies relating to Revenue Recognition.

Lucent Technologies- booking of fictitious sales by treating the goods sent to the distributors on consignment bases as final sales leading to overstatement of earning.

Satyam Computers Limited-it was the fourth largest IT company in India at that time and employing 50000 employees with turnover of US$ 2.0 billion. The company within a short span of time achieved a sizable turnover and had listed on NASDAQ. But in7th January,2009 it shocked the world community, when its CEO admitted massive fraud involving falsification of accounts. The CEO admitted that the Balance Sheet of the Company as of September,2008 has inflated (non-existent) cash and bank balances of Rs. 5,040 Crores, nonexistent accrued interest to the tune of Rs. 376 Crores. At the same time the liabilities were understated by Rs. 1,230 Crores and debtors were overstated by Rs. 490 Crores. He further informed that actual revenue and profits last quarter was Rs. 2,112 and Rs. 61 Crores instead of Rs. 2,700 and           Rs. 649 Crores respectively. The management along with auditors of the company diverted the funds of the company to their real estate business and done window dressing to produce false picture of the financial stability of the company before the world.

 

LET’S CONSIDER CASE OF NATIONAL SPOT EXCHANGE LIMITED

BRIEF FACTS: The NSEL was promoted by Financial Technology Group (FTG) and National Agricultural Cooperative Marketing Federation of India (NAFED). As on 31^st March,2013 the share capital of company consists of 4.50 Crores of Equity Shares of Rs. 10/- each. The entire share capital except 100 shares were held by Financial Technologies Limited (FTL) owned by Mr. Jignesh Shah.

NSEL commenced operation in 2008 and is currently operational in 16 states providing delivery-based Spot-Trading in 50 commodities. The exchange has developed a market for trading in commodities in India and has provided a platform to agriculturists in India to trade with their commodities same and trading in shares.

All contracts on the NSEL were single day duration and positions outstanding at the end of day results into compulsory delivery. Each seller has to compulsory deliver the commodities in the NSEL designated warehouses. Before deposit, the goods have to be compulsory weighed and certified by the warehouse supervisor. NSEL guaranteed the performance of all contracts executed on the exchange through a settlement guarantee fund. Notwithstanding default of any member, payout is guaranteed by the exchange. All positions outstanding are subject to margin however margin is not applicable on the sellers who deposited goods in the warehouse and pledge the Warehouse Receipt with the exchange.

Further NSEL in addition to Spot Contracts, introduced product in the nature of “Repo or Repurchase Contracts”. In a repo transaction the seller sells the underlying asset on a Spot Basis with an agreement to buy it back (repurchase) later at a pre-determined price. The repurchase price provides an assured profit to the seller in first leg; there are two legs of each repo-transaction.

These are

1. In first leg the seller (suppose Mr. X) sells goods to the buyer (Mr. Y) say for Rs. 100 Lakhs for Spot Delivery. The goods are kept in the warehouse maintained by the exchange.

2. At the same time Mr. X and Mr. Y agree that after some time, say a month, the seller Mr. X will buy the goods back from the buyer Mr. Y for say Rs. 101 Lakhs.

In above transaction Mr. X, the seller borrow one month time from the buyer Mr. Y against the collateral of commodities laying in the warehouse under control of the NSEL. The different between the price of first leg and second leg i.e., Rs. 1.00 Lakhs becomes profit earned by the buyer Mr. Y within a period of one month and in the same way he can earn profit of Rs. 12.00 Lakhs /p.a.

Through this mechanism the investor would lend money for say 30 days against the receipt of commodities stocked in a warehouse. The returns could be as high as 14-15%. The borrowers who, otherwise were not able to borrow from normal banking channels due to poor credit ratings, borrow through this mechanism.

In July,2013 the Forward Market Commission (FMC) banned the new Forward Commodity Contracts and this led to payment crises in NSEL.

On 8^th August,2013 the NSEL released complete list of buyers and stock held by them, since there was panic in the market due to stoppage of trading in commodities at NSEL. The list shows there were 21 buyers having outstanding liability of Rs. 5,580 Crores, against which stocks tendered by them in NSEL warehouses are worth of Rs. 6,063 Crores.

The exchange appointed SGS, a Swiss firm to access the quantity and quality of goods lying in various warehouses. SGS later reported that stocks in the 20-odd warehouses it has inspected are less than 20% of the declared amount against which financing has been taken from NSEL.

The crisis of NSEL has brought the other group companies of FTL also under focus. FTL is promoter of Multi Commodity Exchange of India Limited (MCX) and MCX Stock Exchange Limited. All the three companies are under scrutiny from the regulators. Another group company Indian Bullion Market Association (IBMA) has regularly traded on NSEL. Since trading by group companies on Stock -Exchange is against the rules.

In the above scandal the role of Auditors cannot be ignored. Without there consent or their involvement these types of frauds and transactions can not be taken place.

The counts of the company were audited by Mukesh P Shah & Co, from years 2005-06 to 2008-09. For next three years till 2011-12, M/s. SV Ghatalia & Associates were the auditors. Again M/s. Mukesh P Shah & Co. has been appointed as Auditor for FY 2012-13, before the outbreak of the payment crisis. On 21^st September,2013 the auditors withdrew their reports.

The report that there was shortage of stocks as depicted and mentioned in the financial statements of company leads to the conclusion that the auditors were failed to perform their duties of stock taking and reconciliation, since finances were issued to the sellers on the basis of stocks deposited by them in the designated warehouses of NSEL.

 

 

CONCLUSION: The cases like Satyam Computers and NSEL do highlight the critical role of independence of auditors in the corporate governance. Corporate Governance failure does result is massive wealth destruction for all the stakeholders. It also highlights that merely making rules will not lead to better corporate governance, it has to be accepted as a way of life at all level of the management. Before Satyam the government and the business community are not giving importance on implementation of CorporateGovernance in the organization. The stakeholders were left on the mercy of big -corporate houses and the management of the companies. Although the Companies Act,2013, SEBI and other enactments providing some punishments to the wrongdoers, but that were not sufficient. In may cases the auditors of companies were also involved and had not performed their duties for the benefits of stakeholders. After Satyam the SEBI, RBI, Government has taken various steps so that Corporate Governance Provisions should be followed by organizations. Through implementation of Corporate Governance and reporting procedures, we shall prevent to some extent these types of frauds and scandals. It is also necessary to formulate strict rules and regulations for professionals also who are certifying the financial statements and other reporting of companies. There should be harsh punishment for them because the Government and the public has shown trust in them and it is their duty to show true and fair pictures of Financial Stability of a corporate through their reports. All stakeholders generally invest their monies on the basis of Financial Statement of a company certified by them.

DISCLAIMERthe case law produced above is only for knowledge and information of readers. the views expressed here are the personal view of the author and same should not be considered as professional advice. in case of necessity do consult with professionals.