Bulls, Bears and Other Beasts

by Santosh Nair

  The so-called ‘buyers’ of the commodities were no longer genuine buyers of commodities but investors looking to earn a return of 12-15 per cent on their funds. Brokerages started marketing this product as something of an assured-return scheme, where the expected returns could only be higher and never lower. The brokerages too gained from this racket, as they would lend funds to their clients at 12 per cent, which would then be invested in the paired contracts earning 15 per cent. Every month, when the contracts were rolled forward, the brokerages would deduct their interest charge and credit the rest to their clients’ accounts.

  The ‘buyers’ did not realize their counterparties were no longer genuine sellers of commodities. The ‘sellers’ were now mostly, or entirely, entities seeking to borrow money at 14-15 per cent to deploy it elsewhere for bigger returns. As subsequent investigations showed, there were around 13,000 investors who were lending money to twenty-five borrowers on NSEL.

  It never occurred to anybody how the same stock of sugar, cumin, castor oil, paddy, raw wool and castor seed could be pledged for months on end without their quality deteriorating over time. Theoretically, if the borrower chose to default after a few months, the lender would have been in a soup because he would not have been able to recover the original value of the commodities if he were to take possession of them and sell them.

  But the borrowers never defaulted on their interest payments and the investors were quite happy with that. They were only bothered about the interest rates, and certainly did not want a situation where they would have to sell the goods in the warehouses to recover their money.

  Murmurs about how NSEL was a vyaj badla platform masquerading as a commodities spot exchange had begun doing the rounds. The Ministry of Consumer Affairs finally woke up – belatedly – and in July ordered NSEL to stop issue of fresh contracts and settle all outstanding contracts on their due dates instead of allowing them to be carried forward.

  That triggered what was initially thought to be a ‘payment crisis’, but was actually the exchange’s death knell, exposing the scam underlying transactions on it. The borrowers did not have the funds to repay the lenders on the due dates. At stake was around Rs 5,600 crore of investor money to be repaid. NSEL had a settlement guarantee fund (SGF), and exchange officials tried to pacify jittery investors saying the exchange would honour their trades even if the borrowers did not. But that turned out to be a false assurance. Initially, the exchange claimed that it had around Rs 840 crore in the SGF, but a few days later said there was only Rs 65 crore. This revealed that the exchange did not have a credible risk management system. The exchange then claimed there was enough collateral (commodities) in the warehouses to repay the investors.

  But the full extent of the scam became clear only a few days later when the exchange began checking the warehouses for the commodities stocked in them. The majority of the receipts turned out to be fake as the quantity of the goods in the warehouses was just a fraction of what was mentioned on the receipts. In some cases, the commodities had already been pledged to banks, but receipts had still not been issued against them. Initially, NSEL CEO Anjani Sinha said he and his management were responsible for the lapses in risk management and operations that had led to the crisis. But he later retracted his statement, saying FTIL founder Jignesh Shah was fully aware of the happenings at NSEL.

  Many thought it would not be too hard to recover the funds as there were only twenty-fourborrowers in all. But many of these entities had already diverted the funds they had borrowed to their group companies. In many cases the money had been invested in real estate, making it harder for the authorities to recover the funds. Anjani Sinha was arrested a couple of months after the scam surfaced, and Jignesh Shah was arrested in May the following year. Between these arrests, some of the big borrowers also got to see what a prison looks from the inside. But other than a handful of small investors, most of the investors who had put their faith in NSEL are yet to recover their money, even as investigators are trying to trace the money trail leading out of NSEL.

  Initially, the government appeared to show little sympathy for the NSEL investors. It knew that ignoring 13,000 investors, most of them HNIs who had lost money investing in a complex derivatives product, was unlikely to cost it politically. When the NSEL Investors Forum approached a senior bureaucrat, he publicly rebuked the members for investing in an unregulated exchange like NSEL despite being better informed than the average investor. The chiding was not entirely undeserved, but two PSUs, PEC and MMTC, too had invested in the NSEL contracts. And what about the government’s own failure to keep track of the developments at NSEL? There were adequate indications that the exchange was flouting every rule in the book. The Ministry of Consumer Affairs had even shot off a show cause notice to NSEL in October 2012. But there had been no follow-up action.

  I had been hearing about trouble brewing at NSEL in June itself that year. Since the positions I had in both FTIL and MCX were not my own, I had little to worry about. But having been around in the market for so long, I also knew that matters could get out of hand quickly. I approached the person who had arranged for me to play market-maker in the stock and told him about my concerns.

  ‘You worry unnecessarily, Lala, these things can be managed without too much trouble, as they have been so far,’ he told me.

  I did not press the matter further.

  The stock prices of both FTIL and MCX began to slide rapidly in the third week of July after the Ministry of Consumer Affairs ordered NSEL to stop issuing fresh contracts. I once again got in touch with the person who was playing the music conductor in both stocks. I knew something was amiss and wanted to get out of my positions. But I knew that would result in my falling out of favour with some influential people in the market. Also, I hated to back out of a commitment once I had agreed to it.

  But I was keen to hear what he had to say.

  ‘Yes, things look a bit tough for now, but nothing to be alarmed about. Even otherwise, you will not be losing anything from your pocket if things take a turn for the worse,’ he said. I could sense an edge of irritation in his tone.

  I left it at that, though my trader’s instinct told me there was a disaster looming. Despite not wanting to be proved right this time, my fears turned out to be justified. On the evening of 31 July, NSEL announced it was suspending trading in all contracts, except e-series contracts, until further notice. Delivery and settlement of all pending contracts were to be merged and deferred for fifteen ays. It was an admission that the borrowers had defaulted on their obligations.

  The following day, share prices of both MCX and FTIL collapsed within minutes of the market opening. FTIL, which had closed at Rs 541 the previous day, nosedived to Rs 180, giving little time for traders to react. MCX shares crashed 20 per cent to Rs 512, and trading in it was frozen because there were only sellers in the stock. There was no way the bulls could get out.

  The fall in FTIL upset me greatly because I had been told just the previous evening not to square off my long positions as it would add to the panic. I am sure the other market-makers too must have been told the same thing. But the steep erosion in price meant that I had to deposit additional margins with the stock exchange. I had expected a 10-15 per cent fall in the stock, but a 65 per cent slide was beyond my most pessimistic estimate.

  I knew that if I dumped the positions, it would be a while before I could hope to be reimbursed for the losses. I called up my contact to check if the previous evening’s instruction still held. I was told it did, and was asked to buy some more.

  ‘But I will need funds for the margin,’ I said.

  ‘It will be arranged in a couple of hours’ time. Let me call you back,’ he said.

  The call never came. I squared off my positions in FTIL, not sure if I would be paid my dues in the near future. But I was still saddled with my long positions in MCX, which crashed another 20 per cent the following day, with no buyers for the stock. The exchanges then reduced the intra-day circuit filter to
10 per cent. That only slowed the pace of decline, but did nothing to calm panicky investors who continued to head for the exit. The stock fell 10 per cent three days in a row, with still no signs of buyers, though the stock had halved over the last five trading sessions and was now quoting less than Rs 300. The exchanges then reduced the intra-day circuit filter to 5 per cent.

  I and a few other traders who had fairly big long positions in the stock knew it would be some time before long-term investors considered the stock. But we also knew there would no dearth of traders looking to make a quick buck off a temporary rebound in price. On the sixth day, we got together and started buying the shares as soon as they crashed to Rs 280. As big quantities began to get traded, many sellers immediately withdrew their orders thinking the stock was poised for a short-term bounce. Many traders too jumped into the fray, hoping to sell the stock at least 10 per cent higher over the next two or three sessions. The stock began to recover, but there had to be sufficient demand for the stock so we could exit our positions without attracting too much attention. We traded among ourselves to further boost volumes and, having created an appetite for the stock, managed to sell out quietly.

  We incurred a small loss on this operation in addition to the losses on the positions we had been holding. Still, we’d have lost more money had we waited. MCX fell 5 per cent on each of the following three days, again with no buyers for the stock.

  By the third week of August, FTIL had fallen below Rs 150, though the selling fury had abated. The market was worried that FTIL would have to foot the Rs 5,600 crore bill owed by NSEL to its investors, since NSEL was its 100 per cent subsidiary. In its bid to assuage FTIL shareholders, the management declared that it was not liable for NSEL’s dues as the two companies were separate entities. This argument may have been legally sound, but sent out the signal that FTIL was trying to disown responsibility for the events at NSEL, denting the credibility of Jignesh & Co.

  MCX was on a much better wicket compared with FTIL, and the panic selling in its stock may have been overdone. But the market concern was no longer about the company’s earnings prospects; it was about its corporate governance standards. The poor internal controls and lax risk management procedures at NSEL raised doubts about the systems and processes at MCX too. Also, FTIL’s claim that NSEL was a separate entity led investors to believe that the parent company would not think twice before cutting them loose should a similar fate befall MCX.

  Eventually, Jignesh would lose ownership of both his companies, spend three and a half months in jail, and have his assets attached as the authorities went about recovering the lenders’ money.

  42

  The Long Arm of the Regulator

  The year 2014 started on a promising note. The rally that began in September 2013 was showing no signs of fatigue. With each passing day, the market seemed to be getting more confident of the BJP coming to power at the Centre. The party’s prime ministerial candidate Modi promised to transform the economy in no time if his party was voted to power. Weary of endemic scams and runaway inflation, everybody was willing to believe that Modi had a magic wand to set things right. The stock market bulls were bracing for what they thought would be the return of the golden period for the economy and the mother of all bull runs. I too was one among them.

  Suddenly, things started going rapidly downhill for me. I received a letter from the regulator seeking clarification about the trades I had done in a bulk drugs company a few weeks before it was acquired by a mid-sized pharma company. I will come clean on this one. I had done the trades for a well-connected investment banker who was advising the acquirer. I had taken up some positions myself, in addition to the shares I had bought for the banker. I had executed the banker’s trades through some fictitious client accounts and then settled in cash. There was no way he could be linked to the trades, even though they had been done based on the information he had provided. I thought I had covered my tracks well by spreading the orders across a few brokers I could trust. Later I learnt that all of them had received letters from the regulator seeking an explanation for the trades they had done in the stock. I knew at least one of them would squeal on me to escape trouble. That would put me in a spot because I had traded quite heavily in the stock just ahead of the acquisition.

  Even as I was grappling with this letter, there arrived another seeking details of my trades in a mid-cap IT stock. In this case, I had dealt for a fund manager who would later buy a huge quantity for his fund. To cut a long story short, this too was an unlawful trade.

  Both trades were over a year old and I had forgotten about them. But somebody at the regulator had investigated them. I could understand their smelling out the trades in the bulk drugs firm because even the media had hinted at insider trading because of the rise in share prices ahead of the deal. But the letter relating to the trades in the IT firm could only have been the result of an anonymous tip-off to the regulator. With a good lawyer I would be able to wriggle out of it. I thought about it and finally concluded that somebody powerful was targeting me. I had no clue as to who that person could be, but it had to be somebody I had unknowingly offended. I told GB about my predicament and he promised to check if my fears were justified.

  He called me a couple of days later, confirming my suspicions.

  ‘You were right, Lala,’ he said, coming to the point directly. ‘You are in the bad books of Mr V. Apparently he has not forgiven you for going after his stock at a time when he had pledged his shares.’

  Mr V was among the top twenty-five industrialists in the country, and I had heard stories of how he could be extremely charming but also extremely vindictive if he believed he had been slighted.

  ‘I thought he was mature enough to understand that there was nothing personal about it,’ I said.

  ‘That is how you see it. But your raid on his stock came at a vulnerable point in his business, and he has not forgiven you for it. In fact, he had sworn to force you out of the market, and is now doing everything he can to make good his threat,’ GB said.

  ‘I am not going anywhere,’ I said defiantly.

  ‘You don’t have to,’ GB assured me. ‘Let me see what can be done about this.’

  A few days later he called again. He had nothing cheerful to say.

  ‘The way I see it, Lala, Mr V is now in a much sounder position than he was two years ago. He now has some powerful friends in the right places. You can dig in your heels, but there will be more show cause notices coming your way. What I am more worried about is that some of the charges will be hard to shake off. Your only defence would be to name the people for whom you did the trades. But that will be bad for your reputation and business even if you get away with lighter punishment.’

  I thought about it. There was no easy way out.

  ‘What do you suggest, Govindbhai?’

  ‘Retreat for the time being if it helps sate somebody’s sense of revenge. I can call in a few favours and ensure that you don’t come to harm legally. When things clear, you can always return. After all, there are no permanent friends or enemies in this market,’ he said.

  My exit was not on the high note I would have liked it to be. Things happened a little too quickly to allow me to plan out my next course of action. The big boys of the trade and a few close friends knew my hand had been forced. But to most acquaintances I was retiring at the top of my game, to try my hand at something more challenging.

  ‘I envy you, Lala,’ many a friend would tell me, ‘it takes guts to say “I have had enough of the market”.’

  Through a combination of discipline and good fortune, I had ensured that money would be the least of my concerns. There was enough to last me a lifetime and more, so long as I did not crave a private beach or an island in the Caribbean. But money alone was not the answer to everything, as I always knew. Here I was, in the prime of my life at 46, with no clear idea as to what to do next. Other than guessing with a fair degree of accuracy where stock prices were heading, I had no other real skill to s
peak of.

  A few friends suggested that I manage the portfolios of HNIs. The catch here was that I would have to do that unofficially, since I had agreed to stay away from the market. But there was no denying that I was known in the market and that there were enough people who could do with my services. A few promoters and even a couple of big names of Dalal Street sounded me out, but I was fussy about whom I would now work with or for.

  ‘How long do you intend to enjoy your retired life?’ GB asked, when I had gone over to his place for dinner at his invitation.

  I immediately sensed that he must have thought of something for me.

  ‘Let me hear out your proposal, and I shall decide,’ I told him, smiling.

  GB started with surprise, then chuckled.

  ‘Always alert, whether or not in front of the screen, Lala; that is what I like about you,’ he said, and told me what he had in mind. A leading industrialist wanted me to manage the share prices of his group companies and also make money from trading in other stocks. Of course, my name would not figure anywhere officially.

  “He is willing to offer 25 per cent of the profits and a free hand; I think that is good. If you make outsized profits, the share can be further negotiated,’ GB said.

  ‘Tell me that you have not already committed to him,’ I said.

  He grinned.

  ‘I have not committed, but I think this deal is a good way for you to stay in the market and at the same time keep a low profile. And you don’t have to be bound to him forever. Should something bigger come up, you are free to pursue it. Think about it,’ GB said.

  The offer made sense. I needed to stay in the game till I could figure out what to do. There were plenty of offers of a ‘consultancy’ nature, but this was something that would help me stay agile as a trader. Trading is something I have enjoyed and wanted to do till I felt the urge to do something else.