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The NSEL-FT Forced Merger Is Not About Piercing Limited Liability. It's About Fraud.


Too many articles have come out decrying the order by the Government to merge FT and NSEL. They all quote the same thing – FT was just an investor and therefore it should not bear any liability greater than the amount of money they invested into it. It’s against the concept of limited liability. I would have believed this if there was no five letter word “Fraud” involved.

For instance, I think that it’s perfectly fine that Vijay Mallya can spend his personal money while Kingfisher owes lots of money to banks. Because his personal liability is different from that of the company. He is not required to pay back the company’s debt. Of course, he could be, if any of two things happen:

  • If Mallya has fraudulently embezzled Kingfisher funds or conspired with it to fraud someone else, it would not be an overreach to use this information to demand that he pay back such loans too.
  • If Mallya has personally guaranteed debt borrowed by Kingfisher.

In Mallya’s case, they have never proved the first part (and there are no allegations of such embezzlement from the borrowers yet). The second may be true according to reports, so they can still get his money for Kingfisher’s debt.

Let’s look at the FT-NSEL case:

  • NSEL is a 99% subsidiary of FT
  • NSEL has, according to evidence, fraudulently introduced illegal contracts to offer some sort of guaranteed returns to investors through pair trades.
  • When the fraud unravelled, NSEL lied, and have been unable to recover money from the 24 parties that formed one side of the 5,600 cr. unsettled trades, with more than 13,000 investors on the other side
  • FT has, according to the government, the FMC, and many other reports actively colluded with NSEL management in pushing these trades forward, even as the whole thing unravelled. This was done as FT, not as those individuals in their personal capacity.
  • It’s evident that FT benefited as a company – from consolidated income increases on one end, and from hefty fees paid by NSEL to FT on the other.
  • FT has therefore both benefited from, and been actively involved in the fraud that NSEL perpetrated.

It is because of this that the government would choose to merge FT and NSEL. This is basically saying: If you collude to defraud and now owe people a lot of money, then you owe it together; FT can’t just put everything onto NSEL.

The concept of limited liability is not what is at stake here – I believe that even if there was no cross ownership, the two could (and should) have been merged. In general, we should rely on a regulatory body or the government to do such a thing; and it should only be invoked in an extreme case. In this case, both conditions apply.

It is just wrong to keep on harping about limited liability without mention of a fraud of this magnitude and the obvious collusion of the two companies. Without those, the merger would have been unnecessary (and indeed, I’d be on the other side if the government would make it happen). In fact, take the Sahara case. Some of Sahara’s liabilities are with some companies, some with others – yet, Sahara’s Roy is expected to sell assets belonging to completely different companies in order to pay back those investors. It’s okay in Sahara’s case, so why not for FT-NSEL? The movie dialogue goes:

Tumhara khoon khoon, humara khoon paani?

(your blood is blood, and our blood is water?)

Lastly let’s spare a thought for the “minority” shareholders of FT who supposedly got dragged into this. Taking the NSEL liability on is bad news. They will be fine if NSEL’s assets are used, that is, they can recover from the “borrowers” who have refused to give NSEL the money. (But they might give it to FT?)

If not, then FT will have to sell what they own (the brokerage software, their residual ownership of MCX and the stake in the data and other businesses). This money will go straight to pay the NSEL liability, and not to FT shareholders, who will be left with a company that owns nothing, which effectively takes their stake to zero. Is this a terrible thing?

Such things are part of the game. Enron went to zero. Hundreds of other companies, where promoters committed fraud, went to zero. You don’t find yourself feeling lousy about Zenith shareholders because the company was unable to pay up their FCCB debt, even if it eventually emerged that the promoters sold Zenith assets to themselves. (The correct approach is to prove it and put management behind bars, but the shares will still go to zero) Promoter-abuse has always been a good enough reason for the stock to collapse, and equity shareholders should know that risk.

And they had more than a year to sell their shares. This scam was covered in August 2007. If investors wanted to salvage themselves they could have sold anytime between last year and now. It was increasingly obvious FT was involved; if they stayed invested, they took the risk of FT not getting battered in the process – and that strategy just failed. Normal business answer: you took the risk, it didn’t work out, you’ve lost your money. Luckily, since you weren’t involved in a fraud with the company, your liability is limited to your investment in FT’s shares, not any further.

But if FT did “prima facie” collude with NSEL to harm investors on the exchange, it makes perfect sense to throw limited liability out the window and merge the two companies.

Note: What I really do believe is that FT should go behind the NSEL borrowers and try their best including attaching property etc. to recover the money. That would be a win-win for everyone. But apparently, there is no appetite for this – especially if it turns out that Mr. Shah is sent back to jail.


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