NSEL broker-client agreements one-sided, contrary to bye-laws

Put onus of physical checks of the commodities on the investor, absolve NSEL of central counterparty obligations

Brokers of National Spot Exchange Ltd (NSEL) are standing on shaky legal grounds, as the member-client agreements have several clauses contrary to the exchange’s bye-laws. These clauses absolve both the broker and the exchange of many responsibilities.

The member-client agreement is a fundamental document that establishes the framework of the relationship between the broker, the exchange and the investor

Further, experts say these agreements are liable to be considered “one-sided” and not be upheld by courts. In markets regulated by the Securities and Exchange Board of India, there are clear guidelines and model agreements prescribing the content of these agreements. These also have prescribed rules against any predatory clause being included by the financial services provider in the form of “non-mandatory” clauses. But NSEL and its members, operating in an unregulated environment, seemed to have a free hand in making the client/investor responsible for almost everything. (HONEY TRAPS?)

The member-client agreement of a broker with one of the highest dues said, “The constituent acknowledged all trades/transactions entered on the trading system of NSEL for purchase and sale of commodities would be between the constituents, that is, between buyers and sellers inter se and the constituents would be personally liable to each other/counter-party.”

Absolving NSEL of the central counter-party obligation, the fundamental promise of any exchange, the agreement states, “The constituent acknowledges and agrees in case of any difference/dispute arising between the constituent and the member or the counter-party constituent pursuant to the dealings under this agreement, NSEL shall have no role in the dispute and the constituent shall settle this with the other party without making the exchange a party to the dispute.”

While many investors are likely to have signed similar or even verbatim agreements, they are now crying foul. “The broker told us ‘just sign these (without reading)...If you start reading, you may never get to finish’,” said Vishva Nidhi Dalmia of the NSEL investors’ forum. He added his lawyers had told him such one-sided agreements would not be upheld in courts.

S S Dhingra, a Delhi-based investor, said he hadn’t signed any such agreement, adding these agreements were fundamentally bad, as investors didn’t know who the counterparty was in the exchange system. He pointed to an observation issued to NSEL on August 16 by the Forward Markets Commission quoting bye-law 9.6, which said, “Once a trade is matched and marked to market by the clearing house, the exchange shall be substituted as counter-party for all net financial liabilities of the clearing members in specified commodities in which the exchange had decided to accept the responsibility of guaranteeing the financial obligation.”

These inconsistencies might return to haunt brokers who enticed investors to enter paired contracts of T+2 and T+25 settlements on the NSEL platform. While NSEL investors are now demanding their money on the T+25 contracts be repaid, some so-called borrowers have already moved court, saying they hadn’t taken delivery of the commodities.

Several agencies, including the Income Tax Department, have checked the warehouses and found little or no stock. Further, while the presentations sold it as arbitrage products, suggesting the client need not handle commodities directly, some member-client agreements put the onus of checking the commodities on the client. The agreement mentioned earlier states, “I/we shall ensure the commodities are according to the contract specifications of the exchange and within the tolerance limits set in the contract specification and such commodities are delivered at the designated warehouse of the exchange before the scheduled pay in time fixed by the exchange.”

“I/we further understand in case of failure on my part to deliver the specified commodity at the specified delivery centre within the specified time set by the exchange, such commodities shall be procured by the exchange through auction procedure at my cost and risk. I/we shall be liable to make good of such losses that may be recovered from the members by the exchange on my account,” it adds.