Warren Buffett, one of the World’s greatest investors, colourfully described “derivatives” as “weapons of mass destruction”. He called them “time bombs” and warned that they are a “threat to the global economy and financial markets”.
N. Jayakumar, the whiz-kid investor with Prime Securities, would have done well to pay heed to Warren Buffett’s sage advice.
Old timers will recall the sensational news of June 2013 when Gitanjali Gems, which was a favourite amongst punters, crashed. In the first half of 2013, Gitanjali’s stock price surged from about Rs. 300 to a peak of Rs. 649. Thereafter, the stock crashed like a ton of bricks. Its CMP is Rs. 40 which means that there is a spine-chilling loss of 94%.
Several novice investors lost their shirts in the meltdown of the stock.
N. Jayakumar and his concerns, Prime Securities and Prime Broking, were amongst the affected parties. Prime Securities held 225,000 shares, while Prime Broking held 17,02,269 shares, of Gitanjali Gems.
Prima facie, Jayakumar appears to have overextended himself. His Prime Broking entered into “long dated NIFTY options contracts” for a value of Rs. 400 crore. By way of security, Prime Broking provided stocks in various companies to National Securities Clearing Corporation Ltd (“NSCCL”). However, these stocks included junkyard companies like ABG Shipyard Ltd, Alok Industries Ltd, Ananjneya Lifecare Ltd (later known as Dr. Datsons Labs Ltd), Flexituff International Ltd & Gitanjali Gems Ltd. SEBI, as part of a risk management exercise, decided that these junkyard stocks are not eligible to be given as security. Consequently, NSCCL directed Prime Broking to replace the stocks and threatened that if he did not so, it would dump the stocks in the market and recover whatever it could.
Jayakumar appeared before the NSCCL and solemnly promised to replace the stocks or provide adequate margin though he did not do so completely. There was a shortfall of about Rs. 95 crore. NSCCL declared Prime Broking as a defaulter and also sold some of the stocks for what it could recover.
The surprising part is that two companies called Sarvin Mercantile Private Limited and Trusha Infrastructure Private Limited suddenly turned up and claimed that the shares of Gitanjali Gems that Prime Broking had pledged with NSCCL actually belonged to them and that neither Prime Broking nor NSCCL had any right to them. Criminal complaints were filed by these companies against Prime Broking and Jayakumar. The EOW froze the sale of the shares.
As a result of the claim by Sarvin and Trusha, NSCCL suddenly found that it had no assets of Prime Broking in its custody which would be sufficient to meet the losses suffered by Prime Broking from the said “long dated NIFTY options contracts”.
The result of this sorry state of affairs is that there was a loss of Rs. 95 crore which NSCCL paid from its own pocket.
To add insult to injury, Prime Broking filed a suit against NSCCL claiming a whopping sum of Rs. 213.02 crore by way of damages for “reputational loss”, “business loss” etc.
Prime Broking also challenged its being declared a “defaulter”. One of the contentions raised was that NSCCL ought to have sold off the entire lot of Gitanjali shares in one lot. However, NSCCL explained that this was not feasible because the stock was already trading in the lower circuit and the market had no appetite for more of the junkyard stock. The Securities Appellate Tribunal dismissed Prime Broking’s challenge by a scathing remark that “the appellant (Prime Broking) who is guilty of violating the margin money norms is not justified in accusing that NSCCL has failed to sell the pledged Gitanjali shares between March 18, 2013 to April 27, 2013”. SAT also testily observed that arguments of Prime Broking and Jayakumar are “without any merit and deserves to be rejected”.
Thereafter, NSCCL dragged Prime Broking to the Bombay High Court with a winding up petition. The High Court has upheld the plea and directed that Prime Broking should be wound up for failure to pay the dues to NSCCL.
The High Court gave NSCCL a clean chit by observing “the actions of (NSCCL) at least prima facie appear to be bonafide in not selling these shares (of Gitanjali)” while simultaneously slamming Jayakumar and Prime that “prima facie, the claim of damages as pleaded by (Prime Broking) is unlikely to succeed”. The Court also fumed that “the defences of (Prime Broking)” are “prima facie not bona fide”.
Now, whether the winding up order will provide any succor to NSCCL requires to be seen. When I last peered into the Balance Sheet of Prime Broking, all that I could spot are the junkyard stocks referred to above, which have no value today.
Of course, the larger question that requires to be probed is why NSCCL permitted Prime Broking such huge margins on the strength of junkyard stocks. Even a novice knows that stocks like ABG Shipyard, Alok Industries, Ananjneya Lifecare (a.k.a. Dr. Datsons Labs), Flexituff International etc are of the junkyard category and can never be accepted as collateral for even a rupee’s debt. These stocks are also extremely illiquid and can never sustain heavy volumes.
Hopefully, NSCCL will learn a lesson for this unfortunate episode and be more careful in future in granting margin limits to brokers. Hopefully, N. Jayakumar will also have learnt a lesson of the perils of playing with deadly weapons such as the “long dated NIFTY options contracts” and he will now confine himself to the cash segment, as advised by Warren Buffett!