Forensic audit finds flaws in ICEX market-maker scheme

A forensic audit of the Indian Commodity Exchange (ICEX) has highlighted irregularities in the liquidity enhancement scheme (LES) launched by the bourse for diamond, steel and rubber contracts, among others. The LES involves paying money to certain brokers for providing two-way quotes on any trading contract to generate market interest.

The forensic auditor, Choksey and Choksey LLP, has said in its report that the “process raises suspicion around questionable practices in selecting market-makers (brokers).” The copy of the draft audit report, which was submitted to SEBI a few weeks ago, is with BusinessLine .

SEBI had ordered a forensic audit of ICEX based on a complaint of alleged misuse of the LES by the exchange’s officials.

The auditor pointed out that “certain important criteria for a member (broker) becoming a market-maker like a networth certificate from a CA and assurance of no disciplinary action against members were not incorporated in the final scheme. As per the email trail, the criteria were indicated to be relaxed for becoming a market-maker. These changes indicate that the CEO aimed at the entry of certain low profile/inexperienced members to become market-makers.”

The auditor also said that there was a pricing difference of more 50 per cent between selected and rejected market-makers. “The applicants with higher bids were selected instead of the one with the lowest bid as per their policy. Also, there were no caps on maximum payouts to brokers,” the report said.

Of the seven applications received by ICEX, four brokers were selected as market-makers — Gogia Capital, MSB e-Trade Securities, Mauxampuria Securities and Findoc Commodities.

“Certain brokers did not have experience of market making or physical delivery of goods. Mauzampuria Securities and Findoc Commodities did not have experience of market making but they were passed over as technically qualified in the LES committee,” report says.

Increase in expenses

The auditor found an unusual increase in ‘other expenses’ of Gogia Capital along with an increase in income during the December 2019 quarter. “It is pertinent to note that being empanelled as a market-maker in ICEX during the quarter ended 31st December 2019 led to an increase in income,” the report said.

The auditor observed that in the LES period, ICEX suffered a loss every quarter, which kept increasing, without an increase in employee benefits expense, operating cost, financial cost and depreciation and amortisation expense.

The auditor further compared the LES of ICEX with other exchanges and found the incentives for precious stones and commodities other than precious stones were equal, which was unusual. As per the report the LES incentive for commodities, other than precious stones, should have been less. ICEX is the only exchange in India to have launched trading in diamond futures.

An email query sent to ICEX did not elicit a response.

The LES was introduced in ICEX in October 2019. The ICEX had to stop the LES after SEBI and two public interest directors on the board of the exchange received anonymous email complaints on misappropriation of LES funds. The allegation was that the key management personnel of ICEX were in collusion with the market-makers and siphoned off funds allotted for LES.

In April, thus, the LES was suspended and the board of ICEX in consultation with SEBI appointed Chokshi & Chokshi LLP to undertake forensic audit on execution of the LES.