FEMA probe: StanChart, TamilNad Mercantile Bank may have a lot of explaining to do

On Thursday, the Enforcement Directorate (ED) issued show-cause notices to, TamilNad Mercantile Bank (TMB) and Standard Chartered Bank (SCB) on charges of violation of Foreign Exchange Management Act (FEMA) in connection with a 2007 purchase of TMB shares by a group of investors including former PepsiCo India head Ramesh Vangal’s Katra group and series of transactions thereafter.

The total value of FEMA contravention, in the case of TMB, was found to be Rs 274 crore, while in the case of Standard Chartered, it is about Rs 334 crore.

The 2007 share exchanges, which involved acquisition of about 33 percent in TMB, was done through a series of transactions involving an escrow account associated with SCB’s Mauritius arm, of which Standard Chartered India was a sub-agent. Post the 2007 share deal, SCB subsequently claims to have acquired 4.64 percent stake in TMB.

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The charges raised by ED primarily points fingers at TMB officials, including the then chairman of the bank, M G Maran, for facilitating the transaction in contravention of FEMA rules and to StanChart for aiding the said transaction using the escrow account, violating norms.

Further, the ED has found that TMB had allowed similar transfer of shares to foreign entities in December 2011 and June 2012. None of the transactions, including the one in 2007, had prior approvals of the Reserve Bank of India (RBI).

Back in 2007, the whole plot was perceived to be an attempt by the Ramesh Vangal-led investor group to wrestle the control of TMB from NRI businessman C Sivasankaran. A total of 18 investors were involved in the deal, of which 12 had accounts in the escrow account.

But the critical aspect here is that the case doesn’t only pertain to the FEMA violation. There can be more than meets the eye.

In 2011, the Reserve Bank of India (RBI) had raised questions to StanChart on the deal and had commenced an investigation on whether the foreign bank acquired more than the permissible 5 percent stake in TMB through the backdoor. Under banking norms, no entity can acquire more than 5 percent in a local bank.

Standard Chartered had claimed to have bought the 4.64 percent stake in TMB through its subsidiary -Subcontinental Equities Ltd - from two investors - Katra Holdings and RST. But, the situation got complicated when Katra Holdings claimed that the firm hasn’t sold its 3.64 percent stake to Standard Chartered.

Here is how the events unfolded. The 2007 share transaction was facilitated by Project Windmill escrow account, an account operated by US-based private equity (PE) group Corsair Capital Llc to facilitate the deal and of which SCB was a sub-agent.

During its investigation, the RBI had found that SCB first extended a loan of $20 million to Katra to acquire TMB shares. Later, Subcontinental Equities bought the stakes of Katra and another investor, RST Ltd, taking its total stake to 4.64%. But Katra has so far denied this transaction.

Further, the RBI had said that “the arrangements under which such substantial portion of the shareholding is held under the escrow arrangement is not clear and lacks transparency”.

The role of TMB’s Maran in the case too has raised eyebrows. Issuing show-cause notices, the ED has noted that for facilitating the share transfer from Indian investors to foreign investors, Maran received consideration from the foreign investors to the tune of $6.85 million in his overseas account at Singapore and is proposing action against Maran for FEMA violations.

More than the Fema violation angle, which is already been established by ED, the critical question is whether StanChart, one of the oldest foreign banks in India, attempted to flout the Indian laws to acquire a significant stake in a local bank without the RBI’s approval.

If indeed that is the case, the chain of transactions and the intention behind needs a serious re-look. Both Standard Chartered and TMB will have a lot of explaining to do then.