By Shivanand Pandit
The Securities Exchange Board of India (SEBI) recently took hard action against the National Stock Exchange of India Limited (NSE), over an algorithmic trading scam. In five distinct orders, the SEBI penalised NSEs Ravi Narain and Chitra Ramakrishna and a host of other individuals for the co-location scam.
SEBI ordered both Narain and Ramkrishna to expel a part of their salary drawn when they were at the helm of affairs at the NSE. Narain has been directed to give 25 per cent of his salary from financial year 2011-12 to 2012-13 and Ramkrishna has been directed to pay eject 25 per cent of her salary during 2013-14 to the Investor Protection and Education Fund (IPEF) within 45 days from the date of the order. Both have also been banned from being allied with any listed firm or market infrastructure institution bourse, clearing corporations, depositories for five years.
The SEBI banned NSE from accessing the securities market for 180 days and ordered the exchange to disgorge or eject around Rs.1,000 crore (Rs 624.89 crore plus 12 per cent interest from April 1 2014) to the IPEF within 45 days from the date of the order for untrue and unjust trade practice under the Prohibition of Fraudulent and Unfair Trade Practices) Regulations and for not putting the tick-by-tick (TBT) architecture in place. TBT is a data feed, which delivers information about every change in the order book on the NSE.
The SEBI mentioned that the NSE has failed to exercise due attentiveness while offering co-location facility which has adversely affected integrity of the capital market. Co-location refers to the system wherein a broker’s server is kept in the exchange premises to shrink latency or delay while executing trades. It helps brokers to get advantage over others due to nearness to exchange servers as data transmission takes less time. Orders reach exchange servers quicker than those who have not availed of the facility
The average net profit margin was 77 per cent throughout the years 2010-11 to 2013-14 and by applying the margin on NSE’s revenues from co-location facility (excluding rack charges) from 2010-11 to 2013-14, the profit from co-location activity worked out to Rs.624.89 crore.
In relation with dark-fiber matter, where leased lines were allotted that led to privileged access, an additional fine of Rs 62 crore with 12 per cent interest was levied on the NSE. The SEBI held the NSE brokers namely GKN, Sampark and Way2Wealth guilty of contravening the legal provisions. The SEBI has also passed an order against OPG Securities, forbidding the brokerage from accessing the capital markets for a period of five years and the brokerage has been instructed to pay Rs15.57 crore with 12 per cent interest.
It is really sad that SEBI woke up late and decided that NSE had committed a fraud. The delay was mainly on account of SEBI’s protracted inquiries. The investigations were conducted by many different committees, including a cross-functional team of committees comprising officials from SEBI, Deloitte, Indian School of Business and Ernst &Young.
The order of SEBI transmits clear messages to market infrastructure institutions that, exchanges cannot act in a way that destroys the confidence of investors. The order indicates that, exchanges have to ensure that all the processes are well-documented and administered.
The order is a lesson to NSE in many ways. Complexities of developing technology have to be gasped perfectly and the NSE should put tremendous efforts to enhance the skill levels of their senior staff to tackle challenges thrown by technology. Increasing utilization of algorithmic trading systems and co-location processes made the policy issues complicated. This bestows users significant advantage in data access, particularly in an age where Artificial Intelligence based algorithmic trading systems can exploit milliseconds. To avoid this unbalanced environment the NSE has to fabricate a strong policy to curb abuse.
The NSE should have constructively accepted instead of denying the whistle-blower Ken Fong’s first complaint in 2015. He has sent three letters to the SEBI in January, August and October of 2015. On the basis of the complaint the exchange should have taken action against its staff conspiring with trading members. Obviously the whole damage to the image due to investigations could have been avoided. Therefore, henceforward the NSE should be open to criticism and take remedial actions.
The exchange should create a firewall between its functional employees and trading members thereby dirty tricks of making money can be checked. Power packed checklist has to be given to each employee on the dos and don’ts. And frequent system audits have to be conducted and all the third party agreements have to be scrutinized regularly.
Meanwhile, all the individuals in NSE against whom SEBI raised the red flag have managed to get interim stay from the Securities Appellate Tribunal (SAT). The SAT has stayed all the action against Narain till it hears SEBI. Lawyers involved are also confident that after Narain’s stay, it is likely that the SAT may also give an interim stay on action against Ramkrishna and other officials.
The SAT also stayed actions against Ajay Shah, Sunita Thomas, Krishna Dagil, Suprabhat Lala and stated in its order that the matter involving Ajay Shah and others dated back to 2009 and there were no complaints against them in those 10 years, and therefore the balance of convenience was in their support. Interim relief has been granted to three blacklisted brokerage firms namely, OPG Securities, Way2Wealth brokers and GKN securities. However, these brokerage firms have to deposit 50 percent of the disgorgement money as security.
*The writer is tax specialist, author, public speaker based in Margao, South Goa