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NSE co-location scam

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The NSE co-location scam relates to the market manipulation at the National Stock Exchange of India, India's leading stock exchange. Allegedly select players obtained market price information ahead of the rest of the market, enabling them to front run the rest of the market,[1][2] possibly breaching the NSE’s purpose of demutualisation exchange governance and its robust transparency-based mechanism.[3] The alleged connivance of insiders by rigging NSE’s algo-trading and use of co-location servers ensured substantial profits to a set of brokers.[4][5][6] This multi-dollar, widespread market fraud came to light when markets' regulator, the Securities and Exchange Board of India (SEBI), received the first anonymous complaint through a whistle-blower's letter in January 2015.[7][8] The whistle-blower alleged that trading members were able to capitalise on advance knowledge by colluding with some exchange officials. The overall default amount through NSE’s high-frequency trading (HFT) is estimated to be 50,000 crores over five years.[9][10]

The NSE co-location case is under investigation by the Central Bureau of Investigation (CBI), the Securities and Exchange Board of India (SEBI) and the Income-tax Department (I-T department) who are probing the involvement of NSE and SEBI officials, as well as NSE's former and current executives and brokerages.[11][12][13]

Unverified

The Brokers-NSE Nexus

The brokers-NSE nexus came to the forefront with the co-location scandal. The broker entity to receive maximum benefit in the scandal was OPG Securities, which was provided multiple login IPs and allowed access from the secondary servers.[14][15] Due to favourable access, OPG Securities and other entities benefited instead of other brokers and their clients. Other firms on the list of 22 brokers who repeatedly logged in early on the NSE servers include: Alpha Grep, SMC Global, Barclays Securities, Kredent, Pace, Religare Securities, NYCE, Motilal Oswal, Kotak Securities, DE Shaw, Crimson, Advent, Mansukh Stock Brokers, JM Global, AB Financial, Indus Broking and Quant Broking.[16][17]

According to the forensic audit reports by EY India, Deloitte Touche Tohmatsu LLP & ISB, 62 brokerages have enjoyed preferential access though NSE’s HFT platform and at present SEBI has only served the SCNs to 3 firms namely- OPG securities, its associate firm-GKN securities and Way2Wealth.[18]

The CBI investigation revealed that 90% of the time OPG securities, in collusion with unknown officials of the NSE, was first to access the NSE servers.[19] SEBI’s TAC report also revealed that OPG securities was given access using the co-location facility during 2010-2014 that enabled it to log in to the NSE server before any other entity and receive data before any other broker in the market.[20][21] SEBI has alleged in its show-cause notice that the firm has earned close to ₹ 25 crore in profit.[22]

According to the whistle-blower, OPG Securities alone had trades worth over Rs. 6,000 crore on the NSE using co-location.[23] In addition, the exchange's "order book" was exported to FIIs and FPIs, helping them make illegal gains in the stock market.[24][25] While OPG Securities used the base technology, Omnesys Technologies provided the trading software. Whistle-blower Ken Fong's letter points to Bangalore-based, front-end technology provider Omnesys, a company that sold trading software to NSE's members and is said to have benefited, legitimately, from its ability to connect ahead of others to the exchange's servers. The whistle-blower states Omnesys was so sure of the early bird strategy that it had profit-sharing arrangements with clients.[24] Omnesys gave the technology to NSE members on a profit-sharing basis and the NSE’s wholly owned subsidiary secured 26 per cent stake in Omnesys at a huge discount.[26] Chitra Ramakrishna, NSE's then-deputy managing director, was sitting on the board of Omnesys technologies according to documents from the registrar of companies.[27] As the whistle-blower mentioned in his first letter dated, 14 January 2015, Omnesys was the market leader with its DMA product being highly popular on the institutional desk. This is important since the NSE was the second largest shareholder of Omnesys and worked closely with them for several years.[28]

Action by Agencies against perpetrators

SEBI Action

In November 2015, the whistle-blower’s letter referred to SEBI’s technical advisory committee (TAC) report that concluded in March 2016, that NSE systems were prone to 'manipulation' and thus recommended an investigation.[20] This was when SEBI directed the new NSE board to conduct a forensic audit of its systems and deposit revenue from co-location trading in an escrow account.[29] This was a blow to NSE’s plans of going public as the co-location server facility stream accounted for nearly 35–40 per cent of the NSE’s core revenues.[21] The NSE added public interest directors to its board. They include: Ashok Chawla, former finance secretary; Naved Masood, former secretary in the Ministry of Corporate Affairs; TV Mohandas Pai, chairman of Manipal Global Education Services; Dinesh Kanabar, former deputy CEO of KPMG in India, and Dharmishta Raval, former SEBI executive director.[30] The board then appointed Deloitte to conduct a forensic inquiry. The Deloitte report, submitted to SEBI on 23 December 2016, found that the exchange's tick-by-tick (TBT) system was prone to manipulation and restated the findings by the SEBI panel that some stock brokers obtained preferential access to servers.[31] The NSE also admitted this in its draft prospectus.[32] In a written reply, Minister of State for Finance, Arjun Meghwal told the Lok Sabha in 2016: "The architecture of NSE with respect to dissemination of tick-by-tick through transmission control protocol (TCP) or internet protocol (IP) was prone to manipulation or market abuse. And this system has been discontinued by NSE from 3 December 2016."[21] SEBI’s action so far has been to nudge the NSE into conducting investigations by two big global consulting firms, Deloitte and Ernst & Young, despite the fact that both had a potential conflict of interest, having handled major projects or consulting assignments for the bourse. Ravi Narain, as MD and CEO of the NSE, was also the head of the sub-committee which chose Deloitte for the forensic audit of NSE, despite being fully aware that Deloitte was working on a large project for NSE’s disaster recovery centre (DRC). This was a clear case of conflict of interest.[33][21] In July 2018, SEBI issued a second show cause notice to the NSE, many of its former and existing executives, and senior officials alleged to have violated the SEBI Act, Securities Contracts (Regulation) Act, 1956 and Prohibition of Fraudulent and Unfair Trade Practices and broker regulations.[34] The notice comes even as the CBI has booked brokers and unidentified officials at the NSE and SEBI for preferential access through the co-location service.[35][36] In August 2018, the Madras High Court issued notice to SEBI seeking appropriate action against NSE employees for the alleged fraud in co-location services and directed SEBI to file its response.[37] SEBI has already initiated adjudication proceedings against NSE and around 30 entities involved in this scam.[38][39][40] However, SEBI will take a call on consent plea only after final judgment by the Madras High Court HC on writ petition filed against NSE.[41]

NSE vs. Moneylife Case

On 8 July 2015, Sucheta Dalal wrote an article on Moneylife's portal alleging that certain NSE officials were leaking sensitive data related to HFT or co-location to a select set of market participants so that could trade faster than their competitors.[42] The article was based on an alleged complaint made to SEBI in January by an official of a Singapore-based hedge fund. The whistle-blower’s first letter came from Singapore and was addressed to BK Gupta, deputy general manager of SEBI, and dated 14 January 2015. It was copied to Sucheta Dalal from Moneylife.[28] The co-location scandal came to light when the NSE filed a defamation suit on 21s July 2015, claiming damages of Rs.100 crore in the Bombay High Court against Moneylife, to stop the publication and circulation of the article. However, the court dismissed the case and asked the NSE to pay Rs.1.5 lakh each to journalists Debashis Basu and Sucheta Dalal. The court also imposed a penalty of Rs.47 lakh on the NSE to be paid in the form of a donation to Masina Hospital and Tata Memorial Hospital in Mumbai. The court also ordered SEBI to investigate the charges levelled by the whistle-blower.[43]

References

  1. ^ "Top NSE Officials 'Facilitated' Co-Location Fraud, Says SEBI Show-Cause Notice". 2018-08-18.
  2. ^ "NSE whistleblower's 4th letter alleges rigging of currency market; manipulation at NSE". 2018-08-10.
  3. ^ Basu, Debashis (2018-08-20). "Should NSE be allowed to file 'Consent Terms'?". Business Standard India.
  4. ^ "NSE moves Sebi to settle co-location scam". 2017-07-21.
  5. ^ "Co-location case: I-T dept conducts searches on NSE brokers". Times of India.com. 2017-06-21.
  6. ^ "Letters from a whistle-blower to SEBI on NSE rot". 2015-09-27.
  7. ^ "Algo Scam: SEBI's Show-cause Notice to NSE 14 an Escape Route?". moneylife.in. 2017-06-06.
  8. ^ "Moneylife's NSE Expose: Why the battle against the stock exchange is not just their own". thenewsminute.com. 2015-11-01.
  9. ^ "Why Income Tax officers are zeroing in on Ajay Shah". sundayguardanlive. 2017-11-26.
  10. ^ "Is NSE becoming its own Judge, Jury and Acquitter?". pgurus.com. 2017-11-19.
  11. ^ "Sebi finds lapses at NSE in co-location case, issues show-cause notices to related parties". The Financial Express. 2018-07-05.
  12. ^ "Sebi finds lapses at NSE in co-location case, issues show-cause notices". Business Standard. 2018-07-05.
  13. ^ "I-T dept brings in ED to check money trail in NSE co-location case". Business Standard. 2017-11-21.
  14. ^ "NSE Co-Location Case: CBI Books OPG Securities Owner, Others For Manipulating NSE System". 2018-05-30.
  15. ^ "Algo Scam: SEBI's Show-cause Notice to NSE 14 an Escape Route?". 2017-06-06.
  16. ^ "NSE co-location case: SEBI heat now on brokers who logged in first repeatedly". 2017-10-12.
  17. ^ "NSE co-location audit: 3 brokers misused secondary server and ignored exchange warning". 2018-08-01.
  18. ^ "NSE algo trading case: 62 broking firms may have had preferential access to NSE servers". 2019-01-11.
  19. ^ "Ajay Shah: Cambridge Analytica-style mastermind of financial markets". 2018-06-09.
  20. ^ a b "First Information Report" (PDF). 2018-05-28.
  21. ^ a b c d "NSE crisis: Will Sebi initiate a deeper probe into the alleged unfair trade practices?".
  22. ^ "SEBI Co-Location Probe: How Much OPG Gained With First Access To NSE's Server". 2018-08-21.
  23. ^ MUCH–SUPPRESSED BY NSE: SEBI’S TAC REPORT
  24. ^ a b "Letters from a whistle-blower to SEBI on NSE rot". 2018-09-12.
  25. ^ "Why Income Tax officers are zeroing in on Ajay Shah". 2017-11-26.
  26. ^ "National Stock Exchange of India Limited Twenty-Thirds Annual Report (2014-2015)" (PDF). 2015.
  27. ^ "Why is NSE bogged in negatives? Maybe it needs to put protocol first". 2017-05-30.
  28. ^ a b "Blowing the Whistle on Manipulation in NSE". 2015-06-19.
  29. ^ "Sebi examining NSE directors' role in algo-trading investigation". 2017-05-28.
  30. ^ "The Times Group".
  31. ^ Basu, Debashis (2018-08-19). "Should NSE be allowed to file 'Consent Terms'?". Business Standard India.
  32. ^ "Letters from a whistle-blower to SEBI on NSE rot | mydigitalfc".
  33. ^ "Perilous Monopoly | Outlook Business".
  34. ^ "NSE Gets Second Show-Cause Notice from SEBI in Co-Location Probe".
  35. ^ "Co-location case: CBI names NSE, SEBI officials, OPG Securities".
  36. ^ Pandey, Devesh K. (2018-05-30). "CBI books stockbroker for illegal NSE access". The Hindu.
  37. ^ "Madras high court puts Sebi on notice in multicrore stock trading scam - Times of India".
  38. ^ "Sebi initiates adjudication against NSE, others in co-location case". 2018-12-12.
  39. ^ "NSE Algo Scam: SEBI Initiated Adjudication against 28-30 Members". 2018-12-12.
  40. ^ "Sebi initiates adjudication against NSE, others in co-location case". 2018-12-12.
  41. ^ "Sebi keeps NSE's consent petition on hold in the co-location case". 2019-01-11.
  42. ^ "Moneylife's NSE Expose". 2015-09-01.
  43. ^ "NSE withdraws its Rs100 crore defamation suit against Moneylife, pays Rs50 lakh as cost and penalty". 2017-09-12.
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