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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

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.[14] 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.[15] 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.[16] 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.[17] 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.[18] The NSE also admitted this in its draft prospectus.[19] 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."[16] 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.[20][16] 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.[21] 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.[22][23] 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.[24] SEBI has already initiated adjudication proceedings against NSE and around 30 entities involved in this scam.[25][26][27] 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.[28]

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.[29] 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.[30] 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.[31]

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. ^ Cite error: The named reference FIR was invoked but never defined (see the help page).
  15. ^ "Sebi examining NSE directors' role in algo-trading investigation". 2017-05-28.
  16. ^ a b c Cite error: The named reference NSE4 was invoked but never defined (see the help page).
  17. ^ "The Times Group".
  18. ^ Basu, Debashis (2018-08-19). "Should NSE be allowed to file 'Consent Terms'?". Business Standard India.
  19. ^ "Letters from a whistle-blower to SEBI on NSE rot | mydigitalfc".
  20. ^ "Perilous Monopoly | Outlook Business".
  21. ^ "NSE Gets Second Show-Cause Notice from SEBI in Co-Location Probe".
  22. ^ "Co-location case: CBI names NSE, SEBI officials, OPG Securities".
  23. ^ Pandey, Devesh K. (2018-05-30). "CBI books stockbroker for illegal NSE access". The Hindu.
  24. ^ "Madras high court puts Sebi on notice in multicrore stock trading scam - Times of India".
  25. ^ "Sebi initiates adjudication against NSE, others in co-location case". 2018-12-12.
  26. ^ "NSE Algo Scam: SEBI Initiated Adjudication against 28-30 Members". 2018-12-12.
  27. ^ "Sebi initiates adjudication against NSE, others in co-location case". 2018-12-12.
  28. ^ "Sebi keeps NSE's consent petition on hold in the co-location case". 2019-01-11.
  29. ^ "Moneylife's NSE Expose". 2015-09-01.
  30. ^ Cite error: The named reference moneylife.in was invoked but never defined (see the help page).
  31. ^ "NSE withdraws its Rs100 crore defamation suit against Moneylife, pays Rs50 lakh as cost and penalty". 2017-09-12.
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