Author: Kavidharani R, Presidency University, Bangalore
Introduction
Allegedly, the NSE co-location scam represents one of the largest cases of market manipulation, with some traders of its stock market acquiring information a millisecond before everyone else, constituting a miscarriage of transparency in the stock exchange.
The controversy broke out in January 2015 after a whistleblower wrote a letter alleging that some trading members had colluded with officials at the NSE to have prior knowledge of the data, by which they benefited in making profits while executing high-frequency trades. The market manipulation is estimated to involve around ₹500 billion across five years.
The scandal is in the co-location facility launched way back in January 2010, which was meant to give traders faster access to trading information. But it appears that brokers took undue advantage to mint huge profits.
The SEBI, CBI, and the Income Tax Department have been investigating whether there indeed was collusion between the NSE officials, SEBI staff, and the brokers. The case has reached the Madras High Court, which has reportedly issued a notice to the SEBI and other agencies, hearing a Public Interest Litigation (PIL) by the Chennai Financial Markets and Accountability (CFMA).
The probe is continuing to unravel all the mysteries of this big-ticket case and the regulatory loopholes that allowed this market scam to occur.
Resignations in NSE
For the first time, The Economic Times reported on May 22, 2017, that SEBI had served the show-cause notices to NSE, then headed by Chitra Ramkrishna, and fifteen people associated with the exchange, including its two former MDs, Chitra Ramakrishna and Ravi Narain. The notices were sent to Ravi Narain, then vice-chairman of NSE, and, who was the CEO and MD at that time of the alleged violations. Others who got the notice included Ravi Varanasi, the head of the surveillance department, and Suprabhat Lala, who headed the trading division at NSE from 2010-2013. Former technology heads Ravi Apte and Umesh Jain and former chief operating officer Subramanian Anand were among others who got the communication.
As market regulators tighten the noose, Ravi Narain resigned on June 2, 2017, while Chitra Ramakrishna stepped down at the end of last year in December 2016. In the markets, some media reports suggest her quitting was triggered by governance-related issues such as diminishing confidence ignited partly by the co-location issue and partly by the appointment of Anand Subramanian as Group Operating Officer and Advisor to MD, with a mandate to report directly to the MD, bypassing the Human Resources department. Board members scrutinized Subramanian’s appointment and fat salary, which ended in his exit in October 2016. Narain and Ramakrishna were part of the promoter team of the NSE 1994.
Following the show-cause notices, twelve of the fourteen highprofile executives, including Narain and Ramakrishna, had in July 2017 applied to SEBI to settle the co-location matter under the consent mechanism. This ADR allowed the accused party to settle by agreeing to penalize without admission or denial of the accusation. Meanwhile, while in this off period, Vikram Limaye took over as MD and CEO of NSE, declaring that he would resolve the co-location matter with SEBI. But the exchange’s ADR application returned yet again, considering it to be a more in-depth investigation by the CBI — in March 2018.
P. Chidambaram’s Conduit
The allegations rang out for P. Chidambaram regarding the misuse of office when he was a Finance Minister from 2004 to 2014 under the United Progressive Alliance regime. That also involves a close aide, K.P. Krishnan, who worked as a joint secretary and additional secretary for the capital market. The allegations say that P. Chidambaram was the man behind the NSE Co-location scam. In January 2010, the NSE surreptitiously launched high-frequency trading (HFT) and colocation facility without taking any SEBI nod. Normally, SEBI issues a discussion paper and gets views of its TAC before any such market launch, but in this case nothing of the sort was done.
There were concerns about the period of this indecision of SEBI when it was being alleged that favorably disposed IAS officials like C. B. Bhave, Chitra Ramakrishna, and Ravi Narain held major posts in the market regulators, SEBI and NSE. Their closeness to K.P. Krishnan and Chidambaram reportedly furthered the activities of NSE, including HFT, which made the stockbrokers and their clients, particularly the FII or Foreign International Investors very happy. Despite the repeated complaints of the Bombay Stock Exchange and the FT Group’s MCX-SX, SEBI did not halt this HFT system for several years.
NSE was reported to have provided its co-location facility to select FIIs close to Chidambaram as a DMA without formal SEBI approval. It has further been alleged that this facility and the laying of dark fibre between the NSE and the BSE had provided privileged information access to these select members. Installations of the nature have been likened to entering Fort Knox and therefore will never take place without high-level approvals, said to point towards probable involvement of the highest offices in the Ministry of Finance.
High-Frequency Trading and Market Manipulation
The NSE’s co-location facilities interoperated HFT traders into the same server, and then they acted in unison and controlled the market as per their requirement for five years. There were very influential lobbyists like Ajay Shah, an NIPFP professor-cum-ex-consultant in the Finance Ministry. As Shah was somewhat close to P. Chidambaram and K.P. Krishnan, he controlled decisively the design of the NIFTY50 and knew all the Algorithms and so on.
The whistle-blower’s letter has asserted that all these entities, under the garb of research, accessed granular time series data with the NSE. It further used such data to develop algorithmic programs that allowed brokers like OPG and Alpha Grep to be in an influential position in the market. Havingsuch access allowed them to critically gain an information upper hand with respect to the rest of the market participants, and make substantive profits, at the cost of fairness and transparency in the market.
Regulatory and Legal Actions
The probe by SEBI, CBI, and the Income Tax Department is getting to the bottom of the details of the NSE-colocation scandal and correcting the regulatory lapses that occurred in the web of such a colossal fraud linked to the marketplace. The Madras High Court’s action is in answer to a Public Interest Litigation (PIL) filed by the Chennai Financial Markets and Accountability (CFMA), which has exposed the wider ramifications of this scandal to market integrity and investor confidence.
Case law: NSE vs. Moneylife
In the July 8th, 2015 the journalist Sucheta Dalal wrote an expose in Moneylife’s portal wherein she accused certain top officials at NSE of leaking sensitive HFT and co-location data to a few market participants. This information allowed those participants trading sooner than the competition, thus getting undue market advantage. The story was brought forward by a whistle-blower in an official of a Singapore-based hedge fund who wrote a letter to SEBI in its Deputy General Manager, BK Gupta, marked it to Sucheta Dalal, Moneylife on the 14th of January 2015.
The co-location scandal became slightly more public after the NSE responded on July 21, 2015, with a defamation suit against Moneylife for damages to the tune of ₹1 billion, with the goal of having the article removed and pulped. The Dismissal on Oct 12, 2015, the Bombay High Court dismissed the suit, arguing that press freedom and functional journalistic activity are valid reasons to publish information that could possibly expose suspected market irregularities. The court has ordered the NSE to pay ₹150,000 each to journalists Debashis Basu and Sucheta Dalal. Besides, a penalty of ₹4.7 million was imposed on NSE, which shall be donated to Masina Hospital and Tata Memorial Hospital in Mumbai.
This judicial outcome not only came as a validation for the journalists but also stated the gravity of the allegations. Furthermore, the court urged SEBI to conduct a detailed investigation of allegations made by the whistle-blower so that claims of market manipulation and data leak were duly investigated. It happened to be one of the milestones in unfolding the NSE Co-location scam and alerted the intense regulatory oversight and transparency to be followed in Indian financial markets.
Conclusion
The co-location scandal at the NSE has revealed deep weaknesses in the governance and regulatory oversight of India’s financial markets. The allegations of market manipulation, unfair trading advantage, and collusions of NSE officials with a few brokers have severely dented the credibility of the National Stock Exchange. The exposure by the whistle-blower and ensuing investigation brought out the dire need for transparency and stringent implementation of market regulations.
The defamation suit against Moneylife and the subsequent penalization resulting from these legal battles reflect the critical role of investigative journalism in keeping the wrongdoings of powerful institutions in check. Of course, the changes are work in progress and aim at ironing out the problems at the systemic level by SEBI, CBI, and other regulatory bodies to restore investors’ confidence.
Strong, effective, and stringent mechanisms preventing such malpractices in the future need to be devised and implemented by the regulatory authorities as further investigations are carried out. Fairness and transparency in trading practices will be vital for maintenance of integrity in India’s financial markets and hence necessitates regulation towards the interest of all the investors.
