High-frequency trading is causing more and more concern, especially among global regulators
High frequency trading (HFT), through computer-generated algorithms, is something that few retail investors are even aware about, despite its massive role in our equity markets. According to a discussion paper of the Securities & Exchange Board of India (SEBI) in 2013, HFT accounted for a massive 94% of all trades in the equity derivative segment in a single month—February 2013—on the largest exchange. Stock exchange sources say that the percentage is probably higher today across the two national exchanges. HFT is automated trading conducted at microsecond speeds throughout the trading day. Large traders execute this by renting space to locate their servers within the stock exchange premises in order to get the benefit of faster transaction speeds. What are the implications of such trading?
According to a briefing note of the senior supervisory group (SSG) of global market regulators, put out in April 2015, “The risk that HFT activity specifically, and algorithmic trading more generally, poses to firms and the financial markets has sparked debate and raised concern among market participants and regulatory agencies globally.” The SSG comprises market supervision agencies from 10 countries and the European Union.
The concerns expressed by the group are:
Systemic risk is amplified and an error with an algorithm, at a relatively small firm, could cascade throughout the market.
Technology failures, exceptional or unanticipated market conditions could lead to a firm carrying significantly more risk overnight than it had intended, and without timely oversight.
Internal controls may not have kept pace with market complexity. More specifically, the note says, “malfunctions and outages at financial institutions and critical entities such as exchanges are not new, but their potential impact can be amplified.”
Losses can accumulate rapidly in the absence of adequate controls. The SSG note cites examples such as the “2010 Flash Crash (a large-order execution algorithm operating in an unexpected way), the 2012 Facebook IPO (an exchange system problem), and the 2012 Knight Capital incident (the malfunction of an order routing system).” The note says that regulatory action that followed these incidents “highlighted control shortcomings related to insufficient testing and new rules.”
Apart from international regulatory concerns and greater scrutiny of HFT trading, faster access to some traders has become a matter of litigation. According to a report in The New York Times, a group of large pension funds has filed a suit alleging that stock exchanges favour high-frequency traders at the expense of other investors. The pension funds allege that exchanges offer a number of paid services used by high-frequency traders, including detailed data feeds, special types of orders and the ability to place computer servers in the exchanges’ data centres. Thus, the exchanges have a “financial incentive to create an uneven playing field.”
In India, the first reporting requirement on SEBI’s new guidelines for HFT trading with additional checks & balances was issued in May 2015. These reports are due for the September quarter. While HFT was earlier available only to large traders who could pay hefty costs, fees and rent in the region of Rs40 lakh per annum, media reports suggest that it will be extended to smaller brokers with shared server space. Does this mean that SEBI has found an answer to all the issues that are of concern to global regulators? We don’t know; because the market watchdog gets away with generalised threats or instructions but remains unaccountable when it comes to specifics.
From not being sure about the applicability of its own regulation to issuing bizarre order of refunding money with 10% interest, SEBI’s repeated bungling under three different chairmen is shocking
The Securities Appellate Tribunal (SAT) on Tuesday set aside part of an order of Securities and Exchange Board of India (SEBI) that directed Osian’s Connoisseurs of Art to refund the unpaid amount of Rs102 crore raised from investors along with interest at 10% per annum. The Osian’s Art Fund was a CIS (Collective Investment Scheme) promoted by Neville Tuli, an art dealer. CIS is any scheme made by any company under which the contributions by investors are pooled, to receive profits.
The tribunal held that art funds came under the regulator’s (SEBI) jurisdiction and that Osian’s Art Fund was indeed a CIS. But the tribunal asked the regulator to re-examine its order to refund money. It said the regulator had not explained why Osian’s Connoisseurs of Art needed to return money to investors since the scheme neither offered guaranteed returns nor offered interest on invested amount. While passing this order, SAT has exposed how SEBI has repeatedly bungled in handling this case. Here is the sequence of events that shows how pathetic has been SEBI’s record in the Osian’s case.
Before the Scheme was launched: Osian’s Art Fund was launched in 2006. Osian claims in an affidavit that: “Prior to the launching of the scheme the appellant had formal meeting with SEBI’s Executive Director Pradeep Kar on February 15, 2006 and also had informal discussions and correspondence with SEBI on the question as to whether the scheme would attract registration under any of the regulations framed by SEBI. However, no response was received by the appellant from SEBI in that behalf. The SEBI chairman at that time was M Damodaran.
After the Scheme was launched: SEBI had begun its investigation of Osian in 2007, issuing a show cause notice to Osian on 12 October 2007. However, shockingly, SEBI officials went to sleep after issuing this show cause notice. Even as the show cause notice was pending, on 13 February 2008 SEBI had issued a press release, stating that Art Funds/Schemes were CIS and that floating such schemes without obtaining registration from SEBI would be in violation of Section 12 of SEBI Act read with Section 11 and Section AA of SEBI Act. In spite of the press release the appellant, Osian, has failed to apply for and obtain registration under CIS Regulations. Once again SEBI kept quiet. Osian was allowed to operate as it is. M Damodaran was the SEBI chairman till 18th February 2008.
After the Scheme ended: The scheme closed in 2010 and Osian was paying back only a part of the money and only selectively. One of them was A. K. Muthuswamy, of Chennai. He complained about Osian to SEBI. In shocking reply, SEBI told him on 31 January 2011 that the scheme was not covered under CIS and therefore, the investors, who have invested in the scheme of the appellant, cannot seek redressal of their grievances from SEBI. Remember, a few years ago SEBI had issued a show cause notice and also issued a press release about Osian being an art fund! At this time, the SEBI chairman was CB Bhave who left office in February 2011.
The matter went to the SAT. On 29 November 2012 SAT said that SEBI’s 31 January 2011 communication to Muthuswamy was wrong and directed SEBI to re-examine the issue in accordance with law. By an order passed on 15 April 2013, SEBI held Osian guilty of sponsoring and managing a CIS without obtaining certificate of registration from SEBI, in contravention of Section 12(1B) of SEBI act and Regulation 3 of the SEBI’s (Collective Investment Schemes) Regulations, 1999. By that order, Osian was directed to wind up the CIS and refund the monies collected but not paid to the investors. In addition, Osian was also directed to pay the amount of profits/income earned that is due to the investors as per the terms of its offer or pay interest at the rate of 10% per annum on the amount invested from the date of investment till the date of refund, whichever is higher. The SEBI chairman this time was UK Sinha, who is expected to end his term a little later from now.
Osian went to the SAT against this order arguing that it was not a CIS. SAT has now rejected this contention. “The scheme floated by Osian fulfils all the conditions set out Section 11AA(2) of SEBI Act and therefore, the decision of SEBI in holding that the scheme floated by SEBI falls within the scope of CIS cannot be faulted”, said the SAT Order.
However, the SAT Order also points out, “SEBI does not find fault with the scheme of Osian which neither offered guaranteed return nor offered interest on the amount invested. In such a case, on what basis Osian is directed to refund the amount invested with interest at the rate of 10% per annum is not set out in the impugned SEBI order.”
SAT goes on to say “…for the error committed by SEBI in misconstruing its own regulations and for the inordinate delay on part of SEBI in arriving at correct conclusion, whether Osian can be penalised by directing to refund the amount with interest at the rate of 10% from the date of investment needs consideration, especially when the scheme has come to an end in the year 2010 and the terms of the said scheme neither offered guaranteed return nor offered interest on the amount invested.”
SAT has said that although regulation 65 of CIS Regulations empower SEBI to direct refund with interest in appropriate cases, how in the facts of present case, directing refund of the amount invested with interest is justified, is not set out in the SEBI order of 2013.
Hence, the SAT ruled that it is setting aside the directions contained in the SEBI order, to the extent that it directs Osian to refund the monies at 10% interest per annum. Instead, the SAT Order has directed SEBI to decide those issues afresh after affording an opportunity of hearing to Osian and AK Muthuswamy.
PACL’s small investors from remote districts are in a panic about their investments, as the company gives them a run-around; but SEBI recovery proceedings can begin only after 11 November 2015, as per SAT order
Lakhs of investors who put their hard earned money in PACL formerly Pearls Agrotech Corp Ltd, a collective investment scheme (CIS), are in a panic about the fate of their investment after the company has been ordered to refund their money. It may be recalled that this company has raised a whopping Rs49,000 crore from people across the country, claiming to have bought them a stake in land, like a land mutual fund. PACL has also used India’s slow legal system very effectively to delay regulatory action for several years, while it continued to collect money from people. In fact, it has doubled the money raised, even after Securities & Exchange Board of India (SEBI) began action against it.
The All India PACL (Pearls) Investors Association, on 13 October 2015, organised a protest-cum-meeting of investors in Parbhani district of Maharashtra. The Association, led by Rajan Kshirsagar, has started collecting applications forms from all investors in PACL, in order to send it to SEBI for further proceeding. Thousands of people from Parbhani district had invested thousands of rupees in PACL and all are now facing a severe financial crunch, which is magnified by the drought in the entire region.
During the meeting, it was decided to call for a protest before the Collector at Parbhani on 2nd November demanding action against PACL. The Association also demanded seizure all assets of PACL by SEBI for refunding money to investors. SEBI should algo create a lien on PACL assets in proportion of money invested by investors, SEBI should create a system to record complaints from investors in Parbhani district within next 15 days. "SEBI should also take action against other 95 companies barred from conducting similar CIS schemes," Kshirsagar said in a statement.
Video recordings by the Association have stories about how people were convinced to become agents of PACL and have ended up persuading their family and friends to invest in the company.
Sangita Jadhav, from Jintur taluka, personally invested Rs1 lakh in PACL. She also made several others to invest money in the CIS. Sangita says she joined PACL in 2009 and brought several people into the scheme. But her condition today is so bad that these investors are continuously asking her for refund of their money and she had to even keep her mobile handset switched off for most of the days as she has no answer. According to her, for more than two years, PACL told her that the company had filed a petition in High Court. "How many times, I can give next dates to people. Even thought people in the PACL office continue to give future dates whenever we ask for refund of our money," she says.
Sangita says, "About 30 people from my village had invested money in PACL. The company stopped paying us since October-November 2013. The bonds, which I submitted for redemption in November 2013, are still unpaid. All investors are now thinking about taking out a morcha to SEBI and seek refund of our money.”
Another investor-cum-agent, Sudhakar Kshetre, says since he was unemployed, he joined PACL in 2007. "PACL had lot of expectations (from us) and since there was no other job available, I started working for them. From then, I made my relatives, friends and other people to invest about Rs10 lakh in PACL. This is apart from my own investment of around Rs30-40,000," he says.
"These people are harassing me for getting their money back. They say we invested money since you asked us to do so and since we do not know the company, you pay back (the money). 'You came to our house seeking money, now, you pay it back' is what people are telling me. Some people are even threatening to commit suicide in front of my doors. But I think, unless we all investors come together and take our case before SEBI, no money would come from PACL," Kshetre added.
Market regulator SEBI, the Securities Appellate Tribunal (SAT) and the Supreme Court have all ruled in favour of investors and directed PACL to refund money. SEBI, in a welcome move has started collecting applications or letters from all investors of PACL, both online and offline and sending it to the company for redressal. As per the order from SAT, the recovery proceedings can be initiated only after 11 November 2015, and till that time, investors will have to only wait.
If this is the situation in one small and remote district of Maharashtra, the plight of investors across India can only be imagined. Moneylife Foundation had written to SEBI asking it to create a separate email or format for PACL investors to lodge their grievances, especially since many are not very literate and are clueless about SEBI and the online complaint filing process of SCORES.
Hopefully, other organisations and activists will be able to help people in the process. Moneylife Foundation has said that it will be happy to work with SHGs and NGOs around the country to collate information in various languages and forward it to SEBI. Those who need its help may contact firstname.lastname@example.org .