The Securities & Exchange Board of India’s (SEBI) show-cause notice to 14 top officials of the National Stock Exchange (NSE) hit the headlines at the end of May. But is it really a step forward in the investigation into serious charges made by an anonymous whistleblower about mismanagement and worse in the high frequency trading (HFT) segment of India’s leading Exchange?

The notice, issued by Maninder Cheema of SEBI, runs into a massive 350 pages (mainly padded up with correspondence and investigation reports). However, on reading the omnibus show-cause notice, slapped on ‘key management persons’, it appears more like a winding up procedure rather than punitive action.

SEBI’s notice copiously cites provisions from various regulations to charge the 14 officials with failure to ensure ‘fairness’, ‘transparency’ and ‘equitable’ dealing, without attempting to pinpoint responsibility even after two detailed investigations—one by SEBI’s technical advisory committee (TAC) and a forensic audit by Deloitte Touche Tohmatsu India LLP (Deloitte), both of which have corroborated the charges made by the anonymous whistleblower.
Moneylife was the first to bring the whistleblower’s letter to public attention and was sued by the NSE for its effort.

It is common knowledge that three or four persons in the NSE’s top management called the shots (they certainly took the credit for every success, as would be evident from an analysis of salaries and payments from the NSE’s Employee Welfare Trust); yet, all 14 seem to have been jointly and severally held responsible for management and policy decisions as well as operational issues.

The notice is largely a narration of the findings of SEBI’s TAC and the Deloitte report, much of which is already in the public domain. The main charges are that NSE’s tick-by-tick (TBT) system architecture was prone to easy manipulation and allowed brokers to connect first to get a price advantage; brokers who connect first through multiple IPs (internet protocol) could ‘crowd out’ others; and, certain brokers were given access to servers (including back-up servers) which had less of a load, giving them a big price advantage. Further, NSE had no standard operating procedures (SOP) for allocation of members to co-located (colo) servers, or documented policies and protocols with regard to various aspects of the TBT system, or retention of electronic records for key officers. There were oral instructions from ‘seniors’ about allocation and switching of colo servers. Requests by some brokers were entertained with alacrity while others were curtly denied. The upshot was that the favoured brokers reaped huge profits. Both, TAC and Delloitte, have documented the fact that NSE’s officials often misled them or did not cooperate in the investigation.

The enormity of these systemic issues and favouritism is evident when you consider the fact that the algorithm-based HFT whipped up average trading volumes of nearly Rs3 lakh crore a day in 2015-16 and large institutional brokers invested significant sums of money in technology and colo servers precisely to get that nano second of advantage in accessing prices. So let’s look at what one would have expected to find in the show-cause notice.

1) The SEBI notice says that that the NSE management dismissed charges made by the whistleblower (sent by SEBI to NSE on 9 February 2015 and 9 July 2015) as “completely baseless, devoid of facts and imaginary.” In the light of subsequent findings, shouldn’t senior management be specifically asked to explain the basis of the denials?

2) SEBI notes that the NSE allowed a non-ISP like Sampark Infotainment to lay fibre in its premises for various members in violation of its own policy. The dark fibre connected NSE and the Bombay Stock Exchange (BSE) and allowed one firm, Alpha-Grep, to benefit substantially before connectivity was opened up for others. Surely, this ought to have been an easy issue on which to pin specific responsibility for the decision? Especially when SEBI’s TAC report details how Sampark Infotainment and Reliance Sampark officials had visited the NSE nearly 120 times to survey the site, lay the ‘dark fibre’ link and do the testing.

3) SEBI’s notice makes no mention of the sudden increase in turnover of Alpha-Grep (a subsidiary of Way2Wealth Capital Services, which has a powerful political connection), although it is confirmed by the TAC report. The overall trading turnover of Ways2wealth increased from 3.31% in January 2014 to over 9% in the second half of 2015, says the TAC. And, its share of algo-trading on the Exchange increased from 12.98% to over 25% in the same period. Elsewhere, it notes that Ways2Wealth’s turnover increased from 7.5% in April 2015 to 12% by August 2015, and dropped to around 10.6% after December 2015, “presumably as a result of other brokers being allowed to lay their colo line.” Hence, it says, “we can causally attribute” the increase in market share to laying the ‘dark fibre’. It is interesting that SEBI’s notice does not mention any of this and stops at noting that the NSE violated its own policies by allowing Sampark Infotainment to lay a dark fibre link to connect with the BSE. Surely, this was not a collective decision by 14 NSE employees?

4) The notice says that NSE “employees, including key management persons, have not cooperated with SEBI, Expert Committee as well as the forensic auditor” and that they “failed to provide requisite information sought by SEBI.” Again, there is no charge against specific individuals, although some of them had quit before the investigation began.

5) The forensic audit has raised serious questions about three persons, namely, Jagdish Joshi (especially), Avdhut Gharat and Mahesh Soparkar, in helping OPG Securities, which was allowed to log on to less crowded servers and allotted multiple log-in IPs. SEBI’s notice documents these observations and the fact that OPG Securities wrote to these three officials “thanking them for their support in terms of prompt response and useful advice in making their operations more efficient.” OPG Securities has moved the Delhi High Court, challenging the NSE’s claim that it had logged on to the secondary server, despite several warnings. It will be interesting to see if NSE is able to produce any of the warning letters.

6) The forensic audit specifically noted that Jagdish Joshi was very prompt in responding to OPG Securities and not to others like Barclays Capital, Adroit Financial and Pace Stockbroking. The last mentioned had its request to switch to a better server curtly turned down on the grounds that “we don’t change parameters on member request.” There is extensive documentation of how brokers, like OPG, used as many as 22 IPs to log into colo servers first and crowd out others from getting prices before it in the TBT system.

All this highlights rampant favouritism. SEBI quotes the forensic report which says, “It may be relevant to note that MTBT (multicast tick by tick) was introduced in April 2014 and Jagdish Joshi left the NSE in May 2014, after which we have seen a decline in the number of first connects.” And, yet, the notice has no specific charge against any individual.

Media reports, as well as our own sources, say that the NSE is seeking legal advice and is most likely to seek a closure by filing consent terms. This is apparently to allow the Exchange to move ahead, free the funds that SEBI has ordered to be impounded in an escrow account, and go ahead with its public issue. Allowing this without a complete clean-up would be dangerous for the markets at a time when the derivatives turnover has soared to over Rs8 lakh crore on 1 June 2017. It will only set up the Exchange for a similar misuse in future and could make the market vulnerable to a possible flash crash.