An independent agency, appointed to conduct a forensic audit of National Stock Exchange (NSE)'s algo trading system and examine unfair access to some brokers in algorithmic trading have found the allegations to be true, reveals the draft red herring prospectus (DRHP) filed by the Exchange for its Rs10,000 crore initial public offering (IPO).

While NSE refrained from mentioning name of the independent agency, according to reports it was Deloitte India. According to the Agency's findings, the system architecture of the NSE’s transmission control protocol (TCP) or internet protocol (IP) based tick-by-tick (TBT) system was prone to manipulation. The TCP-IP based TBT system architecture indicated that data was disseminated in a sequential manner whereby the stock broker who connected first to the server received ticks (market feed) before the stock broker who connected later, it said.

The same was also confirmed by the government. Earlier this month, in a written reply in the Lok Sabha, Arjun Meghwal, the Minister of State for Finance, stated, “Preferential access was given to stock broker(s), wherein it was possible for stock broker to log into multiple dissemination servers through multiple internet protocols assigned to him. It was also possible for a single member to have multiple logins to a single dissemination serve through multiple IPs assigned to it. It was observed that stock broker(s) had multiple advantages by logging in first or even second and third.”

Here are the observations of the Independent Agency, which NSE, in the DRHP filing says that it had forwarded to the SEBI.

1. The system architecture of the Company’s TCP-IP based TBT system was prone to manipulation. The Independent Agency’s analysis highlighted trends for certain periods where a few stockbrokers appear to be the first to connect to specific servers significantly more often than others. The TCP-IP based TBT system architecture indicated that data was disseminated in a sequential manner whereby the stock broker who connected first to the server received ticks (market feed) before the stock broker who connected later;
2. The Independent Agency observed indications of potential preferential treatment to a few stockbrokers. Different stockbrokers were treated differently and there was no uniform approach applied across stockbrokers with respect to allocation of new IPs across ports on existing servers and movement from one server to another. Ticks were disseminated faster to members connected to less crowded servers, thereby giving an advantage to such stock brokers;
3. The Independent Agency’s analysis indicated that one particular stockbroker almost consistently connected first to the fall back or secondary server during the period from 10 December 2012 to 30 May 2014 and was very often also the second stock broker to connect during this period. The Independent Agency observed that the particular stock broker’s continuous access to the fall back or secondary server during the period from 10 December 2012 to 30 May 2014 may not have been possible without the knowledge of certain employees identified in the report, who did not take any action despite consistent connections to the fall back servers against protocol;
4. In order to ensure that norms of fair access were not breached, it was possible for our Company to negate the advantage of connecting first by implementing a randomiser for the TBT systems which would randomly pick a connection to begin dissemination of data, though a randomiser was implemented in another server;
5. The Independent Agency has observed that while it has not validated the performance of the Multicast TBT system (which was introduced in April 2014) in an operating environment, on the basis of a review of the architecture of the Multicast TBT, the issues related to benefits from early connectivity and sequential dissemination of ticks appear to have been addressed.
6. In relation to the question of whether we breached our own policies by permitting entities that are not internet service provider to lay fibre optic cables at our co-location facility for various stock brokers, the Independent Agency has observed that in the absence of a specific policy and operating procedure, it appears that our Company relied on such entities’ undertakings rather than satisfying itself about the entities’ status as a licensed provider of point to point connectivity;
7. While the Independent Agency observed indications of differential behaviour being shown towards a few stock brokers by certain employees identified in the report, the Independent Agency has stated that it is not in a position to comment on whether this would amount to collusion or connivance;
8. The Independent Agency observed lack of documented policies and protocols with respect to various aspects of the functioning of the TBT system; and
9. After our Company confirmed completion of the data restoration exercise for all TBT servers, the Independent Agency came across additional TBT servers which had not been put through the restoration process, and the persons interviewed by the Independent Agency were unaware of them.

The Independent Agency has also made observations that due to absence of protocols related to data retention, email and other information for certain former employees of NSE was unavailable.

NSE says on 19 December 2016, its Board took on record the report given by the Independent Agency and decided to initiate a review of its Multicast TBT systems, including the processes and procedures, data retention, job rotation, mandatory leave, and segregation of duties. The Exchange says, on 23 December 2016, it has forwarded the review report to market regulator SEBI.

Earlier in 2015, when Moneylife published two articles about algo trading in NSE, based on letters received from a Whistleblower, the Exchange filed Rs100 crore defamation suit. This, however, was dismissed by the Bombay High Court. NSE then filed an appeal before a Division Bench of Bombay HC, which is now pending before the Court.

In its DRHP filing, NSE had stated the amount involved in this court matter is Rs118 crore. As per the order from the Single Bench of HC, the Exchange was asked to pay Rs1.5 lakh each to Moneylife's Editor & Publisher Debashis Basu and Managing Editor Sucheta Dalal as costs and Rs47 lakh to two trusts, Tata Memorial and Masina Hospital from Mumbai as donations.