NSE Dark Fibre Scam: SEBI Alleges Manipulation, Irregular Acts, Poor Due Diligence, Fraud, Misrepresentation and False Statements
Following its investigation of a whistleblower’s complaint, market regulator Securities and Exchange Board of India (SEBI) has established the nexus between senior officials of the National Stock Exchange of India Ltd (NSE) and Sampark Infotainment Pvt Ltd, which was allowed to provide brokers connectivity to co-location (Colo) without any valid license. NSE has been directed to deposit Rs62.58 crore to SEBI’s Investor Protection and Education Fund (IEPF), as a punitive action against this negligence.
The SEBI order alleges mismanagement, manipulation “irregular acts, absence of due diligence, misrepresentation and false statements” in the whole “dark fibre” episode.
"...the way the Colo facility has been mis-managed and manipulated by certain trading members with the active connivance of an unauthorised service provider and the officials of NSE, as evident from the discussions and observations made by me in the earlier paragraphs of this order, shows NSE's apathy towards the principle of transparency, fairness and equity mandated by SEBI on them. Under the circumstances, the irregular acts, absence of due diligence, misrepresentation and false statements that have come to notice in this entire narrative of point-to-point (P2P) connectivity involving Sampark, have put a question mark on the corporate ethos and credibility of the exchange trading system...The roles played by all the noticees as highlighted above have cumulatively resulted into not only a fraud on the trading platform of a recognised leading stock exchange but also have upset the very foundation of a securities market institution that is built upon faith and confidence of the investing public at large," says SK Mohanty, whole time member of SEBI in his 202-page order.
A dark fibre or unlit fibre, with respect to network connectivity, refers to an already laid but unused or passive optical fibre, which is not connected to such active electronics or equipments which do not have other data flowing through them and are available for use in fibre-optic communication.
NSE, on 31 August 2009, had issued a circular for Colo, which allowed brokers to avail P2P connectivity since 2009. NSE Colo allows stockbrokers to take on rent specific racks designated for this purpose and co-locate their servers and systems within the exchange premises, in order to have a low latency connection to the exchange. The primary objective of co-location services is to reduce latency for connectivity to the exchange’s trading systems for direct market access (DMA), Algo trading and smart order routing (SOR).
However, in April-May 2015, NSE allowed Sampark Infotainment, an unauthorised service provider to give P2P connectivity to two brokers, Way2Wealth Brokers Pvt Ltd (W2W) and GKN Securities (GKN), from its Colo facility to BSE's Colo centre.
SEBI says, "Sampark allegedly laid dark fibre connectivity for these brokers with the promise of more bandwidth and lower latency for their data transmission and continued the service even after it was found that Sampark did not possess the necessary license from the department of telecommunications (DoT) to provide the required P2P connectivity to the brokers of NSE."
In May 2017, SEBI issued its first set of show cause notices (SCNs) to 11 entities, even as NSE had filed for consent mechanism. In July 2018, a second set of notices was issued, after SEBI recorded statements of various NSE officials, brokers and others involved.
The first SCN clearly mentions roles played by NSE officials to regularise the dark fibre connectivity provided by Sampark to give it post facto legitimacy. It states, "Arrangements between Sampark and Reliance Communications Ltd (RCom) were facilitated by NSE to regularise the irregular Sampark connectivity."
SEBI’s SCNs were backed by three detailed reports: SEBI’s technical advisory committee (TAC), NSE-appointed forensic auditor, Deloitte Touche Tohmatsu India LLP (Deloitte) and, finally, an independent audit by Ernst & Young. Significantly all three investigations established wrongdoing.
The reports said Delhi-based OPG Securities was consistently able to connect to NSE’s trading system ahead of other trading members, as alleged by the whistleblower’s letter. The TAC also found that the architecture of NSE with respect to dissemination of TBT through TCP/IP was prone to manipulation or abuse. (Read: TAC Report Proves Systemic Lapses at the NSE)
The second set of SCNs alleges that NSE has undergone practices of denial of services to certain stockbrokers resulting in discrimination and non-adherence to principle of fairness and equal opportunity.
In June 2015, two brokers Mansukh Securities and Finance Ltd and Millennium Stock Broking Pvt Ltd, had applied for connectivity between NSE and BSE through Sampark. However, stating that Sampark did not have the license to place a multiplexer (MUX) in meet-by-room (MMR) of NSE, Millennium’s request was rejected.
Mr Mohanty from SEBI, in his order, says, "I find that rather than addressing the issue of preferential treatment given to some stock brokers, NSE has made contradictory submissions. If NSE really did not have any say over the P2P connectivity so long as the connectivity terminated directly at the Colo rack, then it did not have any right to deny some stockbrokers to avail the P2P connectivity to their racks while allowing the same to a few others. Therefore, NSE cannot escape from the responsibility of providing fair and equitable access to the exchange infrastructure by taking the plea that the P2P connections taken directly to the racks of brokers are not within their jurisdiction. It becomes also pertinent to note that the other two stock brokers of NSE were denied the P2P connectivity through Sampark, inter-alia, on the ground that Sampark did not have the requisite license and the said facts came to the notice on 22 and 23 June 2015. However, the facility to W2W and GKN were continued and Sampark was allowed to continue to provide services to W2W and GKN."
"...while W2W and GKN got their connectivity from Sampark without any hassle and delay, Millennium had to continuously chase r NSE for Sampark connectivity till it was given connectivity by RCom on 5 September 2015, after Sampark sold its infrastructure to RCom," the SEBI whole time member added.
Millennium Stock Broking and Mansukh Securities, subsequently, availed connectivity from RCom on 22 August 2015 and 9 October 2015, respectively.
In its submission, NSE demanded action against BSE, while pointing out that by refusing to empanel Sampark, the BSE had allowed W2W and GKN to establish connectivity into the MMR of BSE Colo centre managed by Netmagic.
Mr Mohanty says, "I find that during the relevant period of time BSE had outsourced its Colo centre to Netmagic, a third party vendor, which was managing and renting out rack spaces to stock brokers in Colo centre. Unlike the Noticee (NSE), which had consciously adopted a policy of not permitting its registered stock brokers to establish direct connectivity from its Colo facility to their racks in BSE Colo centre as a matter of their own regulatory reasons, BSE did not have any such policy."
"...there were numerous instances of concerns regarding preferential treatment with regard to access to NSE Colo, discriminatory treatment with regard to site visit for some brokers and not for others, rejecting the application of Microscan Computers Pvt Ltd to provide service to Shaastra Securities Pvt Ltd, while at the same time allowing Sampark to provide connectivity to W2W and GKN, arranging the cabling within its Colo facility to provide unfair advantage to W2W, indicating fraudulent conduct on the part of NSE and its officials. I do not find any such concerns found in the investigation with respect to BSE Colo centre. Therefore, it will be erroneous to suggest that the facts in the case of NSE's Colo facility and the facts pertaining to BSE Colo centre are comparable," he added.
"...considering the gravity of the allegations that have been established against the NSE, additional exemplary directives need to be issued to the NSE, which could pose an effective deterrence and dis-incentive to the NSE to perpetrate such kind of violations in future so far as administration and governance of its Colo facility is concerned. In this regard, to meet the ends of justice and in the fitness of things, I deem it proper to direct NSE to deposit a reasonable portion of revenue earned by the NSE through its Colo facility during the period from 8 May 2015 to 10 September 2015 (i.e. the period during which Sampark was permitted to provide P2P connectivity to the two brokers) to the Investor Protection and Education Fund (IPEF) of SEBI, which would be utilised for the objectives of the IPEF."
For the illegality and denial of fair treatment to all stockbrokers in the dark fibre connectivity issue, NSE was asked to pay Rs62.58 crore along with an interest at 12% from 11 September 2015 till the payment is made.
NSE was asked to conduct an audit every six months for next three years of its network architecture and infrastructure of its Colo facility and its linkages to the trading infrastructure by an independent CISA/CISM qualified and CERT-In empanelled auditor.
Within next three months, SEBI has asked NSE to prepare a comprehensive documents policy, including guidelines, standard operating procedures and protocols for Colo facility.
Chitra Ramakrishna, the then managing director and chief executive (CEO) of NSE is barred from holding any position in any market player for the next three years. Similarly, Subramanian Anand, former group operating officer and ex-advisor to the MD at NSE is also barred for three years from holding any position in the stock market participant.
Ravi Varanasi, head of business development at NSE is also barred from holding a position or associate with any stock exchange, clearing corporation or depository for next two years. Nagendra Kumar SRVS, head of NSE’s membership department and Deviprasad Singh, head for Colo support at the Exchange, are also barred from holding any position for the next two years.
W2W’s CEO MR Shashibhushan, and directors CK Nithyanand and BG Srinath, GKN Securities’ partners Sonali Gupta, Om Prakash Gupta and Rahul Gupta and Prashanth D’souza, CEO of Sampark are also barred from holding any position with a market participant or entity for the next two years.
W2W and GKN was directed to pay Rs15.34 crore and Rs4.9 crore with an interest of 12%, respectively. Both the brokerages are also barred from taking any new client for the next one year and are not to undertake any trade for two years.