Has the Securities and Exchange Board of India (SEBI) let off the National Stock Exchange (NSE) rather lightly for its series of reckless behaviour in what is called the algorithm (algo) scam? Or is the Rs1,100-crore penalty (including interest for five years) imposed on India’s leading Exchange harsh? Opinion on the issue is divided; but most people believe that the Exchange has got away lightly. After all, SEBI’s order on the algo scam starts its conclusions saying: “To sum up, even though sufficient evidence is not available before me to conclude that the Noticee No.1, NSE has committed a fraudulent and unfair trade practice as contemplated under the SEBI Regulations…”
Yes, after as many as seven investigations, including forensic audits and five separate orders into the algo scandal, SEBI has not been able to prove fraud, collusion or quantify illegal gains. In fact, after reading the orders, which detail the charges and the defence of each of the noticees, before recording its conclusions, one gets the feeling that SEBI has simply not done enough to use its draconian powers to investigate and establish wrongdoing or illegal gains by those who manipulated the system.
Desktop Investigation
In July 2013, the Securities &Exchange Board of India (SEBI) Act and two others Acts that define its operations, were amended to give it extensive powers of search & seizure, attachment of properties, arrest and detention of defaulters and pass disgorgement directions to recover the wrongful gains made in contravention of laws. It also got powers to seek information from other regulators in India and abroad and, finally, to settle complaints.
And, yet, in the biggest investigations that it has conducted, against the largest market infrastructure institution (MII) and first-line regulator under its watch, it did not use any of these extensive powers of search, seizure, attachment, detention, etc.
Instead, SEBI opted for what is called a ‘desktop’ investigation, which was limited to examining email records and ordering the NSE itself to commission investigations without even tackling the various conflicts of interest that were evident to everybody right then. It is almost as though SEBI has got so used to regulatory capture by the NSE, that its officials feel too diffident to adopt a tough line.
Of course, SEBI insiders would counter this strongly by pointing to the fact that there is a brand new board and a new managing director (MD) and chief executive officer (CEO) at the NSE, and, despite the failure to establish fraud, culpability or ill-gotten gains, it has nailed the Exchange on lack of due diligence, unfair access, permitting asymmetry in information, allowing unfair trading access and preferential treatment to some, lack of operating procedures, etc.
In a separate order on the dark fibre episode, it talks of mismanagement of the co-location facility (that allowed faster access to large traders by locating their servers in the Exchange), working in connivance with unauthorised service-providers and unfair dealing. If you look closely at the orders, all the allegations made by the whistleblower, which Moneylifefirst published in 2015 (and the three subsequent ones), have been established; but SEBI’s investigation hasn’t managed to go beyond that, to unearth wrongful gains. One saving grace is that SEBI has honourably let off several present and past executives who had been needlessly dragged into the proceedings.
In all the five orders, SEBI hasn’t even attempted to establish NSE’s non-cooperation and refusal to provide information, which we have been told time and again by various insiders and was part of every investigation report.
SEBI’s orders made headlines, mainly because of the Rs1,100-crore penalty (Rs624.89 crore at 12% interest) imposed on the Exchange seems large by Indian standards and its indictment of two former MDs, viz., Ravi Narain and Chitra Ramakrishna, who were part of the Exchange’s founding team and ruled the capital market for over 25 years. SEBI has barred them from the capital market for five years and asked them to disgorge a part of their salaries for the relevant period.
While the penalty is considered huge and unreasonable by some commentators, the NSE and the brokers have got off lightly. In fact, I would argue that this may be even better than a settlement by consent, which had apparently been proposed by the NSE but was rejected just a few hours before SEBI issued its orders. NSE’s foreign investors, keen to get the stock listed, are correct in suggesting that the Exchange should pay up and put the problem behind it.
Consider the options before it.
Already, over 40% of NSE’s earnings from the colo facility are being impounded under SEBI’s orders and placed in an escrow account since December 2016. If it challenges the order, this situation will continue for at least four to six years, before a final judgement from the securities appellate tribunal (SAT) and the Supreme Court. Then, too, it may only be a partial victory, since it is hard to believe any regulator will give it a clean chit, given that multiple reports have established widespread negligence on the part of the Exchange.
The NSE can pay up and move on. If not, the only winners will be the multiple, expensive law firms that it will employ to fight its case. In fact, the more the adjournments and delays, the more the firms will earn.
If the NSE decides to fight the order, it will raise some intriguing questions about SEBI’s boast that it has already effected a complete clean-up of the top management by changing the entire board as well as the MD and CEO.
Interestingly, ever since Vikram Limaye, the present MD and CEO, took over, he has been at pains to make a break from the past and has been at pains to mend equations with all stakeholders (which he admits were shattered). If the NSE chooses to contest SEBI’s order, this would signal that the Exchange wants to continue with the hubris that led to its downfall.
On the other hand, if it accepts the order, the amount that will be paid is less than the sum that is already impounded. Moreover, given that the business of the Exchange itself is unaffected, it can use the six-month period when it is barred from the market to work on its initial public offering (IPO) which will still attract a lot of support. The NSE is not the first major exchange in the world that has suffered such a setback and grown past it. Both, NASDAQ and New York Stock Exchange (NYSE) have had their share of scandals, but have dealt with them and moved on.
The same goes for the three brokerage firms that have already rushed to the SAT seeking a stay on SEBI’s orders. These are large firms who access expensive co-location facilities because of the sheer size of their trades. The penalties imposed on them are not very significant. They could not possibly have expected to get away easier in a consent proceeding where they would pay up without admitting or denying guilt.
To my mind, this timid investigation by the regulator is a big worry. For a decade or more, since CB Bhave became the SEBI chairman, the NSE has had the regulator in its grip and was allowed to ride roughshod over competition, intermediaries, investors and even the media. It has, often, defied even the regulator, refused to provide information and dictated terms. Even when there was an investigation, SEBI’s orders against the big bourse have not gone beyond issuing a warning.
SEBI has two orders on the Ajay Shah episode, where he and his sister-in-law, Sunita Thomas (whose husband Suprabhat Lala headed NSE’s market operations at one time), have been indicted along with a few others. The entire episode underlines how Ravi Narain and Chitra Ramakrishna, who were close friends of this group of academics and intermediaries, ran the Exchange like a private club. Their relationship was common knowledge, within the Exchange and at the regulator; and, yet, no question on conflict was raised until the algo scandal broke out and all these relationships came in for scrutiny due to a specific complaint.
When SEBI ordered a clean-up of the Exchange leading to the exit of Ravi Narain, Chitra Ramakrishna and her confidant Anand Subramaniam (who had parachuted into the number two position at the bourse without appropriate qualifications or appointment processes being followed), it seemed as if the regulator was, finally, calling the shots.
The biggest irony is that the NSE was set up to cut the Bombay Stock Exchange (BSE) to size, because it was operating like an unruly brokers’ club. The ‘professionally’-run NSE, which was initially a shining contrast, was allowed to turn into a bigger monster, with powerful political and bureaucratic support and just two people calling the shots and controlling its own board as well as the market regulator. Will this order against the NSE, finally, change the equation between the regulator and intermediary? The real test of the efficacy of this order will be if SEBI emerges free from regulatory capture.
1.SEBI issues five separate orders in the algo trading or Colo scam on 30th April.
2.NSE to deposit Rs624.89 crore at 12% interest, plus Rs62.5 crore in dark fibre case (totalling around Rs1,100 crore) in SEBI’s investor education and protection fund and barred from accessing capital markets for six months in two separate indictments.
3.Two former MDs Ravi Narain and Chitra Ramakrishna indicted, barred from being associated with any market intermediary or market infrastructure institution for five years; ordered to disgorge portion of their salary for relevant period and credit it to the investor fund.
4.OPG Securities Pvt Ltd barred from accessing capital markets for five years and fined Rs15.57 crore for securing unfair access to NSE’s systems.
5.Economist Ajay Shah, his sister-in-law Sunita Thomas and her firm Infotech Financial Services Pvt. Ltd and director Krishna Dagli accused of conflict of interest and misuse of confidential trading data for writing algorithm-based software. The NSE asked to initiate action against them. Mr Shah also barred from holding a management position or associating with any exchange, clearing corporation and brokerage firms for two years. Sunita Thomas and Infotech cannot provide services to any SEBI-registered firm for a period of two years.
6.Suprabhat Lala, associate vice-president of NSE and husband of Sunita Thomas, barred from positions at MIIs (market infrastructure intermediarieis) for two years.
7.Ravi Varanasi, NSE’s chief of business development, barred from holding positions in MIIs and associating with listed companies for a period of three years in dark fibre case.
8.OPG Securities fined and its directors Sanjay Gupta and Sangeeta Gupta barred from accessing the securities market for five years.
9.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.
10.W2W and GKN were 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.
It is a foregone conclusion that NSE, its officials,its high profile economist consultants & the brokers, all of them have got away lightly for the unfair trading practices and fraud. This was gleefully admitted in no uncertain words by the current incumbent CEO/MD in a public interview as well.
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