NSE Allowed Preferential Access in Currency Market Too, says E&Y Report: NSE Algo Controversy
Three member brokers of National Stock Exchange of India Ltd (NSE) got secondary server access and received maximum ticks due to lack of defined policies and procedures by the Exchange, reveals a forensic review.
 
In the audit, Ernst & Young LLP (India) or EY, also pointed out multiple logins to a single server through multiple internet protocol (IP) addresses, allowed by four member team of NSE.  
 
"Analysis of batches received by members indicated that 92% of ticks were received first by members connected on ports of secondary server. We were also informed by NSE that secondary POP was always active for members to make connections and same TBT market data feed was disseminated to all the POPs including secondary POP. Based on PDC logs we noted that secondary POP had connected to PDC on each trading day after it was operationalized in February 2012. The top three members who connected to secondary server were Adroit Financial Services Pvt Ltd (461 days), Parwati Capital Market Pvt Ltd (441 days) and IKM Investors Pvt Ltd (421 days)," EY says in the report.
 
 
EY says, "We further noted that there were 21 members who connected only to the secondary server and not to any of the primary servers on at least one of the trading days. Below is the list of top 10 members who logged in only to secondary server on at least one of the trading days."
 
 
NSE provided their members a colocation (Colo), which is a paid facility for doing Direct Market Access (DMA) and Algorithmic Trading (Algo trading) within its premises at Bandra Kurla Complex in Mumbai. NSE offers Colo services across market segments, which are Cash Market (CM), Currency Derivative (CD), Interest Rate Futures (IRF) and Futures & Options (F&O) segments. Except those mentioned in the ‘NSE Colocation Guidelines’ released on 16 April 2012, the Exchange had not defined policies and procedures around secondary server access.
 
Through this Colo service, EY says members were able to receive real time tick-by-tick (TBT) market data broadcast. Dissemination of such TBT was done through transmission control protocol/ internet protocol (TCP/IP) in NSE architecture till 30 November 2016. The same TBT data was also shared through a multicast architecture since 7 April 2014.
 
NSE had appointed EY to conduct a forensic review of certain allegations around colocation facility provided by NSE in the currency derivatives and interest rate futures segments. EY reviewed TCP/IP tick-by-tick architecture, available process and policy documents, emails and electronic documents of relevant employees and relevant logs of dissemination servers that were operational from 1 January 2010 to 31 December 2015 at NSE. It submitted its report on 3 November 2017 to NSE Board. Later it held discussions with Securities and Exchange Board of India (SEBI)'s Technical Advisory Committee (TAC), which led to certain additional checks. EY completed the work and submitted its report on 18 May 2018. 
 
At NSE, there were three point-of-presence (POP) servers, including secondary with two ports each and consequently six independent dissemination queues. A member would need to be first on all the six ports across three POPs to be disseminated all the batches first on that trading day.
 
"Based on analysis of timestamp of batches received by member IPs, it was noted that around 28% to 55% and about 75% to 98% of batches were received first by members who had logged in first on respective ports of primary server and secondary server respectively indicating that a member logging in first on a port may not receive all batches first on that port," EY says.
 
The forensic report highlights how in the absence of defined policies and load balancing process, four members from NSE were assigning member IPs to ports manually. It says, "Based on our discussions with NSE team, we were informed that it was a practice (no documented policy) to limit the number of maximum IP allocations to a port of a primary POP to 30. Such assignment of member IPs to ports was done manually by four members within the PSM IICS team. We were also informed that a dynamic load balancing process was not implemented which would have distributed load evenly across the ports based on the number of connections made on each trading day."
 
"There was no randomisation implemented on the ports. Further, there was no dynamic load balancing to evenly distribute the member connections across all available ports on each trading day. On account of the above weaknesses, NSE’s TCP/IP TBT architecture may have caused ticks to be disseminated earlier to members who logged in ahead of others and members who logged on less loaded server/port. However, a member would need to be logged in first on all the six ports (across three POPs) to be disseminated all the ticks first on that trading day. There was no member who logged in first on all six ports on any trading day," the Report says.
 
Based on the information shared by the Exchange, EY says, it appears that on four trading days in 2012 (4 May 2012, 18 May 2012, 7 June 2012 and 8 June 2012), NSE monitored connections to secondary server (for CD/IRF segment) and also communicated to members that they should not be connecting without intimation by exchange and later also termed such connections as an ‘offense’. "During discussions, NSE informed us that such limited monitoring on secondary server connections in 2012 was carried out at the time of TBT infrastructure migration to colocation datacentre and till the operations were stabilised. Further, NSE informed us that they did not monitor secondary server connections after 2012," it says.
 
The forensic audit also found out how members were using multiple logins to a single dissemination server through multiple IPs. It says, "Based on the TBT IP allotment process as explained by NSE, there was no restriction based on any policy or procedure on a member to avail multiple TBT IPs. Similarly, multiple TBT IPs of a member could have been configured on the same port of the same dissemination server. Such configurations were done manually by a four member team of production support and management (PSM) IICS team based on the number of connections made on the ports of the primary server on that trading day."
 
Based on the review of login logs, EY says it observed that there were 36 members out of 58 members since operationalisation of secondary server, who had accessed both the primary servers (POP11 and POP13) at least once. Out of remaining 22 members who accessed either of the primary servers, 15 members had only one TBT IP.
 
"While no member logged in first and second and third on all the ports, there were 48 members out of 59 members who had logged in first on at least one of the trading days on either of the ports in the review period. There were four members, who had logged in first, second and third on one of the six ports on at least one trading day. Adroit Financial Services had logged in first and second and third on same port for 43 days (4% of the review period), which is maximum for a member," the review says.
 
"However," EY says, "three members, Parwati Capital Market, Adroit Financial Services and Mansukh Securities & Finance Ltd logged in first on either of the ports for more than a quarter of the review period or for more than 275 days out of total 1,103 trading days."
 
The main reason for this, according to the forensic review, is lack of randomisation in TCP/IP TBT architecture at NSE. “Our review of the available source code of the Primary Data Centre (PDC) and POP and discussions with NSE personnel indicates that randomisation was not implemented. In the absence of a randomizer, dissemination on each port of a TBT server was sequential based on login time of a member,” EY says in its report. 
 
 
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    COMMENTS

    tanay

    2 years ago

    What is the inference of this report? Does it mean that the only problem is that random load distribution to servers was not implemented, and there is no player who got undue advantage since no one was able to connect to all 6 ports across 3 POP's??

    Probe ordered against management of MSEI; Moneylife reported the story in May
    The Securities and Exchange Board of India (SEBI) has ordered an inquiry into allegations of mismanagement, flouting of rules and siphoning of funds against the management of Metropolitan Stock Exchange of India Ltd (MSEI), Parliament was told on Friday.
     
    In a written reply to a question, Minister of State for Finance Pon Radhakrishnan told the Lok Sabha that the government as well as the SEBI, the regulator for securities market in India, had received complaints from two whistleblowers about irregularities and fraud at MSEI. 
     
    "The complaints have been examined in detail by SEBI and as an interim measure, directions have been issued to the governing board of MSEI, inter alia, to constitute a Committee of Public Interest Directors (PIDs) to examine all the allegations levelled by whistleblowers against the management of MSEI," he said.
     
    Radhakrishnan added that based on the recommendations of the committee, SEBI will take suitable action against the entities and persons found to be involved in the malpractices.
     
    In their complaints, the two whistleblowers levelled allegations against officials of the Exchange, including the Managing Director and CEO, regarding mismanagement, flouting of rules and laws, personnel-related issues, and siphoning and misappropriation of funds. 
     
    "MSEI has engaged the services of forensic auditor for the purpose of examination, including assessing the actual magnitude of fraud. Allegations against brokers are (being) separately looked into," the Minister said. 
     
    "Further, the MD and CEO of MSEI has been directed to proceed on an indefinite leave to ensure fair and uninterrupted examination of the charges levelled in the complaints of the whistleblowers," he added.
     
    Earlier in May 2018, Moneylife had published allegations from some employee shareholders of MSEI. They had alleged the youngest and the third national level stock Exchange had used member's fund for its working capital requirements and other activities, which was pointed out in an audit report. (Read: Employee shareholders turn whistleblower over irregularities in Metropolitan Stock Exchange; Exchange denies allegations)

    The Exchange, however, has refuted all allegations made by the whistleblowers. In an email to Moneylife, MSEI had said, "It has come to our attention that a handful of people have been trying to malign the image of the exchange by making baseless allegations and malicious statements against the Board of Directors, Management, Auditors and key people at MSEI. We strongly refute these baseless allegations and have initiated appropriate legal action against the suspected perpetrators."
  • User 

    COMMENTS

    HD Motiramani

    2 years ago

    Diversion of funds for operations is a common practice in India.

    26 Years Later, the 1992 Scam Trials Linger, Show No Signs of Ending
    At the beginning of 2018, all 17 offices of the insurance ombudsman were headless; even today, nine posts remain vacant. The Securities Appellate Tribunal (SAT) has over 400 cases pending because the government has not bothered to make appointments; left with only one out of three members and no presiding officer, SAT can only issue temporary orders that too on urgent matters. Many public sector banks (PSBs) continue be headless. Although we have two finance ministers, of whom one is busy with blog posts and tweets, the finance ministry hasn’t found time to make these crucial appointments.
     
    Now, contrast this with two statutory bodies created in 1992 in the wake of the Harshad Mehta scam. They were supposed to be wound up after taking charge of the assets of all scam-accused and distributing the proceeds after the expeditious hearing of cases was complete. But our judicial system is so broken that both, the special court and the custodian, have almost become permanent establishments funded by the Central government. They have been around for a quarter century and may survive another 25 years, going by the pace at which the cases are being tried with over 120 civil cases still pending. 
     
    After the Rs5,000-crore securities scam of 1992 engulfed the entire financial system, the government first passed the Special Court (Trial of Offences Relating to Transaction in Securities) Ordinance in 1992 for speedy trial of cases. It was amended in 1994 to include civil cases. A special court was set up in Mumbai to ensure faster trial of cases, with an appeal only to the Supreme Court. Importantly, these cases were limited to securities transactions in a small period—from 1 April 1991 to 6 June 1992. The office of a custodian was set up under the Act, to take charge of scam-related assets and to ‘notify’ the scam-accused. It seized all assets of the notified persons without any distinction between income from legitimate business or income of the persons notified and the scam. 
     
    Every year, the Union Budget allocates Rs13 crore for running this office; it is strangely located in Delhi and not Mumbai which is the scene of action. It also has an office in Bengaluru, probably because Canara Bank, one of the two biggest litigants, is located there. Over 26 years, the government has spent Rs338 crore on the custodian’s existence. The way scam cases have dragged would have been a national embarrassment, but for the fact that most people have long forgotten it and/or are uninterested.
     
    On 14 May 2017, the Times of India reported that the custodian had “disbursed more than Rs6,000 crore to banks and the income-tax (I-T) department by selling assets of the Harshad Mehta’s family alone and identified another Rs200 crore to be auctioned.” The Harshad Mehta group’s involvement in the scam was probably under Rs2,000 crore; but assets of over Rs6,000 crore have reportedly been recovered from them. The main assets with the custodian belong to stockbrokers whose businesses were shut down and tiny amounts from some individuals. There is, obviously, little to be recovered from other equally complicit institutions such as State Bank of India, Canara Bank and its associates, UCO Bank, Standard Chartered Bank (SCB), Citi Bank, HSBC, Fairgrowth Financial Services, ANZ Grindlays, Andhra Bank as well as several private and public sector companies. 
     
    The case for winding up the 1992 scam investigation becomes even more compelling when you compare it with the spate of recent scams and the loot of PSBs by large industrial houses. Nirav Modi (Rs11,400 crore plus), Mehul Choksi (Gitanjali Gems over Rs6,000 crore) and Jatin Mehta (Winsome Diamonds over Rs7,000 crore) had fled the country after dumping huge losses on banks. Vikram Kothari of Rotomac could defraud banks of Rs3,700 crore in a ballpoint pen company. And the humungous bad debts—of Essar, Videocon, Bhushan Steel, Electrosteel and many others—are going to inflict damages running into several lakh crore of rupees, mainly on PSBs even if bankruptcy proceedings lead to a change in ownership. 
     
    Isn’t there a clear case for a pragmatic decision to wind up and settle cases against some of the 1992 scam and stop it clogging up our courts? But who has the political courage to do it?
     
    Let us look at why the securities scam investigation had been so messed up. The 1992 scam was sensibly handled initially through a multi-disciplinary committee headed by R Janakiraman (former deputy governor of the Reserve Bank of India). The committee included the central bureau of investigation (CBI) and the I-T department, which ought to have ensured that they worked as a team to recover the money and punish the guilty as well. 
     
    The committee published six detailed reports that laid bare what had gone wrong and who was accountable. It also formed the basis of the Joint Parliamentary Committee (JPC) report, although that, by its very composition, ensured that it had a political spin. Unfortunately, the Supreme Court decided that the Janakiraman report and the JPC report had no evidentiary value and could not be used in Court.  
     
    That, in itself, was not such a setback; because the basic work of joining the dots and understanding banking and financial issues and violations was already done. Here’s why things didn't work out that way. Nobody put CBI on the clock or ensured that with the basic groundwork already done, it would have to show some speed as well. CBI took three years to file charge-sheets, some even later. 
     
    As many as 45 cases criminal cases were filed including some in cases where banks were unwilling to complain and said they had not lost any money. The cases continue to drag on and one, involving Fairgrowth Financial Services, was decided last week. 
     
    The Special Courts Act gave the first preference to I-T dues which set the stage for a huge problem. The I-T department came up with demands totalling over Rs30,000 crore (including interest and penalty) which was a ridiculously large multiple of the scam itself. Unless the tax authorities put a stop to such exaggerated claims, no dispute or recovery will ever be complete or closed in India. 
     
    The custodian’s office acts as a sort of recovery agent for the tax department and is managed by government employees on ‘deputation’ from other departments. It has neither the mandate nor the capability of managing assets that it has seized after ‘notifying’ scam accused, although ensuring this was imperative. It took decades for the custodian to get shares held by various scam-accused transferred in its own name and ensure that benefits such as dividends, bonuses, etc, were correctly received. As recently as last year, it was harassing ordinary, innocent investors unconnected with the scam. It sent out demand notices, asking investors to submit dividends and bonuses earned with interest, going back to 1992 on the grounds that they belonged to Harshad Mehta. 
     
    This mis-management is especially unfair because the liability of the scam-accused is constantly increasing, since they are held responsible for interest payments. And, yet, their assets are seized; their stock portfolio is not properly managed. Many of the shares held by the Mehta group have seen a dramatic increase in value over the years. Some others with the custodian would have fetched a good return if sold at the right time. Similarly, the value of properties and physical assets has also gone up considerably; but the tax demands with interest compounded will continue to run ahead of this valuation creating an impossible situation.
     
    The NDA (National Democratic Alliance) government has been quick to adopt Americanisms such as ‘grandfathering’ and ‘sunset clauses’ for tax laws. Wouldn’t it be in line with its promise of maximum governance and minimum government to set up a ‘credible’ structure to wind up the special court after winding down the cases, de-notify the accused and get the tax department to come with a sane assessment which will actually bring some revenue to the exchequer? Instead, what we have is a meandering litigation that is a drain on PSBs’ resources, pain for those who have got dragged into it and enriches only the legal community.
     
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    User 

    COMMENTS

    B. Yerram Raju

    2 years ago

    Piysh Goel had the audacity to say that Governance in PSBs has improved!! When will these bluffs end and sanity begin?

    R JAYAKUMAR

    2 years ago

    While I like lot of reports which come in MoneyLife, somehow the genes is for only negative reporting. We are already burdened with too much negative reporting by the media in all formats.

    Hence my suggestion is please do report positive articles also.
    Why not highlight major achievements by Indians in various fields and so on. It will make the readership more interested in Money Life.

    REPLY

    Sumitha Manivel

    In Reply to R JAYAKUMAR 2 years ago

    Most Moneylife readers are more interested in articles that analyse issues facing investors than in achievements of Indians,there are other magazines for that.

    Avinash Venkata

    In Reply to R JAYAKUMAR 2 years ago

    Empowering small investors with critical information is not negative reporting.

    K S Jegannathan

    2 years ago

    The owners of this publication know all the facts relating to this scam. However, to my knowledge, I feel the bear cartel is responsible. In those days BSE was acting like a club with all the benefits loaded to the bears with badla, undha badla etc. and acting under one man known by the nickname, Cobra which itself is indicative of how things were. As Mehta was a bull, the bear cartel started feeling the heat not to know what to do and resorted to somehow fixing Mehta which they finally succeeded.

    REPLY

    Sachin Purohit

    In Reply to K S Jegannathan 2 years ago

    Based on your level of interest in this security scam, let me recommend a book by this same writer, The Scam (unless you have already read it). This is the most detailed work I have read on this topic.

    B. KRISHNAN

    2 years ago

    If my memory is correct, Harshad Mehta owed the banks less than 1000 crores, but the custodian has recovered 6000 crores. So Harshad Mehta was right in the claim he had made at that time that he was capable of clearing all his debt, if only he could be allowed to act freely. It made good print for newspapers at that time, but now it is more than likely that there would have been no "scam" at all, if the regulators had acted prudently!
    I was one of the small investors caught in the stock market burn-out caused by the "scam", and scared away many a small investor from the market.

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