Will SEBI initiate ‘immediate action’ on lapses and constitute a team with ‘appropriate background ’ as recommended by its own expert committee?
The powerful technical advisory committee (TAC) of the Securities & Exchange Board of India (SEBI) conducted a detailed investigation of the National Stock Exchange’s (NSE) high frequency trading (HFT) and vindicated the contentions of an anonymous whistleblower who wrote three letters on how the Exchange’s trading systems gave better access to certain entities allowing them to make huge profits.
TAC’s investigation team prepared a detailed report and discussion of its findings and follow-up have been extensively reported by The Mint
too has perused a copy of the findings discussed by TAC at SEBI. But before we proceed further, a quick recap of the issue. Readers of Moneylife know that the NSE has filed a Rs100-crore defamation suit against us for bringing the contents of the letter to public attention sometime in June 2015. A notice of motion to gag us until the suit comes up for hearing was, however, shot down by Justice Gautam Patel of the Bombay High Court, who also ordered the NSE to pay Rs50 lakh as penalty mainly to two hospitals in Mumbai. Unknown to us, the whistleblower sent a second letter to SEBI in August 2015 detailing how it can verify his allegations of how NSE’s systems were compromised. SEBI kept mum about this even as it watched the outcome of NSE’s defamation charge against us.
In October 2015, the whistleblower sent me a third letter which would prove his charge that certain influential entities managed to rake in huge profits through preferential access. This was sent only to me, but had explosive information on a ‘dark fiber’ link between the NSE and the Bombay Stock Exchange (BSE) which allowed a huge advantage to a third entity. We decided to share the letter with SEBI and the finance ministry, since our intention was to bring the truth before the people through proper investigation.
Before we go into TAC’s findings, let me explain what HFT, or algo trading, is. These are automated trades conducted at millisecond or microsecond speeds throughout the day by computer programs developed to process market data. They buy and sell large quantities of securities, based on price patterns without human intervention, making huge profits from wafer-thin margin on massive volumes. It is these that explain the massive froth of trading turnover running into over Rs1 lakh crore every day.
With this background, we will let the findings of SEBI’s TAC speak for themselves. TAC, chaired by Dr Ashok Jhunjhunwala, met on 15 March 2016 to discuss a report submitted by Prof Om Damani who was entrusted with the task of investigating the whistleblower’s letters. TAC recorded its thanks to Prof Damani for his ‘outstanding efforts’ and also noted that his project team of IIT-Bombay had undertaken a data analysis that was in the nature of a forensic audit. It then took note of the following findings confirmed from the whistleblower’s letter.
Technical details about how brokers could get advantage in connecting to the NSE’s servers because the Exchange had no ‘load balancers’ and ‘randomisers’ in its systems architecture.
That OPG Securities, a brokerage firm mentioned in the first letter, had, indeed, tried to exploit loopholes and it is ‘plausible’ that OPG and some other brokers were given preferential access to back-up servers. More importantly, that OPG ‘gained materially’ by exploiting the system. In this connection, it further said that while it has studied data and submissions from the NSE, “It is not possible from the data available alone to investigate and determine the extent of collusion of NSE officials with OPG/ others.”
The team also found that OPG’s ability to happily exploit the system ended when the system architecture changed. The committee agreed “that OPG Securities was able to exploit the architecture to gain undue and unfair advantage and NSE failed to prevent such manipulative practices by OPG.”
The team found that the architecture of NSE with respect to dissemination of Tick-by-Tick (TBT) through TCP/IP was prone to manipulation/abuse. When SEBI requested NSE to investigate this, NSE claimed that their architecture could not be, and has not been, misused. In spite of NSE not providing adequate details on the issue, the available data was examined and the report conclusively shows that OPG consistently logged in to the servers with better hardware specifications. It also finds that information on back-up servers was not transparently communicated to all brokers in 2011-12 and earlier.
From the third letter, it was confirmed that the staff of Sampark Infotainment, visited NSE on multiple occasions for laying fibre cables, installation, etc, on behalf of Ways2Wealth and GKN. The whistleblower had contended that Sampark had provided a ‘dark fibre’ link to Ways2wealth, giving better access. Here is what the TAC-commissioned report says, “With regard to the issue of dark fibre, the Committee was of the view that in violation of its own policy on allowing only ISPs, NSE allowed non-ISPs like Sampark, to lay fibre in its premises for various members.”
The report further said that NSE had “violated norms of fair access and allowed some brokers to benefit. Also, when the complaint was made to NSE, its management had dismissed it and did not initiate any steps to check the possibility of any collusion with the staff of NSE.”
TAC did not stop at merely accepting the report. It says, “SEBI may initiate immediate action for lapses on the part of NSE and exploitations made by OPG under the guidance of the Committee,” and that SEBI should constitute a team of people with appropriate background to “investigate the collusion aspect between NSE officials and OPG.”
We are delighted that a full investigation by TAC has brought some larger issues to attention which the committee plans to discuss, review and examine in future. First is the all-important issue of how to build capacity within SEBI to proactively detect wrongdoing/ system abuse at the brokers’ end and inside stock exchanges. Secondly, whether the “fibre connectivity between two co-location facility provides any unfair advantage to the brokers vis-à-vis retail players/ investors.” In fact, regulators around the world are debating the second issue of how automation has made retail investors as well as institutional investors outside the HFT group into second-class investors. But, so far, hapless and disaggregated investors have been losing the battle because they do not have a powerful and united voice. TAC plans to go deep into the larger issue of “the robustness of the architecture of NSE and BSE and whether randomisation needs to be introduced” as well as SEBI’s policy with regard to co-location and algorithmic trading, its impact and the actions that are required.
As always, we have emailed SEBI chairman and NSE’s top brass as well as several members of the NSE’s board of directors, but have received no reply to findings of the TAC. The responses from OPG Securities and Ways2Wealth are already in the public domain; the former has denied the findings.
Interestingly, after details of SEBI’s findings were published by various media entities, the Association of National Exchange Members of India (ANMI), which represents 900 members, is understood to have told the news agency Bloomberg that it plans to take up the issue with the regulator.
Clearly, the battle to get at the truth is far from over. NSE’s defamation case against us and appeal against Justice Gautam Patel’s order persists. Let us not forget that the finance ministry as well as the Standing Committee of Parliament have asked SEBI for a copy of TAC’s report. It remains to be seen if they initiate any action.
(Sucheta Dalal is the managing editor of Moneylife. She was awarded the Padma Shri in 2006 for her outstanding contribution to journalism. She can be reached at [email protected])