The NSE co-location scam relates to the market manipulation at the National Stock Exchange of India, India's leading stock exchange. Allegedly select players obtained market price information ahead of the rest of the market, enabling them to front run the rest of the market,[1][2] possibly breaching the NSE's purpose of demutualisation exchange governance and its robust transparency-based mechanism.[3] The alleged connivance of insiders by rigging NSE's algo-trading and use of co-located servers ensured substantial profits to a set of brokers.[4][5][6] This widespread market fraud came to light when markets' regulator, the Securities and Exchange Board of India (SEBI), received the first anonymous complaint through a whistle-blower's letter in January 2015.[7][8] The whistle-blower alleged that trading members were able to capitalise on advance knowledge by colluding with some exchange officials. The overall default amount through NSE's high-frequency trading (HFT) is estimated to be ₹500 billion over five years.[9]
The NSE co-location case is under investigation by the Central Bureau of Investigation (CBI), the Securities and Exchange Board of India (SEBI) and the Income Tax Department who are probing the involvement of NSE and SEBI officials, as well as NSE's former and current executives and brokerages.[10][11][12]
In 2019, the Madras High Court issued a notice to SEBI, MCA, ED in response to a Public Interest Litigation (PIL) filed by the Chennai Financial Markets and Accountability (CFMA).[13]
Background
In January 2010, the NSE began offering a co-location facility to members. Members could place their servers in the Exchange's premises in return for a fee. This allowed them faster access to the buy and sell orders being disseminated by the exchange's trading engine.[14] The term 'co-location' means 'a setup wherein the broker's computer is located in the same area as the stock exchange's server.'[15] In addition, High-frequency trading (HFT) or algorithmic trading refers to the use of electronic systems, which can potentially execute thousands of orders on the stock exchange in less than a second. Also, retail investors monitoring prices are subject to a delay as compared to the tick-by-tick data broadcast a user receives in a co-location facility.[16] Unusually, the SEBI did not put out a discussion paper to collect market feedback before permitting to proceed with the facility. There are no public records on HFT executed on the NSE.[17] SEBI needs to consult with Technical Advisory Committee (TAC) for such market developments.[18]
Resignations at NSE
The Economic Times first reported that on 22 May 2017, SEBI issued show cause notices to the exchange and fourteen individuals, including former managing directors Chitra Ramakrishna and Ravi Narain.[24][25] Notices have been sent to Ravi Narain, vice-chairman of NSE, who was serving as chief executive officer (CEO) and managing director (MD) at the exchange during the period when the alleged violations took place. Other officials include Ravi Varanasi, who was the chief of NSE's business development vertical and was heading the surveillance department of the exchange during this period, and Suprabhat Lala, chief of regulation and head of the trading division during 2010–13. Among other officials who received show cause notices were former technology heads — Ravi Apte, and Umesh Jain, and former chief operating officer Subramanian Anand. NSE vice-chairman Ravi Narain had put in his papers on 2 June 2017, amid regulators intensifying their probe into the alleged lapses in high frequency trading.[26][27] Chitra Ramakrishna, MD and CEO resigned from the exchange in December 2016. The media reported that Chitra's resignation the result of two governance-related issues at NSE. One was the loss of confidence in the NSE top management due to the colocation controversy.
Role of Ajay Shah
Other unidentified officials of the NSE and stock market regulator SEBI are under suspicion as well to allow the illegal activity to continue for years.[36] Ajay Shah played a key role in the exploitation of NSE TBT architecture. The probe agency has detected that Ajay Shah had allegedly collected NSE trade data in 2005-06 under the garb of doing research and passed the data to a company that prepared algos.[37] The scam was exposed in 2015, when a whistleblower sent a letter to SEBI alleging that NSE provided preferential access to a few high-frequency traders and brokers to the exchange's trading platform. Consequently, the regulatory body initiated an investigation into the matter.[38] SEBI found that Shah had officially entered into a data-sharing agreement with the NSE after 2012. Prior to this, he and his wife, Susan Thomas got the information from the exchange informally as researchers. Although Chitra Ramkrishna and other top NSE executives clearly denied that they shared data with Shah in his personal capacity, Shah told SEBI that he and his wife were signatories to a data-sharing agreement with the NSE. Also, prior to the contract, the data flow was to Ajay Shah and Susan Thomas.[39] Ravi Apte, the Chief Technology Officer of NSE told SEBI that he had facilitated the transfer of data to Shah under the impression that an agreement was signed between Shah and NSE.
The Brokers-NSE Nexus
The brokers-NSE nexus came to the forefront with the co-location scandal. The broker entity to receive maximum benefit in the scandal was OPG Securities, which was provided multiple login IPs and allowed access from the secondary servers.[43][44] Due to favourable access, OPG Securities and other entities benefited instead of other brokers and their clients. Other firms on the list of 22 brokers who repeatedly logged in early on the NSE servers include: Alpha Grep, SMC Global, Barclays Securities, Kredent, Pace, Religare Securities, NYCE, Motilal Oswal, Kotak Securities, DE Shaw, Crimson, Advent, Mansukh Stock Brokers, JM Global, AB Financial, Indus Broking and Quant Broking.[45][46] According to the forensic audit reports by EY India, Deloitte Touche Tohmatsu LLP & ISB, 62 brokerages have enjoyed preferential access though NSE's HFT platform and at present SEBI has only served the SCNs to 3 firms namely- OPG securities, its associate firm-GKN securities and Way2Wealth.[47] The CBI investigation revealed that 90% of the time OPG securities, in collusion with unknown officials of the NSE, was first to access the NSE servers.
Action by Agencies against perpetrators
SEBI Action
In November 2015, the whistle-blower's letter referred to SEBI's technical advisory committee (TAC) report that concluded in March 2016, that NSE systems were prone to 'manipulation' and thus recommended an investigation.[49] This was when SEBI directed the new NSE board to conduct a forensic audit of its systems and deposit revenue from co-location trading in an escrow account.[58] This was a blow to NSE's plans of going public as the co-location server facility stream accounted for nearly 35–40 per cent of the NSE's core revenues.[50] The NSE added public interest directors to its board. They include: Ashok Chawla, former finance secretary; Naved Masood, former secretary in the Ministry of Corporate Affairs; TV Mohandas Pai, chairman of Manipal Global Education Services; Dinesh Kanabar, former deputy CEO of KPMG in India, and Dharmishta Raval, former SEBI executive director.[59] The board then appointed Deloitte to conduct a forensic inquiry.
NSE vs. Moneylife Case
On 8 July 2015, Sucheta Dalal wrote an article on Moneylifes portal alleging that certain NSE officials were leaking sensitive data related to HFT or co-location to a select set of market participants so that could trade faster than their competitors.[126] The article was based on an alleged complaint made to SEBI in January by an official of a Singapore-based hedge fund. The whistle-blower's first letter came from Singapore and was addressed to BK Gupta, deputy general manager of SEBI, and dated 14 January 2015. It was copied to Sucheta Dalal from Moneylife.[57] The co-location scandal came to light when the NSE filed a defamation suit on 21 July 2015, claiming damages of ₹1 billion in the Bombay High Court against Moneylife, to stop the publication and circulation of the article. However, the court dismissed the case and asked the NSE to pay ₹150,000 each to journalists Debashis Basu and Sucheta Dalal. The court also imposed a penalty of ₹4.7 million on the NSE to be paid in the form of a donation to Masina Hospital and Tata Memorial Hospital in Mumbai. The court also ordered SEBI to investigate the charges levelled by the whistle-blower.[127]