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THE NSE SCAM

The capital market watchdog, the Securities Exchange Board of India (SEBI), has acted tough against the National Stock Exchange (NSE) over an algorithmic trading scam. The order pushes back NSE’s Rs.10000 crore IPO.

In five distinct orders, SEBI has punched the NSE, its two former managing directors Ravi Narain and Chitra Ramakrishna and a host of others for what is known as the co-location scam. Narain will forfeit 25 per cent of his FY 12 and FY 13 salary whereas Chitra will fork out 25 per cent of her FY 14 salary. The amount will be deposited in the Investor Protection and Education Fund (IPEF). Both have been banned from being associated with any listed firm, market infrastructure institution, bourse, clearing corporation or depository for five years.

The SEBI also banned NSE from accessing the securities market for 180 days and ordered the exchange to pay around Rs.1000 crore to the IPEF for not putting the Tick-by-Tick (TBT) architecture in place. TBT is a data feed, which delivers information about every change in the order book. SEBI ruled that the NSE failed to exercise active attentiveness while offering co-location facility, which has affected the integrity of the capital market. In co-location, a broker’s server is kept in the exchange premises to shrink delay while executing trades. Orders reach exchange servers quicker than those who have not availed of the facility. A day after, Ravi Narain stepped down from the board of auto major Escorts and agrochemical enterprise, PI Industries. Narain’s gross remuneration between FY11 and FY13 stood at Rs 24.3 crore, while Chitra took Rs 4.5 crore in FY14.

What lies in the future?

It is sad that the watchdog took plenty of time to decide that NSE has committed a fraud. Several committees, including a cross-functional team of SEBI and comprising officials from Deloitte, Indian School of Business and Ernst &Young, conducted the investigations.

However, the decks are now clear for NSE’s IPO after six months. Although the volume of the penalty is substantial, NSE’s finances are not likely to be overly hit. Further, with turnover from co-location contributing to 26 per cent, 34 per cent and 44 per cent of equity cash, equity derivative and currency derivative turnover respectively, the NSE would be glad to be free to use the future revenue from this facility.

Also, regarding SEBI’s instruction to transfer all revenues of co-location facility with effect from September 2016 to a separate bank account, around Rs.2000 crore was transferred to a different bank account. The order of SEBI transmits few clear messages to exchanges that they cannot act in a way that destroys the confidence of investors.

A good lesson for NSE

There are lessons galore. Like: complexities of developing technology have to be fully grasped and the NSE should enhance the skill levels of their senior staff. Increasing utilisation of algorithmic trading systems and co-location processes made the policy issues complicated. This gives users a significant advantage in data access in an age where AI based algorithmic trading systems can exploit in milliseconds.
The NSE should create a firewall between its functional employees and trading members. Power-packed checklist has to be given to each employee on the do’s and don’ts. And various system audits have to be conducted and all the third party agreements scrutinized regularly.

Kahani Mein twist

The tradition of getting interim relief continues. One by one against whom the SEBI has raised the red flag in the NSE scandal managed to get a temporary stay from the Securities Appellate Tribunal (SAT). The SAT has stayed all the action against Narain until it hears SEBI. Lawyers involved are also confident that Chitra Ramkrishna may also get an interim stay.

As a final point, a substantial penalty on a corporate, which has over the years kept aside much higher sums for probable forfeits, does not create panic. Further, not holding any employee criminally accountable categorises the problem as ‘system failure,’ which allows everyone to move on. The NSE was born out of a desire to counterbalance the ‘broker mafia’ dominated at the Bombay Stock Exchange (BSE). We all know that the NSE with more than 80 per cent share in the cash market and 100 per cent in the equity derivatives, kept the Indian capital market at par with the global yardstick. The exchange should consider this issue as a final call to brush its internal practices. – Shivanand Pandit

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