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Market regulator SEBI has rapped the National Stock Exchange for negligence of duty as a first level regulator.
The NSE was let off with a warning for not having proper systems and procedures to check cases of excessive client code modifications by 10 brokers during March 2010.
SEBI observed client code modifications amounting to Rs 55,000 crore in March 2010. In December 2010, it directed NSE to conduct a special audit of this activity and submit a report.
Show-cause notice
Though NSE submitted details to SEBI, the regulator served a show-cause notice (SCN) to the exchange under the Securities Contracts regulation Act for failure to put an appropriate mechanism for supervising client code modification.
SEBI also mentioned failure to provide information and clarification sought for. NSE in its reply said that modifications were an integral and operative part of the system and was permitted by SEBI to take care of human error while entering orders.
NSE also submitted that excessive use of this facility resulted in the exchange initiating disciplinary proceedings against errant brokers.
NSE said in its reply that it was difficult to know the intent behind the modification or require prior approval of the exchange with recorded reasons for every modification, given that millions of orders were entered everyday.
The exchange further explained that modifications of client codes did not become illegal when such incidences were higher in number.
No thorough analysis
SEBI observed that NSE had analysed the data collected but did not thoroughly analyse the reasons and factors contributing to such large number of modifications.
It also quashed NSE's argument that brokers with higher volume of trading and higher institutional client base were more prone to this activity by pointing out that six out of the 10 brokers listed did not have any institutional trading activity.
Analysis of the data revealed modifications were concentrated among a few clients of these 10 brokers who had accounted for 31 per cent of the modifications but only 8.76 per cent of the total traded value.
Devoid of merits
SEBI also observed that NSE did not have a mechanism to penalise the repeat offenders. It also pointed out that the exchange had introduced a penalty structure in its equity and currency derivatives segments only after receiving this SCN.
Hence NSE's argument of client code modifications being automatically recorded in the system and the penalty framework being implemented was devoid of any merits said SEBI.
It failed to apply its mind to the unusualness of the happenings and hence acted negligently in discharge of its duty as a first level regulator.
SEBI said that such failure had occurred due to the complacency on NSE's part that its systems and procedures were far superior.
SEBI observed that the value of modifications were far less in March 2011 (Rs 0.86 lakh) and July 2011 (Rs 0.39 lakh) giving an impression that prior to SEBI intervention client code modification was being done in cases other than that for rectifying the genuine errors under the garb of existing practices.
On being convinced that NSE was jus negligent and not party to the mischief, SEBI let NSE off with a warning as monetary penalty was not appropriate for matters related to discharge of regulatory functions.
And suspending or interrupting the working of an exchange was also not an option as it could be considered only in extreme cases, said SEBI.
>raghavendrarao.k@thehindu.co.in
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