SEBI mishandles NSE co-location case

PALAK SHAH | Updated on June 02, 2019

Co-location Losing the plot?   -  SHAILESH ANDRADE

Instead of conducting an inquiry to establish fraud, it has dismissed preferential access to data as a code of conduct lapse

The move by the Securities and Appellate Tribunal (SAT) to grant an interim stay on SEBI’s strictures against the National Stock Exchange (NSE) and the 12 key accused, which include brokers, in the ‘preferential access’ scandal shows the market regulator in poor light. The seeming lack of thoroughness in the investigation stands out.

The key question is why SEBI did not conduct any investigation into collusion and fraud at the NSE. The co-location case points to market rigging, through a ‘deliberate procedural lapse’ in the trading systems at the NSE. But SEBI has viewed this merely as a ‘violation of code of conduct’ norms. SEBI’s ₹1,000 crore disgorgement order does not measure up to the scale of wrongdoing.

A more serious charge under Prevention of Fraudulent and Unfair Trade Practices (PFUTP) was dropped by SEBI against NSE and its officials in the co-location case. In its order, SEBI said, “alleging fraud against the exchange, in this scenario, (is) tantamount to attributing intention or knowledge of which there is no proof.” Instead of joining the dots, such as linking NSE’s defective co-location systems, which lacked essential safeguards, with the sharing of key data with conflicted researchers, SEBI seems to have broken down the colossal case of preferential access into several isolated instances and concluded that procedural lapse cannot be termed as ‘fraud.’

Previous scams

History shows that the origin of any markets scam can be traced to a ‘procedural lapse’ at varying levels. The Harshad Mehta and Ketan Parekhscams, for instance, involved a procedural lapse in the banking system. But a criminal probe conduced after the initial leads resulted in the unearthing of mega scandals.

SEBI says it dropped the PFUTP charge in the co-location case due to “absence of facts pointing towards collusion of employees with trading members (TMs), or proof of specific discrimination towards any specific TM... or accrual of monetary benefits/ unjust enrichment to any employee or TM.” The issue here is whether SEBI can justifiably arrive at these conclusions without a thorough probe.

Curiously, the key mandate of forensic auditors against the NSE was just to check systemic lapse; the emphasis was never on detecting fraud. How can SEBI be certain that there was no fraud when no investigation was conducted to determine the same? Also, there are complaints of conflict of interest between the forensic auditors and the NSE. Was the co-location issue a mere code of conduct violation?

Years ago, SEBI had registered a criminal complaint regarding forgery of a letter involving PR executives of Pyramid Saimira. In that case, it took police assistance to conclude there was price rigging. Why not adopt the same approach for the current preferential access case?

SEBI’s Technical Advisory Committee, in its report, had said the NSE architecture was prone to manipulation, market abuse, and that some TMs got preferential access, an advantage over others. But SEBI has pinned this to “flouting principles underlying the conduct of the business of a stock exchange.” The fact that NSE ignored complaints of misuse of its architecture has been conveniently ignored too.

SEBI holds researchers Ajay Shah, trading software seller Sunita Thomas and her company Infotech Financial at fault for violating PFUTP rules in order to extract data from the exchange for ‘commercial gains’. But a full trail of their alleged collusion with NSE bosses is left unexplored.

The regulator did not issue any paper for public comment, as it does before announcing any major initiative, when NSE launched co-location in 2009. Was a thorough proposal seeking permission to start co-location submitted by NSE to SEBI and did the exchange allow any inspection of its systems to the regulator?

The NSE could well argue in court that its profit from co-location can’t be termed as ‘ill-gotten wealth’ as there is no charge of ‘fraud’ against it, and hence no huge disgorgement is required. The same goes for brokers. Since there is no ‘fraud’ at NSE, what wrong could brokers have done? Why should they agree to ‘disgorge’ even a penny? SEBI’s method of calculating NSE’s ‘ill-gotten wealth’ that is marked for disgorgement is questionable. By its logic, the NSE earned ₹1,000 crore from co-location, but all the accused, including brokers who got preferential access to the exchange systems, did not even make ₹100 crore.

Also, the NSE and its officials who could not be charged with violation of PFUTP in one case of preferential access were subject to ‘fraud’ and charged with violation of PFUTP (by attributing intention or knowledge) in another case involving dark fibre cable network. Dark fibre and co-location are just two aspects of preferential access or connectivity to the exchange.

In the dark fibre case, SEBI has asked NSE to deposit ₹62 crore of estimated ‘ill-gotten wealth’, but where is the estimate of the money the exchange officials made?

The move by CBI, which inforrmed the Delhi High Court that its investigation was not restricted to the FIR which was initially registered, is welcome.

Unfortunately, it took a PIL to get an investigating agency to promise that it will examine all entities, irrespective of the seniority of those allegedly involved..

Published on June 02, 2019

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