Sebi : India’s market regulator formally closed a long-running investigation into an alleged case of co-location at the National Stock Exchange (NSE) and some of its top officials. The case was spotlighted for years but was finally dismissed, citing a lack of evidence to prove wrongdoing.
On Friday, Kamlesh Varshney, a whole-time member of SEBI, ruled that the regulator did not have enough material to justify charges of collusion between OPG Securities Pvt. Ltd., a brokerage firm, and the NSE. According to SEBI’s findings, there was not enough proof to meet the “preponderance of probability” test, a standard of proof that requires more convincing evidence than not.
A ruling ended nearly a decade of cases and allegations and probes into the co-location facility offered by the stock exchange to brokers, which was said to afford an unfair edge to some participants.
The Co-Location Controversy: What Triggered the Case?
The co-location facility offered by the NSE allowed brokers to place their servers on the premises of the stock exchange. This facility gave them an edge that others would not have-they could receive price data feeds a fraction of a second before other participants, translating into significant financial gains from high-frequency trading.
The firestorm began in 2015 when three whistleblowers approached SEBI with their complaint: some of the brokers had been receiving special treatment from the National Stock Exchange’s NSE co-location facility. They alleged that several of the brokers, including OPG Securities, had gained entry into the co-location facility before other brokers and profited as a result at others’ expense. This gave these favored brokers an undue advantage, earning them enormous profits at the expense of others.
Table of Contents
Prone to Manipulation: SEBI’s Initial Findings
As a result of these whistleblower complaints, SEBI investigated the claims. A SEBI committee discovered that the NSE had a faulty system architecture for the distribution of tick-by-tick data, which is market data provided in real-time, and has its potential for manipulation and market abuse.
During the investigation, SEBI was able to identify 15 stockbrokers with which it suspected violated the insider trading laws. Among them was OPG Securities, alleged to have exploited its privilege of accessing co-location to gain unfair advantage in access to market data and its dissemination before others. The Central Bureau of Investigation (CBI) took notice also and filed a case against OPG Securities with charges of manipulating the system to its advantage for two years in 2018.
NSE Faces Penalties for Lapses in High-Frequency Trading
During its probe, SEBI found what it termed lapses in the NSE’s handling of the high frequency trading service through co-location. For its failure in monitoring and managing the service effectively, SEBI imposed penalties on the NSE and asked the stock exchange to disgorged ₹624.89 crores (approximately $75 million). The regulator also banned the NSE from having market fund access for six months.
However, the NSE contested the decision of SEBI and appealed to the Securities Appellate Tribunal (SAT). SAT has reduced the disgorgement amount of ₹624.89 crore to ₹100 crore (approximately $12 million), thus significant release from penalties.
OPG Securities Penalised Too
While it penalized the NSE, SEBI had singled out OPG Securities, a brokerage house in which it was alleged the scams took place, and had issued an order to disgorge ₹15.75 crore plus interest. The appellate tribunal had upheld the penalty against the NSE. The appeal relating to OPG Securities was later allowed, the disgorgement order passed against the firm was set aside, and the matter was remitted back to SEBI for an order determining the actual quantum of penalty levied against OPG Securities.
SEBI’s Findings: No Due Diligence Was Done, And No Collusion Was Deciphered
SEBI finally concluded after years of investigations that though the NSE failed at some point in some regards related to the handling of the co-location facility on its part, there was no clear collusion between officials of OPG Securities and NSE.
SEBI found that the NSE did not have a defined policy for how the facility of co-location should be used by the broker and that the exchange failed to regulate how its secondary server is being used by the brokers. In particular, SEBI noted that NSE lacked due diligence in issuing guidelines on the service without monitoring its delivery.
SEBI report identified:
The issuance of guidelines without monitoring showed lack of due diligence.
But while this reflected poor practice on NSE’s part in running the facility, SEBI maintained that these lapses did not in themselves amount to any conspiracy with OPG Securities in which such collusive conduct was being indulged.
Case against OPG Securities: Consent or Misuse?
First of all, the case had wrongfully used the secondary server of the NSE in order to get ready access to market data, and this was not something that OPG Securities was appreciative of. Even though SEBI established that OPG Securities had accessed the secondary server until May 2015, it was still after a June 2012 warning by the NSE.
SEBI further clarified that it reflected “tacit acquiescence” by the NSE to enable OPG Securities continued access on the server. SEBI, however, pointed out that 93 other brokers had accessed the secondary server over the same period. This reduces the probability of any isolated collaboration between OPG Securities and NSE.
SEBI order stated:
The fact that OPG was logging on to the secondary server till May 2015 even after a warning in the first half of June 2012 does indicate indirect consent by NSE to OPG. The fact that 93 trading members were logging to the secondary server during this period reduces the probability of collusion.
There is no evidence of collusion: Deloitte, EY, and External Forensic Reports
The SEBI relied on multiple forensic reports from various external auditors, including Deloitte and EY, as well as findings from its own internal committees. After all this extensive analysis no report could prove that there existed collusion between OPG Securities and the NSE.
This vagueness of concrete evidence was too overwhelming for SEBI to digest, and thus it had to close the case against NSE and its officers. With regard to all these proceedings against all the parties-including the respondents-NSE officials-this is how the final order concluded by dispensing the same with orders.
A Long Road to Conclusion : A Decade of Allegation and Investigation
Co-location is one of the landmark cases in the history of recent times in India’s financial markets. It brought up huge questions as to whether the stock market operation processes are fair and transparent as well as an easy reason that some participants have access to advantages that others do not have access to.
High-frequency trading in particular throws up challenges to regulation-the fast-moving world of finance is an area where leading-edge technology can execute trades in a matter of fractions of a second. This field has a potentiality to bring about market efficiencies but can also conceal the door for some abusive possibilities -the allegations against the NSE and OPG Securities are clear examples.
Despite all these reservations, the move to close the case by SEBI shows that it is not easy to nail wrongdoing in such a complicated affair. There is no clear evidence now, despite years of digging and a number of forensic reports coming out over time. So, it was against this backdrop that SEBI finally decided to drop the charges.
Conclusion: NSE Clears Its Name, but Questions Remain
The SEBI order disposed of the co-location case and cleared the NSE along with its officials from any malpractices. However, the case raises numerous questions on market regulations and technology existing as indispensable in stock market trading.
Although the NSE was indeed guilty of mismanagement in its administration of the co-location facility, there is no evidence of collusion, which means the exchange and officials involved will not face any such legal suits. However, this case still comes as a reminder to financial markets to look into transparency, good behavior, and proper conduct in all markets where technological utilization will lead to new ways of doing trading.
As the dust settles over this very public case, regulators and market participants alike need to reflect on what they have learned to ensure that such controversy is avoided in the future.