Photo: Mint
Photo: Mint

Opinion | Will Sebi please state NSE’s crime and get on with it?

Sebi has delayed taking action against NSE as well as making its findings public

If you think compliance is expensive, try non-compliance," said Paul McNulty, a former US deputy attorney general. From the looks of it, the National Stock Exchange (NSE) and some of its officials are paying the price for some serious non-compliance.

In mid-2016, the markets regulator Securities and Exchange Board of India (Sebi) pretty much overhauled NSE’s board of directors. This was after NSE failed to cooperate with the regulator’s technical advisory committee in its probe about irregularities in the exchange’s co-location facilities, a report by Bloomberg Quint said. Not soon after, Ravi Narain and Chitra Ramkrishna, stalwarts of the exchange, made unceremonious exits.

NSE’s investors have been hurt too. The exchange’s much-awaited IPO has been endlessly delayed. The exchange has also been asked to set aside revenues accruing from its co-location services in a separate account. In the past seven quarters, an amount of 1,441 crore has been set aside, which is about 40% of the exchange’s consolidated profit before tax for the period.

Still, there is a general sense of angst that Sebi has not done enough in the NSE co-location case.

The case first came to light at Sebi as long back as January 2015, when an anonymous whistleblower wrote to its market regulation department. The letter alleged that NSE staff had colluded with some trading members to help them get faster access to the exchange’s servers, between 2011 and 2014. The fact that Sebi’s market intelligence failed to pick this up for over three years is itself highly disappointing.

What is far worse is how it has shilly-shallied for over three years after it was given the information. It’s not that it hasn’t done anything, but it clearly hasn’t done enough.

The matter became public in June 2015 when Moneylife magazine published a copy of the whistleblower’s letter on its website. NSE denied any wrongdoing. It even dragged Moneylife to court with a defamation suit. As this column said last year, the attempt by the exchange to cover up was far worse than the crime itself. This is simply because a cover-up always involves top officials, while the latter could just be the doing of a few bad elements in an organisation.

After a preliminary investigation, it soon became evident to Sebi that something was truly amiss at NSE’s co-location facilities, and the exchange was attempting a cover-up. This in itself should have been ground for strong action. But for some inexplicable reason, the regulator asked the exchange to appoint a third-party auditor to examine its concerns, and then send an action-taken report to the regulator. Asking NSE to investigate itself is a prime example of the regulator’s failure to take decisive action in the case.

Now, after multiple investigations and forensic audits, Sebi is frustrated with the inability of auditors in pinpointing blame, according to news reports. The trading member that gained the most from the preferential access is said to have made a profit of 25 crore, leading to worries that the case may be dismissed as an instance of making a mountain out of a molehill.

But the main concern here isn’t how much money trading members with preferential access made. From the viewpoint of market integrity, the key issue is what NSE’s top officials did when they discovered their systems had been breached. Did they intimate Sebi? News reports suggest it tried to evade Sebi’s queries on the matter. If so, the regulator should take the exchange’s top officials to task.

According to an expert in market regulation, a common weakness among Indian regulators is that they fail to take appropriate action initially, and are then forced to take disproportionately harsh action later.

If multiple forensic audits haven’t unearthed the kind of incriminating evidence Sebi was hoping for, it should neither be surprised nor discouraged. It only needs to prove that the exchange couldn’t provide fair access to all members, and that NSE’s top officials attempted to hide this when it came to light.

Based on this, it has enough provisions in its laws to act against the erring officials. If any evidence comes to light later in the investigations being done by the Central Bureau of Investigation, appropriate action can be taken at that stage.

As it is, Sebi has considerably delayed taking action against NSE as well as making its findings public. It has also maintained a dangerous silence.

The first official word on the case came out in December 2016, when NSE listed it as part of the risk factors in its draft red herring prospectus filed with Sebi. The regulator itself has been mum about the issue, except to say that it is investigating the case and that it has initiated enforcement action. J.R. Varma of Indian Institute of Management, Ahmedabad said in blog post last year, “Sebi seems to have taken the narrow and untenable view that the operations of a large financial market infrastructure are of concern only to its shareholders and so disclosure is required only when the institution goes public."

It’s high time Sebi broke its silence about the most critical institution it oversees, and also quickly takes action in the co-location matter and bring it to a close.

Close