Should NSE be allowed to file ‘Consent Terms’?

Stock exchanges in India are both regulators and regulated entities. In regulatory parlance, stock exchanges are the first line of regulators. The website of the National Stock Exchange (NSE) says “in its role of a securities market participant, NSE is required to set out and implement rules and regulations to govern the securities market… NSE has a set of Rules and Regulations specifically applicable to each of its trading segments. NSE as an entity regulated by SEBI undergoes regular inspections by them to ensure compliance.”

But what happens when the primary role of exchanges, which is to provide a fair marketplace, breaks down when there is a scam by which some brokers have managed to systematically game the stock market system? Can senior employees of the exchange hide behind consent rules and bury the scam? (The consent rules allow a wrongdoer to pay a fine and go scot-free without denying or admitting the wrongdoing.) This is a question that the board of the Securities and Exchange Board of India (Sebi) needs to deliberate upon while it deals with the consent application of the NSE regarding the algo scam, which has rocked the exchange since 2015, leading to a series of high-profile departures.

Sometime in early 2015, a whistleblower wrote a letter to Sebi officials, alleging and explaining in great detail how certain brokers were able to systematically log in ahead of others to the NSE’s co-location servers, and reap super profits. Sebi acted like a post office, sending the letter to the NSE, asking for its response and, after getting a reply that denied all the allegations, kept quiet. However, the content of the letter was carried in Moneylife.

The NSE management, then led by Chitra Ramakrishna and Ravi Narain, took a public stand that these allegations were false. They tried to intimidate and wreck us with a ~1 billion defamation case, which was thrown out by the Bombay High Court. When the whole thing became high-profile, Sebi listened to its Technical Advisory Committee’s suggestion to set up an expert team from the Indian Institute of Technology, Bombay, which upheld the whistleblower’s allegations. Two more investigations, one by Deloitte and another by Ernst & Young, came to similar conclusions. This was followed by the exit of the vice-chairman, Mr Narain, and managing director, Ms Ramakrishna, among others, under a cloud. Sebi then issued a weak show cause notice.

After three years of slow investigation and more details spilling out in public, Sebi sent a second set of show cause notices in early July this year to the NSE and several of its former employees. NSE Managing Director Vikram Limaye has been quoted as saying that the exchange will file consent terms and be done with this monumental scam. Should it be allowed to? One of the cardinal principles of law is coming to the court with “clean hands”. Under this doctrine a plaintiff is not entitled to obtain a remedy if it has acted unethically or has acted in bad faith regarding the subject of complaint. The NSE’s hands have always been unclean in the algo scam episode. Here is a small sample:

Consistently denying that there was anything wrong with its systems;

Intimidating the media — something it has been accused of doing even earlier;

Stalling and denying information to the IIT Bombay team;

Misrepresenting facts to various investigators; Breezy and casual replies on oath to Sebi interrogators;

I will give just two examples of the above. The first is a quote from the expert committee (of IIT Bombay). “NSE has not fully co-operated with us as they have not given timely response, or have not responded at all, and have not deployed enough resources to answer all queries in timely fashion.” The second example is from the wishy-washy interrogation of Sebi. When asked what steps were taken to ensure “equal and fair” access, Ms Ramakrishna, with whom the buck should stop, said “while these principles (of equal and fair access) would be embodied in the actual practices and implementation, the respective departments may have had their own monitoring ranges…” Whatever does this even mean? Can someone at that level get away by such shirking of responsibility?

At no stage in the last three years has any senior official of the NSE been contrite and apologetic about the algo scam. If a broker is caught doing anything out of the way, the NSE shuts down its terminal, inflicting an immediate loss of business and tarnishing its reputation. And here are a bunch of salaried employees on an international pay-scale, who “failed to ensure fair, transparent and equitable access to its members”, concluded Sebi, and continued to pretend that the algo scam was no big deal. Many of the accused are still in charge of running key functions of the exchange.

This is not the first time that the NSE has been caught with a faulty system and loose monitoring. On two previous occasions (illegal modification of the client code and flash crash of October 2012), Sebi allowed the NSE to get away, even though the regulator concluded in the second report: “If only NSE had in place a proper system/process… the incident that happened on October 5, 2012 would not have happened.” It will be a travesty of justice if Sebi is too incompetent and the NSE too big to be pinned down for clear-cut wrongdoing again and again. After all, can we have a system where the NSE’s top brass will collect the upside of a near monopoly with thousands of billions of yearly profits and no downside when caught napping?