Algorithm controversy: Sebi issues show-cause notices to NSE, former CEOs

With show cause notices issued to NSE and 14 individuals, the controversy moves towards closure

Capital market regulator Securities and Exchange Board of India (Sebi) has issued show causes notices (SCNs) to the National Stock Exchange (NSE) and 14 individuals as a part of probe against the exchange in the ‘unfair access’ controversy. 

Among those issued the SCNs include former chief executive officers (CEOs) Chitra Ramkrishna and Ravi Narain. The former had unexpectedly quit NSE in December 2016, while the latter currently serves as the vice-chairman on NSE’s board. Other individuals to have received the Sebi SCN are some officers in the technology and business operations department. 

Sources said all the individuals will have to reply to the notices in individual capacity, while the exchange will reply separately. All the entities are seeking legal advice for responding to the SCNs Business Standard has learnt. Those served the notices have been given 21 days to submit their replies.

Sebi has sought inputs and explanations on alleged lapses at the exchange that came to light after the regulator’s internal probe and also by third-party auditor Deloitte India.  

The notices have been sent after Sebi appointed an enquiry officer to examine the facts and findings of the case. Business Standard was the first to report on the appointment of the enquiry officer.

Sources said Sebi has expedited the probe in the matter and a final order in the matter could be passed in less than two months. 

All you need to know about the case:

The case dates back to 2015 when the market regulator received three complaints letters highlighting flaws in NSE’s algorithm trading systems. The letters also made allegations of “unfair access” to certain brokers at the exchange's collocation facility.
According to the letter, between 2011 and 2014, the set up at NSE allowed certain brokers (who connected first to the exchange’s system) received data ahead of others and thus were able to react to information before anybody else.   

Following the letters, Sebi sets up a team to do fact-finding of the complaints in late 2015. Based on the preliminary finding, the Technical Advisory Committee (TAC) of Sebi constituted a committee to further examine the allegations against the country’s largest stock exchange.  

In March 2016, the expert committee submitted its report to Sebi. The committee makes critical observations against the bourse stating it violated norms of fair access by allowing some brokers to benefit. It also alleged that the exchange didn't immediately initiate any steps to check possibility of collusion between its staff and brokers. The expert committee also highlighted that NSE’s systems were prone to manipulation and as a result one OPG Securities was able to exploit its systems.

Sebi asked NSE to respond to the report and allegations made by the TAC-constituted panel. In its reply in May 2016 and June 2016, the exchange said it has addressed various issues raised by the expert committee. It further said it would work closely with the TAC to make further improvements.

In September 2016, Sebi directed NSE’s board to set up an independent examination, including a forensic audit, to address all concerns highlighted by Sebi expert committee.

In November 2016, NSE appointed Deloitte to conduct the forensic investigation.

NSE submitted Deloitte’s report to Sebi on December 23, 2016. The key report also suggested NSE’s systems were prone to manipulation. It also says there was lack of documented policies and protocols on dissemination of data, data retention among other things.

In January, Sebi directed NSE to submit a comprehensive action plan to address the issues and findings raised in the forensic report. It also asks the bourse to submit a roadmap and action plan in two weeks to address issues raised in the report and details on technological and procedural changes required at NSE. The exchange submitted a comprehensive report to Sebi on the new systems and process put in place.

In February, Sebi said the majority of directions issued have been implemented by NSE, while some are yet to be implemented.

In March, Sebi directed NSE to conduct carry out an audit on its currency derivatives and cash segment to check whether the systems used in these categories are also prone to manipulation. The exchange appointed EY to carry out the said audit.

In April, Sebi Chairman Ajay Tyagi had said co-location issue will take a few months time to get addressed. 

Earlier this month, Sebi appointed an enquiry officer to work on the matter and within days issued SCNs.