The NSE co-location scam relates to the market manipulation at the National Stock Exchange of India, India's leading stock exchange. Allegedly select players obtained market price information ahead of the rest of the market, enabling them to front run the rest of the market, possibly breaching the NSE's purpose of demutualisation exchange governance and its robust transparency-based mechanism. The alleged connivance of insiders by rigging NSE's algo-trading and use of co-located servers ensured substantial profits to a set of brokers. This widespread market fraud came to light when markets' regulator, the Securities and Exchange Board of India (SEBI), received the first anonymous complaint through a whistle-blower's letter in January 2015. The whistle-blower alleged that trading members were able to capitalise on advance knowledge by colluding with some exchange officials. The overall default amount through NSE's high-frequency trading (HFT) is estimated to be ₹500 billion over five years.
The NSE co-location case is under investigation by the Central Bureau of Investigation (CBI), the Securities and Exchange Board of India (SEBI) and the Income Tax Department who are probing the involvement of NSE and SEBI officials, as well as NSE's former and current executives and brokerages.
In 2019, the Madras High Court issued a notice to SEBI, MCA, ED in response to a Public Interest Litigation (PIL) filed by the Chennai Financial Markets and Accountability (CFMA).
Background In January 2010, the NSE began offering a co-location facility to members. Members could place their servers in the Exchange's premises in return for a fee. This allowed them faster access to the buy and sell orders being disseminated by the exchange's trading engine. The term 'co-location' means 'a setup wherein the broker's computer is located in the same area as the stock exchange's server.' In addition, High-frequency trading (HFT) or algorithmic trading refers to the use of electronic systems, which can potentially execute thousands of orders on the stock exchange in less than a second. Also, retail investors monitoring prices are subject to a delay as compared to the tick-by-tick data broadcast a user receives in a co-location facility. Unusually, the SEBI did not put out a discussion paper to collect market feedback before permitting to proceed with the facility. There are no public records on HFT executed on the NSE. SEBI needs to consult with Technical Advisory Committee (TAC) for such market developments. However, no notification was received from SEBI in regard to it approving for all exchanges. During that time, the managing director of the NSE was Ravi Narain and C. B. Bhave was the chairman of SEBI. It is mentioned in passing in the NSE's 2009-10 annual report statement: "In keeping with global trends, the exchange has provided members a co-location facility for low latency high frequency trading. The Co-location data center is an international standard, state of the art, highly robust, resilient and secure infrastructure."
The whistle-blower's letter that was addressed to SEBI and copied to the leading financial magazine, Moneylife. clearly stated that:when the co-location was started by NSE it took some time for the more enterprising to figure out what was happening in the system. By the end of the year, smart people had all figured out the way to game the system lay in being the first one to connect to the server and preferably the server, which was fastest. The co-location case was initiated when certain members associated with HFT allegedly teamed up and worked in coalition for about four years, i.e. 2010- 2014 overriding rules and regulations set in place by SEBI, the market regulator. According to an unnamed individual familiar with SEBI's investigation: "Access to co-location facilities and HFT trading gave the select brokers differential advantage such as display of market data, viewing order book prior to order execution."
Resignations at NSE The Economic Times first reported that on 22 May 2017, SEBI issued show cause notices to the exchange and fourteen individuals, including former managing directors Chitra Ramakrishna and Ravi Narain. Notices have been sent to Ravi Narain, vice-chairman of NSE, who was chief executive officer (CEO) and managing director (MD) at the exchange during the period when the alleged violations took place. Other officials include Ravi Varanasi, who was the chief of NSE's business development vertical and was heading the surveillance department of the exchange during this period, and Suprabhat Lala, chief of regulation and head of the trading division during 2010–13. Among other officials who received show cause notices were former technology heads — Ravi Apte, and Umesh Jain, and former chief operating officer Subramanian Anand. NSE vice-chairman Ravi Narain had put in his papers on 2 June 2017, amid regulators intensifying their probe into the alleged lapses in high frequency trading. Chitra Ramakrishna, MD and CEO resigned from the exchange in December 2016. The media reported that Chitra's resignation the result of two governance-related issues at NSE. One was the loss of confidence in the NSE top management due to the colocation controversy. The second was the controversy surrounding a high-ranking official at NSE, Anand Subramanian, who was re-designated on 1 April 2015 as Group Operating Officer and Advisor to the MD. This appointment happened after communication from the NSE, MD and the CEO's office bypassing the Human Resources department. Complaints regarding this appointment, and Subramanian's high salary, reached the board prompting it to examine the appointment process. This led to Subramanian leaving the exchange in October 2016. Both Narain and Ramakrishna were part of the NSE's founding team, having joined the bourse in 1994.
After receiving show cause notices from SEBI, 12 out of 14 high-profile current and former top executives of NSE including Ravi Narain and Chitra Ramakrishna filed an application with SEBI to settle the co-location issue under consent mechanism in July 2017. The consent process is an alternative dispute resolution mechanism, allows an alleged wrongdoer to settle a pending issue by accepting a penal action without admitting or denying the guilt. During this period, in July 2017, Vikram Limaye took charge as MD and CEO of the NSE. He gave assurances that he would approach SEBI for a settlement of the co-location issue and would find the underlying cause of this issue. However, a consent application filed by the exchange was later returned in March 2018 after the CBI investigation gathered momentum.
Role of Ajay Shah Other unidentified officials of the NSE and stock market regulator SEBI are under suspicion as well to allow the illegal activity to continue for years. Ajay Shah played a key role in the exploitation of NSE TBT architecture. The probe agency has detected that Ajay Shah had allegedly collected NSE trade data in 2005-06 under the garb of doing research and passed the data to a company that prepared algos. The scam was exposed in 2015, when a whistleblower sent a letter to SEBI alleging that NSE provided preferential access to a few high-frequency traders and brokers to the exchange's trading platform. Consequently, the regulatory body initiated an investigation into the matter. SEBI found that Shah had officially entered into a data-sharing agreement with the NSE after 2012. Prior to this, he and his wife, Susan Thomas got the information from the exchange informally as researchers. Although Chitra Ramkrishna and other top NSE executives clearly denied that they shared data with Shah in his personal capacity, Shah told SEBI that he and his wife were signatories to a data-sharing agreement with the NSE. Also, prior to the contract, the data flow was to Ajay Shah and Susan Thomas. Ravi Apte, the Chief Technology Officer of NSE told SEBI that he had facilitated the transfer of data to Shah under the impression that an agreement was signed between Shah and NSE. Further, he stated that the data transfer was requested by Ravi Narain, former MD, and Ramkrishna.
SEBI's internal team has already concluded its investigation on the case and submitted its report. In July last year, SEBI issued show cause notices to NSE, some of the former and current senior NSE officials, brokers, services providers and Ajay Shah.
The role of Ajay Shah, Susan Thomas and the entire co-location scandal has been exposed in detail by journalist Palak Shah in his book ‘The Market Mafia’.
The Brokers-NSE Nexus The brokers-NSE nexus came to the forefront with the co-location scandal. The broker entity to receive maximum benefit in the scandal was OPG Securities, which was provided multiple login IPs and allowed access from the secondary servers. Due to favourable access, OPG Securities and other entities benefited instead of other brokers and their clients. Other firms on the list of 22 brokers who repeatedly logged in early on the NSE servers include: Alpha Grep, SMC Global, Barclays Securities, Kredent, Pace, Religare Securities, NYCE, Motilal Oswal, Kotak Securities, DE Shaw, Crimson, Advent, Mansukh Stock Brokers, JM Global, AB Financial, Indus Broking and Quant Broking. According to the forensic audit reports by EY India, Deloitte Touche Tohmatsu LLP & ISB, 62 brokerages have enjoyed preferential access though NSE's HFT platform and at present SEBI has only served the SCNs to 3 firms namely- OPG securities, its associate firm-GKN securities and Way2Wealth. The CBI investigation revealed that 90% of the time OPG securities, in collusion with unknown officials of the NSE, was first to access the NSE servers. SEBI's TAC report also revealed that OPG securities was given access using the co-location facility during 2010-2014 that enabled it to log in to the NSE server before any other entity and receive data before any other broker in the market. SEBI has alleged in its show-cause notice that the firm has earned close to ₹ 250 million in profit.
According to the whistle-blower, OPG Securities alone had trades worth over ₹60 billion on the NSE using co-location.Much–Suppressed by NSE: Sebi's TAC Report In addition, the exchange's "order book" was exported to FIIs and FPIs, helping them make illegal gains in the stock market. While OPG Securities used the base technology, Omnesys Technologies provided the trading software. Whistle-blower Ken Fong's letter points to Bangalore-based, front-end technology provider Omnesys, a company that sold trading software to NSE's members and is said to have benefited, legitimately, from its ability to connect ahead of others to the exchange's servers. The whistle-blower states Omnesys was so sure of the early bird strategy that it had profit-sharing arrangements with clients. Omnesys gave the technology to NSE members on a profit-sharing basis and the NSE's wholly owned subsidiary secured 26 per cent stake in Omnesys at a huge discount. Chitra Ramakrishna, NSE's then-deputy managing director, was sitting on the board of Omnesys technologies according to documents from the registrar of companies. As the whistle-blower mentioned in his first letter dated, 14 January 2015, Omnesys was the market leader with its DMA product being highly popular on the institutional desk. This is important since the NSE was the second largest shareholder of Omnesys and worked closely with them for several years.
Action by Agencies against perpetrators
SEBI Action