NSE IPO papers: Audit found unfair access for brokers

Mumbai: A forensic audit of the National Stock Exchange of India’s (NSE) trading systems showed that its algorithmic trading platform and co-location facility were “prone to manipulation” and allowed “potential preferential access” to some brokers, NSE said in its share sale document.

The audit report observed that consistent preferential access to some brokers may not have been possible without the knowledge of certain NSE officials and employees who didn’t do anything about it.

The report, however, stopped short of calling differential treatment to some brokers “collusion or connivance”, saying that the auditor was not in a position to do so.

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The audit report said that NSE did not have specific processes to retain data and therefore the auditor could not access email correspondence and other information relating to the exchange’s former employees.

The audit was conducted by Deloitte India, Mint reported earlier, but NSE just refers to it as an independent agency in its so-called draft red herring prospectus (DRHP). Deloitte India’s audit has found instances of technical lapses, Business Standard reported on 15 December. The public offer via an offer for sale is estimated to raise Rs10,000 crore.

“At this stage, the disclosures by NSE are mere potential risk factors. Sebi (Securities and Exchange Board of India) would need to take a prima facie view whether these findings are adequate (for penalizing the exchange),” said Sumit Agrawal, founder of Suvan Law Advisors. “At most, the DRHP may be kept pending till the investigation in the matter is complete.”

The independent audit report observed that for certain periods, a few stock brokers appeared to be the first to connect to specific servers more often than others. NSE’s systems architecture meant that the first person to connect also accessed the data first, the report said. That translates into an unfair advantage in high-frequency trading , in which traders use electronic systems which execute thousands of orders in less than a second.

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The audit report pointed out that different stock brokers were treated differently and there was no uniform approach towards matters such as allocation of new access points across ports on existing servers and movements from one server to another.

“Ticks (market data) were disseminated faster to members connected to less crowded servers, thereby giving an advantage to such stock brokers,” said the report, which has been excerpted in NSE’s offer document.

Allegations of unfair access for some brokers at NSE first came to light when a whistleblower who went by the pseudonym Ken Fong wrote to Sebi, alleging that the bourse’s systems were being misused and that some people consistently enjoyed advantages to the detriment of others. Sebi referred these complaints to its technical advisory committee for investigation.

Mint had reported on 5 April that the Sebi committee concluded that NSE violated norms of fair access and allowed some brokers to benefit. The committee has also asked the regulator to probe whether there was “collusion” between NSE officials and a trading firm.

Following these observations, Sebi had written to NSE on 9 September to commission a forensic audit of its systems and deposit all the revenues generated out of co-location facility in an escrow account. Subsequently, NSE appointed Deloitte to conduct a forensic audit of its systems.

The report has also observed that NSE was lax in documenting matters related to its data dissemination systems. It said NSE didn’t have a specific policy and operating procedure for permitting entities that are not Internet service providers to lay cables at its co-location facility.

NSE said it has submitted the report to Sebi on 23 December for further action. The bourse’s board on 19 December also considered the report and decided to review its tick-by-tick trading systems.