Deserved penalty

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Deserved penalty

SEBI’s order on the National Stock Exchange is a welcome regulatory action


Why in news?

  • A four-year-long investigation into a possible scam in an Indian securities exchange has finally come to an end.
  • The Securities and Exchange Board of India (SEBI) last week ordered the National Stock Exchange of India (NSE) to pay a fine of about 1,000 crore within 45 days for its supervisory laxity that led to some of its broker-clients gaining preferential access to certain market data.
  • Two former NSE chiefs have been ordered to pay back a part of their past salaries as punishment for their failure to ensure that the exchange was fully compliant with all provisions of the norms governing securities exchanges.

The fraud

  • In 2015, a whistleblower wrote a letter to SEBI alleging that NSE gave preferential access to a few high-frequency traders and brokers to the exchange’s trading platform, leading to an investigation by the SEBI.
  • NSE’s co-location facility allows low latency and fast execution to trading members.
  • The NSE has committed a fraudulent and unfair trade practice as contemplated under the SEBI (PFUTP) Regulations.
    • It is established beyond doubt that the NSE has not exercised the requisite due diligence while putting in place the TBT architecture.
    • The same created a trading environment in which the information dissemination was asymmetric, which cannot be considered fair and equitable.
    • This failure of the NSE to ensure equal and fair access, in the facts and circumstances has resulted in violation of Regulation 41(2) of SECC Regulations 2012
  • In its order, SEBI noted that the NSE’s use of the tick-by-tick server protocol had allowed certain high-frequency trading firms using the exchange’s secondary server to receive important market data before other market participants, who were thus put at a disadvantage.
  • While it has not yet been proven decisively that the firms with preferential access to data from the exchange managed to profit from such data, the episode raised serious questions about market fairness.
    • After all, millions of retail investors believe that stock exchanges provide a level playing field to all the players.
    • SEBI ruled that it did not find sufficient evidence to conclude that the NSE committed a fraudulent act, but was unequivocal in ruling that the Exchange had failed to exercise the necessary due diligence to ensure that it served as a fair marketplace.
    • The fact that the NSE had opted to switch to a new data transmission system, which relays data to all market participants at the same time, prior to a whistle-blower’s complaint in 2015 may have worked in the NSE’s favour.


  • What SEBI is asking the NSE to pay is more than a quarter of its combined overall operating revenue for four years, after the regulator ruled that a high-frequency trading firm benefited from unfair market access. It’s also more than whatever money the exchange made from HFT until changing its system in 2014.
  • It also directed the NSE to submit an action taken report in this regard along with the observation of its Governing Board to the SEBI, within three months from date of the order.
  • This is overkill, especially since the regulator couldn’t establish the graver charges of fraud or unfair trade practice.
  • It all boiled down to whether the technology used by the NSE to roll out its high-frequency business provided an equal and fair trading environment to everyone who had opted to place their computers close to the exchange’s, hoping to pare microseconds when executing trades.

Way ahead

  • Despite the sizeable fine that it imposes on the NSE, the SEBI verdict must surely come as a relief to the erring stock exchange for at least two reasons.
    • First, the fact that it has not been found to have intentionally favoured certain market players over others should help it retain investor confidence.
    • Also, the exchange, which had been barred from proceeding with its initial public offering during the pendency of the SEBI probe, will now finally be able to tap the capital markets to fund its growth, after a six-month moratorium. While there is bound to be debate about the magnitude of the fine, overall the financial penalty is a welcome regulatory action.
  • Millions of investors choose to do their trading on market platforms like the NSE every year in the belief that the marketplace offers an equitable environment to carry out their trades.
  • As the markets regulator, SEBI must deal with breaches of their supervisory brief by exchanges in an exemplary manner to ensure that small investors retain confidence in the fairness and soundness of key institutions that enable a market economy.

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