NSE co-location case: Benefit to broker under CBI, SEBI lens

“The CBI is reliant on ISB (Indian School of Business) Hyderabad, the 2017 report is zero on gains or gains made on account of loopholes in the NSE system. 30 brokers have been listed in the ISB report. These brokers made profit (from trading) between 2010-14 2,582.6 crore,” said a person with direct knowledge of the matter, requesting anonymity.

Mint has reviewed a copy of the ISB report, which names these brokers and their trading profits between 2010-14, in an April 2019 order of the Securities and Exchange Board of India (SEBI) found the NSE system to be unfair. In its order, SEBI observed that there was potential for misuse and manipulation of the NSE system during that period.

Some of these brokers are also part of SEBI’s final probe, which is probing profit and loss caused by unfair access to the system of NSE.

“The final phase of the SEBI investigation involves a thorough scrutiny of the granular data of the brokers who were using the co-location facility of NSE. This exam is once again being conducted by ISB as it understands the NSE system and data sets.”

“The guilty will be established only after the final report. SEBI and ISB are analyzing the data of these brokers to ascertain whether and to what extent these alleged profits were used by the brokers due to misuse of loopholes in the NSE system. This suggests that the brokers named so far in the report may not necessarily be guilty.

In a Right to Information (RTI) reply on March 17, the markets regulator said “28 brokers have been investigated by SEBI in connection with the NSE co-location case”, without disclosing the specifics of the stage of investigation.

Mint could not trace the names of two brokerages out of 30 checked by the ISB, which were excluded by the regulator. Mint contacted all 30 brokers mentioned in the report for feedback, if any.

The ISB report in November 2017 analyzed ‘any unusual economic or financial gains made by logging in earlier’ by members who joined the NSE. It has estimated the total so-called profit made by these 30 brokers from trading 2,582 crore.

According to the report, the scope of the ISB was to ascertain the monetary gains made by the 17 members in the Deloitte report. These are the members who allegedly took advantage of the NSE system for early login gains. NSE gave a list of additional 13 members to ISB for analysis.

Between 2010 and 2014, NSE used to broadcast market information to the brokers co-located in the exchange premises through the so-called unicast system. Under the unicast system, data packets are sent one-by-one to the brokers’ destination computers, with the connectors receiving the first preference or the first login advantage over the others. Several members previously logged in by gaining improper access to the secondary server. The report also listed the number of times members access the NSE system through uncongested secondary servers.

A whistleblower pointed out a flaw in the system in January 2015. Following the complaint, NSE moved to a multicast system that simultaneously broadcasts data to all co-located brokers. Despite listing the profit figures, the ISB made an observation that the initial login benefit was ‘not misused’.

“Such an outcome would have resulted in higher initial login profits for TMs (trading members) who allegedly attempted to make an unfair profit. This conjecture is based on the assumption that capital would have flowed to those TMs that would have flown to other TMs.” The fact that TMs make less profit of Rs.50 when logging in early indicates that opportunities to make larger profits were not taken advantage of. TM and the market in general are conspicuous. We were not aware of the initial login status of the TMs and hence did not invest more capital despite higher profit potential,” the ISB said.

The ISB report analyzed intraday and overnight profits made by 30 brokers, including proprietary trades and client side trades. These brokers include some of the major algo or high frequency traders, foreign and domestic brokerages. The brokers used co-location services of NSE, which allowed them to place their servers on the exchange premises to reduce latency in receiving or sending information.

“It appears that one TM, OPG Securities, has made higher profits by logging in early. They make higher profits of close to approx. 25 cr when they login quicker than the circumstances when they don’t. OPG Securities’ profits from proprietary trades on the days they log first outweigh the gains from proprietary trades when they don’t log in first. OPG Securities owns profit in the days of first login 15.55 crore,” the ISB said in its report.

OPG Securities is at the center of a CBI probe into alleged misuse of server architecture in criminal conspiracy with unidentified NSE officials.

The secondary servers had the highest number of logins by OPG Securities, Pace Stock Broking, Crimson Financial Shastra Broking (now known as Tower Capital) and SMC Global.

Kotak Securities earned a gross income of 650 crore in intraday and overnight trading in 1,327 trading days between 2010 and 2014. To be sure, the final profit figure will need to be adjusted for taxes and operating expenses. Also revenue can be a function of trading strategy and not just so called preferential access. Another domestic firm, Religare Broking Ltd. has made intraday gains. 135 crores. Responding to an email query, Religare disputed the figure and said that neither SEBI nor ISB reached out to the firm with any queries. Philips Capital makes profit in overnight trading 452 crore in the same period.

“Profits from proprietary trading of OPG Securities and IKM Securities exceed the days of first log in,” the ISB said in its report.

Citi Broking, which declined to comment, showed intraday trading gains of Rs. 107 cr and overnight trading loss 506 crores. Goldman Sachs, another foreign broker analyzed by the ISB, also declined to comment. Barclays logged the first 91 days out of 1,327 trading days; Its commercial advantage was commensurate with 409 crores.

Other firms named in the report include APT Portfolio, AB Financial Services, Way2Wealth, Tower Research (formerly Shastra Securities), QuadI, Pace Stock Broking and SMC Global.