Co-location case: Another damp squib from Sebi

Amidst the ongoing turmoil at the Securities and Exchange Board of India (Sebi), characterised by allegations of conflict of interest against its chairperson Madhabi Buch and a rebellion among its employees, the regulator announced on Friday the dismissal of charges against the National Stock Exchange (NSE) and seven of its former executives, including former Managing Directors and Chief Executive Officers Ramkrishna and Narain. Additionally, charges against Anand Subramanian, Ravindra Apte, Umesh Jain, Mahesh Soparkar, and Deviprasad Singh have also been dropped.

Sebi attributed this decision to a lack of evidence substantiating the claims. The market regulator acknowledged that while there were certain deficiencies at the NSE's colocation (colo) facility, there was no proof of any “collusion” or “connivance” with the brokerage firm OPG Securities, which allegedly obtained “unfair” access to the exchange’s secondary server.

“It is held that due to the absence of sufficient material/evidence/ objective facts on record in this case, the test of ‘preponderance of probability’ fails to produce enough justification for the establishment of collusion/connivance between OPG and its directors with Noticees,” Kamlesh Varshney, whole-time member, Sebi said in an 83-page order.  

Sebi figured out that the available evidence did not meet the "preponderance of probability" standard required to prove collusion or connivance between OPG Securities (OPG) and NSE officials.

"Due to the absence of sufficient material/evidence/objective facts on record in this case, the test of 'preponderance of probability' fails to produce enough justification for the establishment of collusion/connivance between OPG (Securities) and its directors with notices (NSE and its seven employees)," the market regulator said.

This case pertains to the purported preferential access granted to specific brokerage firms, including OPG Securities, through 'dark fibre' connections to the colocation facilities ahead of other members.

The recent ruling follows a directive from the Securities Appellate Tribunal (SAT) in January 2023, which instructed Sebi to reassess the situation within a four-month timeframe.

Furthermore, the tribunal had mandated the Whole Time Member (WTM) to investigate the allegations of collusion and connivance involving OPG and its directors regarding any NSE employees.

In its ruling on Friday, Sebi acknowledged that there was no contention regarding the absence of a comprehensive policy governing the use of the colocation facility by the NSE. It also noted the failure to adequately monitor the utilisation of the secondary server by trading members without justifiable cause.

Flashback to the Co-location case 

This decision followed a January 2023 ruling by the Securities Appellate Tribunal (SAT), which had overturned Sebi’s April 2019 directive for NSE to return ₹625 crore.

The co-location service, launched by NSE in 2009, allowed brokers to install their servers within NSE's data centres for a fee, granting them access to market data fractions of a second before others.

The controversy emerged in 2015 when whistleblowers alerted Sebi to concerns over preferential access. A Sebi committee found vulnerabilities in NSE's data dissemination system that could be exploited, prompting investigations into 15 stockbrokers, including OPG Securities.

In 2019, Sebi ordered NSE to return ₹624.89 crore and barred it from the market for six months. However, after NSE's appeal, SAT reduced the amount to ₹100 crore.

Sebi also ordered OPG Securities to return ₹15.75 crore with interest, but this was later overturned, and the case was sent back to Sebi for reconsideration.

SAT further directed Sebi to reassess the case within four months, focusing on recalculating the disgorgement amount, revisiting allegations of collusion, reviewing claims of crowding out other participants, and determining penalties for any destruction or concealment of evidence.

Sebi's primary task was to determine if OPG and its directors gained an unfair advantage through secondary server access or by excluding other traders.

Earlier, SAT ruled that simply being the first to log into the primary server did not give an unfair advantage, thus narrowing the scope of Sebi’s investigation.

Following the SAT ruling, Sebi issued fresh notices to NSE and others in May 2023. Throughout the process, Sebi provided the recipients with access to documents and allowed opportunities for cross-examination.

Despite these opportunities, Sebi found no substantial evidence against NSE or its former executives. NSE defended its co-location practices, explaining that the secondary server was intended only as a backup in case the primary server failed, and any misuse was addressed through disciplinary measures, including actions against OPG traders.

Ramkrishna argued that the evidence did not support any accusations against her, either personally or professionally, and claimed the charges of negligence and connivance were contradictory, reflecting inadequate consideration.

Similarly, Subramanian contended that the show cause notice lacked specific evidence against him despite several reports. He argued that the allegations had no solid foundation.

Sebi dismissed charges against NSE’s former executives and other individuals, citing insufficient evidence of collusion.

While Sebi noted that NSE lacked a clear policy for managing its co-location facility and did not properly monitor traders' use of the secondary server, this did not substantiate claims of collusion with OPG Securities and its directors.

Despite these findings, as highlighted in the 2023 SAT ruling, Sebi concluded that the lack of oversight did not prove collusion between OPG and NSE officials.

In a separate ruling, Sebi ordered OPG Securities to return ₹85 crore and imposed a six-month trading ban in addition to the previously ordered five-year prohibition.