Where Angels Prey

Where Angels Prey is a novel by Ramesh S Arunachalam. Please refer to www.whereangelsprey.com for more information

Friday, September 25, 2015

SEBI Must Recognise That Sucheta Dalal’s Drive for Investigation into “Algo Trading Issues at NSE” is EXTREMELY Important for the Overall Health and Safety of Indian Capital Markets


Ramesh S Arunachalam, September 25th 2015


A) Algo Trading and Securities and Exchange Board of India (SEBI):


It is with deep concern as a citizen of this country that I am writing this blog piece as I read an interview by Chairman SEBI dated July 30th 2015 on “Algo Trading”. While I appreciated the intent as conveyed through the interview in terms of cracking down on those misusing algorithmic trading[i] (in the future), I was somewhat concerned by the (SUPPOSED) self-admission in the same interview:

 “’If somebody is doing it deliberately, we have a surveillance mechanism to take action against them. Whether we have enough mechanism to stop them, I would not claim that much. But we can certainly catch them and penalise them,’ Sinha said.” (http://businesstoday.intoday.in/story/sebi-to-take-stern-action-on-algo-trades-misuse-chairman/1/222241.html)

If the above quotation is INDEED a TRUE statement of what Mr Sinha had said, I must say that I am very alarmed with this statement as it is imperative for SEBI, as the capital markets regulator, to have appropriate mechanisms to catch people misusing algorithmic trading/HFT/HST. I am sure that you all would agree that there can be no compromises on that! The entire purpose of regulation is to do its best to prevent failure of markets, systems and organisations etc and I sincerely hope that SEBI develops stronger mechanisms to catch people misusing algorithmic trading/HFT/HST.

This is because as per recent reports Algorithmic trading/HFT/HFS are said to be gaining market share and are already said to occupy around 46% of the total trade volume at NSE and over 30% of the total trade volume at BSE. In the USA and Europe, while they occupy very significant amounts of trade by volume (between 75% - 80% of total trade volume in USA and around 60% of total trade volume in Europe respectively), it is widely expected that Asian markets like India[ii] will offer greater avenues for the growth of Algorithmic trading/HFT/HFS in the future – something which makes the above statement even more significant since algorithmic trading per se and the technology associated with Algorithmic trading/HFT/HFS still have many problems as evident from the examples given below.

Let me first deal with what has happened in India and then dwell on the technological and other problems related to algorithmic trading that have occurred globally over the last few years.


B) Algo Trading: The Indian Scenario


In India, where Algorithmic Trading is growing very fast, we have had issues such as the following. Several other CRITICAL issues have been raised later in this piece, especially with regard to algorithmic and high frequency trading in India.

“On May 6, four large orders in Nifty May futures, ranging between 7,000 and 39,000 contracts, were traded between 9:41am and 9:53am. The deals were worth Rs 1,470 crore and the stock market crashed wiping out all gains made the year before. All of these were algorithmic. ... the benchmark Sensex and Nifty tanked, losing over 2 percent to wipe out entire gains made last year. The main reason: algorithmic trading. Such mishaps have happened before, despite SEBI tightening its rules for algo-trades, as traders call them. This form of high-speed trading rose 12 percent on the Bombay Stock Exchange, to account for almost 30 percent of total trades. Its share is higher in the National Stock Exchange, with nearly 46 percent of trades happening on the platform. ...Since it happens at tremendous speed, way quicker than what human traders are capable of, it is much more efficient. However, that can also result in large trades that can swing the market and result in significant losses for ordinary investors, like what happened on May 6[iii]. Most investors don't stand a chance of trading in stocks that are being traded algorithmically.”[iv]


C) Algo Trading: Global Scenario


There are many issues with algorithmic trading/HFT/HFS as espoused by the following global events of the last few years - whether the flash crash of May 6th 2010 where over an estimated trillion dollars were lost within a couple of hours or the Knight Capital case (August 2012) where a single company is said to have lost around 441 million US $ within an hour. While in the flash crash, HFT’s caused and exacerbated the already depressed markets in response to an algorithm selling a specific product, the Knight Capital case was that of an algorithm going ROGUE.

Likewise, because of technology and related aspects, the following incidents occurred: the NASDAQ OMX FACEBOOK IPO glitch (of May 2012) where several millions were apparently lost[v] or the BATS’s IPO which was scuttled by a computer glitch in March 2012 or The Madrid-based Bolsas y Mercados Espanoles which suffered a glitch that halted trading at the stock market for more than four hours in August 2012 or The Tokyo Stock Exchange Group’s second major system error in seven months that halted derivatives trading for about 95 minutes in August 2012 and so on.


D) Architecture of Capital Markets Globally, Technology and Associated Problems:


As noted above, it is quite troubling and perplexing to witness the technology mishaps that have occurred recently in the world of capital markets and the key point is that if it can happen in the most advanced market of the world, the USA, India is no less vulnerable. For more than two decades, technology has shaped and continues to define the architecture of capital markets globally; hence, it is imperative at this stage in the evolution of the markets to come to certain realizations about the inherent risk that lies in this dependency on information technology for the industry overall.

The problems emanating from the technology employed by the new kids on the block for investing are best summarised as follows:

“In the four years since the collapse of Lehman Brothers drove the global financial system to the brink of oblivion, new technologies have changed Wall Street beyond recognition. Despite efforts at reform, today's markets are wilder, less transparent, and, most importantly, faster than ever before. Stock exchanges can now execute trades in less than a half a millionth of a second—more than a million times faster than the human mind can make a decision. Financial firms deploy sophisticated algorithms to battle for fractions of a cent. 

Designed by the physics nerds and math geniuses known as quants, these programs exploit minute movements and long-term patterns in the markets, buying a stock at $1.00 and selling it at $1.0001, for example. Do this 10,000 times a second and the proceeds add up. Constantly moving into and out of securities for those tiny slivers of profit—and ending the day owning nothing—is known as high-frequency trading.’

Computer programs send and cancel orders tirelessly in a never-ending campaign to deceive and outrace each other, or sometimes just to slow each other down. They might also flood the market with bogus trade orders to throw off competitors, or stealthily liquidate a large stock position in a manner that doesn't provoke a price swing. It's a world where investing—if that's what you call buying and selling a company's stock within a matter of seconds—often comes down to how fast you can purchase or offload it, not how much the company is actually worth.” [vi]


Consider the following which illustrates very vividly as to what technology mishaps can (un) do in the capital markets:
“At 9:30 A.M. on August 1, a software executive in a spread-collar shirt and a flashy watch pressed a button at the New York Stock Exchange, triggering a bell that signalled the start of the trading day. Milliseconds after the opening trade, buy and sell orders began zapping across the market's servers with alarming speed. The trades were obviously unusual. They came in small batches of 100 shares that involved nearly 150 different financial products, including many stocks that normally don't see anywhere near as much activity. Within three minutes, the trade volume had more than doubled from the previous week's average.

Soon complex computer programs deployed by financial firms swooped in. They bought undervalued stocks as the unusual sales drove their prices down and sold overvalued ones as the purchases drove their prices up. The algorithms were making a killing, and human traders got in on the bounty too.

Within minutes, a wave of urgent email alerts deluged top officials at the Securities and Exchange Commission. On Wall Street, NYSE officials scrambled to isolate the source of the bizarre trades. Meanwhile, across the Hudson River, in the Jersey City offices of a midsize financial firm called Knight Capital, panic was setting in. A program that was supposed to have been deactivated had instead gone rogue, blasting out trade orders that were costing Knight nearly $10 million per minute. And no one knew how to shut it down. 

At this rate, the firm would be insolvent within an hour. Knight's horrified employees spent an agonizing 45 minutes digging through eight sets of trading and routing software before they found the runaway code and neutralized it. By then the firm had not only lost 441 million but also caused havoc in the market

By then it was shortly after 10 a.m., and officials from the NYSE, other major exchanges, and the Financial Industry Regulatory Authority were gathering for an emergency conference call. It didn't end until 4 p.m.”[vii]

What ever happened in Knight’s case?

“Computers and clever maths enable traders to buy and sell in the blink of an eye. But does high-frequency trading make matters worse when things go wrong?”[viii]

“At Knight, some new trading software contained a flaw that became apparent only after the software was activated when the New York Stock Exchange opened that day. The errant software sent Knight on a buying spree, snapping up 150 different stocks at a total cost of around $7 billion, all in the first hour of trading.” [ix] The software was essentially buying high and selling low, which humans would not do!

“Knight’s trades were not like those of the flash crash, when stocks of some of the world’s largest companies suddenly began trading for as little as a penny, and no buyer could credibly claim the transaction price reflected the correct market value.”[x]

“Between 9:30 a.m. and 10:00 a.m. EDT, one of Knight’s trading algorithms reportedly started pushing erratic trades through on nearly 150 different stocks, from Berkshire Hathaway (BRK/B) to Nokia (NOK) to Exelon (EXC). Trading volumes soared in many of them, so much so that the most traded stock on a typical day, the SPDR S&P 500 ETF (SPY), finished the Aug. 1 session as the 52nd-most traded stock, according to Eric Hunsader, CEO of market data service Nanex.

Nanex put together this chart showing what was going on in shares of one of the most volatile stocks, Exelon. Knight’s buggy algorithm was apparently buying high and selling low, the opposite of a competent trading strategy. From the Nanex chart: “[A]lmost all these trades alternate between buying at the offer and selling at the bid, which means losing the difference in price. In the case of EXC (Exelon), that means losing about 15 cents on every pair of trades. Do that 40 times a second, 2,400 times a minute, and you now have a system that’s very efficient at burning money.”[xi]

“It totally freaked us out,” Hunsader says. “If it hadn’t been stopped, it would have been a total disaster.” He adds that the glitch led to 4 million extra trades in 550 million shares that would not have existed otherwise.

Knight operates as a market-making and trading firm filling retail orders from such brokers as E*Trade Financial (ETFC) and Fidelity Investments. According to its website, the firm’s market-making unit executed a daily average of $19.56 billion worth of equities in June, with a volume of 3.1 billion shares. The $440 million loss is now bigger than the company’s market cap, which was $296 million as of Thursday afternoon, according to data compiled by Bloomberg.

What seemed to surprise folks in the industry most about the mishap is that Knight has cultivated a reputation as one of the best market-making firms in the business, with trading technology that is as fast and secure as anything else currently deployed. “Technology breaks,” Joyce said in an interview on Bloomberg Television’s Market Makers program on Thursday morning, adding: “It ain’t good. We don’t look forward to it.”

Says Bill Black, a former federal regulator who helped investigate the S&L crisis of the '80s and '90s, imagine trading algorithms causing "a series of cascade failures"—like the domino effect that followed Lehman's collapse. "If enough of these bad things occur at the same time," he says, "financial institutions can begin to fail, even very large ones." It's not a question of whether this will happen, Black warns. "It is a question of when."

Years of mistakes and bad decisions led to the 2008 collapse. But when the next crisis happens, it may not develop over months, weeks, or even days. It could take seconds.” [xii]

“Then-SEC chair Mary Schapiro summed up at an October market technology roundtable. ‘But we also know that technology has pitfalls. And when it doesn't work quite right, the consequences can be severe. Just imagine what can happen if an automated traffic light flashes green rather than red, if a wing flap on a plane goes up rather than down, if a railroad track switches and sends the train right rather than left.’”[xiii]

“So far, the problems caused by algorithms appear to be mostly accidental. But what if someone designed a program intended to wreak havoc? John Bates, a computer scientist who, in the early 2000s, designed software behind complicated trading algorithms, worries that the kind of tools he's created could end up in the wrong hands. "Fears of algorithmic terrorism, where a well-funded criminal or terrorist organization could find a way to cause a major market crisis, are not unfounded," he wrote in 2011. "This type of scenario could cause chaos for civilization and profit for the bad guys and must constitute a matter of national security.

Honest mistakes are one thing, but there are also an increasing number of incidents of rogue traders, fraud and greed-gone-wrong. Looking at this compendium of fat finger or algorithmic errors and fraudulent or rogue trading, I think we have been lucky so far that their impact has not been more serious. The scary thing is that things could have gone a lot more wrong. The flash crash illustrated how quickly things can move and how inter-related the markets are. In 2010 we have seen incidents in equities, futures, FX and oil markets. A cross-asset “splash crash” that cascades across multiple markets is theoretically possible – whether it’s accidental or even premeditated.”[xiv]

And that would be disastrous and that is why I get worried when SEBI’s chairman says that they do not have the surveillance mechanisms to deal with issues arising from algorithmic trading gone ‘purposely wrong’!

And nobody substantiates the perils of modern day technology better than SEC’s Commissioner Luis A. Aguilar[xv] and I quote,

“It’s true that modern information technology has revolutionized the infrastructure of the nation’s capital markets in beneficial ways.[2]  But this technology also presents significant risks, and carries the potential for immense harm to investors.  This is particularly true as to our nation’s equity markets, where the vast majority of trade quotations are generated by pre-programmed, automatic algorithms.[3]

Many of these algorithms have hair-trigger settings, and, as market crisis after market crisis has shown, they are able to unleash massive waves of quotations the instant certain circumstances arise.[4]  Because these automated systems execute trades at blinding speeds, humans cannot keep up, and may not be able to intervene quickly when something goes awry.[5]

Consequently, in today’s markets, a single rogue algorithm can trigger a cascading series of errant trades, destroying billions of dollars of market value in the blink of an eye.[6]  This destruction of market value and subsequent upheaval harm investors and undermine their faith in the fair and orderly functioning of the capital markets.[7]  Each new market crisis increasingly jeopardizes the Commission’s mission to protect investors, maintain fair and orderly markets, and facilitate capital formation.

Over the past several years, market disruptions have illustrated the dangers of automated trading systems in stark relief.  Exchanges are proving especially vulnerable.  In fact, there have been at least 27 serious technical malfunctions at exchanges around the world in the last three years alone.[8]  For example, the BATS exchange has suffered three serious software mishaps in the past two years, including a long-lived failure to provide the best price for 433,000 separate trades over a five-year period.[9]  But BATS is certainly not unique.  For example, over the last two years, several of the largest exchanges have suffered software malfunctions, including the New York Stock Exchange, the Chicago Board of Options Exchange, and Direct Edge.[10]  And, in perhaps one of the most publicized mishaps, a software glitch badly disrupted the Facebook IPO.[11]   

Providers of stock quotes, which are known as securities information providers (or SIPs),[12] are also at risk.  Trading on Nasdaq was paralyzed for three hours last year when its quotation system malfunctioned, and Nasdaq suffered a similar mishap just two weeks later.[13]

Additionally, I am increasingly concerned about the cybercriminals that are targeting our capital markets by attacking or exploiting weaknesses in its technological infrastructure.  Cyber-criminals succeeded in penetrating Nasdaq’s peripheral computer systems repeatedly in 2011, and even succeeded in planting a so-called “digital bomb” in Nasdaq’s servers.[14]  And, in 2012, more than half of the world’s exchanges were the subject of a cyber-attack.[15]  It seems rare when a week goes by without some report of a cyber-attack.

This dismal catalogue of technical glitches and cyber-attacks demands a robust, comprehensive, and thoughtful response.”[xvi] 


E) Implications for Regulation and Supervision of Capital Markets:


And as someone with close to three decades of experience in information technology and financial services with an strong practical emphasis on control, regulation and supervisory arrangements amongst other things, it is rather perplexing for me to understand why the technology mishaps that have been occurring with regular frequency in the world of capital markets (especially in recent times) have NOT yet led us to appreciate the huge risk that technological dependence holds for capital markets and try and simultaneously address the same.

Ever since the most rudimentary form of electronic trading started in America in the mid-late 1970s and gained popularity in the late 1980s, there is no doubt that for over the last twenty five years now and still counting, technology continues to define the overall structure and evolution of global capital markets. There are obviously many (huge) benefits from this but at the same time, there are huge problems as well which we need to recognise ASAP so that they can be mitigated (if not completely redressed). Please note that any problems that are not recognised cannot be mitigated

Especially, given the various happenings of the last 5 years (that were enumerated above), where technology has either caused or exacerbated problems of great magnitude in the capital market, it is about time we recognise the basic fact that there is an enormous inherent (technology) risk which lies in this dependency on information technology for the capital market industry overall. And there is no doubt what-so-ever that this critical risk needs to be addressed with renewed vigour, dynamism and eclectic strategies in a continuous manner as otherwise the capital markets will continue to remain vulnerable and at risk.

As noted above, not only the capital markets but also stock exchanges are at huge risk because of the perils of technology. 


F) Vulnerability of Stock Exchanges in Changing Scenario:


The vulnerability of exchanges is especially critical as they are vehicles that transform ‘hard earned savings of people’ into ‘investments’ through stock market and related services which form a very important part of the overall economic milieu of our country. In fact, the Order (dated 23.06.2011) of the COMPETITION COMMISSION OF INDIA (in CASE NO. 13/2009 between MCX Stock Exchange Ltd and National Stock Exchange of India Ltd and DotEx International Ltd)[xvii] nicely highlights the importance of stock market services and stock exchanges for the economy of India and the same is briefly summarized below:

“1.5 Stock exchanges are enmeshed in the economy of a nation and are the most important mechanism of transforming savings into investments. Over the ages, as economies developed, industrialization occurred and markets became more organized, a need for permanent finance was felt world over. Entrepreneurs needed money for long term whereas investors also required liquidity. The answer was development of the institution of stock exchanges.

1.6 A stock exchange is an entity that provides services for stock brokers and traders to trade stocks, bonds, and other securities or derivatives. Stock exchanges also provide facilities for issue and redemption of securities and other financial instruments, and capital events including the payment of income and dividends. Securities traded on a stock exchange include shares issued by companies, unit trusts, derivatives, pooled investment products and bonds. To be able to trade a security on a certain stock exchange, it must be listed there. Usually, there is a central location at least for record keeping, but trade is increasingly less linked to such a physical place, as modern markets are electronic networks, which gives them advantages of increased speed and reduced cost of transactions. Trade on an exchange is by members only. There is usually no compulsion to issue stock via the stock exchange itself, nor must stock be subsequently traded on the exchange. Such trading is said to be off exchange or over-the-counter. This is the usual way that derivatives and bonds are traded. Increasingly, stock exchanges are part of a global market for securities.”

Thus, it is VERY clear from the above that the public utility, role and importance of STOCK EXCHANGES - which are indeed an integral part of the Indian economy - cannot therefore be understated! Without any doubt, stock exchanges are key institutions in the economy and they not only need to be efficient (doing things the right way) but also effective (doing the rights things), adaptive (satisfy needs of their existing and potential users with technology and innovation), accountable (to the country as whole, its citizens and their immediate users), transparent (provide appropriate and timely disclosure on products, processes and the like) and well governed (without any conflicts of interest)!

All of the above also make the regulation and supervision of stock exchanges very critical and herein, the role of the capital market regulator such as SEBI and other regulatory authorities assumes tremendous significance as stock exchanges are akin to public authorities/bodies[xviii] that transform “savings” into “investments”. As a result, there is a huge public responsibility on the part of the regulator (s) to ensure that these hard earned savings are not lost as savings form the backbone of any modern economy like India.


G) Whistle Blower’s Letter to SEBI and Investigation of the Same by SEBI:


Given the above context, I have recently also come across in the public domain, a letter[xix] addressed to Shri B K Gupta, DGM, Market Regulation Department, Division of Market Supervision, SEBI, BKC, Mumbai. This is the address given in the said letter which can be found at the links given below.

Please KINDLY see copy of the letter at http://www.naavi.org/uploads_wp/nse_manipulation.pdf. Amongst other things, the (WHISTLE BLOWER’s) letter alleges several wrong doings at NSE and requests SEBI to investigate the matter.

The following news item (http://m.livemint.com/Industry/F3LUvGix8dPhzDtHZotvqL/Moily-panel-seeks-Sebi-report-on-alleged-malpractices-at-NSE.html) says that SEBI has initiated an investigation but NSE supposedly denies the same (as per the same news report). The question here is how can an investigation concerning NSE be done without NSE’s knowledge? This is very confusing therefore and hence, this article and am specifically looking for answers to the questions given hereafter.


H) SEBI’s Investigation of The Whistle Blower’s Letter – Some General Questions:


My general questions to SEBI as a concerned citizen are as follows:

a)      Whether any such investigation has been initiated by SEBI on the basis of the whistle blower’s letter given in the links above?

b)      If yes, what is the status of this investigation and what are the findings? Based on the investigation findings, are the allegations levelled in the Whistle Blower’s letter true?

PLEASE KINDLY NOTE THAT I AM ASKING SEBI TO LET ME KNOW (BASED ON THE INVESTIGATION FINDINGS) AS TO WHETHER THE ALLEGATIONS LEVELED IN THE WHISTLE BLOWER’S LETTER (GIVEN IN LINK ABOVE) ARE INDEED TRUE!

c)      If the investigation is on-going, when is it likely to be completed?

d)     Who are the people investigating the issues mentioned in the letter? Do they have any (inherent) conflicts of interest in terms of investigating potential/plausible lapses in their own duties and functions? This is very critical!

e)      What is the subject of the investigation? What are the terms of reference? Does it cover all aspects alleged in the above WHISTLE BLOWER’s letter? Are all levels of analysis (SEBI internal level, NSE level, other market participant level etc) that are required to be covered in such an investigation being covered?

f)       Who and which people (in specific), what processes and which events are being probed and investigated? It must be noted that some of the people who were in a position of responsibility at various organisations in different positions at several levels (for the years concerned – i.e., 2009 to date) may have left the service of the concerned organisations. In that case, have they as well as their successors been called for the enquiry?

g)      Have all documents and resources including all computer logs of all servers including backup servers pertaining to the above period been examined? If so, what do they indicate with regard to the various specific issues mentioned in the Whistle Blower’s letter?

As noted above and reemphasized here, it is pertinent to note that as per an available news report, the NSE denies any investigation -  (http://m.livemint.com/Industry/F3LUvGix8dPhzDtHZotvqL/Moily-panel-seeks-Sebi-report-on-alleged-malpractices-at-NSE.html).

If the above news item is true and there has been no investigation so far, why has there been no investigation as yet? This is especially a critical question NOT ONLY in the light of the WHISTLE BLOWER’s letter but also on the basis of SEBI Chairman’s statements dated July 30th that sufficient surveillance mechanisms do not exist (as on date) with SEBI with regard to taking action against people who deliberately misuse algorithmic trading. Please see paragraph #1 given above (in this piece) and SEBI Chairman’s (SUPPOSED) own quote reproduced therein.

Also, is it not SEBI’s duty to investigate any potential and/or plausible issues with regard to High Frequency Trading (HFT) - or Algorithmic Trading - that has caused extensive damage worldwide? I can relate many instances where HFT or Algorithmic trading has led to and/or has exacerbated huge shocks in the market and caused huge losses to the tune of several billion dollars. Therefore, in my humble opinion, I feel it is imperative for SEBI to investigate and get to the root of the matter and determine whether what has been alleged in the WHISTLE BLOWER’s letter is true or not?


I) SEBI’s Investigation of The Whistle Blower’s Letter - Specific Questions for SEBI:


I also have several specific questions (SEBI and Supervisory level) which are outlined below and would like SEBI to provide me answers to as I am very concerned as a citizen of the country:

a)      Did any of the following departments at SEBI - Market Intermediaries Regulation and Supervision Department (MIRSD), Special Enforcement Cell (SEC), Investigations Department (IVD), Market Regulation Department (MRD), Integrated Surveillance Department (ISD) – find anything unusual in terms of patterns and behaviour with regard to HFT and Algorithmic trading during the period 2009 – 2014?

b)      Given that SEBI Chairman himself admits that surveillance mechanisms are insufficient, what does SEBI propose to do to safeguard and protect India’s wealth and people from the ills of HFT or Algorithmic trading, which are experiencing burgeoning growth worldwide?

c)      If what has been alleged in the WHISTLE BLOWER’s letter has been found to be true by SEBI’s own investigation, what lessons can be learned regarding the existing supervisory mechanisms (within SEBI and across its departments) as well as controls (at various levels including at stock exchanges) in terms of their effectiveness and ability to prevent (such) undesirable events and behaviour with regard to algorithmic trading in the future? What changes in the supervisory mechanisms and controls (at various levels) would be required in the immediate future to protect the Indian economy and ensure its financial stability?

d)     If what is alleged in the WHISTLE BLOWER’s letter has been found to be true by SEBI’s own investigation, were any of the above departments (and/or NSE) aware of these happenings as they unfolded? Specifically, if they were aware and did not act, were there any conflicts of interest that prevented the people concerned from doing their duties?

e)      And if the above is indeed true as per point’s c and d (given above), what does SEBI propose to do in terms of future course of action?


J) SEBI’s Investigation of The Whistle Blower’s Letter - Specific Questions for SEBI/NSE:


I also have several specific questions (NSE level) which are outlined below and would like SEBI/NSE to provide me answers to as I am very concerned as a citizen of the country:

a)      As per SEBI’s investigation, did a sophisticated market manipulation occur at NSE for several years at NSE Collocation data centre with active collaboration of NSE data centre staff as alleged in the Whistle Blower’s letter?

b)      If the above is true on the basis of SEBI’s investigation, did NSE Management ever get to know of this? What does SEBI’s investigation say with regard to this?

c)      If as per SEBI’s investigation, the matter did come to knowledge of NSEs management team, what did they do? Did they take action against the people concerned? Or did they choose to ignore or keep quiet about it?

d)     Does SEBI’s investigation suggest that the market manipulation - that the Whistle Blower is alleging in his letter – enabled certain vested brokers to get market price information ahead of the rest of the market? In other words, specifically, does SEBI’s investigation suggest some vested brokers were enabled to front run rest of the market? This is very critical!

e)      Specifically, did SEBI’s investigation involve inspection of all the logs from (all) the main and back up servers at NSE (NSE collocation and data centre)? What do they indicate in terms of who logged in on a daily basis to which server? Is there a pattern whereby certain vested brokers were always found to have logged in the earliest and also on the lowest load servers? Specifically, do the logs also indicate that specific brokers logged on immediately after the servers were switched on and especially, to the lowest load and strongest performing servers? Was this a daily feature? What about highly volatile days? Is there a pattern to this in terms of specific brokers always logging on to such systems? If yes, as per SEBI’s investigation, who were the specific brokers who benefitted and what does each of their individual (payment) settlements indicate?

f)       As per SEBI’s investigation, did any of these specific brokers have any specific linkages to any of the staff at NSE including those at the data centre, co-location centre and/or elsewhere at NSE including the operational and management staff at various levels?

g)      As per SEBI’s investigation, did any of the NSE staff join the payrolls of the any of the above mentioned type brokers? If yes, who were these staff, what positions had they occupied at NSE and which brokers did they ultimately join and in what capacities? Have they been called for the investigation? What are SEBI’s findings?

h)      In other words, does SEBI’s investigation reveal that some specific brokers were privy to the information as to which server would be started at what time so that they could be the first one to connect and enjoy all the advantages of logging in first and especially on to the lowest load servers?

i)        In terms of quantification, would this superior and earlier access advantage (for some vested brokers) make access to crucial price information several (say, 100) times faster than the average person on collocation? What about non collocation persons?  Were they never in the picture? Put differently, the manipulations aside, did collocation itself provide a huge unfair advantage vis-à-vis others? Were non collocation people analogous to those who never even reached the stadium by the time the race was to start? What does this suggest about co-location in terms of in providing unfair advantages to a relative few as compared to the larger market? What are the implications for co-location from the perspective of anti-trust laws?

j)       The WHISTLE BLOWER notes in his letter that

“there is globally a practice of time synchronisation across all exchange servers and all servers at collocation synchronise themselves with the exchange clock (down to milli second). Though the device costs only a few thousand dollars, it was surprisingly missing from the exchanges infrastructure.”

Does SEBI’s investigation reveal this to be true and if yes, which brokers took advantage of this and for how long? And if the above is true, does SEBI’s investigation pin the blame for such a serious lapse at NSE on anyone specifically? What are the implications for SEBI’s supervision of the stock exchanges? This is again a very critical issue!

k)     What does your investigation say with regard to following alleged assertion in the Whistle Blower’s letter which notes that:

“When Umesh Jain joined as CTO in Oct 2012 he started off by meeting a lot of players in the system and when he discovered this most common issue was TBT servers he setup a simple solution in a couple of months. Being a new person willing to listen he found himself flooded with logs indicating the high differential between multiple servers. Latency difference of 50 ms across servers was common. He realized this needed to be fixed. He dismantled the system of TBT allocation and to ensure fairness put in what is called a load balancer. The load balancer would be the server to which everyone would need to connect and in turn it would dynamically decide which TBT server the application would connect internally based upon the overall load so that load is evenly distributed. This change clearly represented the biggest challenge to the model of those who were trying to game the system. Omnesys suddenly found it had lost the edge in IOC servers and saw a drift away from its managed services. OPG then figured out there should be a way to outsmart the system. Once more the obliging data centre staff came in handy. While the system had an automated allocation of TBT servers they still had the backup servers which were to be connected only in case the primary went down though they were equally powerful. They figured out if they let OPG connect to the Backup servers with zero load he would still be getting far better latency. They obliged and the cycle continued.”

Has the above been established by SEBI’s investigation? Again, does SEBI’s investigation pin the blame for such a serious lapse (the lack of a load balancer for servers) at NSE on anyone specifically? What are the implications for SEBI’s supervision of the stock exchanges? This is again a very critical issue!

l)        What does SEBI’s investigation reveal with regard to this assertion by the Whistle Blower who notes that:

“Around this time coincidentally a couple of global players went live with their servers at NSE collocation. The local guys could not figure out the working but the global players clearly had more exposure of what was happening. One more improvement which the new CTO brought was the ability to sync servers with the exchange clock. Suddenly the cat was out of the bag (for a select few who understood what happening). It was now possible to see what time the exchange generated the price broadcast, what time it was received by the different servers and what time the trade got executed. Since it often got filled before the broadcast was received by the market it was obvious something was amiss. Exchange simply could not explain it away as random differences or the abilities of the different software’s. Armed with the logs (though not necessarily understanding why this was occurring) different firms started approaching NSE to explain the sequence of events. While officially the stand was variability of TBT servers and loads, someone within NSE must have started understanding what was happening. NSE decided to go to the global standard of multicast at collocation so that everyone would get the price concurrently. He further notes: “In hindsight the events which unfolded clearly leave a trail of what most probably happened. Someone smart in NSE must have put the complaints and the trades together. Suddenly there was a shuffling of lower level staff at the NSE datacenter. Practically all the operational people were changed. The issue of handling senior staff was still there. If they were fired they could come out in the open and if they were not moved they would again create some similar situation. The matter was quietly hushed up. And everyone was given an honorable exit. The external parties who understood the happenings were quietly accommodated in different ways (I will come that near the end of my letter) and in a surprising move the data centre incharge left to join MCXSX as data centre incharge (after the Jignesh shah episode) so its not difficult to add up things. NSE soon started multicast…”

Does SEBI’s investigation reveal this to be true? If so, does SEBI’s investigation pin the blame for such a serious happening at NSE on anyone specifically? What are the implications for SEBI’s supervision of the stock exchanges?

m)    What does SEBI’s investigation reveal with regard to the comment by the Whistle Blower who notes that:

“The easiest way to verify or throw out this complaint is to go back to the data and see if supports the same. If NSE stores its internal order logs of order and trade with milli second timestamp, it will be very easy to verify when did the first trade happen which caused and abrupt price movement and when did the IOC multileg order get fired by different members. If the latency difference between the orders generated across members is in the range of 200 micro seconds there is obviously not foul play, but if the difference is in the range of 20 milliseconds you know the working explained above. As a confirmation you may verify that this pattern exists across days or is a one off event for the member. In case the millisecond time stamp is not available for some hard to fathom reason NSE maintains an order number which is chronological in order of the receipt of order by its system. For the purpose of analysis you need to filter all the multi-legged IOC orders received by the exchange on few sample volatile days in say 2012. If the order numbers of a selected few members are always ahead of similar orders received from other members you can be sure of the front running. You can also examine the fill ratio of orders across members (i.e., how many of the IOC orders fired got traded as a percentage).Since the working has been explained in detail above you should be able to correlate the same with the above data. One more easy way to cross verify would be to check which member server connected to which TBT ip of the exchange as it would clearly indicate the load skew.”

Does SEBI’s investigation reveal this to be true?

n)     What does SEBI’s investigation reveal with regard to the following comment by the Whistle Blower who notes that:

“Coming to my part of the interest. I was actually working for one of the Singapore based firms and have shifted to a new HFT firm recently. The problem which we face is that in quid pro quo for keeping quiet NSE has given certain privileges to my earlier firm which are not available to me at the new firm. This is resulting in degraded performance of the algos. If SEBI will take some action I am sure the current unfair advantages would stop as NSE will be forced to be more cautious otherwise it will be difficult for us to work in an unlevel playing field.”

 Does SEBI’s investigation reveal this to be true? And does SEBI’s investigation pin the blame for such a serious happening at NSE on anyone specifically? What are the implications for SEBI’s supervision of the stock exchanges?

It is high time that SEBI provided specific answers to the above questions in larger public interest.


K) Discussion:


To summarise, it seems important for SEBI to provide the following information ASAP with regard to the allegations made in the Whistle Blower’s letter:

  • Specifically, SEBI must make public, a copy of its investigation report (with all supporting documentation in a comprehensive manner) on the WHISTLE BLOWER’s letter and the allegations therein and provide conclusive evidence on whether the allegations are true or not?
  • Second, if such an investigation has not been conducted as yet, it is imperative that SEBI immediately orders a fair and independent investigation into the issues arising from the Whistle Blower’s letter.
  • Third, SEBI must also disclose to the general public on what it is doing about algorithmic trading, high frequency trading (HFT) or high speed trading (HST) that perpetuate a fraud on the capital markets. In other words, what is SEBI doing about algorithmic trading, HFT, HST that make huge bogus orders and cancel them in the next millionth of a sec. This is neither market making nor genuine trade in capital markets – this deceptive behaviour is plain simple rigging and fixing of capital markets and cannot be allowed to go on.
  • Fourth, SEBI must also inform to the public what it is doing to those users of algorithmic trading, HFT and HFS who (may) gain undue speed and time advantages through various corrupt practices, as has been alleged in the whistle blowers letter
  • Fifth, SEBI must also let the public know on whether it has instituted independent third party audits and supervision of stock exchanges and their members/users and their various algorithms to ensure that “ROGUE” algorithms are weeded out to the best extent possible

One FINAL point is in order.

Overall, all of the above aspects highlighted with regard to algorithmic trading/HFT/HST - and their technology/other problems per se - raise several important questions with regard to the ordinary investor and the protection of their investment:

  • What does all of this signify for the process of investment in capital markets whereby peoples’ hard earned savings are converted to investment?
  • What does it mean for the ordinary investor and their confidence in the capital markets?
  • What are the implications for investor protection?
  • What does all of this signify for a company’s fundamentals and buying and selling of stock based on that?
  • What does it mean for hard work that goes into creating the value of a stock?
  • What does investing ultimately become?
  • What happens to peoples’ savings that they are trying to convert into investment?
  • What happens to the economy that is hugely dependent on peoples’ savings?
  • Plus many more

Therefore, unless SEBI acts swiftly and decisively, peoples’ investments, stocks, institutions, and the country as a whole may be at huge risk as one fine day we may be told that all our wealth has been eroded due to a rogue algorithm and a reading of SEBI Chairman’s interview of July 30th 2015 certainly does not give me confidence in India’s globally interlinked capital markets. 

And it is high time that SEBI recognises the immense contribution made by Ms Sucheta Dalal and Moneylife in bringing to fore the critical issues concerning "ALGO TRADING" so that the health and safety of Indian capital markets can be enhanced. And without any doubt, it must be stated that when SEBI and NSE's priority must be to answer the above given substantive questions in larger public interest, it is ironical that a defamation suit and related proceedings have been filed (by NSE) against Ms Sucheta Dalal and Moneylife. And it goes without saying that NSE's above attempt at initiating defamation proceedings against Ms Sucheta Dalal and Moneylife is more a strategy to deflect from answering several key questions that have been highlighted above.
[i] High Frequency Trading (HFT) and High Speed Trading (HST) are subsets of Algorithmic Trading and are often seen as the primary (although not only) culprits for the various problems and issues associated with Algorithmic Trading.

[ii] If Indian markets stay fundamentally strong to attract global capital over the next five years, we can see the proportion of algo trades equaling that of the US in the next five years. Please see http://www.huffingtonpost.in/2015/06/07/highspeed-trading-is-skew_n_7528172.html. Thus, algorithmic trading/HFT/HST may be here to stay because they are the order of the day with advancement of technology and humankind.

[iii] Call it dark humor or whatever. May 6th seems to be dooms day as May 6th 2010 was the flash crash day and the above incident of NIFTY and SENSEX tumbling was also on May 6th (albeit 5 years later) 2015.


[v] While the exact figures of these losses may vary, the magnitude and impact of these losses are unlikely to change. Besides, the purpose of quoting these examples is to underscore the perils of technology and the consequent impact of algorithmic trading rather than provide precise figures of these losses!










[xv] http://www.sec.gov/about/commissioner/aguilar.htm. He was set to retire in June 2015 but he is still serving as commissioner until July 16th 2015 as per the following - http://www.sec.gov/news/statement/benefits-of-shortening-the-securities-settlement-cycle.html. He may have retired from this position by now!



[xviii] This is a view espoused by the Hon Supreme Court as well as many of the Hon High Courts in India as part of their judgments on stock exchanges and related issues.


[xix] Nothing in this article may be construed as defamatory because I am merely asking questions of SEBI (and NSE). I am not making any assertions regarding the Whistle Blower’s Letter referred herein, which only a free, fair and independent probe can throw light on. The Whistle Blower’s Letter was first published by Moneylife and the same is the part of an ongoing libel case against the defendents (Moneylife, Ms Sucheta Dalal and Mr Debashish Basu). The same was dismissed at the level of a Hon Single Judge, Hon Bombay High Court. The same is now said to be in appeal before a Hon division bench of the Hon Bombay High Court.   
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