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    Why is NSE bogged in negatives? Maybe it needs to put protocol first

    Synopsis

    NSE has had a history of ignoring good corporate governance practices and its senior management has a penchant for opaque decision making, enquiries reveal.

    ET Bureau
    On February 28, Securities and Exchange Board of India (Sebi) chairman UK Sinha's last day in office, the markets regulator wrote to the National Stock Exchange (NSE) asking it to expand an ongoing investigation into futures and options to the cash and currency segments.

    Sinha's parting shot has effectively placed India's biggest stock exchange, which is preparing for a mega public offer of shares, under an open-ended investigation with incalculable consequences. NSE has hired EY for a forensic audit. A top exchange official fears one impact could be on the valuation of its shares as revenue from the collocation centre (where clients pay to locate their servers next to the exchange's to be faster by fractions of seconds) or about a third of the exchange's total income has to be kept in a separate account until the probe is over.

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    Sebi expanded a probe that began after a whistleblower using a pseudonym Ken Fong wrote to it in January 2015 alleging that NSE gave certain clients preferential access to its servers helping them nose ahead of competitors. NSE has strongly defended the integrity of its systems and rigour of its people but two investigations--one by a Sebi-appointed expert team and another by independent forensic auditor Deloitte Touche Tohmatsu--found both wanting.

    On December 27, ET had published a story on the irregular appointment of its chief operating officer Anand Subramanian and arbitrary decisions by top managers.

    Now, fresh enquiries by ET have revealed that NSE has had a history of ignoring good corporate governance practices and its senior management has a penchant for opaque decision making.

    “There is no internal transparency in this organisation. NSE has a culture of top managers taking decisions and nobody knows how they are taken. It has hurt our image internally as well as externally,'' one of the top managers at NSE told ET. Another senior member of t he top ma nagement said people prefer oral instructions to written. The Deloitte forensic report too points to lack of clearly laid down processes and protocols at the organisation. After it concluded the investigation, Deloitte found some additional servers that NSE team had no knowledge about. These were not examined because the investigation was over by then.

    RED FLAGS

    NSE denies that connecting first to its collocation servers guaranteed a strategic benefit to traders. Whistleblower Ken Fong's letter points to Omnesys, a company that sold trading software to NSE's members and is said to have benefited, legitimately, from its ability to connect ahead of others to the exchange's servers. Unlike Omnesys, OPG Securities, the firm that is the focus of the investigations, is alleged to have found an unauthorised backdoor for preferential access.

    In 2008-09, NSE through its subsidiary NSE DotEx bought a 26% stake in Omnesys, which was until then a struggling enterprise with accumulated losses of a little over `4 crore. Founded in 1997 by Shrikant Pandit, a Bangalore-based entrepreneur, the company sold another 10% stake around the same time to one JP Nayak. Articles of association of the company suggest that for all practical purposes NSE's and Nayak's shareholdings were considered similar. Yet, while Nayak shelled out `64.82 as premium per share NSE paid `46.12 apiece.

    Shrikant Pandit told ET that the claims brought against Omnesys were baseless. “Omnesys maintains the utmost transparency in its business conduct, offering services to customers with honesty and integrity,'' he said in response to a detailed questionnaire from ET.

    The whistleblower states Omnesys was so sure of the early bird strategy that it had profit sharing arrangements with clients. It was con necting early by continuously pinging the servers and logging in the instant they came on, a perfectly legitimate strategy that others were slow to catch on. The letter said profit sharing arrangements were masked as fee for managed services. ET could not independently verify this.

    Omnesys' financials show that its golden run did coincide with the period when NSE was using a system architecture which releases price and order information sequentially known as tick-by-tick. It means the first to connect will receive the information first.

    Omnesys posted a pre-tax profit of `9.5 crore in 2009-10, the year NSE started collocation.Over the next three years, the company's profits rose peaking at over `15 crore in 2011-12. In 2012-13, Omnesys posted a profit of `12.4 crore on revenues of about `40 crore. In 2014 NSE began shifting to multicast technology which broadcasts information to everyone at once.

    In mid 2013, newswire and data company Thomson Reuters bought Omnesys for `240 crore or a premium of about `700 per share. In financial year 2013-14 when the ownership changed Omnesys made a loss of `12.6 crore, regulatory filings show.

    An NSE spokesperson said the organisation had a strategic minority stake in the company. “We cannot comment on reasons for any financial loss, if any, made by Omnesys after we exited. Neither Omnesys nor its clients had any preferential access to NSE data centre,'' the spokesperson said. A representative for Thomson Reuters declined to comment saying the company's financials are private.

    CASUAL GOVERNANCE

    NSE's tryst with little known private companies is not new. A company called Infotech Financials Pvt Ltd, which sells trading software Chanakya, is currently registered at the Chandivli home of an NSE vice-president who earlier headed trading. The vice-president is married to Infotech Financials' owner.

    As head of trading he would have handled clients who were common to Infotech, including at least two that figure in the collocation controversy. An NSE official said the VP, as head of trading, had no role to play in the collocation centre.

    Infotech lists NSE first on its list of clients on its website. Infotech claims it built a risk management system for the National Securities Clearing Corporation, a wholly owned subsidiary of NSE.

    ET could not independently ascertain if Infotech has had any recent business relationship with NSE as the company's founder did not respond to phone calls made and a text message sent to her mobile phone.

    An NSE spokesperson told ET in a written reply that it never engaged Infotech. The spokesperson also said that “to the best of our understanding and information,“ family members of the vice-president had not extended consultancy service to any broker who is alleged to have benefited from preferential access to the exchange server. He added that there is no question of conflict of interest as the company was set up by the wife of the VP well before their marriage. ET has pointed out the instances of Omnesys and Infotech merely to highlight NSE's general lack of corporate hygiene as an institution and the casual manner in which top managers treat systems and processes. As the senior manager quoted earlier said, “The hubris of our people has hurt the institution.''

    RULE BY CONVENTION

    During the forensic audit, a key NSE employee told Deloitte that an internal decision was taken in early 2012 to distribute members with multiple IPs (Internet Protocol) to more than one server to minimise the risk. There was no record of the decision nor could anyone recall who took it, the Deloitte report says.

    “Our review highlighted a lack of documented policies and protocols with respect to various aspects of the functioning of the TBT (tickby-tick) system, including manner of allocation of member IPs to servers, connections to secondary servers, etc,'' the auditors wrote.

    They also said their key challenge was the availability of historical information. “Due to absence of protocols related to data retention, email and other information for certain former key team members of NSE's COLO (collocation) operations was not available.'' A former top manager at NSE told ET that he was once shocked to find that it did not have a risk register. “There was a complete lack of corporate governance there. Often the top two people made decisions and key people whom the decisions affected were not kept in the loop,“ he said on condition of anonymity.



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    (What's moving Sensex and Nifty Track latest market news, stock tips and expert advice, on ETMarkets. Also, ETMarkets.com is now on Telegram. For fastest news alerts on financial markets, investment strategies and stocks alerts, subscribe to our Telegram feeds .)

    Download The Economic Times News App to get Daily Market Updates & Live Business News.

    Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

    Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

    ...more
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