Sebi blasts NSE over order modifications

The market regulator has flayed the National Stock Exchange (NSE) over its failure to report the rampant client code modifications — or alteration of codes used to identify entities who trade on the exchange — witnessed in March 2010.

Trades involving client code modification had exceeded Rs55,000 crore that month.

“NSE, being a self regulatory organisation having the first level authority for supervision of the trading community… should have taken the initiative to inform Sebi about these recurrent client code modifications as an aberration and further, should have devised a solution to curb the recurrence of these incidents,” the Securities and Exchange Board of India (Sebi) said in an order to “warn NSE to be more cautious and perceptive in discharge of its regulatory duties.”

Client code modifications are used for tax evasion, facilitated through transfer of gains or losses between accounts, said a market source.

Sebi had conducted an examination of modifications done at the stock exchanges after the finance ministry and the revenue department noted substantial client code modifications in the derivative transactions at the NSE.

The regulator sent a query to the exchange on the basis of the government’s letter on November 22, 2010, asking NSE for details of client modification, to which NSE replied on December 3, 2010.

In February 2011, Sebi issued a show cause notice to NSE stating that the exchange has not provided the information and clarifications that Sebi sought, that it failed to conduct a special audit suggested by Sebi and that it failed to put an appropriate mechanism for the supervision of the modification of client codes.

Subsequently, NSE addressed some of these issues and also clarified to the regulator that it had taken action against six out of the top 10 brokers who had modified orders during March 2010.

Sebi, however, noted that NSE did not have any mechanism to penalise the repeat offenders and that it only took action to identify the genuineness of the client code revisions after Sebi’s intervention in the matter. 

“…NSE has been negligent in discharge of its duties even though it might not have been a party to the mischief,” said the Sebi order.

The regulator chose not to impose a penalty, monetary or otherwise, on NSE.