1. Introduction: Factual Matrix of the Scam
The National Stock Exchange (“NSE”), a recognized stock exchange introduced the colocation facility in 2009, which enabled the brokers to install their servers in the data Centre of NSE. In 2015, it was claimed by a whistle-blower that the NSE co-location Centre was subjected to market manipulation by allowing the non-empanelled internet service provider to lay fibre cables on its premises for a few stockbrokers. Subsequently, the Securities and Exchange Board of India (“SEBI”) conducted an internal inquiry to look into the matter. The internal inquiry (Technical Advisory Report) confirmed the claims of the whistle-blower. It also confirmed that NSE’s architecture is susceptible to market abuse/manipulation.
Moreover, the issue became even more complicated after the Central Bureau of Investigation’s (“CBI”) FIR against a Delhi-based stock broker (Promoter of OPG Securities Pvt Ltd) for allegedly manipulating the NSE system. Without any proactive intervention from law enforcement agencies, SEBI took note of the NSE’s alleged lapses in high-frequency trading through co-location facilities only in 2016. In that line, SEBI has rejected several consent applications filed by the NSE to settle the matter through negotiation. In April 2019, SEBI directed the NSE to disgorge Rs. 625 crores, along with an interest of 12% per annum since 2014 and barred NSE from accessing securities market for a period of six months owing to the lapses in the co-location facility.
Eventually, SEBI came up with its final orders (on February 11, 2022) that contained a detailed analysis of the co-location scam and issued directions against NSE, the former Chief Executive Officer and Managing Director of NSE (Ms. Chitra Ramakrishna and Mr. Narain). The order has become an elephant in the room owing to its non-comprehensive approach towards effective corporate governance. Though the final order of SEBI comprehensively analysed the technical aspect of the co-location scam, it vehemently failed to effectively address the serious concerns raised by it. Having the co-location scam of NSE in the backdrop, the present article concentrates on major issues connected with NSE’s co-location scam that the existing legal framework fails to address, viz., ineffective discharge of director’s responsibilities, undue appointments, and lack of accountability of SEBI.
General Responsibility of Directors and its Effectiveness
The directors and Key Managerial Personnel (“KMP”) of the stock exchange were mandated with the principle of fair access and quality under Section 26 (1) & (2) of the Securities Contract (Stock Exchanges and Clearing Corporations) Regulations, 2012 (“SCRA”). Nevertheless, the mandate has been defeated in the entire course of NSE’s colocation scam as it is merely binding on an ethical and moral basis. This ethical regulatory mandate becomes futile or ineffective from the perspective of the boardroom culture as emphasised by T.T. Ram Mohan. Arguably, the boardroom culture is known for attractive, lucrative, and prestigious perks that virtually make the Board puppets of the management.
The directors who are against the management often feel isolated and ignored. For instance, despite being aware of the irregularities in the appointment of the Chief Strategic Advisor (“CSA”) of NSE, the Board opted to keep the discussion out of the minutes deeming it to be sensitive and confidential. Having understood the lack of checks and balances in effective enforcement of the general responsibilities of the directors, the Indian legislative framework has mandated the position of Independent Directors (“IDs”) in public companies. However, are the IDs really independent enough to serve the purpose? The answer is in the negative, particularly in curtailing the NSE’s co-location scam. As in this case, despite having ample knowledge of the NSE’s co-location scam and associated mismanagement, the IDs failed to initiate appropriate actions against the Board or report to the SEBI. The failure of IDs’ role in checking the powers of the Board and the Management could be attributed to the systemic flaws/gaps in the legislative framework.
Despite the fact that the law (Section 149 read with Schedule IV of the Companies Act) appears to be proactive and comprehensive in regulating/mandating the conduct of IDs, it is riddled with irony and remains a toothless tiger. Arguably, giving power to the Board to appoint and evaluate the performance of IDs and subjecting the same to the approval of the Management can be termed counterproductive, vide Schedule IV of the Companies Act and Rule 17(10) SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”). Thereby, it has the potential to substantially impair the ability of the IDs to dispassionately evaluate and review the functioning of its own appointing/evaluating authorities viz., both the Board and the Management, vide Schedule IV of the Companies Act, at II (2) & VII.
In this regard, the Uday Kotak Committee Report (2017) asserted that true independence is a function of behaviour that cannot be ensured through regulatory requirements. Therefore, the self-assessment of independence through the undertaking of IDs was recommended, consecutively mandated and, subject to the Board’s evaluation of the veracity of the same, vide Regulation 25 (8) & (9). Arguably, there are two inferences from the above recommendation and existing legal mandate. Firstly, ensuring the independence of ID through mere self-declaration (which is morally biding on ID) implies the lenient approach of the regulating authority in enforcing the independence of the ID. Secondly, while the sole object of the ID’s role is to challenge the powers of both the management and the Board of Directors, the existing legal framework aspires to make IDs completely independent of the Management (not from the Board). Therefore, from the context of NSE’s colocation scam, it is inferred that the existing legal framework doesn’t ensure true independence of IDs and still remains a toothless-tiger.
To overcome this deficiency and ensure effective corporate governance in its true spirit, appointment of IDs in recognized stock exchanges through an independent committee under the aegis of SEBI or the Union Government from the databank assumes significance. This would act as a real check on the internal mismanagement with the true independence of IDs. In that line, the recent amendment to the LODR Regulations could be considered as a proactive move towards ensuring the true independence of ID as it mandates special resolution of shareholders to approve the appointment, re-appointment and removal of ID, vide Rule 10 (2A). Thereby, this amendment creates a theoretical possibility of independence to ID as final approval of appointment/removal lies absolutely at the hands of shareholders.
Further, the concept of minimum compensation to IDs envisaged by the Uday Kotak Committee is a laudable measure towards incentivizing competent persons to serve as IDs. The committee proposed to fix minimum total remuneration for an ID per annum, minimum sitting fee for every board meeting and audit committee etc. Nevertheless, the same has not been accepted by SEBI; a decision which should be reconsidered. Having discussed the ineffective compliance of general responsibility of directors and need for true independence of ID, the subsequent chapter attempts to critically analyse the undue appointment in NSE – a crucial issue connected to NSE’s colocation scam that the existing law fails to address.
Undue Appointments in NSE
Mr. Anand Subramanian – the CSA of the NSE was unduly appointed by Ms. Chitra Ramakrishna (former CEO/MD of NSE) without ample qualification. The former CEO/MD of NSE was the only person to interview the CSA without any documents indicating the need, qualification and expertise of the CSA. Thus, arguably, the former CEO/MD of NSE tactfully appointed Mr. Subramanian as CSA (Consultant) with the intention of evading the required legal mandate and accountability. While the Companies Act, 2013 defines KMP and appointment through Board resolution with terms & conditions of appointment and remuneration, the Companies Act (as well as the SEBI regulations) are silent about other appointments initiated by the Board, such as private consultants.
Further, the Companies (Appointed & Remuneration of Managerial Personnel) Rules, 2014 obligate the board to disclose the ratio of remuneration of each director to the median remuneration of the employees; justification for the average percentile increase in the salaries of managerial personnel in comparison with salaries of employees, and the ratio of employees who receive remuneration in excess of the highest-paid directors etc. While there are mechanisms for accountability and regulations in the appointment of managerial personnel/ board members, appointments such as ‘Consultants’ are absolutely left to the discretion of the board without any checks and balances. Therefore, it has become increasingly necessary to revisit the provisions of appointment and include the appointments other than managerial personnel (viz., consultants) and their remuneration within the legislative regulatory realm to disincentivize and curtail misuse of power in appointments.
While internal checks assume importance for effective corporate governance, the accountability of external monitors/regulators becomes yet another controversy that the next chapter attempts to address.
Accountability of the Regulator in Corporate Governance
SEBI has been vested with a paramount duty to regulate the securities market and protect the interest of the investors in the security market. In the instant case, SEBI uncovered crucial legal violations including leakage of confidential data from NSE to a third party. It is a serious violation of the legal mandates on confidentiality and access to information as regulated by Securities Contract (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2012 [vide Regulation 26 (2) r/w Part B (ix)]. SEBI ultimately failed to address this issue which assumes SEBI’s lack of understanding of the responsibility and gravity of its role as a regulatory body and a quasi-judicial authority.
On the other hand, in the aftermath of SEBI’s final order, it was revealed by the CBI that it was Mr. Subramanian (CSA) who had been impersonating as “Himalayan Yogi” with the view to influence the decision of the former CEO/MD of NSE.
SEBI’s conduct in NSE’s colocation case is just a tip of the iceberg. The Securities Appellate Tribunal (“SAT”) as well as other judicial bodies have raised serious concerns several times to make SEBI accountable for its reckless decisions. To quote a few, the Madras High Court in 2006, observed that the SEBI’s actions are clear abuse and colourable exercise of power. The Bombay High Court in 2015 deemed the order of SEBI an ‘abuse of power’ and considered it ‘arbitrary, illegal and void’. Similarly, in 2016, SEBI rendered an unconditional apology to SAT for the improper discharge of its quasi-judicial duties. Hence, despite being a quasi-judicial body, SEBI must be subjected to an accountability mechanism to ensure that it takes diligent measures towards market regulations, corporate governance, and curtails misuse & non-diligent use of power. A periodic independent audit may be carried out to evaluate the regulator’s performance towards realizing its objective. Further, the regulator’s accountability could also be ensured through reporting mechanisms and proactive oversight of the judiciary and the Union Ministry of Finance.
The article has critically analysed the issues connected with the NSE’s colocation scam that the existing legal framework (and SEBI’s final order) fails to address. First, the mandate of the principle of fair access, equality and general responsibility of directors and KMPs has not been met in reality. While the role of IDs becomes crucial, the regulations on IDs seem proactive and comprehensive under Section 149 read with Schedule IV of the Companies Act, 2013, but it remains a toothless tiger. Therefore, it becomes the need of the hour to vest the power of appointing IDs of recognised Stock Exchanges to an independent committee under the aegis of SEBI or the Union Government.
Second, the appointment of the CSA by the former MD/CEO of NSE with no expertise/experience and with higher remuneration than the KMPs indicates the legislative loophole that is often materialised by the BOD to make appointments arbitrarily. Towards which, Section 203 (2), 197 of the Companies Act and Section 5 of the Companies (Appointed & Remuneration of Managerial Personnel) Rules shall be revisited and bring all the appointments (including consultants) into the regulatory checks.
Third, SEBI’s final order failed to address the confidential data leakage from NSE despite being completely aware of it. Hence, it is pertinent to make SEBI accountable for its decisions through a periodic independent audit to evaluate the regulator’s performance and reporting mechanism.
This article is authored by Valan A, a student at Tamil Nadu National Law University.