By Jayshree P Upadhyay

MUMBAI, Sept 5 (Reuters) - India's markets regulator

launched a formal investigation into Jane Street's trading

practices even though its surveillance department had

recommended otherwise, due to continued complaints from market

participants, two sources with direct knowledge of the matter

said.

The Securities and Exchange Board of India (SEBI) also

believed inadequate data was used in the initial probe into the

U.S. high-frequency trading firm, the people said, amid fears it

might have manipulated the country's stock and bond markets.

SEBI on July 4 temporarily barred the firm from local

markets on allegations of market manipulation, which the company

has denied.

SEBI imposed a $567 million penalty on Jane Street, which

the company has deposited. While it can restart trading in

India, it has refrained from doing so, Reuters reported last

month.

On Wednesday, Jane Street filed an appeal before the

Securities Appellate Tribunal (SAT) against SEBI seeking

documents and data which led to the formal inquiry.

The firm questioned why the regulator went against the

advice of its own surveillance department that the inquiry

against Jane Street should be closed and sought documents that

supported the regulator's change of stance.

The appeal will be heard on Monday by the Tribunal.

Emails sent to SEBI and Jane Street seeking comments were

not answered. The firm had earlier declined to comment on its

appeal.

According to the two sources, SEBI's top leadership was not

satisfied with the robustness of the first examination concluded

by its own surveillance department on December 11 and chose to

initiate a formal investigation towards the end of December

2024, which gives it powers to seek data from the trading firm's

custodian bank and domestic trading partner.

A formal investigation is a quasi-legal process under Indian

regulatory rules, in contrast to an internal enquiry.

According to Sumit Agrawal, a former SEBI official and

founding partner of Regstreet Law Advisor, once a formal

investigation is initiated any prior conclusions lose their

weight, and the process begins anew.

"Earlier determinations, whether favorable or adverse, are

set aside in favor of an independent investigation," he said.

The regulator had also continued to receive complaints from

market participants of manipulation of India's key indexes, the

two people said.

The firm in its appeal has sought copies of these

complaints.

One such complaint was filed by UAE-based options trader

Mayank Bansal on December 17, who told Reuters that

"communication between a market participant and the regulator is

premised on confidentiality".

The department which oversees India's market regulation

later that month recommended opening an investigation to bring

finality to the matter, the first source said.

SEBI tasked a new team with reviewing the firm's trading

activity over a much longer time frame than the trading data

examined by its surveillance department. The data was also much

more detailed, the two people said.

While the regulator continued the investigation it issued a

warning to the firm through Indian exchanges in February that it

should refrain from taking large positions on days when

derivatives contracts expire, according to regulator's 4 July

order. Price volatility can often spike around those

expirations.

But the firm's trading performance on May 15 which earned it

3.7 billion rupees ($42.28 million) forced SEBI's hand to pass

an order, said the first source.

"SEBI officers worked overnight to finish its investigation

in June, which ultimately led to passing the order," the first

person said.

($1 = 87.5060 Indian rupees)