Departing from its two earlier decisions, the
Securities Appellate Tribunal (“SAT”) has now held front running to be
an offence. It has held that it is a fraudulent and manipulative act in
violation of the Securities and Exchange Board of India (Prohibition of
Fraudulent and Unfair Trade Practices Relating to Securities Market)
Regulations, 2003 (“PFUTP Regulations”). This is in the case of Vibha
Sharma vs. SEBI (Appeal No. 27 of 2013, dated 4th September 2013). It
thus upheld SEBI’s Order which had levied a penalty of Rs. 25 lakh on
profits made on account of such front running of Rs. 7,15,854. Two days
later, SEBI too amended the PFUTP Regulations to introduce a
clarificatory amendment that apparently to intends to include front
running amongst the list of prohibited acts. The concept of front
running and an earlier decision in the case of Dipak Patel vs. SEBI
(Appeal No. 216 of 2011, dated 9th November 2012) were discussed in this
column a few months ago. However, to refresh the memory of readers, the
concept of front running is briefly discussed below. Front running, in
context of stock market trading, is, in simple terms, using of
information of impending and usually large orders and putting one’s own
orders ahead of execution of those orders. The advantage is that, by
putting orders in front, such a person is able to buy at a lower price.
Then, he will profit by reversing such transactions when the large
orders are executed and his shares are sold to such person at a higher
price. Take an example. A client places a large order for purchase of
shares of Company X with its broker. The experienced broker realises
that such a large order will certainly result in increase in the market
price of the shares on that day. He thus buys shares on his own account
before executing the client’s order. This usually results in the
expected increase in the price. Thereafter, he executes the client’s
order and on the opposite side he offers for sale his own shares at the
higher price. The client thus has to pay a higher price, the difference
being the profit of such broker. This series of acts by the broker is an
example of front running. The situations can be multiplied. The
employee of the broker may carry out such act. The broker may share the
information with someone who may carry out such trades. Employees of
institutional investors may do front running. And so on.
SEBI
has laid down a large variety of acts, generally and specifically, that
are treated fraudulent or manipulative practices under the PFUTP
Regulations. However, curiously, there is a specific Regulation 4(2) (q)
which deals with, while not using that term, front running by
intermediaries. The Regulations prohibit intermediaries from engaging in
such acts.
The SAT had earlier held in Dipak Patel’s (Appeal
No. 216 of 2011, decision dated 9th November 2012) case held that this
Regulation applied specifically to intermediaries only and there are no
other provisions in the Regulations/Rules/Act that specifically prohibit
front running by non-intermediaries. Hence, persons who are not
intermediaries cannot be held guilty of such charges. In that case, an
employee of a foreign institutional investor had, as per the findings,
advance information of certain proposed trades of his employer. He
conveyed this information to his cousins in India. Using this
information, the cousins carried out such advance trades. Then these
trades were reversed when his employer came to acquire the shares in the
market. The advance trades were at a lower price and these shares were
sold to the employer at a higher price, and substantial profits were
made. However, the employee was not an intermediary. Thus, the SAT held
that he could not be held liable under the PFUTP Regulations. SAT,
accordingly, had observed:-
“In the absence of any specific
provision in the Act, rules or regulations prohibiting front running by a
person other than an intermediary, we are of the view that the
appellants cannot be held guilty of the charges levelled against them.
There is no denying the fact that when the appellants placed their
order, these were screen based and at the prevalent market price.
Admittedly Passport was the major counter party for trading in the
market and was placing huge orders and hence possibility of order of
traders placing orders for smaller quantities matching with orders of
Passport cannot be ruled out. Therefore, it cannot be said that they
have manipulated the market. The alleged fraud on the part of Dipak may
be a fraud against its employer for which the employer has taken
necessary action. In the absence of any specific provision in law, it
cannot be said that a fraud has been played on the market or market has
been manipulated by the appellants when all transactions were screen
based at the prevalent market price.”
Thus, what was emphasised
was that, if at all, it was a fraud by the employee on the employer. And
for such fraud, the employer may take due action. But there was no
fraud or manipulation by the employee on the markets. Hence, there was
no violation of the PFUTP Regulations.
SAT followed the above
decision in Sujit Karkera vs. SEBI (Appeal No. 167 of 2012 dated 17th
December 2012) and this decision was on the same lines.
These
decisions created some dissatisfaction and were well debated. Now,
however, SAT has given a decision holding a view contrary to its earlier
decisions. As will be seen later, SEBI too has amended the law with
retrospective effect.
The findings of SEBI in the present case
were also similar. To point out a few, the Appellant was the wife of the
equity dealer of Central Bank of India (“CBI”). In 14 out of 16 trading
days, the trades of the Applicant matched with that of CBI. It was
found that the Appellant used to buy ahead of CBI and then sell the
shares when CBI came to purchase the shares of that Company on the same
day. It was noted that the Appellant sold all of the shares purchased on
that day to CBI. The price of purchase and the price of sales were
noted and in particular, the manner in which a higher-than-last traded
price was put as offer price for sale to CBI by the Appellant was noted.
SAT considered both its earlier decisions. However, using the
following reasoning, it departed from them and held that front running
was a fraudulent market practice and violation of 3(a), (b), (c), (d)
and 4(1) of the PFUTP Regulations and thus punishable. It observed:-
“A
minute perusal of the judgment of Dipak Patel makes it evident that act
of front running is always considered injurious be it an intermediary
or any other person for that reasons. We would like to give a liberal
interpretation to the concept of front running and would hold that any
person, who is connected with the capital market, and indulges in front
running is guilty of a fraudulent market practice as such liable to be
punished as per law by the respondent. The definition of front running,
therefore, cannot be put in a straight-jacket formula.”
The SAT also observed:-
“Advance
information of definite trade by CBI at manipulated price of particular
scrip was available to Appellant no. 1 and on basis of this information
she traded in security market and secured undue profits, which was
disadvantageous to other investors, since they were not privy to this
privileged information and resulted in manipulation of securities in
market.”
It could not be specifically proved that the Appellant received information from her husband by way of recording of phone calls, etc. However, SAT took into account the curious fact of consistent matching of transactions, timing and of course the relation between the Appellant and the employee of CBI, her husband.
The findings in the orders of SEBI and SAT clearly suggest that that the Appellant with her husband profited at the cost of CBI. Nevertheless, certain thoughts come to mind.
Would this not be treated as a fraud on CBI, the employer, by the employee by sharing information with the Appellant, his wife? And therefore this should be actionable by CBI and not SEBI?
The Order says that there was a loss/disadvantage to other investors. This too is difficult to understand. The Appellant purchased the shares from other investors on the same day. Later during the day, she sold the same at a higher price to CBI. But if this had not happened and CBI had come directly in the market, would not the sellers got the same price as they got in original sale as the transactions would have taken place in the same manner? The counter-argument possible is that though this may be a fraud by the employee on the employer, the fraud was carried out on the stock market which is a public arena for investors generally and not in a private transaction.
Finally, the question of redundancy of Regulation 4(2) (q) remains. If such transactions are violation of the other general provisions of the PFUTP Regulations, then what is the relevance of Regulation 4(2)(q)? Would not such an interpretation by SAT/SEBI make such a Regulation redundant and thus such interpretation violative of accepted principles of interpretation of statutes? The counter-argument is of course that if such a universal rule was made, then the various prohibitions say, on stock brokers, may be interpreted as not applicable to persons who are not stock brokers.
Nevertheless, the decision of SAT now creates a precedent that front running is a violation of the PFUTP Regulations and thus punishable.
SEBI has also amended the PFUTP Regulations by inserting an Explanation to Regulation 4 by a Notification dated 6th September 2013. The Explanation reads:-
“Explanation—For the purposes of this sub-regulation, for the removal of doubts, it is clarified that the acts or omissions listed in this sub-regulation are not exhaustive and that an act or omission is prohibited if it falls within the purview of regulation 3, notwithstanding that it is not included in this sub-regulation or is described as being committed only by a certain category of persons in this sub-regulation.”
Thus, it seeks to clarify that (i) the prohibited acts/ omissions in Regulation 4(2) are not exhaustive and (ii) acts/omissions included in Regulation 3 are prohibited even if Regulation 4(2) does not specifically include them or prohibits them only if committed by certain category of persons. Effectively, this Explanation seems to provide that if front running can be held to be covered under Regulation 3, then it will be an offence. This is despite the fact that Regulation 4(2) covers only front running committed by intermediaries.
In view of the above, front running, whether by intermediaries or non-intermediaries, will be an offence under the PFUTP Regulations. This is unless the SAT decision is appealed before the Supreme Court which, taking also into account the clarificatory amendment to the Regulations, gives a different decision.
