This case principally concerns the trading of derivatives namely Future Contracts by Indiabulls Securities Limited (appellants) as alleged by the Securities and Exchange Board of India ("SEBI") in a synchronized manner. In the past, the SEBI has noted with an increasing concern, the nature of transactions occurring in the trading segment of the capital market and hence carried out the following steps:
1. SEBI commenced an inquiry with the support of the Integrated Market Surveillance System (IMSS) in the Futures and Options Segment which revealed peculiar patterns of trading from the period of January to March 2007.
2. The result of the inquiry was that on June 18, 2007, the whole time member of the Board issued an ad-interim ex-parte order directing certain entities including the appellants to desist from such activities.
3. Before the ad-interim ex-parte order could be finalized, the Board found an opportunity to issue another show cause notice on October 5, 2007.
4. The Appellant appeared before the Adjudicating Officer and submitted its defense. However, by an order dated February 25, 2009, held the appellants guilty of aiding the clients in executing synchronized trades and imposed a monetary penalty of Rs. 15, 00,000
5. Against this order, appellant appealed to the Securities Appellate Tribunal ("SAT").
The main allegation by SEBI was that the brokers were buying and selling almost the equal quantities of Futures Contracts within the day and that this was synchronized in nature. They have been held guilty of executing 23 non genuine and reverse trades on behalf of 15 clients in 21 futures and 2 options contracts. Out of the 15 clients, 9 did one trade each, 2 did 2 trades each and 3 did 3 trades each. The sum total of the close out difference (COD) has been 35.44 lakhs and 17 have been carried out online by the clients through the internet themselves.
ISSUES:
1. Whether the appellants had aided and abetted their clients in executing non genuine transaction with respect to futures contracts in collusion with counter party clients and brokers in the Futures and Option Segment ("F & 0") of the National Stock Exchange of India Limited. (NSE).
2. Whether the appellants had misused the stock exchange mechanism in violation of Regulations 3(a), 3(b), 3(c) , 4(1), 4(2)(a), 4(2)(b) of the SEBI Prohibition of Fraudulent and Unfair Trade Practices Regulations 2003 (FUTP Regulations) and Regulations 7A(1), (2), (3) and (4) of the SEBI Stock Brokers and Sub Brokers Regulations 1992.
STATEMENT OF ARGUMENTS:
SEBI argued:
1. That the appellants have been indulging in synchronized and reverse trading by buying and selling an equal number of contracts with significant difference in the buy/sell price which is not permissible as it gives rise to market manipulation on account of being fictitious in nature.
2. That the reverse trades matched, which makes it apparent that such trades were pre-meditated. They have also made a reference to a NSE Circular dated March 10, 2005 to stock brokers which advises them to refrain from such transactions.
Appellant argued:
1. That as a broker it has always exercised due diligence and care in the transactions carried out on behalf of its clients. During the period of investigation, 1,69, 71, 078 trades had been undertaken for 1, 21, 306 clients having a turnover of Rs. 1,11,659 crores out of which only 23 trades had been called into question as given above. Out of these 23 trades had a COD of less than Rs. 1 lakh and in 5 trades it was less than 2 lakhs. The appellant contends that going by the nature of the transactions, no conclusion can be reached that the appellant had "aided and abetted" its clients in executing manipulative trades or any devious devices to manipulate the market. The assumption of SEBI is that the prices in the F&O segment must necessarily move in tandem with the prices/values of the underlying cash segment. But it has been overruled by the board in the Rakhi Trading Case where it has been held that they need not necessarily move in consonance with each other.
2. That the appellant has acted only as a broker between the parties and has acted on behalf of them. It is not necessary that the brokers were also was party to the pre mediated plan if any. If the appellant knew that the trades were fictitious, then they would have no hesitation in upholding the findings of SEBI.
SUMMARY OF THE SAT'S DECISION:
1. The Court held that the trades cannot be considered manipulative on the ground that the prices in the F & O segment should necessarily move in tandem with those in the cash segment citing the Rakhi Trading Case.
2. The Court also stated that the appellant had only acted as a broker and carried out directions of his clients which he ought to do. Also, 17 trades were executed by the clients themselves through the internet and the broker has very little control over them. Thus, the Court found merit in the case of the appellant.
CRITICAL APPRAISAL:
Arguments by SEBI.
Counter argument by the Appellant.
SAT's response and perception of the argument
Prices in the cash and F&O segment should move in consonance with each other, otherwise it may lead to market manipulation
Indiabulls rebutted by citing the Rakhi Trading Case where it is clearly stated that there are instances when prices in the cash and F &O segment do not move together.
The Court upheld its order in the Rakhi Trading Case.
SEBI stated that the appellant executed 23 trades on behalf of its clients which were reversed between the same parties which is not permissible as it amounts to synchronized trading.
Indiabulls replied that it had performed its duty and only represented the client.
The Court stated that in the present complex market conditions it is impossible to implicate the broker.
Derivatives are financial contracts whose values are derived from other assets and have no independent value of their own. They are integral to the capital market as they help in risk transfer, catalyze entrepreneurial activity and increase investments in the long run. Future Contracts are a type of derivative contract in which there is an agreement to buy/sell an asset at an agreed price at a future date. In this case, SEBI alleged that the appellants have been indulging in synchronized/reverse trading in future contracts.
Synchronized trades in India are governed by the SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003 ("PFUTP" Regulations). They are trades wherein two or more people execute trades amongst themselves with a prior understanding vis-à-vis time, price and quantity of the transaction. They are per se not illegal but when done with a fraudulent and deceptive intention to create misleading appearance of trading and to manipulate price and volume, they are highly questionable. Reverse trades is a form of synchronized trades wherein the seller of the shares ultimately buys the same shares from the original purchaser of the shares and is restricted to two people. However, the validity of reverse trades has been a hotly debated topic as they are considered bad in law due to the resulting abnormal profit or loss. The main difficulty is to determine till what extent the trades are legal as there is a very thin line of difference between what is permissible and non permissible.
The first concern of SEBI was that the appellants were engaged in trade reversals in a matter of seconds as it violates Regulation 3 of the PFUTP Regulations which prohibits a person from buying selling or otherwise dealing in securities in a fraudulent manner or using or employing in connection with purchase or sale of any security, any manipulative or deceptive device and also Regulation 4 which prohibits a person from indulging in fraudulent or unfair trade practices. The SAT has made reference to the Rakhi Trading Case, where it has been held that the prices in the F & O segment should not necessarily move in consonance with the underlying cash segment. It has been rightly said that "Movement of index in the cash segment does not influence the index options in the F&O segment because the strike rate is directly linked with the index value in the cash segment. However the converse is not always true." Further it has also held that the cash market may move up today but the F&O segment may move after a period of time and by then the markets may be down as usually only short term speculators trade in the F&O segment. Volatility and potential for greater losses may trigger movements in the F&O segment without any equivalent in the cash market. This highly complicated situation in the market makes the role of the broker in market manipulation questionable.
The main responsibility of SEBI is to make the market as tamper proof as possible because manipulating the price discovery mechanism goes against the fundamental concept of a stock exchange where prices are discovered through the mechanism of demand and supply of a particular commodity. In pursuance of this, the SEBI very recently issued a Master Circular on Matters related to Exchange Traded Derivatives but it has failed to make a mention of any regulations for stock brokers in order to restrain them from indulging in any unfair trades. It may give them scope to exploit the market and this loophole needs to be looked into.
There are many precedents in this area of trading such as Jindal Stainless Ltd, Ketan Parekh but none of them have been able to clearly demonstrate till what extent synchronized trading is legal. A perusal of various cases of similar nature indicates a trend of favorable orders by the adjudicating officer in favor of the Board, only to be reversed by the SAT in favor of the appellants. This adherence to precedents is an easy weapon of abuse by market players. An outrageous deviance from pre-set orders is not being suggested. However, a shift to viewing each case on its own merits and non reliance on pre- determined cases would be appreciated as there can be no specific way of viewing such cases.
The second concern of SEBI was that the brokers were part of a premeditated plan in manipulating the trade with the clients. The defense of the appellant which was accepted by the Court was that they were doing their job of representing the client, and even if there was manipulation, they could not have been party to it as the client is only a number on the stock exchange to them. A remedy to prevent the brokers from using this argument as an escape mechanism can be in holding them vicariously liable for acts of their clients. There exists a relationship of principal and agent between the client and broker. Hence, liability on basis of vicarious grounds would suffice in deterring brokers from manipulation.
CONCLUSION:
A perusal of decisions given by the SEBI reflects that there is no clarity on the position of synchronized trades in our country. A clean market place is desirable in a vibrant economy. To achieve this, SEBI as a regulator is trying to reign in the manipulators, yet the obscurity as to the legality of synchronized trades, leaves scope for manipulation. This big picture should not be veiled off in the complicated arguments between legal entities.
