[Akhil Kumar and Ayushi Singh are fourth-year and third-year students respectively at NUALS Kochi.]
The Supreme Court has recently upheld an order passed by the Securities and Exchange Board of India (SEBI) in 2009 against Rakhi Trading Private Limited and others. The judgement is of significant importance primarily because it has explained the role of SEBI in the market in relation to punishing culprits indulging in manipulative practices such as “synchronized trading,” which is a kind of transaction wherein both the buying and the selling order quantities are identical and happen on the same time on the trading platform. The judgement under analysis reiterated the apex court’s outlook regarding the need of transparent norms of trading in securities and of fairness, integrity and transparency in the securities market in India.
The Factual Matrix and the Arguments Presented
The case involved six respondents - three traders and three brokers. A show cause notice (SCN) was issued to the respondents on the ground of execution of non-genuine transactions in the Futures and Options (F&O) segment on October 05, 2007. The primary allegation against the respondents was that of buying and selling securities in the derivatives segment at a price that was nowhere near the market price in synchronized and reverse transactions. The Adjudicating Officer (AO) passed an order after receiving replies to the SCNs and holding personal hearings with the parties, making a finding that the respondents made a profit of Rs. 107.79 lakhs within a matter of minutes/hours despite an absence of a significant difference in the value of the underlying security. The fact that such transactions took place repeatedly also made the AO believe that the transactions were fraudulent and violative of regulations 3(a), (b) and (c) and 4(1), 2(a) and (b) of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (PFUTP Regulations). Consequently, a penalty of Rs. 1,08,00,00 was imposed under Section 15HA of the SEBI Act, 1992 (Act).
Aggrieved by the SEBI order, the respondents filed an appeal before the Securities Appellate Tribunal (SAT) under sections 15T of the Act. Allowing the appeal, the SAT set aside the order passed by the AO, holding that the Nifty index could not be influenced or manipulated by movement of prices in F&O segment. It held that since there was no impact on the market, the impugned transactions did not violate the provisions of the PFUTP Regulations. The SAT also took the view that the circular dated March 10, 2018 issued by the NSE was not legally binding primarily because such directions could only be issued by the SEBI. Further, the brokers succeeded in the instant case because of two additional reasons:
The fact that two clients had executed matched trades did not necessarily mean that the brokers were involved.
A majority of the impugned transactions were undertaken by the parties themselves over the internet.
Aggrieved by the decision of the SAT, the SEBI approached the Supreme Court of India under section 15Z of the Act. It was contended on behalf of the SEBI that the SAT had misunderstood the case, and that the transactions between the parties were fraudulent and non-genuine. It was the argument of the appellant that a profit of Rs. 107.79 lakh was made by the respondents within a matter of several minutes without any change in the value of the underlying security. The repeated number of such transactions over a period of time showed that the transactions were fraudulent in nature.
The counsel on the behalf of the respondents argued that the decision rendered by the SAT was per se valid and proper. The respondents also sought to distinguish the case of Ketan Parekh[1] on the ground that the said judgement pertained to dealings in cash whereas the instant matter concerned with the F&O segment only. It was also argued by the respondents that they did not violate any of the above-mentioned provisions of the Regulation or the Act.
The Judgment
The Supreme Court held that the transactions were unfair and of a fraudulent nature. The Court found the actions of the traders to be in violation of regulations 3 (a), 4 (1), and 4 (2) (a) of the PFUTP Regulations and the appeals were allowed. However, there was no evidence to show that the brokers acted in violation of the PFUTP Regulations aside from the mere fact that they facilitated the impugned transactions. It was noted that the SEBI was not able to prove negligence or connivance on the part of the brokers. The Court did not adjudicate upon the issue of the transactions being an act of tax planning as such a ground was not raised in the SCN and by the AO.
Understanding the Ruling
The case highlights the powers and duties of the SEBI particularly in regard to regulating the market conditions. In the case of SEBI v. Kishore R Ajmera, the apex court held that in the absence of a direct evidence in synchronized transactions, preponderance of probabilities shall be the standard of proof with regard to civil liability. The genuineness of the transactions was doubtful because one party was making continuous profits while the other was making continuous losses. The court opined that a trade practice is unfair if the conduct defeats the ethical standards and good faith dealings between the parties involved in business transactions. It was also observed that “an intentional trading for loss per se is not a genuine dealing in securities. The platform of the stock exchange has been used for a non-genuine trade.” The primary objective of any trade is to make profits and not that of making planned losses.
The order of the SAT with respect to change of beneficial ownership not arising in the derivatives segment was found to be erroneous. Beneficial ownership is a kind of ownership wherein a person who actually holds the beneficial interest in the shares does not have his name in the register of members. It is clear that there would be a change of rights in the contract even in the derivatives segment. However, owing to reverse trades, there was an absence of genuine change of rights in the contract. In this regard, reliance was placed on Ketan Parekh. In this case, the SAT had held that: “a synchronised transaction will, however, be illegal or violative of the Regulations if it is executed with a view to manipulate the market or if it results in circular trading or is dubious in nature and is executed with a view to avoid regulatory detection or does not involve change of beneficial ownership.”
The Court also made it clear that the case of SEBI v. Kishore R Ajmera should be relied upon with regard to interpretation of the Act. It was held that market integrity could be affected by both direct and indirect factors. Any kind of fraudulent or sham transaction on the stock market should be discouraged. The pronouncement is indeed a welcome move as this would help the SEBI curb non-genuine transactions and develop a free and fair market. It can be observed that as the market grows, ingenious ways of manipulation are used. In such a scenario it is desirable that the SEBI takes cognizance of and reviews the practices prevailing in the market. It is believed that the reasoning adopted in the judgement will have an impact on all types of trade and not merely on synchronised trading. There have been multiple orders passed by various tribunals where relief was granted to the concerned traders on the ground that the quantity of self-trades constituted less than one percent of the market volume. However, the instant ruling may have a serious impact on such cases where the traders usually escape because of the meagre value of the transactions.
[1] Appeal No. 2 of 2004 before SAT.