Mumbai: A 9 November ruling of the Securities Appellate Tribunal (SAT) that set aside the Securities and Exchange Board of India’s (Sebi’s) order penalizing three persons for alleged front running—the first such instance involving individuals—has raised questions about the efficacy of the law that deals with fraudulent activities in the securities market.
Front running refers to the use of confidential information for buying or selling of securities ahead of a large order with an underlying objective of benefiting from the price move.
The tribunal has overruled a Sebi order that barred three persons from dealing in securities and imposed a fine of Rs.1.13 crore on two of them. They allegedly made a profit of Rs.1.56 crore from 557 synchronized trades on the National Stock Exchange and 50 on BSE between January 2007 and March 2009.
A Sebi investigation found that Kanaiyalal Baldevbhai Patel and Anandkumar Baldevbhai Patel, two traders, traded on information about forthcoming orders from their cousin, Dipak Patel, a former portfolio manager at Passport India Investment (Mauritius) Ltd.
Sebi found that Dipak provided information to these traders about forthcoming trading activity of Passport India and, taking advantage of that, Kanaiyalal placed and executed orders ahead of Passport’s order to make a profit from the price move. Sebi found that the trades were executed using a phone number registered in Anandkumar’s name and, hence, Anandkumar aided and abetted the so-called front running, according to the regulator.
SAT set aside Sebi’s order on the grounds that the existing regulations on Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets Regulations, 2003, (FUTP Regulations) do not clearly define the term “front running” and even if a particular fraudulent transaction can be construed as front running, it applies only to market intermediaries and not individuals.
Securities market lawyers said front running is rampant in India, with confidential information about forthcoming big orders being discreetly passed on by some people at big brokerage firms, but added that because the term is not defined under FUTP Regulations, it makes it difficult for the regulator to book the guilty.
“First of all, it is very difficult to prove front running. Some people at brokerages have advance knowledge of orders and they pass on this information, or even trade through someone else’s account to profit from it. True, it is not defined under FUTP, but isn’t it fraudulent?” said Neeta Sanghavi of counsel and law firm Crawford Bayley and Co.
The SAT ruling is set to get Sebi mulling over the efficacy of FUTP Regulations in their current form, as it leaves out persons as opposed to its earlier 1995 regulations, she added.
The regulations in their current form do not define front running. “More importantly, regulation 4(2) is not exhaustive and such behaviour may come within the general definition of fraud in the regulations,” said another lawyer, who did not want to be named.
Referring to the various definitions of front running, Sebi’s counsel Shiraz Rustomjee argued at the tribunal that the trades in this case were akin to insider trading and are not permitted in the market. The tribunal went through specific clauses of FUTP Regulations to find if “such front running” is barred by the regulatory framework.
“…The aforesaid clause applies only to intermediaries and not to other persons trading in the securities market… The cases cited by the learned senior counsel of the board and referred to above also relate to front running by intermediaries and not by other traders in the market,” the SAT order said. “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.”
Incidentally, the 1995 FUTP Regulations had covered such trading activity by “any person”, apart from intermediaries, but after it was amended in 2003, the regulation covers only intermediaries.
“…The 1995 regulations prohibited front running by any person dealing in the securities market and a departure has been made in the regulations of 2003 whereby front running has been prohibited only by intermediaries,” SAT said in its order.
Sebi didn’t respond to an email seeking comment.