SAT now holds front running to be an offence

The Securities Appellate Tribunal (“SAT”) has now held
that front running is indeed 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”). It has departed
from its earlier decisions in case of Dipak
Patel (discussed here)
and Sujit
Karkera (discussed here).
It thus upheld SEBI’s Order
(discussed here)
levying a penalty of Rs. 25 lakhs on profits made on account of such front
running of Rs. 7,15,854.

The earlier post discusses in
detail the facts of the present case as per the SEBI Order which can be
referred to for details.

To summarize, in essence, the
SAT in Dipak Patel had held that there was a specific provision in the PFUTP
Regulations dealing with front running and that is Regulation 4(2)(q) of the
PFUTP Regulations. However, this Regulation applied specifically to
intermediaries only. And there are no other provisions in the Regulations/Rules/Act
that prohibits front running by non-intermediaries and hence they cannot be
held guilty of such charges. 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.”

SAT’s decision in Sujit Karkera and others was broadly on
same lines.

Generally,
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. The timing of the purchase and sale, the fact that all the
purchases were sold during the same day, the fact that the price offered by
Appellant at time was higher than the last traded price, etc. were also
highlighted.

SAT noted 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 to disadvantageous to other investors,
since they were not privy to this privileged information and resulted in
manipulation of securities in market.”

While
it is difficult to dispute that the findings indeed suggest that the Appellant
with her husband profited at the cost of CBI, certain thoughts come to mind.

Would
this not be treated as a fraud on CBI by the Appellants and therefore
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?

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) and would not such an
interpretation by SAT/SEBI make such Regulation redundant? 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.

Curiously,
as discussed earlier here,
SEBI had taken a decision
to amend the PFUTP Regulations, by inserting a “clarificatory amendment”,
presumably also to give it retrospective effect, that front running is a
violation of such Regulations. This amendment, though not made and hence its
wording not known, could have been controversial as it would have sought to make
an act a wrong at the time of its commision, though it was not wrong as per the
then prevailing law. This SAT decision (unless overturned by the Supreme Court
if the decision goes in appeal) may now obviate this amendment.