[Guest post by Jitesh Maheshwari, Associate at Mindspright Legal in Mumbai]
Introduction
Self-trades are trades executed on the stock market in which the same entity is both buyer and seller. These trades do not represent a real change in beneficial ownership of the security. Earlier, the position on self-trades was that they create artificial or fictitious volume in the market, and give a false and misleading appearance of trading in the scrip at the exchange; hence, they are per se illegal, wrongful and in violation of securities laws. The same can be observed from plethora of judgments, such as in Balwinder Singh v. SEBI (2013), where the Securities Appellate Tribunal (“SAT”) observed that self-trades(or wash-trades) are per se not allowed under Securities and Exchange Board of India Act, 1992 (the “SEBI Act”) and regulations made thereunder. In Chirag Tanna v. The Adjudicating Officer (2013),the SAT held that self-trades are, admittedly, fictitious and create artificial volumes in the traded scrip. In Triumph International Finance Ltd v. SEBI (2007), the SAT observed that self-trades were fictitious because the buyer and the seller were the same. Further, in Systematix Shares & Stocks (India Limited v. SEBI (2012), the SAT observed that trades, “where beneficial ownership is not transferred, are admittedly manipulative in nature.” In HJ Securities Pvt Ltd v. SEBI (2012), the SAT even made the observation that simply because the number of such self-trades is not large by itself cannot justify execution of self-trades.
Contradictory Orders
From the abovementioned cases, it appears that the position on the legality of self-trades was that just because the buyer and seller in self-trades are same they are per se fictitious and the fact that number of such trades are not large is not a defense available to the person charged for self-trades. However, in other orders, there were some contradictory observations, such as in N.M. Lohia v. SEBI (2010) where, while holding the person trading liable for manipulation, the SAT stated that in case of solitary or a few trades the outcome would be different. Further, the SAT in Smt. Krupa Sanjay Soni v. SEBI (2014), while reducing the penalty imposed by the Securities and Exchange Board of India (“SEBI”) for indulging in self-trades, observed that a few instances of self-trades in themselves would not, ipso facto, amount to an objectionable trade. Further, the Adjudicating Officer, SEBI in the case of Servalakshmi Papers Limited (2013) disposed of the matter by giving the benefit of doubt to the noticee while making the observation that matching of trades from different terminals becomes inevitable in the execution of arbitrage trades involving high volume and turnover. In the matter of Supertex Industries Ltd.(2014), the Adjudicating Officer observed that the quantity of self-trades were incapable of having any impact on the market. Further, SEBI in the matter of Gayatri Projects Limited (2014) dropped the charges against the noticees as there were very few and negligible instances of self-trades. Hence, from these contradictory orders, it can be seen the authorities have taken diverse views on the issue and it may be stated that the position and stand of SEBI and SAT was not settled, which created a conundrum in the capital markets.
Policy of SEBI
There were instances in which action was taken by SEBI even where the volume of self-trades compared to market volume was miniscule. This gave rise to a hue and cry in the capital markets, with appeals flooded SAT, and creating a lot of pressure on SEBI to alter its stance on self-trades. SEBI convened a meeting of stock brokers and legal heads of stock exchanges on October 26, 2016 to decide its approach regarding the issue of self-trades. Separately, in Crosseas Capital Services Pvt. Ltd. v. SEBI, in which SAT clubbed 11 appeals, SEBI’s representative stated that SEBI has decided to have a fresh look into these matters, due to which the cases were restored to the file of Whole Time Member, SEBI.
Pursuant to these developments, SEBI came out with its new policy dated May 16, 2017 (the “Policy”) by which it was observed that intention is a sine qua non for establishing manipulation in case of self-trades, and that accidental or unintentional self-trades are not covered under the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets) Regulations, 2003 (the “PFUTP Regulations”) . Further, it was observed that in all matters of self-trade, an assessment has to be made regarding whether the said trade was intentional or unintentional on the basis of supporting evidence, and that the manipulation caused by indulging in self-trades should be clearly brought out. It was decided by the Policy that the quasi-judicial body may assess the ongoing cases involving allegations of self-trade by analyzing whether any manipulation is arising out of self-trade, or whether any intention to enter into the same is evident from the material on record. If the manipulation or intent can be established, the same may be proceeded with as approved; however, if no intention or manipulation is evident from the case and the only charge is mere occurrence of self-trades, then the entity may be exonerated by the quasi-judicial authority. Further, while assessing the manipulative intent, the volume transacted may also be considered in addition to the other factors.
By this Policy, the position has now been settled that self-trades per se does not create market volume and manipulate the price of scrip, but those self-trades which do so will be treated as fraudulent. The Policy of SEBI marks a positive change in the jurisprudence of fraudulent self-trades in India.
It is pertinent to note here that prior to this Policy, certain orders were passed in the matter of MIC Electronics Ltd. (here, here and here)in which the Adjudicating Officer of SEBI, while proceeding against several entities, discussed the practicalities in execution of trades and observed that a distinction needs to be made between ‘wilful self-trades’ which are done with a motive to induce other to trade in that particular stock, and ‘unintentional self-trades’ which are in the nature of jobbing and had occurred due to technicalities of the anonymous trading system; only intentional self-trades can be considered to be as manipulative. It can be said that the Policy has incorporated the principles laid down in the orders of MIC Electronics.
Cases after the Policy
SEBI has passed certain orders after it came out with the Policy, and in which the Policy has been considered and applied. These are in the matters of Aster Silicates Ltd.and Unitech Limited in which the Adjudicating Officer quoted the Policy and, while observing that the volume of self-trades is less than 1% of the total volume and the impact of self-trades on LTP is not significant on daily basis, dropped the proceeding against the notices.
Although it is nowhere stated in the Policy that the volume has to be less than 1% of total market volume to be treated as bona fide trades, however in both the above orders the proceedings were dropped on that count. As both the orders are passed within a short time after the formulation of Policy, it can be presumed if the total self-traded quantity is less than 1% of the total market volume than it would be a good defense available for the entities charged with allegations of self-trades.
Generally when the trades by an entity result into self-trades, then that entity is slapped by SEBI with a notice for violation of provisions of the PFUTP Regulations and the broker through whom the trades were executed is slapped with a notice for violation of provisions of SEBI (Stock Brokers and Sub-Brokers) Regulations, 1992 (the “Stock Brokers Regulations”) as it failed to exercise due skill, care and diligence and executed self-trades on behalf of the entity.
In another order passed by SEBI in the matter of trading in four scrips viz. Nakoda Textiles India Limited, Gayatri Projects Limited, Nandan Exim Limited & Trimurthi Drugs & Pharmaceuticals Limited, it was noted that that the Policy has been framed by SEBI to address cases wherein there is a charge of violation of the PFUTP Regulations by way of indulging in self-trades and not for the violations under Stock Brokers Regulations.
However, the author believes that reasoning of the above order is incorrect because, in order to make a broker liable for Stock Brokers Regulations in a case relating to self-trades, it has to be first proved that the trades executed by entity were mischievous. To prove mens rea on part of the entity which has indulged in self-trades is a prerequisite for making the broker liable for violation of the Stock Brokers Regulations. The reason for the same is that a broker is held liable for not exercising due skill, care and diligence because it was not able to prevent the unlawful fraudulent trades by its client. But if it is proved that the trades done by its client were not fraudulent and hence not unlawful, then on what basis can the broker be held liable for not exercising due diligence? The Policy has been framed by SEBI to deal with the ‘ongoing cases relating to self-trades’, and the case of a broker against whom the charges are levelled for not exercising due skill, care and diligence for executing self-trades on its client’s behalf, will come within the ambit of ‘cases relating to self-trades’. If the position is not such, then there will be cases where the entity taking protection of the Policy will be exonerated but the broker who took instructions from such entity to execute such trades will be condemned. This will result in treating subjects of same class differently which is arbitrary.
– Jitesh Maheshwari