The Supreme Court’s Liberal Interpretation of the SEBI Regulations on Fraudulent Trade Practices

[Jitesh Maheshwari is an Associate at Mindspright Legal in Mumbai]


The Supreme Court last month passed a landmark judgment in SEBI v. Shri Kanaiyalal Baldevbhai Patel in which front running by a non-intermediary has been bought within  the prohibition of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (the “PFUTP Regulations”). The judgment was delivered by Justice N. V. Ramana and Justice Ranjan Gogoi, each of whom delivered a separate opinion.

The brief history of the decision is that regulation 6 of the previous version of the PFUTP Regulations issued in 1995 prohibited front running and it was applicable to a ‘person’. After these Regulations were repealed, regulation 4(2)(q) of the current version of the PFUTP Regulations continued to prohibit front running, but it was made applicable only to ‘intermediaries’. This gave rise to the controversial issue whether front running was applicable to ‘non-intermediaries’ as well.

The Securities Appellate Tribunal (SAT”) in Shri Dipak Patel v. SEBI (2012) observed that a departure has been made in the 2003 version of the regulations, and that front running has been prohibited only when carried out by intermediaries. This decision was followed by SAT in the same year in Mr. Sujit Karkera v. SEBI. However, in Vibha Sharma v. SEBI (2013) SAT provided a liberal interpretation to the concept of front running and held that front running by any person connected to the securities market is punishable by law, whether or not such a person is an ‘intermediary’.

Due to these contradictory observations of SAT, the issue went before the Supreme Court which settled the position by interpreting the PFUTP Regulations to include front running by non-intermediaries as well. The Court has also provided a new explanation for ‘front running’ that:

It comprises of at least three forms of conduct. They are: (1) trading by third parties who are tipped on an impending block trade (“tippee” trading); (2) transactions in which the owner or purchaser of the block trade himself engages in the offsetting futures or options transaction as a means of “hedging” against price fluctuations caused by the block transaction (“self-front-running”); and (3) transactions where a intermediary with knowledge of an impending customer block order trades ahead of that order for the intermediary’s own profit (“trading ahead”).

However, what is pertinent to note here is that the Supreme Court has reached this decision by liberally interpreting certain provisions of the PFUTP Regulations.

Regulation 3 and 4(1)

It was observed in the part of the judgment delivered by Justice N.V. Ramana that although front running by a non-intermediary is not prohibited by regulation 4(2)(q), it is prohibited by the general or catchall provisions of regulations 3 (a), (b), (c), (d) and 4(1) of the PFUT Regulations. Regulations 3 and 4(1) are general provisions, and regulation 4(2) (i.e., the specific provision) does not provide an exhaustive list of instances which can be termed as fraud. Therefore, it can be simply stated that the instances mentioned from regulation 4(2)(a) to 4(2)(t) are just illustrations of fraud and does not cover all the instances of fraud. Once it is proved that fraud was committed while dealing in securities, then all the general provisions of the PFUTP Regulations, i.e., regulations 3 and 4(1) will be attracted.

Such an interpretation of the provisions of securities law was previously adopted by the Supreme Court in Sahara India Real Estate Corporation Limited v. SEBI (2012) in which it was observed that the expressions like ‘without prejudice’ and ‘may’ employed in section 11(2) of the Securities and Exchange Board of India Act, 1992 (the “SEBI Act”) expresses that the measures referred to in this provision are just some of the powers of SEBI and not all the powers, as SEBI can take any measure which it thinks fit in order to protect the interest of investors.

Definition of Fraud

Due to these observations, now the burden on SEBI in establishing a violation of regulations 3 and 4(1) against a person will be just to prove that the conduct of the person falls within the ambit of regulation 2(b) and (c) which provides for the definition of ‘dealing in securities’ and ‘fraud’. In the part of the judgment delivered by Justice Ranjan Gogoi, a liberal interpretation has been given to the definition of fraud under regulation 2(c). It has been observed that fraud, as per the definition, even includes an act, expression, omission or concealment which, even though was not committed in a deceitful manner, but has (or had) the effect of inducing another person to deal in securities. The burden on SEBI in such a case will not be to prove that the inducement was done dishonestly or in bad faith by the person, but only to establish that the person so induced would not have acted the way he did if he was not induced.

Mens Rea for PFUTP Regulations

It can be inferred from the liberal interpretation of regulation 2(c) by the Supreme Court that SEBI is not required to prove that the intention of the person was to commit the fraud. However, it has even been expressly stated in the judgment that mens rea is not an indispensable requirement to attract the rigour of regulations 3 and 4, and the correct test is one of preponderance of probabilities.

A similar interpretation was given by SAT in Pyramid Saimira Theatre Ltd. v. SEBI (2010) in which the ratio laid down by Supreme Court in Chairman, Sebi v. Shriram Mutual Fund (2006), that mens rea is not a sine qua non for establishing violation of chapter VIA of SEBI Act, was extended to all the provisions of SEBI Act and the PFUTP Regulations. It was also observed that the words indicated in the definition of ‘fraud’ under regulation 2(1)(c) of the PFUTP Regulations “whether in a deceitful manner or not” are significant and clearly indicate that intention to deceive is not an essential requirement of the definition of fraud. The decisions in both these cases were rendered on the basis that proceedings initiated by SEBI are civil in nature.

Even in SEBI v. Skdc Consultants Ltd. (2004) and in SEBI v. Cabot International Capital Corporation (2004) the Bombay High Court observed that as the imposition of the penalty under the SEBI Act and regulations is civil in nature and cannot be equated with penal character, mens rea is not essential for breaches of provisions of the SEBI Act and regulations.

It is pertinent to note here that the above cases were decided on the basis that the proceeding under SEBI Act and Regulations (except under section 24 of the SEBI Act) are civil in nature and not penal in character, but in the judgment the Supreme Court states that even though regulations 3 and 4 invite penal consequences on defaulters, proof beyond reasonable doubt or mens rea is not an indispensable requirement. This means that the Supreme Court in the judgment has reached the same conclusion even after applying the opposite reasoning adopted in the above cases.


Although it has been observed in several decisions by different courts and tribunals that mens rea is not an essential element to establish the violation of provisions of the PFUTP Regulations, this is the first time that such observation has been made by the Supreme Court specifically for PFUTP Regulations. The liberal interpretation of the PFUTP Regulations adopted in the judgment is pro-investor and will allow SEBI to effectively protect the interest of investors in the securities market. However, the author believes that Supreme Court has erred in holding that guilty intention is not a necessary requirement to attract regulations 3 and 4 of PFUTP Regulations.

The Adjudicating Officer, SEBI in the matter of MIC Electronics Ltd. (2017), while proceeding against certain entities in the matter of self-trades has observed that the necessity of ‘intent’ and the element of “fraud” should be examined as a pre-requisite in all the parts of regulations 3 and 4 of the PFUTP Regulations. Even in SEBI’s Policy on Self Trades (discussed here on this Blog), it has been observed that a quasi-judicial body may assess the ongoing cases involving allegations of self-trade by analyzing whether any manipulation arises out of self-trade or any intention to enter into the same is evident from the material on record; 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. This means that the judgment is against the stand of SEBI itself.

It is a settled position that mens rea or intention to manipulate the market has to be proved before declaring a person guilty for indulging in synchronized trades, which are punishable under the PFUTP Regulations. In Ketan Parekh v. SEBI (2006) and Subhkam Securities Private Limited v. SEBI (2012), it has been observed that synchronized trades are not per se illegal, and that only when it is proved that synchronized trades were carried out with the intention to manipulate the market the provisions of PFUTP Regulations will get attracted.

Hence, it can be said that a blanket rule that mens rea of the person is not required to be proved to establish violation of regulations 3 and 4 of PFUTP Regulations is not correct as there are some instances where the mens rea of the person has to be proved, which even SEBI itself acknowledges.

Jitesh Maheshwari

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