[Jitesh Maheshwari is an associate at Mindspright Legal and Rakshita Poddar is a lawyer based in Mumbai]
The Supreme Court of India in its recent landmark judgement of SEBI v. Rakhi Trading Pvt. Ltd., delivered by Justice Kurian and Justice Banumathi, has overruled several orders of the Securities Appellate Tribunal which had held that synchronised trades are illegal only when they are committed with the intention to impact the market. The Court has also shed further light on the concept of ‘unfair trade practice’ as provided under the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (hereinafter “PFUTP Regulations”).
Unfair Trade Practice
The Supreme Court observed for the first time in SEBI v. Shri Kanaiyalal Baldevbhai Patel that terms ‘fraud’ and ‘unfair trade practice’ as provided under the PFUTP regulations are different. The Court observed that the concept of unfairness has a broader meaning than fraud, and that trade practice is broadly unfair if the conduct undermines the ethical standards and good faith dealings between parties engaged in business transactions. It has to be considered comprehensively to include any act beyond a fair conduct of business, including the business in sale and purchase of securities. However, the Court also observed that a generalised or single definition of ‘unfair trade practice’ cannot be exist, and it requires adjudication on case-by-case basis and in accordance with the facts and circumstances surrounding the transaction.
The Supreme Court in Rakhi Trading provided a simplified definition of ‘unfair trade practice’ and observed that it means a practice which does not confirm to the fair and transparent principles of trades in the stock market. However, more importantly, the Court stated that the concept of ‘unfair trade practice’ is also embodied in the preamble to the Securities Contracts (Regulation) Act, 1956. It was observed by Justice Kurian in the judgment: “Securities market, as the 1956 Act provides in the preamble, does not permit “undesirable transactions in securities”. The Act intends to prevent undesirable transactions in securities by regulating the business of dealing therein. Undesirable transactions would certainly include unfair practices in trade.”
It is pertinent to note here that although the Supreme Court in Kanaiyalal recognised ‘fraud’ and ‘unfair trade practice’ as two different terms and only provided the definition of ‘unfair trade practice’, however it kept open the question regarding prosecution for ‘unfair trade practice’. But, in Rakhi Trading, the Court went a step further and recognised prosecution of the traders for engaging in unfair trade practice. It was observed that an intentional trading for loss per se is not a genuine dealing in securities as trading is always done with the aim to make profits, but if one party consistently make losses and that too in pre-planned and rapid reverse trades, it is not genuine; it is an unfair trade practice.
We believe that the recognition of terms ‘fraud’ and ‘unfair trade practice’ as provided under the PFUTP Regulations is likely to have a serious bearing on the cases relating to the PFUTP Regulations, as its expansive and objective definition will include many types of conduct in the securities market which may not come within the definition as provided under the PFUTP Regulations. This is because ‘fraud’ is defined under PFUTP Regulations; however ’unfair trade practice’ is not defined. When a term has no definition and has to be interpreted on case-by-case basis, it then will becomes a residual clause and can include any term which would otherwise not be illegal. In that sense, if something amounts to being unfair, it become illegal.
Impact on Market: Not Necessary
It has been held by the Securities Appellate Tribunal in various orders that synchronised 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.
For instance in Ketan Parekh v. SEBI (2006), it was observed:
“It would, therefore, follow that a synchronised trade or a trade that matches off market is per se not illegal. …… 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 or is executed to create false volumes resulting in upsetting the market equilibrium.”
The principle was also reiterated in Subhkam Securities Private Limited v. SEBI (2012) in which it has been observed:
“It is an admitted position that synchronized trades per se are not illegal. It is only when synchronized trades are executed with a view to manipulate the price of the scrip that the provisions of the FUTP Regulations will get attracted.”
However, the Supreme Court in Rakhi Trading has held that, for an act to fall within regulation 4(2)(a) of the PFUTP Regulations, it is not necessary that the parties entering into the transactions had any intention to manipulate the market and that the market was in fact manipulated. But, the judgement does not state that synchronised trades are per se illegal and has only observed that there are other crucial factors which also have to be seen to determine market manipulation. It was further observed in the judgment that market manipulation is a deliberate attempt to interfere with the free and fair operation of the market and create artificial, false or misleading appearances with respect to the price, market, product, security and currency.
We believe that the judgment is likely to have a far reaching consequence in the securities market. Though the case related to synchronised trades, the reasoning adopted in the judgment will squarely apply to all types of trades including the self-trades. SEBI’s stand itself is that the trades are manipulative if there is a negative impact on the market. SEBI’s policy on self-trades (discussed here on this Blog) states that a self-trade per se does not create market volume and manipulate the price of scrip, but those self-trades who do so will be treated as fraudulent. There are several orders (here and here) which the traders were exonerated on the basis that the quantity of self-trades constituted less than 1% of the market volume. The Supreme Court’s Judgment will have a serious impact on all similar cases and will take within it ambit all the questionable trades, even though with meagre quantity.
Jitesh Maheshwari and Rakshita Poddar