[Aamir Kapadia and Shivam Yadav are final-year BBA, LLB (Hons.) students at Jindal Global Law School]
On 27 May 2024, the Securities and Exchange Board of India (“SEBI”) issued a circular, “Norms for Sharing of Real Time Price Data to Third Parties” (“the Circular”) to, inter alia, stock exchanges generally restricting them from sharing real-time market data with third-party entities (primarily fantasy stock gaming platforms), except in furtherance of regulatory requirements or the orderly functioning of the securities markets. Another exception was carved out for educational platforms, with whom data may be shared with a one-day lag. While the Circular is a positive step towards protecting the interests of retail investors, certain vital concerns emerge from its implementation.
Applicable Legal Regime
Akin to fantasy sports platforms, virtual stock trading platforms allow users to participate in fantasy stock games and tournaments. Instead of trading actual stocks, participants can create virtual portfolios of stocks and compete with others based on their portfolio’s valuation. What differentiates fantasy stock gaming platforms is that the system that ranks the users’ portfolios is tied to the stocks’ actual performance on the stock exchange. Such platforms may either charge a small entry fee (much lesser than any brokers’ fee or stock price) with a financial incentive for contest winners such as the Indian Trading League, or may be offered for free purely for investor education and practice, such as Neostox
Fantasy stock trading games operate in a legal grey area, since they may fall under the definition of a “derivative” under the Securities Contracts (Regulation) Act, 1956 (“SCRA”). Section 2(ac) of the SCRA defines a derivative to include, inter alia, “a contract which derives its value from the prices or index of prices of underlying securities”. Even otherwise, as noted in Rajshree Sugars and Chemicals, this definition is inclusive and does not negate the natural meaning of the word “derivative”, which would ordinarily include a “swap” transaction.
A “swap” has not been statutorily defined in India, though reference may be had to section 1a(47) of the US Commodity Exchange Act, which defines a swap, inter alia, as any agreement or contract that provides for any sale, purchase, or payment which is dependent on the occurrence or non-occurrence of an event associated with a potential financial, or commercial consequence.
Therefore, at least with respect to platforms that charge a fee while promising a financial incentive based on the performance of a virtual portfolio, it is arguable that such contracts constitute derivatives. This is because such contracts derive their value from the performance of the corresponding actual securities constituting the virtual fantasy portfolio of the user.
Even otherwise, it is arguable that such a contract would constitute a “swap”, since it is a contract for payment of a prize or financial payout which is contingent upon the occurrence of an event, i.e., the achievement of the stipulated ranking or other outcome. This view has been adopted by the US Securities and Exchange Commission (“US SEC”) in Forcerank LLC, wherein a platform allowing users to rank stocks based on their predicted performance, upon payment of a fee, promising a financial payout to the top ranks, was held to be a “swap” transaction based on a security. Accordingly, it is submitted that SEBI may consider such platforms to be entering into derivative contracts. It is also apparent that any contract between free-to-play fantasy trading platforms offering no financial incentives and their users would not constitute a derivative contract, due to the absence of any financial exchange or transaction between the user and the platform, i.e., the absence of a contract.
In respect of platforms charging a fee and promising financial incentives, and thereby qualifying as “derivatives”, section 18A of the SCRA provides that derivatives would be valid if, inter alia, they are traded on a recognised stock exchange or are settled on the clearing house of the recognised stock exchange. Further, SEBI Notification No. LAD-NRO/GN/2013-14/26/6667 (“Notification”) prohibits persons from entering into “contract[s] for sale or purchase of [derivatives]” without SEBI’s permission, except for, inter alia, derivative contracts permissible under the SCRA. In this regard, SEBI may draw inspiration from the US SEC adjudication in Forcerank LLC that, since such platforms offered and sold swaps to each player in each game without effecting these transactions on a national securities exchange, it was in violation of securities law requiring that derivatives be traded on a recognised exchange.
However, in India, the fact these contracts are derivatives would not, ipso facto, mean that they are illegal or invalid. Multiple High Court judgments have clarified the scope of section 18A of the SCRA and the Notification. In Percept Finserve and Banyan Tree Growth Capital, it was opined that the operation of section 18A does not invalidate or void any contract, instead merely providing that such contracts must be traded on a recognised stock exchange or clearing house. Accordingly, it was held that merely entering into a contract that is a derivative is not hit by the provisions of section 18A or the Notification, even if it was not carried out on a recognised stock exchange, so long as the contract itself is not traded. Therefore, there is also scope to argue that in India, since users do not “trade” their contract with the fantasy gaming platform with anyone per se, but rather participate in the derivative contract, section 18A and the Notification are not attracted and that such platforms are legal.
SEBI’s Stance
Against this legal backdrop, two plausible but opposing interpretations may be adopted by SEBI. Indeed, SEBI has previously issued an investor warning in 2016 advising against participating in fantasy trading. Further, a 2016 SEBI consultation paper came down heavily against fantasy trading platforms, alleging a lack of transparency and dispute settlement mechanisms that are otherwise present in real trading. As such, in the interests of investor safety, it was proposed virtual fantasy trading be prohibited, though the proposal was never implemented.
Further, in 2016, stockbrokers were prohibited from being associated with virtual trading leagues through multiple circulars. The legality of this move was challenged in SAMCO Securities, wherein the Bombay High Court held the circulars to be constitutional. It reasoned that the circulars were in pursuance of investor protection so as to avoid misguiding and luring of investors into making rash and risky decisions. Therefore, SEBI’s actions were deemed to have been made in the public interest and constituted a reasonable restriction under Article 19(6) on the right to freedom of trade under Article 19(1)(g). Along similar lines, irrespective of the legality of fantasy trading platforms, the present Circular itself would be valid. This is so because the Circular was issued by SEBI to safeguard the integrity of the securities markets and protect the interests of investors, aiming to ensure that investors are not encouraged to participate in potentially harmful financial activities.
Analysis
The measures undertaken by SEBI to curb the flow of information to such fantasy gaming platforms is a welcome development, in as much as it nips the growth of such platforms which posed significant threats to investors. For example, not only are such platforms lacking in transparency as regards their operations, conflicts of interest, and other such disclosures, but there is also no SEBI protection available to unsuspecting investors who may suffer losses at the hands of such platforms. Additionally, such low-cost platforms may encourage extremely risky investment patterns, which uninformed investors may attempt to replicate in the actual securities market to their significant detriment. However, certain critical concerns regarding the implications of the Circular may be considered.
Firstly, SEBI has yet to express a definitive opinion on the legality of such fantasy stock gaming platforms vis-à-vis section 18A of the SCRA. Even if it believes that platforms charging a fee and promising incentives are illegal, there is no reason to restrict the functioning of free stock simulation platforms meant for educational purposes, as they are not derivative contracts.
Secondly, while it may be argued that SEBI recognises the existence of such genuine platforms and provides for information to be shared with such platforms with a delay of one day, such an exception would nevertheless defeat the purpose of such educational platforms. The premise of educational stock simulation platforms is to allow investors to practise their investment techniques without any financial risk or incentive, which would be defeated if there is a delay in the information feed, as the investor would already know how the market has behaved the previous day.
Finally, while the Circular justifiably spells the end of fantasy stock gaming platforms that qualify as derivatives, it also renders superfluous genuine educational platforms. However, if SEBI’s concerns with such educational platforms are also their lack of transparency, disclosures, and encouragement of risky investments, it could have considered regulating such platforms as opposed to defeating their purpose altogether. Such regulation could include mandating various disclosures akin to stockbrokers, as well as a specific warning against implementing risky investment practices in the actual stock market, which would equally satisfy SEBI’s legitimate concerns and make it a proportionate response.
Conclusion
SEBI’s Circular serves as a welcome move by addressing the significant concerns about transparency and risky investment behaviours posed by virtual fantasy trading platforms. However, some pertinent concerns arise, including whether contracts between these platforms and their users constitute “derivatives” that are traded in violation of the SCRA. The Circular also renders infructuous genuine educational platforms that may be helpful to a novice investor, due to the one-day lag in data sharing. Therefore, a more regulation-oriented framework for genuine educational platforms could better serve the dual goals of investor protection and education.
– Aamir Kapadia & Shivam Yadav