Friday, December 21, 2012

SEBI penalises front-running again, does not follow SAT’s order

There is yet another Order of SEBI on front running and SEBI holds that transactions in the nature of front running are violative of the PFUTP Regulations. This is close after SAT’s recent ruling (“the Patel Order”) holding that front running cannot be punished, as discussed by me here, and another later ruling by SAT (“the Karkera Order”) as discussed by Mr. V. Umakanth here. By an Order dated 19th December 2012, the Adjudicating Officer levied penalty of Rs. 25 lakhs on the persons who allegedly made profit of Rs. 7.16 lakhs from transactions that fit the description of what are popularly known as front running transactions.

The facts of the present case, being substantially similar as in earlier cases, need not concern us here to avoid repetition. What is interesting is that, despite the parties drawing attention to the ruling of SAT holding that front running does not amount to violations of the PFUTP Regulations, SEBI has held that it is still punishable under the said Regulations.

It may be remembered that SAT quite clearly held that transactions in nature of front running are punishable under the PFUTP Regulations only if committed by an intermediary and not by others. More specifically, it held that, in absence of any specific provision of law in securities laws, such transactions by non-intermediaries are not punishable at all. To quote the Hon’ble SAT from the Patel Order:-

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.”.

This ruling was followed explicitly in the later SAT ruling in the Karkera Order.

The parties accused in this case did cite the Patel Order before SEBI. However, interestingly, SEBI did not accept this ruling to give relief to the accused on the following ground:-

The Noticees have even produced the judgment of the Hon'ble Securities Appellate Tribunal in Dipak Patel Vs. The Adjudicating Officer (SAT Appeal No. 216 of 2012 decided on 09/11/2012) in which Regulation 4(2)(q) of PFUTP Regulations, 2003 has been interpreted by the Tribunal. However, the present case does not deal with the violation of the said Regulation but Regulation 3 (a), (b), (c) & (d) and 4(1) of PFUTP Regulations, 2003. The CBI deals in shares on its own account and on behalf of its customers. CBI is a publically listed company and any loss incurred on its investments adversely would affect the interests of its own shareholders and customers. Therefore, the fraudulent and manipulative activities of the Noticees fall upon the CBI and its customers and ultimately on the investors of the securities market. In other words, the undue profits earned by the Noticees are nothing but the losses to them.”
Though not specifically made clear, it does appear that Central Bank of India (the employer of one of the noticees) is not an intermediary. If this is the case, then the SAT rulings would directly apply. The statement of SEBI that “the present case does not deal with the violation of the said Regulation” (i.e., 4(2)(q)) is not valid, in context of the SAT rulings as a whole, particularly the words reproduced earlier.

Moreover, the Patel Order did cite and discuss the provisions of Regulation 3(1) (a) to (d) of the PFUTP Regulations.

The point of SEBI that CBI is a publically listed company and so loss incurred by it would be borne by its shareholders may sound valid but this may imply that if there were no such public shareholders, front running would not be a violation. Same concern can be raised for the point that such transactions affect the interests of its customers. Also, to reiterate, this still does not deal with SAT’s ruling that in absence of specific provisions for non-intermediaries, front running cannot be punished.

An opportunity was thus lost to discuss and analyse the provisions individually and in detail relating to fraud and unfair trade practice in the PFUTP Regulations and apply the same to such cases. Instead, as in earlier case, several provisions were merely cited together and the noticees held to have violated them.

This decision also raises again a long standing concern about the non-binding nature in law of SAT decisions as precedents on SEBI. This concern particularly arises because the next appeal after SAT is straight to the Supreme Court.

The ruling of SAT in the Patel Order (and, so, the Karkera Order too) is of course dissatisfactory, and the concerns it raises have already discussed earlier here. One hopes that this issue is resolved soon by appeal to the Supreme Court and/or amendment to the law. For such Orders as the present one are satisfactory neither as practice, nor as precedents for other cases in other contexts.

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