Monday, August 26, 2013

No More Front Running Through The Back Door

[This post is contributed by Anjali R. Menon, who is a Senior Associate at a leading law firm in Mumbai. She also runs a blog at She can be reached at

It relates to the issue of front running, which has been previously discussed on this Blog in the context of cases decided by the Securities Appellate Tribunal (SAT) and the Securities and Exchange Board of India (SEBI). In this post, Anjali discusses some new proposals by SEBI intended to plug some loopholes that exist under the current legal regime]

On 12 August 2013, the Securities and Exchange Board of India (SEBI) at its Board meeting decided to put an end to front running once and for all. Through its press release, SEBI announced that the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (FUTP Regulations) will soon be amended to ensure the following:

(i) the current provisions prohibiting front running will not be regarded as exhaustive; and

(ii) illegal mobilisation of funds without SEBI registration as a collective investment scheme (CIS) would be regarded as a fraudulent and unfair trade practice.

So what does all this imply? What is 'front running' and why are these proposed amendments required?

'Front running' has not been defined in any Indian statute. Although the term sounds like a proactive, diligent act, it is not at all laudatory. The easiest way of explaining 'front running' may be by drawing a parallel with insider trading. Why is the latter prohibited? Because an insider has access to unpublished price sensitive information which could be misused to manipulate the market and reap profits. Front running is like insider trading by an outsider. Who are these outsiders? Now that's the question!

The FUTP Regulations as they currently stand prohibit an 'intermediary from buying or selling securities in advance of a substantial client order' (Regulation 4(2)(q) of the FUTP Regulations). Stock brokers, merchant bankers, portfolio managers, investment advisers, FIIs, asset management companies are some of the intermediaries regulated by SEBI.

SEBI and the Securities Appellate Tribunal (SAT) faced several instances (here and here) of persons benefitting from the price movement of a company's shares by trading in shares of the company based on information of forthcoming orders of another trader in the market. But the authorities could not book the individuals for 'front running' as these individuals were not intermediaries - even though some of these individuals traded on the shares after the confidential information had been passed on to them by intermediaries, and the number of shares traded by such persons were synchronized with and identical to the subsequent price-influencing orders.

There are several other broad provisions in regulation 3 of the FUTP Regulations which ban any person from buying, selling or otherwise dealing in securities in a fraudulent manner, or from employing any manipulative/deceptive device during purchase/sale of any listed security. However, the hands of the authorities were tied because the specific regulation prohibiting front running applied only to intermediaries. The authorities observed that the front running prohibition did not always read this way - the 1995 regulations (which were replaced by the FUTP Regulations in 2003) barred any person and not merely intermediaries from front running.

This is why SEBI has proposed amendments to the FUTP Regulations to ensure individuals and unregistered CISs do not take advantage of this loophole and circumvent the law by undertaking front running. SEBI intends to amend the FUTP Regulations to clarify that the manipulative, fraudulent and unfair trade practices listed in regulation 4 of the FUTP regulations will not be regarded as exhaustive and the general provisions of regulation 3 will have an overriding effect. To put an end to CISs operating without SEBI registration, SEBI has also passed the Securities Laws (Amendment) Ordinance, 2013 (SEBI Ordinance) and declared that any pooling of funds involving a minimum corpus of INR 100 crores will be deemed to be a CIS. The SEBI Ordinance has also intensified SEBI's investigative and enforcement powers - i.e. SEBI can now conduct search and seizure, call for records and information (including telephone call data records), record statements on oath, obtain information from overseas regulators, arrest and detain defaulter’s or attach his assets and bank accounts. SEBI can also establish special courts for speedy disposal of cases.

In one particular case SEBI did not follow the trend set by SAT and sought to impose sanctions on non-intermediaries (an equity dealer of a listed company and his wife) for indulging in front running. But this case will not serve as a precedent for prohibiting non-intermediaries from front running because the rationale for punishing the offenders in this case was very different. Relying on regulation 3 of the FUTP Regulations, SEBI alleged that the ill-gotten profits of the husband-wife duo were nothing but losses suffered by the public listed company, its shareholders and customers and the investors in the securities market.

All in all, the walls are closing in on the front runners - their finishing line is near!

- Anjali R. Menon

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