The Securities Appellate Tribunal (“SAT”) has now held that front running is indeed a fraudulent and manipulative act in violation of the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (“PFUTP Regulations”). It has departed from its earlier decisions in case of Dipak Patel (discussed here) and Sujit Karkera (discussed here). It thus upheld SEBI’s Order (discussed here) levying a penalty of Rs. 25 lakhs on profits made on account of such front running of Rs. 7,15,854.
The earlier post discusses in detail the facts of the present case as per the SEBI Order which can be referred to for details.
To summarize, in essence, the SAT in Dipak Patel had held that there was a specific provision in the PFUTP Regulations dealing with front running and that is Regulation 4(2)(q) of the PFUTP Regulations. However, this Regulation applied specifically to intermediaries only. And there are no other provisions in the Regulations/Rules/Act that prohibits front running by non-intermediaries and hence they cannot be held guilty of such charges. SAT accordingly, had observed:-
“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. There is no denying the fact that when the appellants placed their order, these were screen based and at the prevalent market price. Admittedly Passport was the major counter party for trading in the market and was placing huge orders and hence possibility of order of traders placing orders for smaller quantities matching with orders of Passport cannot be ruled out. Therefore, it cannot be said that they have manipulated the market. The alleged fraud on the part of Dipak may be a fraud against its employer for which the employer has taken necessary action. In the absence of any specific provision in law, it cannot be said that a fraud has been played on the market or market has been manipulated by the appellants when all transactions were screen based at the prevalent market price.”
SAT’s decision in Sujit Karkera and others was broadly on same lines.
Generally, the findings of SEBI in the present case were also similar. To point out a few, the Appellant was the wife of the equity dealer of Central Bank of India (“CBI”). In 14 out of 16 trading days, the trades of the Applicant matched with that of CBI. The timing of the purchase and sale, the fact that all the purchases were sold during the same day, the fact that the price offered by Appellant at time was higher than the last traded price, etc. were also highlighted.
SAT noted both its earlier decisions. However, using the following reasoning, it departed from them and held that front running was a fraudulent market practice and violation of 3(a), (b), (c), (d) and 4(1) of the PFUTP Regulations and thus punishable. It observed:-
“A minute perusal of the judgment of Dipak Patel makes it evident that act of front running is always considered injurious be it an intermediary or any other person for that reasons. We would like to give a liberal interpretation to the concept of front running and would hold that any person, who is connected with the capital market, and indulges in front running is guilty of a fraudulent market practice as such liable to be punished as per law by the respondent. The definition of front running, therefore, cannot be put in a straight-jacket formula.”
The SAT also observed:-
“Advance information of definite trade by CBI at manipulated price of particular scrip was available to Appellant no. 1 and on basis of this information she traded in security market and secured undue profits, which was to disadvantageous to other investors, since they were not privy to this privileged information and resulted in manipulation of securities in market.”
While it is difficult to dispute that the findings indeed suggest that the Appellant with her husband profited at the cost of CBI, certain thoughts come to mind.
Would this not be treated as a fraud on CBI by the Appellants and therefore actionable by CBI and not SEBI?
The Order says that there was a loss/disadvantage to other investors. This too is difficult to understand. The Appellant purchased the shares from other investors on the same day. Later during the day, she sold the same at a higher price to CBI. But if this had not happened and CBI had come directly in the market, would not the sellers got the same price as they got in original sale as the transactions would have taken place in the same manner?
Finally, the question of redundancy of Regulation 4(2)(q) remains. If such transactions are violation of the other general provisions of the PFUTP Regulations, then what is the relevance of Regulation 4(2)(q) and would not such an interpretation by SAT/SEBI make such Regulation redundant? The counter argument is of course that if such a universal rule was made, then the various prohibitions say, on stock brokers, may be interpreted as not applicable to persons who are not stock brokers.
Nevertheless, the decision of SAT now creates a precedent that front running is a violation of the PFUTP Regulations and thus punishable.
Curiously, as discussed earlier here, SEBI had taken a decision to amend the PFUTP Regulations, by inserting a “clarificatory amendment”, presumably also to give it retrospective effect, that front running is a violation of such Regulations. This amendment, though not made and hence its wording not known, could have been controversial as it would have sought to make an act a wrong at the time of its commision, though it was not wrong as per the then prevailing law. This SAT decision (unless overturned by the Supreme Court if the decision goes in appeal) may now obviate this amendment.