[The following guest post is contributed by Nikunj Agarwal, a 4th year student at RML National Law University, Lucknow and Arjun Agarwal, a 3rd year student at WB National University of Juridical Sciences, Kolkata. The authors can be contacted at email@example.com]
It is one of the well-known principles of securities regulation that the primary objective of such regulation is to ensure that the market information is accurate and dissemination of such information is not prejudicial or beneficial only to a particular group over others. Then, zealous pursuit by a capital market regulator to ensure that the quality of information in the market is accurate can only be commended. However, sometimes zealousness translates into rigidity and a conscious choice to overlook the obvious alternatives. It seems that is the case with ‘self trade restriction’ in securities markets in India. ‘Wrongful’ self trades are essentially concerned with manipulation of information about market liquidity and price of the scrip. Therefore, execution of such trades is considered unfair and fraudulent and therefore a breach of the basic norms of securities laws. It also seems obvious that the person entering into any commercial transaction has to ensure that his conduct is not violative of any law of the land.
However, the conundrum of Indian securities law is that the regulator has assumed that every self trade is wrongful and ipso jure violative of securities laws. Further, the problem snowballs when a self trade, on quantitative basis, cannot manipulate price or liquidity information in the market but is still held wrongful and in violation of securities laws. The worst case scenario in Indian law is where self trade occurs due to technical inadvertent matching with no intention to effect or has no actual effect on relevant information in the market and yet it is categorized as wrongful and violative of securities laws.
In this post, we submit that although the law states that self trades are ‘per se’ illegal, there are specific instances where Securities and Exchange Board of India (“SEBI”) and Securities Appellate Tribunal (“SAT”) have departed from a mechanical application of the stated ‘per se rule’. In these cases, a more pragmatic approach, similar to the ‘rule of reason’ approach in competition law, has been adopted. It is here where the subject matter of crucial analysis lies: does the regulator understand every self trade to be ‘wrongful’? In the course of our analysis we will establish that law is still in a state of confusion as regards unintentional technical violations. In such instances, there might be absence of ‘material market harm’ such as where matched trades constitute very low fraction of the total trading volume in the scrip whereby the materiality of market effect is negligible. If the ‘per se rule’ is the applicable law, then even such instances shall be violative of the SEBI (Prohibition Of Fraudulent And Unfair Trade Practices Relating To Securities Market) Regulations, 2003 (“PFUTP Regulations”). However, if the aim and objective of the regulations is to address fraudulent and unfair trading in the securities markets, then penalizing such accidental self trades would be beyond the scope of the regulations.
The Necessity of ‘Intent’
The element of fraud appears to be a pre-requisite in all the parts of Regulations 3 and 4 of the PFUTP Regulations. Further, since the term ‘fraud’ has been principally defined under Regulation 2(c), though inclusively, to mean such trades which are entered into in order to ‘induce others’, it would be difficult to call such trades fraudulent within the meaning of the PFUTP Regulations.
Furthermore, since these trades are accidental in nature, no meaningful deterrence could be achieved where the defaulters could do nothing to prevent such matches from occurring in the future. This clearly means that a distinction must be made between ‘wrongful self trades’ and ‘non-wrongful self trades’. The latter do not mean legitimate or ‘lawful self trades’.
The aim of securities laws must rightfully be to eliminate all avoidable market aberrations. But, pursuing this goal by means of punishing every market aberration might not always serve the purpose. Self trades, if material and substantial, affect market information regarding particular securities. Therefore, as long as a fictitious rule of ‘theoretical market harm’ whereby even single self trade of even one share is deemed to adversely affect the market, any adverse consequence on market information cannot be identified in such instances.
The Varying Standards
The authorities appear to have taken an equivocating stand by applying opposite legal standards in different cases. In Balwinder Singh v. SEBI, the SAT observed that “self trades/wash trades are per se not allowed under SEBI Act/Rules, since these do not result in actual/beneficial ownership of shares and only result in increase in volumes in particular scrip, which create illusion of increased trading in these scrip and may mislead investors in trading in these scrips and disturb/distort securities market”.
In Anita Dalal v. SEBI, the SAT observed:
“Self trades admittedly are illegal. This Tribunal has held in several cases that self trades call for punitive action since they are illegal in nature. In M/s. Jayantilal Khandwala & Sons Pvt. Ltd. vs. Securities and Exchange Board of India, this Tribunal has held that “one cannot buy and sell shares from himself. Such transactions are obviously fictitious and meant only to create false volumes on the trading screen of the exchange”.
Further, in HJ Securities Pvt Ltd v. SEBI, the SAT noted that “Simply because the number of such self trades is not large by itself cannot justify execution of self trades”.
The above ruling must be contrasted with observations of the SAT in Smt. Krupa Sanjay Soni v. SEBI where it had taken a view that "a few instances of self trades in themselves would not, ipso facto, amount to an objectionable trades”. But, in Systematix Shares & Stocks (India) Limited v. SEBI, the SAT observed that “it has been held in several cases by this Tribunal that self trades are fictitious and reprehensible. Trades, where beneficial ownership is not transferred, are admittedly manipulative in nature.” It is pertinent to note here that the SAT seems to have read the law to mean that ‘self trades ipso jure amount to manipulative conduct and therefore punishable under securities laws’.
It is submitted that while framing the test whether to penalize a self trade, the correct approach is to adopt a two-pronged analysis. In the first stage, it must be analyzed whether intention to manipulate or commit fraud is present. Such analysis must inevitably be subjective and intention must not be presumed only by the fact that self trade has happened. If intention is established, for the purpose of establishing liability, a further enquiry into ‘materiality of market harm’ should not be conducted. This is the direct mandate of the PFUTP Regulations since even where no market harm arises, a demonstrated manipulative and fraudulent activity must be punished under the regulations.
In the second approach, where intention to commit fraud or manipulate the market is found lacking and where the entire transaction was not a product of manipulative activity, the true crux of the problem lies. In such cases, the SAT seems to have taken an approach that if the volume of shares traded is large and material impact on market information can be established, such transaction must be punished. In a very recent decision of Re: Bharatiya Global Infomedia Limited and Ors, SEBI adopted the abovementioned approach to find liability for self trades.
It is submitted that the requirements of Regulation 4(2) are very specific in nature. The test laid down in the regulation demand a manipulative intent to affect market information. Even if we read clause (a) as a strict liability clause, the test would be to prove ‘misleading appearance of trading’. However, in cases where the shares traded are highly liquid and self trades happen due to mere technical reasons, the requirements of Regulation 4 are not met. It seems absurd to read a strict liability offence in a regulation meant to punish unfair and manipulative activities. As long as self trade is defined in the regulations is read and understood as a strict liability offence, the approach of the tribunal appears to be ultra vires the regulations.
The requirements of intention and materiality must not be so confused so that one is presumed to lead to the other. As already stated, though securities laws must aim at restricting self trades, it is not the same thing as punishing every instance of self trade as manipulative and unfair trade practice. The reasoning adopted by the SEBI and the SAT for penalizing technical self trades is available in the HJ Securities judgment where the tribunal held that “The appellant is free to adopt any business model but he has to ensure that whatever business model he adopts, it is in conformity with the regulatory framework” Even if the regulations are read to incorporate ‘a duty to prevent market harm’, such duty must be located in the text of specific provision under the regulations.
In instances where all reasonable precautions were taken and yet self trades happen due to technical reasons or inadvertently it seems difficult to invoke the ‘duty to prevent’ to find a violation of the regulations. Invocation of ‘materiality of adverse market effect’ as a new and innovative standard to find a violation of the regulations would be clearly outside the scope and objective of the regulations. Therefore, it is plausible to say that substantiality or materiality of the adverse market effect caused by the self trade should not be invoked as an independent element in finding a liability for violation of the regulations. The standard of substantiality or materiality must be invoked as a supplementary but not independent standard for violation of the regulations.
Therefore, it is submitted that to suggest that ‘self trades are per se illegal’ is both factually and legally incorrect and a rule of reason must be adopted to identify ‘wrongful self trades’ punishable under the PFUTP Regulations. Certainly, the self trades which do not qualify as ‘wrongful’ do not become ‘valid’ and are still subject to restrictions and reprehensions under the securities laws but, as long as a deeming fiction is incorporated into the law, they cannot be branded as manipulative and fraudulent.
- Nikunj Agarwal & Arjun Agarwal