2017 (9) TMI 1269 - SC - SEBI

Supreme Court rules non-intermediary front running constitutes fraud under FUTP regulations 3 and 4(1) requiring confidentiality breach proof

Securities And Exchange Board of India Versus Shri Kanaiyalal Baldevbhai Patel, Securities And Exchange Board of India Versus Shri Dipak Patel, Securities And Exchange Board of India Versus Sujit Karkera And Ors., Pooja Menghani Versus Securities And Exchange Board of India And Vibha Sharma And Anr. Versus Securities And Exchange Board of India

The SC held that non-intermediary front running constitutes fraud and unfair trade practice under FUTP 2003 regulations 3 and 4(1) when specific elements ... Legality of ‘non-intermediary front running’ in security market under FUTP 2003 - Interpretation of word 'Front running' - trading activity of the Passport India Investment (Mauritius) Ltd. (‘PII’) - Meaning of and scope of 'fraud' and 'unfair trade practices' - Interpretation of regulations 3 and 4 - meaning of the word 'inducement' - ‘expressio unius est exclusio alterius’ - law of confidentiality - fiduciary relationship between the employee of a firm to safeguard the confidential information owned by the firm​​​​​​​ - Whether ‘front running by non-intermediary’ is a prohibited practice under regulations 3 (a), (b), (c) and (d) and 4(1) of FUTP 2003? N. V. RAMANA J. - Held that:- A crucial aspect which needs to be observed at this point is the element of causation which is embedded under regulation 2(1)(c) read with regulations 3 and 4. In order to establish the aforesaid charges in this case, it is required by the SEBI to establish that the harm was induced by the materialization of a risk that was not disclosed because of the tippee’s fraudulent practice. Further the charges under the FUTP 2003 needs to be established as per the applicable standards rather than on mere conjectures and surmises. It should be noted that the provisions of regulations 3 (a), (b), (c), (d) and 4(1) are couched in general terms to cover diverse situations and possibilities. Once a conclusion, that fraud has been committed while dealing in securities, is arrived at, all these provisions get attracted in a situation like the one under consideration. We are not inclined to agree with the submission that SEBI should have identified as to which particular provision of FUTP 2003 regulations has been violated. A pigeon-hole approach may not be applicable in this case instant. The law of confidentiality has a bearing on this case instant. “Confidential information acquired or compiled by a corporation in the course and conduct of its business is a species of property to which the corporation has the exclusive right and benefit, and which a court of equity will protect through the injunctive process or other appropriate remedy.” Therefore, a person conveying confidential information to another person (tippee) breaches his duty prescribed by law and if the recipient of such information knows of the breach and trades, and there is an inducement to bring about an inequitable result, then the recipient tippee may be said to have committed the fraud. Accordingly, non-intermediary front running may be brought under the prohibition prescribed under regulations 3 and 4 (1), for being fraudulent or unfair trade practice, provided that the ingredients under those heads are satisfied as discussed above. From the above analysis, it is clear that in order to establish charges against tippee, under regulations 3 (a), (b), (c) and (d) and 4 (1) of FUTP 2003, one needs to prove that a person who had provided the tip was under a duty to keep the non-public information under confidence, further such breach of duty was known to the tippee and he still trades thereby defrauding the person, whose orders were front-runned, by inducing him to deal at the price he did. Taking into consideration the facts and circumstances of the case before us and the law laid down herein above and SEBI v. Kishore R. Ajmera [2016 (2) TMI 723 - SUPREME COURT] can only lead to one conclusion that concerned parties to the transaction were involved in an apparent fraudulent practice violating market integrity. The parting of information with regard to an imminent bulk purchase and the subsequent transaction thereto are so intrinsically connected that no other conclusion but one of joint liability of both the initiator of the fraudulent practice and the other party who had knowingly aided in the same is possible. Consequently, Civil Appeal Nos. 2595, 2596 and 2666 of 2013 are allowed. At the same time, for the same reason, Civil Appeal Nos. 5829 of 2014 and 11195-11196 of 2014 are dismissed. RANJAN GOGOI,J. - Held that:- To attract the rigor of Regulations 3 and 4 of the 2003 Regulations, mens rea is not an indispensable requirement and the correct test is one of preponderance of probabilities. Merely because the operation of the aforesaid two provisions of the 2003 Regulations invite penal consequences on the defaulters, proof beyond reasonable doubt as held by this Court in Securities and Exchange Board of India Vs. Kishore R. Ajmera [2016 (2) TMI 723 - SUPREME COURT] is not an indispensable requirement. The inferential conclusion from the proved and admitted facts, so long the same are reasonable and can be legitimately arrived at on a consideration of the totality of the materials, would be permissible and legally justified. Concerned parties to the transaction were involved in an apparent fraudulent practice violating market integrity. The parting of information with regard to an imminent bulk purchase and the subsequent transaction thereto are so intrinsically connected that no other conclusion but one of joint liability of both the initiator of the fraudulent practice and the other party who had knowingly aided in the same is possible Having regard to the facts of the present cases i.e. the volume of shares sold and purchased; the proximity of time between the transactions of sale and purchase and the repeated nature of transactions on different dates, in considered view, would irresistibly lead to an inference that the conduct of the respondents were in breach of the code of business integrity in the securities market. The consequences for such breach including penal consequences under the provisions of Section 15HA of the SEBI Act must visit the concerned defaulters for which reason the orders passed by the Appellate Tribunal are set aside and the findings recorded and the penalty imposed by the Adjudicating Officer are restored. Consequently and in view of the above Civil Appeal Nos. 5829 of 2014 and 11195-11196 of 2014 are dismissed and Civil Appeal Nos. 2595, 2596 and 2666 of 2013 are allowed. Issues Involved:1. Legality of 'non-intermediary frontrunning' under FUTP 2003.2. Interpretation of regulations 3 and 4 of FUTP 2003.3. Definition and scope of 'fraud' and 'unfair trade practices' under FUTP 2003.4. Applicability of Regulation 4(2)(q) to non-intermediaries.5. Standard of proof required for establishing charges under FUTP 2003.Detailed Analysis:1. Legality of 'Non-Intermediary Frontrunning' under FUTP 2003:The case revolves around whether 'non-intermediary frontrunning' is prohibited under the SECURITIES AND EXCHANGE BOARD OF INDIA (PROHIBITION OF FRAUDULENT AND UNFAIR TRADE PRACTICES RELATING TO SECURITIES MARKET) REGULATIONS, 2003 (FUTP 2003). The Supreme Court considered several appeals where SEBI alleged that individuals engaged in frontrunning by using non-public information to trade securities ahead of substantial orders, thereby making profits.2. Interpretation of Regulations 3 and 4 of FUTP 2003:Regulation 3 prohibits fraud in dealing with securities, while Regulation 4 prohibits manipulative, fraudulent, and unfair trade practices. The Court emphasized that these regulations are broad and inclusive, designed to cover a wide range of fraudulent activities. The Court noted that the definition of 'fraud' in Regulation 2(c) is expansive, including acts committed in a deceitful manner or not, that induce another person to deal in securities.3. Definition and Scope of 'Fraud' and 'Unfair Trade Practices' under FUTP 2003:The Court analyzed the definition of 'fraud' under Regulation 2(c), which includes any act, expression, omission, or concealment committed while dealing in securities to induce another person to deal in securities. The Court highlighted that the definition is broad and includes specific instances such as knowing misrepresentation, active concealment, and deceptive behavior. The Court also noted that 'unfair trade practice' is not specifically defined but should be understood comprehensively to include any act beyond fair business conduct.4. Applicability of Regulation 4(2)(q) to Non-Intermediaries:The Court rejected the argument that Regulation 4(2)(q), which explicitly prohibits frontrunning by intermediaries, implies that non-intermediaries are excluded from the regulation's scope. The Court held that the intention of the regulation is to provide a catchall provision, and the deeming provision under Regulation 4(2)(q) was specifically provided for intermediaries due to their fiduciary relationship with clients.5. Standard of Proof Required for Establishing Charges under FUTP 2003:The Court stated that the standard of proof for establishing charges under FUTP 2003 is the preponderance of probabilities rather than proof beyond a reasonable doubt. The Court emphasized that the provisions of Regulations 3 and 4 are couched in general terms to cover diverse situations. The Court held that once it is established that fraud has been committed while dealing in securities, all these provisions get attracted.Conclusion:The Supreme Court concluded that non-intermediary frontrunning is prohibited under Regulations 3 and 4(1) of FUTP 2003, provided the ingredients of fraud and unfair trade practices are satisfied. The Court held that the actions of the individuals involved in the appeals amounted to fraudulent practices violating market integrity. Consequently, the appeals filed by SEBI were allowed, and the findings and penalties imposed by the Adjudicating Officer were restored. The appeals filed by the individuals were dismissed.