2018 (2) TMI 580 - SC - Companies Law

SEBI action against synchronized derivative trading upheld for violating unfair trade practice regulations

The SC upheld SEBI's action against traders engaged in synchronized trading in derivatives segment, finding violations of PFUTP Regulations 3(a), 4(1), ... Buying and selling securities in the derivatives segment - SEBI's action against the traders and brokers - manipulation and synchronization in trading of shares - violation of transparent norms of trading in securities - violation of Regulations 3(a), (b) and (c) and 4 (1), (2)(a) and (b) of the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (“the PFUTP Regulations”) - brokers, violated Regulations 7A (1), (2), (3) and (4) of the Securities and Exchange Board of India (Stock Brokers and Sub-brokers) Regulations, 1992 - KURIAN, J. - HELD THAT:- Having regard to the fact that the dealings in the stock exchange are governed by the principles of fair play and transparency, one does not have to labour much on the meaning of unfair trade practices in securities. Contextually and in simple words, it means a practice which does not conform to the fair and transparent principles of trades in the stock market. In the instant case, one party booked gains and the other party booked a loss. Nobody intentionally trades for loss. An intentional trading for loss per se, is not a genuine dealing in securities. The platform of the stock exchange has been used for a non-genuine trade. Trading is always with the aim to make profits. But if one party consistently makes loss and that too in preplanned and rapid reverse trades, it is not genuine; it is an unfair trade practice. Securities market, as the 1956 Act provides in the preamble, does not permit “undesirable transactions in securities”. The Act intends to prevent undesirable transactions in securities by regulating the business of dealing therein. Undesirable transactions would certainly include unfair practices in trade. The SEBI Act, 1992 was enacted to protect the interest of the investors in securities. Protection of interest of investors should necessarily include prevention of misuse of the market. Ordinarily, the trading would have taken place between anonymous parties and the price would have been determined by the market forces of demand and supply. In the instant case, the parties did not stop at synchronised trading. The facts go beyond that. The trade reversals in this case indicate that the parties did not intend to transfer beneficial ownership and through these orchestrated transactions, the intention of which was not regular trading, other investors have been excluded from participating in these trades. The fact that when the trade was not synchronizing, the traders placed it at unattractive prices is also a strong indication that the traders intended to play with the market. The traders thus having engaged in a fraudulent and unfair trade practice while dealing in securities, are hence liable to be proceeded against for violation of Regulations 3(a), 4(1) and 4(2)(a) of PFUTP Regulations. Appeal Nos.1969/2011, 3175/2011 and 3180/2011 are hence allowed. The orders of the Securities Appellate Tribunal are set aside and that of the SEBI are restored to the extent indicated above. As far as brokers are concerned, we are of the view that there is hardly any evidence on their involvement so as to proceed against them for violation of Regulation 7A of the Brokers Regulations and PFUTP Regulations. Merely because a broker facilitated a transaction, it cannot be said that there is violation of the Regulation. SEBI has not provided any material to suggest negligence or connivance on the part of the brokers. As held by this Court in Kishore R. Ajmera [2016 (2) TMI 723 - SUPREME COURT], there are several factors to be considered. We would especially like to refer to the case of Angel Trading wherein the broker repeatedly wrote to the National Stock Exchange informing them about trades in the options segment that were executed at unrealistic prices and requesting them to put in mechanisms in the Options segment so that these trades are not allowed to enter the system. In the absence of any material provided by SEBI to prove the charges against the brokers, particularly regarding aiding and abetting fraudulent or unfair trade practices, we are of the opinion that the orders of SEBI against the brokers should be interfered with. Accordingly, the appeals filed against the brokers are dismissed. Before concluding, we would like to reiterate the observations made by this Court in Kishore R. Ajmera (supra) and Kanaiyalal Patel [2017 (9) TMI 1269 - SUPREME COURT] regarding the need for a more comprehensive legal framework governing the securities market. As the market grows, ingenuous means of manipulation are also employed. In such a scenario, it is essential that SEBI keeps up with changing times and develops principles for good governance in the stock market which ensure free and fair trading. There shall be no order as to costs. R. BANUMATHI, J. - HELD THAT:- I have gone through the judgment proposed by His Lordship Justice Kurian Joseph. I am in agreement with the conclusion arrived at by His Lordship. However, in view of the importance of the issues involved, I prefer to give my own additional reasonings also for my concurrence. Considering the reversal transactions, quantity, price and time and sale, parties being persistent in number of such trade transactions with huge price variations, it will be too naïve to hold that the transactions are through screen-based trading and hence anonymous. Such conclusion would be over-looking the prior meeting of minds involving synchronization of buy and sell order and not negotiated deals as per the board's circular. The impugned transactions are manipulative/deceptive device to create a desired loss and/or profit. Such synchronized trading is violative of transparent norms of trading in securities. If the findings of SAT are to be sustained, it would have serious repercussions undermining the integrity of the market and the impugned order of SAT is liable to be set aside. On the above additional reasonings also, I agree with the conclusion allowing the appeal preferred by SEBI against the traders. I also agree with the conclusion dismissing the appeal preferred by the SEBI against the brokers. Issues Involved:1. Whether the factual matrix justified SEBI’s action against the traders and brokers.2. Interpretation and application of the Securities Contracts (Regulation) Act, 1956, SEBI Act, 1992, and PFUTP Regulations, 2003.3. Legality of synchronized and reversal trades in the F&O segment.4. The role and liability of brokers in facilitating alleged non-genuine trades.5. Impact of alleged non-genuine trades on market integrity and investor protection.6. The relevance of tax planning in the context of alleged non-genuine trades.Detailed Analysis:1. Whether the factual matrix justified SEBI’s action against the traders and brokers:The Supreme Court examined whether SEBI's actions against the traders and brokers were justified based on the factual matrix. SEBI had proceeded against the traders for violations of Regulations 3(a), (b), (c), and 4(1), (2)(a), (b) of the PFUTP Regulations, 2003, and against the brokers for violations of Regulations 7A(1), (2), (3), (4) of the SEBI (Stock Brokers and Sub-brokers) Regulations, 1992. The Court found that the trades executed by the traders were non-genuine, synchronized, and reversed within a short period, indicating a pre-arranged plan to create a misleading appearance of trading in the market.2. Interpretation and application of the Securities Contracts (Regulation) Act, 1956, SEBI Act, 1992, and PFUTP Regulations, 2003:The Court analyzed the legal framework governing the securities market, including the Securities Contracts (Regulation) Act, 1956, SEBI Act, 1992, and PFUTP Regulations, 2003. It emphasized that the SEBI Act was introduced to protect investors' interests and regulate the securities market. The PFUTP Regulations prohibit fraudulent and unfair trade practices. The Court held that the impugned trades violated these regulations as they were orchestrated to create a false or misleading appearance in the market.3. Legality of synchronized and reversal trades in the F&O segment:The Court distinguished between legitimate synchronized trades and those executed with manipulative intent. It held that synchronized trades per se are not illegal, but they become illegal if executed to manipulate the market. The impugned trades were found to be non-genuine, as they involved pre-arranged transactions with significant price differences executed within seconds, without any significant change in the underlying value. The Court concluded that these trades were orchestrated to create a misleading appearance of trading, thus violating the PFUTP Regulations.4. The role and liability of brokers in facilitating alleged non-genuine trades:The Court examined the liability of brokers in facilitating the alleged non-genuine trades. It held that merely acting as a broker does not make one liable for the clients' actions unless there is evidence of negligence or connivance. The Court found no material to suggest that the brokers were aware of the non-genuine nature of the trades or that they aided and abetted the fraudulent activities. Therefore, the appeals against the brokers were dismissed.5. Impact of alleged non-genuine trades on market integrity and investor protection:The Court emphasized that the securities market must operate on principles of fairness, integrity, and transparency. It held that orchestrated trades, like the ones in question, misuse the market mechanism and affect market integrity. Such trades exclude other investors from participating in the market, thereby undermining the price discovery system and investor confidence. The Court concluded that the impugned trades violated the ethical standards and good faith dealings expected in the securities market.6. The relevance of tax planning in the context of alleged non-genuine trades:The Court noted that the issue of tax planning was not raised in the show cause notices or the adjudicating officer's order. However, it observed that even if the trades were executed for tax planning purposes, they would still be objectionable if they involved non-genuine transactions that manipulated the market. The Court held that the impugned trades were not genuine and were executed to create a misleading appearance in the market, irrespective of any tax planning motives.Conclusion:The Supreme Court allowed the appeals filed by SEBI against the traders, setting aside the orders of the Securities Appellate Tribunal and restoring SEBI's orders. The appeals against the brokers were dismissed due to the lack of evidence suggesting their involvement in the fraudulent activities. The Court reiterated the need for a comprehensive legal framework to govern the securities market and ensure free and fair trading.