2025 (10) TMI 922 - AT - SEBI

Appeal allowed: Front-running charge under Section 12A(c) and PFUTP Regulations not proved on balance of probabilities

Kokila Dipak Desai and Pranav Dipak Desai Versus Securities and Exchange Board of India, Mumbai

The AT allowed the appeal, holding that the charge of front-running under Section 12A(c) and PFUTP Regulations was not established on the preponderance of ... Imposition of a monetary penalty - Front-running - violation of Section 12(A)(c) of the SEBI Act,1992 and Regulations 3(a), (d), 4(1) and 4(2)(q) of SEBI (PFUTP) Regulations - activity and undertaking trades in advance of the trades of ‘Aequitas’ in their own accounts and also in their family members’ accounts - principle of preponderance of probability - HELD THAT:- It is appellant’s case that the report submitted by Wadia Ghandy & Co., does not indicate that appellants were involved in front running. Appellant has annexed the excerpts of the report as Exhibit-F. Shri Kataria drew our attention and pointed that the said report shows that the complainant and Pawan Agarwal were quite close to each other. Pawan Agarwal used to take guidance from the complainant during festive seasons like Diwali about the stocks to be recommended to the clients. The report records that the WhatsApp messages of Pawan Agarwal had shown that such advice was given. He also contended that the report prepared by Wadia Ghandy & Co., was not considered by the adjudicating authority. In this regard, SEBI has taken a stand that it is regulator’s prerogative whether to engage an external body to aid its investigation. It is not in dispute that a report was obtained from Wadia Ghandy. Having obtained the same, the learned AO ought to have dealt with it. Maintaining an absolute silence compels us to draw an adverse inference against the SEBI. Thus, we are of the opinion that the allegation of front running is not established even on principle of preponderance of probability. Appeal is allowed. ISSUES PRESENTED AND CONSIDERED 1. Whether the appellants' trading activity amounted to front-running under the PFUTP Regulations and Section 12A(c) of the SEBI Act, i.e., placing orders in advance of a substantial impending client order using non-public information. 2. Whether the appellants engaged in copying/mirroring trades of a large client (i.e., systematic replication of trades) in violation of Regulation 3(a) and Regulations 4(1) and 4(2)(q) of the PFUTP Regulations. 3. Whether the adjudicating authority's findings were sustainable on the materials on record, including (a) timing and sequencing of orders, (b) pattern and consistency of trades across trading days, (c) availability and use of confidential information by an intermediary's employee, and (d) sufficiency of investigation (including treatment of an external report and failure to examine the complainant). 4. Whether imposition of monetary penalty under Section 15HA of the SEBI Act was justified given the findings and available evidence. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Front-running: Legal framework Legal framework: Front-running, as defined in SEBI circulars, is the usage of non-public information to buy/sell in advance of a substantial impending order in the same or related securities, anticipating a price change once the information becomes public. The PFUTP Regulations and Section 12A(c) impose liability for fraudulent or unfair trade practices by intermediaries and persons with access to client information. Precedent treatment: The Court relied on established authority recognizing the definition and elements of front-running and that intermediaries owe a fiduciary duty; the standard of proof in regulatory adjudication is preponderance of probability and inferences may be drawn from a host of circumstances. Prior decisions emphasize that proof of an impending substantial order and chronological precedence of the alleged front-runner's trade are essential elements. Interpretation and reasoning: The Tribunal examined sequencing and timestamps of specific transactions relied upon by the adjudicator. In the two principal instances invoked by the regulator, the large client's orders were placed prior to the appellants' orders, and in both instances the appellants' orders executed later on the same day (i.e., appellants' orders were not executed in advance of the client's order). Where an alleged front-runner's trade did not precede the client's order, it could not satisfy the defining element of front-running. The Tribunal further noted that isolated single trades do not, without more, establish front-running which ordinarily requires evidence of trading in advance of an impending substantial order and a pattern or intent to exploit confidential information. Ratio vs. Obiter: Ratio - front-running requires first placing an order in advance of the client's substantial order; absent that chronological precedence, front-running is not established on preponderance of probabilities. Obiter - observations on transactional patterns and what may ordinarily constitute front-running in large-scale or continuous misuse of confidential information. Conclusions: The allegation of front-running was not established on the record; specific instances relied upon did not demonstrate the required chronological precedence of appellants' trades over the big client's orders, and hence the front-running charge failed. Issue 2 - Copying/Mirroring trades as violation of PFUTP Regulations Legal framework: Regulation 3(a) and Regulation 4(2)(q) catch conduct amounting to fraudulent or unfair trade practices, including misuse of privileged information by intermediaries; however, mere copying or mirroring of publicly observable trades is not per se prohibited unless tied to misuse of confidential information or other unfair practice. Precedent treatment: Authorities recognize a broad catch-all to capture intermediary misconduct and that fiduciary duty heightens obligations of intermediaries; nevertheless, allegations of mirroring must be supported by cogent material showing exploitation of confidential information or systematic correlation with client trades. Interpretation and reasoning: The Tribunal assessed whether mirroring allegations were supported by consistent, contemporaneous, and exclusive correspondence between appellants' trades and the big client's trades. Key points: (a) several scrips showed appellants traded on dates when the big client did not trade, an uncontroverted fact; (b) the adjudicator relied on listed instances in tables but did not satisfactorily demonstrate that appellants' trades consistently mirrored the client's activity (including both legs of transactions or trading on all days of the client's trades); (c) the regulator had exonerated another noticee on parity grounds for similar non-correlated trading, indicating inconsistent application; and (d) the respondent did not examine the complainant despite available investigation material, weakening the inferential basis. Ratio vs. Obiter: Ratio - copying/mirroring alone, without evidence of misuse of confidential information, consistent temporal precedence, or a sustained pattern exclusive to client trading days, is insufficient to establish a violation under PFUTP on preponderance of probabilities. Obiter - discussion that mirroring may be actionable where there is cogent evidence of access to and misuse of non-public client information leading to systematic replication. Conclusions: The mirroring/copying allegations failed due to uncontroverted evidence that appellants traded independently on numerous dates and lack of cogent material establishing systematic mirroring tied to confidential client orders; therefore the copying/mirroring charge was unsustainable. Issue 3 - Sufficiency of investigation and treatment of evidence (including external report and non-examination of complainant) Legal framework: Adjudicatory proceedings must comply with principles of natural justice and be based on competent materials; regulatory findings may rest on inference but must engage with material obtained, including external expert reports, and where essential witnesses exist, examination may be necessary to test allegations. Precedent treatment: Prior jurisprudence permits reliance on inferences from circumstances but requires that an adjudicating authority consider and address material collected during investigation and apply principles uniformly. Interpretation and reasoning: The Tribunal found deficiencies in the adjudicator's approach: (a) the external report obtained (Wadia Ghandy & Co.) was not addressed in the adjudicating order despite its relevance; silence on that report warranted an adverse inference against the regulator; (b) the complainant was not examined or produced for cross-examination though SEBI had initiated proceedings based on complaints; (c) inconsistent treatment of similarly situated noticees undermined confidence in the adjudication; and (d) absence of cogent material linking the alleged misuse of confidential information to the appellants' trades made reliance on inference unjustified in the circumstances. Ratio vs. Obiter: Ratio - where crucial investigational material (e.g., a report) is obtained and a complainant exists who could materially affect findings, the adjudicator should address such material and, where necessary, examine complainants; failure to do so can vitiate conclusions drawn on inference alone. Obiter - general observation that regulators may not examine every complainant but must ensure essential evidence is considered and reasoned upon. Conclusions: The investigation and adjudication were procedurally and factually deficient in failing to deal with material report evidence and not examining the complainant; these infirmities contributed to the inability to sustain the regulatory findings. Issue 4 - Quantification of illegal gains and imposition of penalty under Section 15HA Legal framework: Penalty imposition under Section 15HA follows adjudication of contraventions; the quantum is to be determined considering factors under Section 15J and the nature of violation. However, imposition presupposes that the underlying violation is established on the requisite standard. Precedent treatment: Regulatory penalties can be imposed on preponderance of probabilities where violations are proved; quantification of illegal gains supports penalty but cannot substitute for establishing the foundational contravention. Interpretation and reasoning: The Tribunal held that since the primary allegations of front-running and mirroring were not established, the consequent quantification of illegal gains and imposition of the minimum penalty lacked a sustaining foundation. The regulator's gross trade value analysis indicating a percentage of tainted trades did not cure the failure to establish the core violation. Ratio vs. Obiter: Ratio - penalty cannot be sustained where the predicate contravention is not established on the material and reasoning provided. Obiter - acknowledgment that where violations are made out, quantification of gains and relevant factors justify penalty assessment under statutory provisions. Conclusions: The penalty was unjustified given that the underlying findings of front-running and mirroring were not established; therefore the monetary penalty was set aside along with the impugned order. Overall Conclusion The Tribunal concluded that SEBI failed to establish front-running or unlawful mirroring on the balance of probabilities due to absence of chronological precedence in key instances, uncontroverted evidence of independent trading by appellants on other dates, failure to consider and address material investigative reports, and non-examination of the complainant. Consequently, the adjudicating order imposing penalty was set aside. The reasoning on these points constitutes the operative ratio of the decision.