2013 (2) TMI 464 - AT - Companies Law

Penalties imposed for violation of regulations 3 of the SEBI(Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 - whether regulation 4(2)(q) is applicable only to intermediaries and not on trades - SEBI conducted investigations into the trading activity of Shri Kanaiyalal Baldevbhai Patel ( KB ) an individual trader and Passport India Investment (Mauritius) Ltd.( Passport ) it was noted that KB had placed and executed orders before the order of Passport and consequently squared off his position when the orders of Passport were placed in the market. Dipak was the portfolio manager of Passport and is also cousin of KB thus providing information regarding forthcoming trading activity of Passport - Held that - There is no hesitation in holding that the alleged transactions of the appellant are in the nature of front running As it is an admitted position on both sides that the regulation 4(2)(q) applies only to intermediaries and not to traders trading in the securities market the appellants were right in stating that front running has been prohibited only by intermediaries. In the absence of any specific provision in the Act, rules or regulations prohibiting front running by a person other than an intermediary, it is opined that the appellants cannot be held guilty of the charges levelled against them. On considering 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 of Deepak 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. thus SEBI has erred in holding the appellant guilty of violating regulation 3.

Summary

Issues Involved:
1. Whether trading done by a non-intermediary based on information about forthcoming orders of another trader violates Regulation 3 of the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulations, 2003 (FUTP regulations).

Detailed Analysis:

Background and Facts:
The case involves three appeals arising from a common set of facts, concerning trading activities between an individual trader (KB) and a foreign institutional investor (Passport). Investigations revealed that KB executed trades based on information provided by Dipak, the portfolio manager of Passport, who is also KB's cousin. The modus operandi involved Dipak informing KB and AB about Passport's forthcoming trading activities, allowing KB to engage in 'front running' by placing and executing orders before Passport's orders and then squaring off his position. This activity resulted in a profit of Rs. 1,56,32,364/- for KB. The Securities and Exchange Board of India (SEBI) viewed this as a violation of Regulation 3(a), (b), (c), and (d) of the FUTP regulations.

Interim Orders and Adjudication:
SEBI issued an ad interim order on May 28, 2009, directing the involved parties to cease trading and to deposit the profits made from the trades. SEBI also initiated adjudication proceedings, leading to a show cause notice on February 28, 2011. The adjudicating officer found the appellants guilty of violating the FUTP regulations and imposed monetary penalties: Rs. 5 crore each on Dipak and KB, and Rs. 1 crore on AB. The appellants challenged these findings in the present appeals.

Arguments by Appellants:
The appellants contended that the trades were executed in the normal course, were screen-based, and at the prevalent market price, thus not amounting to market manipulation. They argued that communication between cousins was natural and that Dipak was advising KB on his business. They also emphasized that there was no finding of profit sharing between Dipak and AB, and that the transactions did not affect the market as they were screen-based. Furthermore, they argued that the term 'front running' was not explicitly mentioned in the show cause notice, and that Regulation 4(2)(q) of the FUTP regulations, which prohibits front running, applies only to intermediaries.

Arguments by SEBI:
SEBI argued that Dipak's conduct was fraudulent and violated market integrity, as he provided sensitive trading information to KB, enabling him to profit. SEBI maintained that the actions amounted to fraud against the market and Passport. SEBI cited previous cases where similar actions were penalized and argued that the charge of front running was implicit in the show cause notice, even if not explicitly stated.

Tribunal's Analysis and Findings:
The Tribunal examined whether the appellants' actions constituted a violation of Regulation 3 of the FUTP regulations. The Tribunal noted that the term 'front running' is not defined in the regulations but is understood as trading based on advance knowledge of large orders. The Tribunal referred to various definitions of front running and concluded that the appellants' actions fit this description.

However, the Tribunal observed that Regulation 4(2)(q) of the FUTP regulations explicitly prohibits front running by intermediaries, not by other market participants. The Tribunal also noted that the earlier 1995 regulations prohibited front running by any person, but the 2003 regulations made a clear departure by limiting this prohibition to intermediaries. Given this regulatory framework, the Tribunal held that the appellants could not be found guilty of violating Regulation 3 of the FUTP regulations.

The Tribunal concluded that while Dipak's actions may constitute a fraud against his employer, they did not amount to market manipulation under the current regulatory provisions. Consequently, the Tribunal set aside the impugned orders and allowed the appeals.

Conclusion:
The Tribunal allowed the appeals, setting aside the penalties imposed by SEBI, and held that the appellants were not guilty of violating Regulation 3 of the FUTP regulations. The judgment emphasized the distinction in regulatory treatment of front running by intermediaries versus other market participants.