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TMI Blog2010 (10) TMI 1186X X X X Extracts X X X X X X X X Extracts X X X X ..... ated the Regulations. It is this order which is under challenge before us. Before noticing the facts and analysing the issues involved, let us understand to the extent necessary for this case what the derivative market is all about. 2. Derivative segment is a comparatively new area of operation for trading activity in the Indian capital market. Derivative trading is governed by section 18A of the Securities Contracts (Regulations) Act, 1956 which was recently inserted with effect from 22-2-2000 and is legal only when such contracts are traded on a recognised stock exchange and settled through the clearing house of that exchange. Derivates are actually a form of financial instruments which are traded in the securities market and whose values are derived from the values of other, more basic, underlying variables like the share price of a particular scrip in the cash segment of the market or the stock index of a portfolio of stocks. Futures and options are the two common derivatives traded on the stock exchanges. A futures contract is an agreement between two parties to buy or sell an asset at a certain date in the future at a certain price agreed upon on the date of the contract. An ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uyer can lose in case the market moves contrary to his perception. In case the price of the underlying or the index value in the cash segment were to go beyond the selected strike rate/exercise price, the buyer would certainly exercise his option under the contract depending upon how high the price or the stock index has gone after adjusting the premium amount. These are some of the motivating factors which weigh with the investors in the options contracts. It is a one sided contract where the loss suffered, if any, by the buyer is limited only to the premium amount whereas the loss which could be suffered by the writer of the contract (seller) is limitless. If during the period of the contract the market perception of the seller (writer) changes or the market starts moving contrary to his expectations, he may, in his anxiety to cap his losses, take a reverse position. He would then put in an offer or accept an offer of a higher premium for the same option and this in effect would result in his repurchasing the contract at a higher rate/premium to avoid greater losses. This could even happen on the same day and if the options contract is illiquid, the parties in the reverse trade c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pearance of trading in these options. All the 14 transactions except one pertained to Nifty, the stock index of NSE. It was observed that the appellant in these transactions had operated through Prashant Jayantilal Patel as its broker and the counter party was Kasam Holding Pvt. Ltd. which executed these transactions through Vibrant Securities Pvt. Ltd. as its broker. One single transaction carried out on a different underlying variable with a different counter party broker (Spark Securities Pvt. Ltd.) trading in its proprietary account was not pressed against the appellant. There were certain generic observations on the transactions of all the entities mentioned in the extract of the examination report the thrust of which was that reverse/close out transactions were executed at prices with significant variation within a short period though no major variation in the underlying price during that period was observed and hence, the trades were prima facie non-genuine. It was alleged that the synchronized transactions had a definite objective of enabling one party to book profits and the other party to book losses in the close out difference. While diagnosing the transactions, the whol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on and arbitrage. Hedgers use derivatives to reduce the risk that they face from potential future movements in a market variable in the cash segment. For example, if an investor owns a number of shares of a particular company but anticipates a possible fall of the share price in the cash segment, he takes an opposite position in the options contract by entering a contract at a lower strike rate below the market price which may offset the loss suffered by him in the cash market. Speculators use the derivatives to bet on the future direction of a market variable and arbitrageurs take offsetting positions in two or more instruments to lock in a profit. Before we examine whether the appellant has assumed any of these positions in its trades in the options contracts and whether those transactions have violated any rule of the game, it is necessary to discuss the anatomy of index option as distinct from stock option where the price of the underlying stock physically traded in the cash market impacts the value of the futures and options contracts. This is because the allegations in the present appeal pertain to manipulated and structured trades in one index option viz., Nifty. 5. Index i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee. Movement of index in the cash segment does influence the index options in the F & O segment because the strike rate is directly linked with the index value in the cash segment. However, the converse is not always true. While transactions in the cash market are based on the current market price of the underlying derived by the principle of demand and supply and in the case of an index, the value depends on the performance of the stocks that constitute it, the pricing in the F & O segment is based on future expected events which may or may not happen. Anticipated future events may not have a discernible effect on the cash segment today where delivery of shares is given/taken immediately. Such events may have a great impact on perceptions in the F & O market where the investor holds an open position and a continuous liability during the currency of the contract which is generally for one to three months with anticipation of future events which are always pregnant with all sorts of possibilities. Again, volatility and potential for greater losses may trigger movements in the F & O market without any equivalent cash market movements. Further, the cash market may move up today but th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n their own perception of the market. The number of persons trading in this segment is comparatively much less than those in the cash segment. The Board has found that only 14 contracts executed by the appellant in the options segment constituted 30 to 50 per cent of the market gross in that segment though Nifty is the most active of the options contracts traded on the exchange and contributed 92.21 per cent of the trades during March, 2007. This is indicative of the fact that the number of players in the options segment is very less. Artificial/fictitious trades in the cash segment do give a false appearance of active trading in a particular scrip by increasing volumes which tend to lure the lay investors to invest in that scrip. The impression given to the investors is that the scrip is highly liquid and much in demand and this interferes with the price discovery mechanism of the exchange and it is for this reason that such trades are held illegal in the cash segment. This, however, cannot be the case in the F & O segment. Since all the trades are executed through the stock exchange and settled in cash through its mechanism they cannot be said to be artificial trades creating a m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t synchronized deals are pre se illegal, for the same reason, it cannot be said that all synchronized transactions are legal and permitted. All synchronized transactions which have the effect of manipulating the market are against fair market practices and hence undesirable and prohibited." We have reproduced the observations from the order of the Board only to highlight that the Board also understands that the law is that only such synchronized trades violate the Regulations which manipulate the market. Since the impugned trades of the appellant in the F & O segment had no impact on the market, we hold that they did not violate the Regulations. Shri Kumar Desai learned counsel for the respondent was equally emphatic in arguing that the appellant had not only executed synchronized trades but had also reversed them during the course of the trading with the same counter party and, therefore, the trades were fictitious and non-genuine and that the adjudicating officer was justified in holding so and imposing the monetary penalty for violating the Regulations. He placed strong reliance on the observations of the Tribunal in Ketan Parekh's case (supra) wherein it has been held ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and the other party booked continuous losses. All these trades were transacted in March 2007 at the end of the financial year 2006-07. It is obvious and, this fact was not seriously disputed by the learned senior counsel appearing for the appellant, that the impugned trades were executed for the purpose of tax planning. The arrangement between the parties was that profits and losses would be booked by each of them for effective tax planning to ease the burden of tax liability and it is for this reason that they synchronized the trades and reversed them. They have played in the market without violating any rule of the game. This Tribunal in Viram Investment (P.) Ltd. v. Securities & Exchange Board of India. [Appeal No. 160 (Mum.) of 2004, dated 11-2-2005], while dealing with a contention as to whether trades could be executed through the stock exchange for tax planning, made the following observations which are relevant for our purpose:- "Even if we consider transactions undertaken for tax planning as being non-genuine trades, such trades in order to be held objectionable, must result in influencing the market one way or the other. We do not find any evidence of that either ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts had executed "reversing transactions", both buy and sell, at abnormal price differences in the premium in the case of options that had no relevance to the movement of prices in underlying securities at that point of time. The members were advised to desist from entering such orders which prima facie appeared to it to be non-genuine. We are of the view that this advisory has no legal binding as it has not cited violation of any rule or regulation and is tentative in nature without bringing out any specifics regarding the suspicious transactions. Moreover, the advisory was issued to the member brokers and is not enforceable against the appellant or other players in the market. It is also interesting to note that while NSE had issued such an advisory to its members, the other most important stock exchange viz. The Bombay Stock Exchange Ltd. Mumbai (BSE) where F&O segment is also in operation did not issue any such advisory to its members. Does it mean that such trades in options contracts are allowed on BSE but not on NSE? Obviously, such an absurdity cannot be anybody's case. Besides, if the Board as the market regulator was concerned with such transactions in the de ..... X X X X Extracts X X X X X X X X Extracts X X X X
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