On September 20, 2017, the Supreme Court has passed a historic judgment, in the matter of SEBI v. Shri Kanhaiyalal Baldevbhai Patel, laying down the meaning of the term “front-running” used under securities law for referring to certain fraudulent trade practises in the securities market. A number of jargons such as, circular trades, price rigging, front running, etc. are used in various SEBI orders to decide upon the breach of various provisions under the SEBI (Prohibition of Fraudulent and Unfair Trade Practises related to Securities Market) Regulations, 2003. However, they are not defined in the PFUTP Regulations and hence, have always remained the subject matter of litigation. In this judgment, the Court has clarified the meaning of “non-intermediary front-running”.
Four different appeals were filled with a common question of law, i.e. what is the meaning of front-running, specifically when the alleged wrongdoer is not an intermediary, as defined under the SEBI Act, 1992. The facts in all these appeals were similar, i.e. the persons, in possession of confidential information related with placing of bulk orders by other investors – majorly foreign and institutional investors – placed a pre-order for buy/sell of securities in scrips of various listed companies. The fluctuation in market price of the scrips caused due to placing of bulk orders was used by them to earn profits. The lower courts (SEBI and Securities Appellate Tribunal) decided that these acts were in the nature of “front-running”. The aggrieved appealed to the Court and prayed to determine the meaning of the term, since the PFUTP Regulations and past judgments were silent on the same.
The Court held that front-running can be broadly categorized in three forms:
- When third parties trade on the basis of tips on a pending block trade (the Court refers to it as “tippee” trading);
- When the person undertaking a block trade himself enters into another prior options / futures contract for hedging the risks associated with the transaction;
- When an intermediary executing a block trade for another customer, undertakes another-prior trade to make profits for itself.
The Court has discussed Type-1 and Type-3 front-running in detail in this judgment. The Court held that Regulation 4(2)(q) of PFUTP Regulations which provides that an act of buying/selling in advance by an intermediary before placing orders for its clients in order to derive profit is an unfair trade practise, is in the nature of “front-running” by an intermediary. The Court held that this provision should be read with its intent which is to prevent front-running in securities in general sense of the term. Therefore, even if Regulation 4(2)(q) only uses the word “intermediary”, it should be read in a manner to imply that “non-intermediary” front-running is also an unfair trade practise. The list provided under Regulation 4(2) is an indicative list and not exhaustive. It further held that fraudulent or unfair trade acts differs from case to case. The parties should not argue that since a particular conduct does not fall under any of the clauses provided in the lists given under Regulation 3 and 4, therefore, a person is not liable under the PFUTP Regulations. The Court refrained from adopting a “pigeon-hole approach”.
Moreover, the Court has also clarified the meaning of certain other terms, such as, “market manipulation” which according to the Court, refers to an “unwarranted” interference with the operation of ordinary market that affects the integrity and efficiency of securities market. Furthermore, the Court has tried to give a meaning to the term “unfair trade practice” too in this judgment. The Court has held that any conduct that “undermines the ethical standards and good faith dealings” between various parties is a determining factor to decide unfair conduct. Moreover, according to the Court “unfairness” is a broader term and includes “fraud”.
The Court further held that one of the essential ingredients to establish an offence under the PFUTP Regulations is that the information must be acquired under “bad faith” which leads to inequitable results. Therefore, it held that one of the prerequisite is that the information must be “confidential”; and when such confidential information is shared by tippee which then leads to an inequitable result, such an act will be considered as “fraudulent” act.
Although the operative part of the judgment only deals with non-intermediary front running, wherein the Court has decided that a narrow interpretation / application of law should not be considered. However, the Court has discussed and decided upon various other issues too, such as, meaning of market manipulation and test of determining fraudulent conduct. The PFUTP Regulations comprises of two major acts – “fraud” and “unfair trade practice”. However, the latter was not defined in the Regulations which increased the scope of interpretation and created ambiguity. Therefore, this judgment gains more importance in the backdrop of increase in matters related to unfair conduct in the securities market.
Recently, SEBI had issued a press release whereby it said that a committee on “Fair Market Conduct” will be constituted to re-look into the laws related to insider trading and fraudulent trade practice in the securities market. It seems that this judgment will be an essential consideration for the committee and it is expected that the report of the committee will consist of some major recommendations related to meaning of such crucial terms used to determine securities frauds.