Any 'THIRD PERSON' other than an Intermediary could also be held liable for "Front Running": Securities Appellate Tribunal (SAT)

In a landmark judgment (Vibha Sharma & Anr. v. SEBI) passed by the Securities Appellate Tribunal (SAT) on 4^th Sept. 2013, the tribunal has held that even a “third person” other than an intermediary could also be held liable for ‘front running’ under SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (“FUTP Regulations”). This case is of immense importance as SAT has finally clarified the position of law on matters concerning front running by third persons. Also, the ruling of SAT in the instant case is significant for the reason that SAT had on the contrary, in 2012, in the case of "Dipak Patel" held that only intermediary could be held liable for the offence of front running and not third person under the FUTP regulations.

Now, before moving on to discuss the reasoning of the tribunal, let’s first comprehend what exactly is “front running”. Front running means buying or selling of securities ahead of a large order so as to benefit from the subsequent price move. This denotes persons dealing in the market, knowing that a large transaction will take place in the near future and that parties are likely to move in their favour[1]. Now, this can be best understood through an illustration: Stockbrokers and traders often have access to inside information regarding the investment plans of their firm. Brokers and traders might be lured to use this insider information to make investments that benefit them personally. Suppose a stockbroker at an investment bank has learned that his bank's executive board will purchase 100,000 shares of Company XYZ stock in the coming week. Knowing that this large purchase will push up the price of the stock, the stockbroker purchases 100 shares of Company XYZ for his personal account, hoping to profit from the price jump.

Now, we shall discuss the facts, arguments advanced by both the parties and the tribunal’s reasoning for holding the appellants guilty of ‘front running’.

BACKGROUND OF THE CASE

Jitender Sharma (hereinafter ‘Appellant 2’) is the husband of Vibha Sharma (hereinafter ‘Appellant 1’). Appellant 2 was, at the relevant time, an equity dealer with the Central Bank of India (“CBI”). Appellant 1 i.e. Vibha Sharma had a trading account with the broker, Eureka Stock & Share Broking Services Limited. Subsequently, a report from National Stock Exchange (NSE) casted some doubt over the trading of some persons. Following this, SEBI initiated an investigation into the trading activities of certain persons which also included Appellant 1 during the period between December 1, 2009 and March 31, 2010.

During the course of investigation, it was divulged that trades were executed in the account of Vibha Sharma i.e. Appellant 1 in such a way that she would buy a certain number of shares and sell the same numbers of shares during the course of the trading day. Also, in 14 out of 40 days during which Appellant 1 account was investigated, it was revealed that there was a complete match between the sell trades of Appellant 1 and the buy trades of CBI. Basically, Appellant 2 aided and advised Appellant 1 i.e. Vibha Sharma since only Appellant 2 i.e. husband of Vibha Sharma was in know of scrip , in advance of other investors, to be taken up for purchase by Central Bank. Thus, Appellant 1 was in know an advance the price at which the CBI will purchase the scrip and hence Appellant 1 was in position to purchase the scrip at considerably lower price [at more or less LTP (last traded price)] and offer the same for sale at price almost matching the price at which CBI was to buy the scrip.

SEBI’s Decision

Owing to this, SEBI appointed an Adjudicating Officer under Section 15-I of the SEBI Act, 1992 to investigate and enquire into the alleged violations and contraventions of the ‘FUTP’ Regulations. Following the investigation, the A.O. concluded that Appellant 1 & Appellant 2 had violated claused (a), (b), (c) and (d) of Regulations 3[2] and 4(1)[3] of the FUTP Regulations. Further, the A.O. levied a penalty of 25, 00,000 on the appellants.

The main question before SAT for consideration-

Aggrived by the impugned order of the Adjudicating Officer, Appellant 1 and 2 appealed in the Securities Appellate Tribunal (SAT). Now, the primary questions for consideration before SAT was- whether any third person other than an intermediary could be held liable for fraudulent trading in securities i.e. for the offence of front running?

APPELLANTS’ Contentions-

The first and foremost contention put forward by the Appellants was that Vibha Sharma’s trades in securities were solely based on the research reports received from various stock broker, analyst, newspaper articles and other publicly available materials and information. They further contended that since 2007 Vibha Sharma has been dealing and trading in securities market, long before her husband appointment as an equity dealer in the Central bank (CBI). Therefore, her trading strategy was similar and akin to any day trader who settles conclusively and seeks to square off all positions before the close of the market. Thus, on the basis of the aforementioned contentions, Appellants 1 pleaded that her trades were in the normal course of business. Further, any matching of sell trades of Appellant 1 and buy trades of CBI was purely coincidental.

Secondly, the Appellants contended that sell trades of vibha Sharma and buy trades of CBI matched only for 14 days out of the total investigation period of 40 days. Therefore, these 14 days were inconclusive and an inadequate sample size to allege that Appellant is guilty of front running.

Lastly, the Appellants relied on the case of Dipak Patel v. SEBI where it was held by the SAT that no person other than an intermediary could be held liable for the offence of front running under the ‘FUTP’ Regulations, 2003.

SEBI’s Contentions-

SEBI argued that for these 14 days, there was complete 100 % matching of trades between Appellant’s 1 sale orders and the CBI’s buy/purchase orders. Appellant 1 would purchase a scrip at the last traded price (LTP) and would subsequently offer the same scrip for sale at a price matching the price at which CBI was to buy the scrip. Now, the price at which Appellant 1 offered her scrip would normally be considerably higher than the LTP (last traded price). Therefore, it was evidently manifest that Appellant 1 had made and garnered undue gains by relying on the information which Appellant 2 provided her but which was not available to the other investors.

Securities Appellate Tribunal (SAT) Decision-

After the perusal of the facts and circumstances of the case, SAT concluded that both the Appellants are guilty of violations of Regulations 3(a), 3(b), 3(c), 3(d) and 4(1) of the ‘FUTP’ Regulations. Now, the main points which the SAT deliberated and discussed in arriving at the decision are as follows-

SAT said that there was liberal interpretation of the concept of ‘front running’ in the case of Dipak Patel decided in 2012. The tribunal further observed that even though SAT didn’t convict the third persons for the offence of ‘front running’ in the Dipak Patel case, it was evident that front running is always detrimental irrespective of whether it is committed by a third person or an intermediary. Therefore, based on the aforementioned contentions, SAT said that the definition of ‘front running’ cannot be put in a strait-jacket formula and a liberal interpretation ought to be applied to the definition.

Secondly, SAT said that it has conclusive evidence which aptly manifests that Appellant 1 has sensitive information regarding trades of CBI much to the detriment of the others investors. The tribunal said that Jitender Sharma i.e. Appellant 2, an equity dealer in secutities with CBI and Vibha Sharma i.e. Appellant 1, a day trader were related as husband and wife. Information concerning the future trades by CBI were communicated to Appellant 1 much before. Thus, in the process of passing of this information, Appellant 1 made considerable undue gains.

Lastly, the fact that 100 % of the sales trades by Vibha Sharma and buy trades of CBI were matched, SAT came to the conclusion that it was not a mere coincidence. The tribunal said that the whole buying and selling of securities by Appellant 1 was pre-mediated vis-à-vis information provided by Appellant 2 regarding the purchase order of CBI.

Analysis of the SAT’s Decision-

This much needed ruling of the tribunal has finally filled a serious lacuna in the regulatory framework concerning the issue of front running. Earlier, the SAT had said that the current FUTP regulations, 2003 prohibited only intermediaries from front running. The prime reason of such liberal interpretation of SAT in the case of Dipak Patel was that the provision of ‘front running’ in FUTP Regulaltion was not exhaustive so as to include any other person also. But one could make the argument that since the provision of 'front-running' in Regulation 4(2)(q) is only illustrative and inclusive, the act of 'front-running' itself tantamounts to 'fraud', in which case the person committing it, whether an 'intermediary' or not, should be irrelevant.

Subsequently, in a SEBI Board Meeting on August 12, 2013, a proposal was approved to introduce an amendment to the FUTP Regulations in order to clarify that the list under Regulation 4(2) is not exhaustive and the general provisions of Regulation 3 of the FUTP Regulations will override.[4]

On September 6, 2013, an amendment to the FUTP Regulations was notified. The amending regulation inserted an Explanation to Regulation 4(2) of the FUTP Regulations which reads as follows:

"For the purposes of this sub-regulation, for the removal of doubts, it is clarified that the acts or omissions listed in this sub-regulation are not exhaustive and that an act or omission is prohibited if it falls within the purview of regulation 3, notwithstanding that it is not included in this sub-regulation or is described as being committed only by a certain category of persons in this sub-regulation."

Therefore, this amendment and the Order seem to settle the position for the time being with respect to the applicability of the FUTP Regulations to persons other than intermediaries in the cases of ‘front running’.

[I can also be contacted at- rishabh.a.09@gmail.com]

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[1] P Ramanatha Aiyar, Major Law Lexicon (4th Edition 2010).

[2] Regulation 3 of the FUTP Regulations prohibits certain dealings in securities. It reads as under: 
"No person shall directly or indirectly-
(a) buy, sell or otherwise deal in securities in a fraudulent manner; 
(b) use or employ, in connection with issue, purchase or sale of any security listed or proposed to be listed in a recognized stock exchange, any manipulative or deceptive device or contrivance in contravention of the provisions of the Act or the rules or the regulations made there under; 
(c) employ any device, scheme or artifice to defraud in connection with dealing in or issue of securities which are listed or proposed to be listed on a recognized stock exchange; 
(d) engage in any act, practice, course of business which operates or would operate as fraud or deceit upon any person in connection with any dealing in or issue of securities which are listed or proposed to be listed on a recognized stock exchange in contravention of the provisions of the Act or the rules and the regulations made thereunder"

[3] Regulation 4(1) reads as follows: 
"Without prejudice to the provisions of regulation 3, no person shall indulge in a fraudulent or an unfair trade practice in securities".

[4] SEBI Board Meeting. PR No. 73/2013 http://www.sebi.gov.in/sebiweb/home/document_detail.jsp?link=http://www.sebi.gov.in/cms/sebi_data/docfiles/26230_t.html, last visited on September 11, 2013