Supreme Court upholds high standards of market integrity by partly allowing SEBI Appeal in Rakhi Trading case

A Supreme Court bench of Justices Kurian Joseph and R. Banumathi has in its recent ruling upheld high standards of market integrity by (partly) allowing an appeal filed by the Securities and Exchange Board of India (SEBI), in a case relating to synchronized trading.

The trades pertain to NIFTY options in the Futures and Options (F&O) segment.

“Section 12A of the SEBI Act, 1992 read with Regulations 3 and 4 of the PFUTP Regulations, 2003 are essentially intended to preserve ‘market integrity’ and to prevent ‘market abuse’”, said the Supreme Court in its 90-page judgment.

While Regulation 3 of the PFUTP Regulations, 2003 speaks of prohibition about certain dealings in securities, Regulation 4 provides for prohibition of manipulative, fraudulent and unfair trade practices.

The Adjudicating Officer had in 2009-10 passed orders against three traders, Rakhi Trading, Tungarli Tradeplace, TLB Securities and their respective brokers Indiabulls securities, Angel Capital and Debt Market, Prashant Jayantilal Patel for engaging in ‘synchronized trading’.

A synchronized trade is one where the buyer and seller enter the quantity and price of the shares they wish to transact at substantially the same time. While synchronized trading isn’t illegal per se, it becomes illegal or violative of the PFUTP Regulations, if it is executed with a view to manipulate the market or if it is dubious in nature.

SEBI finds market manipulation

The Adjudicating Officer observed that most of the trades that were matched were of buying and selling of contracts within a gap of few seconds between the same parties through same set of brokers. The fact that the orders matched exactly both in quantity and price with the same party again and again, created suspicion.

The Adjudicating Officer’s investigation further revealed that manipulative device was used for synchronization of trades and that these trades were fraudulent/fictitious in nature.

The crux of the allegations by the Adjudicating Officer against the traders and brokers was, involvement in synchronized trading and its subsequent reversal which lead to misleading appearance of trading.

Accordingly, the Adjudicating Officer charged the traders for violation of Regulations 3(a), (b) and (c) and 4(1), (2)(a) and (b) of the PFUTP Regulations, 2003. Consequently, a penalty of Rs. 1,08,00,000/- was imposed under Section 15HA of the SEBI Act, 1992.

This decision, however, was overturned in appeal(s) filed under Section 15T before the Securities Appellate Tribunal (SAT).

SAT sets aside SEBI’s orders

SAT set aside the order of the Adjudicating Officer and held that NIFTY is a large well diversified index of stocks which is not capable of being influenced. According to SAT, the synchronization and reversal of trades effected by the parties with a significant price difference, within few seconds had no impact on the market and it has not affected the NIFTY index in any manner or induced investors.

SAT also took the position that there being no physical delivery of any asset, there was no change of beneficial ownership and since what is traded in the F&O segment are only contracts, such synchronized and reverse trades in NIFTY options in the F&O segment “can never manipulate the market”.

The Supreme Court ruling

Supreme Court, however, did not find any merit in the SAT’s reasoning. The Supreme Court said that even in the derivative segment there is a change of rights in a contract and the ownership of the right is restored to the first party when the reverse trade occurs.

In a game where aim is to always make profits, one party was consistently making losses leading to an unfair trade practice. In the Court’s view, this factor alone is sufficient to prove that the alleged transactions weren’t genuine dealings.

The Court further observed that the price discovery system itself was affected by synchronization and rapid reverse trade, which also had the impact of excluding other investors from participating in the market. The Supreme Court, therefore found that the traders  having engaged in a fraudulent and unfair trade practice while dealing in securities, are hence liable to be proceeded against for violation of Regulations 3(a), 4(1) and 4(2)(a) of PFUTP Regulations

However, as far as brokers are concerned, the court was of the view that there is hardly any evidence on their involvement so as to proceed against them for violation of Regulation 7A of the Brokers Regulations and PFUTP Regulations.

“Merely because a broker facilitated a transaction, it cannot be said that there is violation of the Regulation”, said the court.

The Court has through this decision reiterated its stance on the standard of proof required in quasi-judicial proceeding before SEBI, that is of preponderance of probability. Applying the principles laid down in Kishore R. Ajmera, the Court looked at three aspects of the impugned transactions, of ‘buy and sell‘, ‘volume of trade‘ and ‘timing of trade‘.

In its judgment, the Court observed that there was no possibility of such perfect matching of quantity, timing, prices etc. between the same parties unless there was prior meeting of minds or a specific understanding/arrangement between the parties.

“If the findings of SAT are to be sustained, it would have serious repercussions undermining the integrity of the market and the impugned order of SAT is liable to be set aside”, ruled the Court.

Also rereiterating the observations made by this Court in Kishore R. Ajmera  and Kanaiyalal Patel, regarding the need for a more comprehensive legal framework governing the securities market, the Court observed,

“As the market grows, ingenuous means of manipulation are also employed. In such a scenario, it is essential that SEBI keeps up with changing times and develops principles for good governance in the stock market which ensure free and fair trading.”

The Lawyers

SEBI was represented by Senior Counsel Gourab Banerji along with Bhargava Desai and Sahil Tagotra, while Rakhi Trading was represented by Senior Counsel P. Chidambram along with Anisha Upadhyay, briefed by Partner Aniket Gautam from MNSA Legal.

J. Sagar Associates Partners Mayank Mishra and Divyam Agarwal along with Associate Ritunjay Gupta briefed Counsel Somasekhar Sundaresan, who appeared for Angel Capital and Debt Market Limited. Senior Advocate Shyam Divan appeared for Indiabulls Securities Limited and was briefed by a team from Luthra & Luthra.

(Read the judgment)