Supreme Court widens scope of “front-running” to include non-intermediaries

The Supreme Court has widened the scope of front-running and ruled that ‘non-intermediary front-running’ in the securities market will be brought under the prohibition prescribed for fraudulent/ unfair trade practices..The 60 page judgment by a bench of Justice Ramana and Justice Gogoi observed that “unfair trade practice” is not an expression clearly defined..The court clubbed four petitions, two filed by the Securities and Exchange Board of India (SEBI) and two by individuals, since the Securities and Appellate Tribunal (SAT) had taken two different views on whether “non-registered SEBI intermediaries” could be charged with front-running..The primary case is against one Dipak Patel, the portfolio manager of a Mauritius based fund. Dipak provided information to his relatives regarding a forthcoming trading activity on the basis of which a profit of Rs. 1,56,32,364 was made..The case before the Supreme Court is an appeal moved by the SEBI against the findings of SAT. The SAT had overruled the findings of SEBI, which held that such acts are in fact fraudulent/ unfair trade practices, as envisaged in the SEBI (FUTP) Regulations, 2003..While not statutorily defined in India, front running typically involves purchase of securities by an intermediary, who is in possession of information relating to a a large block deal coming ahead, to benefit from the subsequent price move..However, SEBI has defined front running in one of its circular as,.“Front-running; for the purpose of this circular, front running means usage of non public information to directly or indirectly, buy or sell securities or enter into options or futures contracts, in advance of a substantial order, on an impending transaction, in the same or related securities or futures or options contracts, in anticipation that when the information becomes public; the price of such securities or contracts may change.”.A strict reading of provision 4(2)(q) of the SEBI (FUTP) Regulations suggests that front running will be fraudulent only if done by the intermediary involved..However, the Supreme Court, while denying the applicability of expressio unius est exclusio alterius, went ahead to realise the true intention of the law and noted that the object of FUTP Regulations is to curb “market manipulations”/ “market abuse” and maintain “integrity”..The Court further noted that the definition of fraud, as envisaged in the new FUTP regulations of 2003, goes beyond what the Contract Act stipulates. The court noted,.“…the intention of the legislation was to provide for a catchall provision and the deeming provision under sub-clause (q) of regulation 4(2) was specifically provided as the intermediary are in fiduciary relationship with the client”.Realizing that possession of differential information is a pervasive nature of the market and isn’t always objectionable, the court held that such possession becomes fraudulent only when the information has been acquired in bad faith and induces an inequitable result for others..The Court also observed the bearing of law of confidentiality in such cases,.“…a person conveying confidential information to another person (tippee) breaches his duty prescribed by law and if the recipient of such information knows of the breach and trades, and there is an inducement to bring about an inequitable result, then the recipient tippee may be said to have committed the fraud.”.The court held,“Accordingly, non-intermediary front running may be brought under the prohibition prescribed under FUTP Regulations, for being fraudulent or unfair trade practice”, the Court held..Senior Advocate KTS Tulsi argued for one of the appellants and Senior Advocate Arvind Datar appeared for SEBI..Read the Judgment