Front running prohibited practice under SEBI Regulations -Supreme Court

Front running prohibited practice under SEBI Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market Regulations 2003-Supreme Court

Front running

ABCAUS Case Law Citation:
ABCAUS 2079 (2017) (09) SC

The Substantial Question of Law framed/urged for determination:
Whether ‘front running by non-intermediary’ is a prohibited practice under regulations 3 (a), (b), (c) and (d) and 4(1) of FUTP 2003?

Brief Facts of the Case:
One of the party (the fund manager) was holding a position of trust and confidence in one Mauritius based company (investing company) and was privy to privileged/confidential information that the investing company would be making substantial investments in particular scrips through the stock exchanges.

It was alleged that the fund manager had parted the said information to his two cousins who on various dates placed orders for purchase of scrips a few minutes before the bulk orders in respect of the same scrips were placed on behalf of the investing company by the fund manager. The bulk order and the volume, naturally had the effect of pushing up the prices of the particular scrips and no sooner the prices had increased, his cousins had sold the said scrips thereby earning substantial profits.

SEBI had alleged that such practice amounted to fraudulent or unfair trade practice warranting imposition of penalty and visiting the offending individuals with other penal consequences.

While the adjudicating authority held the respondents liable. The Securities Appellate Tribunal (“Appellate Tribunal”) interfered with the orders passed by the adjudicating authority primarily on the ground that on a reading of Regulation 2(c),(3) and Regulation(4) of the SECURITIES AND EXCHANGE BOARD OF INDIA (PROHIBITION OF FRAUDULENT AND UNFAIR TRADE PRACTICES RELATING TO SECURITIES MARKET) REGULATIONS, 2003 (2003 Regulations) it does not transpire that the acts attributable amount to fraudulent or unfair trade practice warranting the findings recorded by the Adjudicating authority and the imposition of penalty in question on that basis.

Contention of the Respondents:

That  the finding with regard to the appellant being guilty of fraud under regulations 3 and 4 of FUTP 2003 is contrary to the definition of fraud as contained in Regulation 2(1)(c) of the said Regulations.

That Sub-clauses (i), (j), (l), (m), (p), (o) and (q) of clause (2) of regulation 4 expressly make themselves applicable only to the case of intermediaries and not to individual buyers or sellers.

Observations made by their Lordships:

The judgment was delivered by a Division Bench with both the Lordships passing their own concurring judgment to record their views as under:

It was observed that regulations 3 and 4(1) bars persons from dealing in securities in a fraudulent manner or indulging in unfair trade practice. However, the unequal possession of information is fraudulent only when the information has been acquired in bad faith and thereby inducing an inequitable result for others.

It was observed that the information of possible trades which a company is going to undertake is the confidential information of the company concerned, which it has absolute liberty to deal with. Therefore, 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.

His Lordship opined that non-intermediary front running may be brought under the prohibition prescribed under regulations 3 and 4 (1), for being fraudulent or unfair trade practice, provided that the ingredients under those heads are satisfied. In order to establish charges against tippee, under regulations 3 (a), (b), (c) and (d) and 4 (1) of FUTP 2003, one needs to prove that a person who had provided the tip was under a duty to keep the non-public information under confidence, further such breach of duty was known to the tippee and he still trades thereby defrauding the person, whose orders were front-runned, by inducing him to deal at the price he did.

It was observed that the emphasis in the definition in Regulation 2(c) of the 2003 Regulations is not whether the act, expression, omission or concealment has been committed in a deceitful manner but whether such act, expression, omission or concealment has/had the effect of inducing another person to deal in securities.

It was observed that the definition of ‘fraud’, which is an inclusive definition and, therefore, has to be understood to be broad and expansive, contemplates even an action or omission, as may be committed, even without any deceit if such act or omission has the effect of inducing another person to deal in securities. According to the Court, the emphasis is on the act of inducement and the scrutiny must, therefore, be on the meaning that must be attributed to the word “induce”

It was stressed that the test to determine whether the second person had been induced to act in the manner he did or not to act in the manner that he proposed, is whether but for the representation of the facts made by the first person, the latter would not have acted in the manner he did

It was observed that the difference between inducement in criminal law and the wider meaning thereof as in the present case, is that to make inducement an offence the intention behind the representation or misrepresentation of facts must be dishonest whereas in the latter category of cases like the present the element of dishonesty need not be present or proved and established to be present. In the latter category of cases, a mere inference, rather than proof, that the person induced would not have acted in the manner that he did but for the inducement is sufficient. No element of dishonesty or bad faith in the making of the inducement would be required.

It was observed that two cousins would not have entered into the transactions in question, had it not been for the information parted with by the fund manager. The track record of earlier trading of the concerned two cousins did not indicate trading in such huge volumes in their normal course of business.

Their Lordship opined that if the parting of information by fund manager to its two cousins amounted to ‘fraud’ within the meaning of Regulation 2(c) of the 2003 Regulations, there is no reason as to how the transactions entered into by cousins in regard to purchase and sale of the shares would not be hit by the provisions of Regulation 3(a) and Regulation 4(1) of the 2003 Regulations.

Their Lordships observed that to attract the rigor of Regulations 3 and 4 of the 2003 Regulations, mens rea is not an indispensable requirement and the correct test is one of preponderance of probabilities.  Merely because the operation of the aforesaid two provisions of the 2003 Regulations invite penal consequences on the defaulters, proof beyond reasonable doubt as held by the Supreme Court is not an indispensable requirement. The inferential conclusion from the proved and admitted facts, so long the same are reasonable and can be legitimately arrived at on a consideration of the totality of the materials, would be permissible and legally justified.

It was  opined that the volume of shares sold and purchased; the proximity of time between the transactions of sale and purchase and the repeated nature of transactions on different dates would irresistibly lead to an inference that the conduct of the parties involved were in breach of the code of business integrity in the securities market. The consequences for such breach including penal consequences under the provisions of Section 15HA of the SEBI Act must visit the concerned defaulters.

Appeals filed by SEBI against the orders passed by the Appellate Tribunal  allowed by  setting aside Tribunals order and the findings recorded and the penalty imposed by the Adjudicating Officer were restored. Appeals filed by the individual parties involved were dismissed.

Front running prohibited practice under SEBI Regulations

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