Securities Law – Regulating Fraud & Unfair Trade Practices

Sumit Agrawal December 03, 2016

@National Institute of Securities Markets (NISM)

CONTENTS

Copyright © Suvan Law Advisors 2016

3

CONCEPT OF FRAUD – COMMON LAW

• Common Law is Judge-made Law. Fraud is a civil wrong. • Tort of Deceit - While the precise definitions and requirements of evidence vary

among jurisdictions, the requisite elements of fraud as a tort generally are the intentional misrepresentation or concealment of an important fact upon which the victim is meant to rely, and in fact does rely, to the harm of the victim

• In the US, common law generally identifies 9 elements needed to establish fraud: (1) a representation of fact; (2) its falsity; (3) its materiality; (4) the representer’s knowledge of its falsity or ignorance of its truth; (5) the representer’s intent that it should be acted upon by the person in the manner reasonably contemplated; (6) the injured party’s ignorance of its falsity; (7) the injured party’s reliance on its truth; (8) the injured party’s right to rely thereon; and (9) the injured party’s consequent and proximate injury. • U.S. SEC’s Section 10b of Securities Exchange Act, 1934 and Rule 10b-5 is akin

to it under various rulings. • Fraud - u/s 421 of the Indian Penal Code and u/s 17 of the Indian Contract

Act. Copyright © Suvan Law Advisors 2016

4

‘FRAUD’ Contract Act Vs. PFUTP Regulations

Section 17 of the Indian Contract Act, 1872 Regulation 2(1)(c) of FUTP Regulations

Exclusive Nature – The definition of ‘fraud’ uses the words ‘means and includes’ implying that the scope and ambit of the definition is restricted to the provisions contained therein.P. Kasilingam & Ors. Vs. P.S.G College of Technology & Ors. – “The words ‘means and includes’, on the other hand, indicate ‘an exhaustive explanation of the meaning which, for the purposes of the Act, must invariably be attached to those words or expressions.”

Inclusive Nature - The Regulation uses the word ‘includes’ while defining the term ‘fraud’, thereby suggesting the inclusive nature of the definition.

Intention – The very definition of Fraud under the contract act uses the term ‘intent’, clearly establishing that intention and motive is an integral ingredient to establish Fraud else its just misrepresentation.

No Intention – The Regulation and later judgements on the same clearly establish that motive or intention are immaterial as far as ‘fraud’ under the regulation is concerned.SEBI Vs. Shriram Mutual Fund – “therefore there is no question of proof of intention or any mens rea by the appellants and it is not essential element for imposing penalty under SEBI Act and the regulations.”

5

SEBI Act, 1992 on Fraud

1. The phrases “fraudulent trade practice” or “unfair trade practice” or “manipulative trade practice” have not been defined or distinguished.

2. Section 11(2) (e) expressly enables SEBI to take measures to prohibit ‘fraudulent and unfair trade practices’.

3. Section 12A prohibits ‘manipulative and deceptive devices’ and Section 15HA provides penalty for ‘fraudulent and unfair trade practices’.

4. Regulation 4 of FUTP Regulations, 2003 prohibits ‘manipulative, fraudulent and unfair trade practices’.

5. Regulations 3(b), 3(c) and 3(d) of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003 mirror the provisions of Sub-sections (a), (b) and (c) of Section 12A of SEBI Act, 1992.

Copyright © Suvan Law Advisors 2016

6

WHAT IS FRAUD IN SECURITIES LAWS

Committed whether in a deceitful manner or not by a

person or by any other person with his connivance or by his agent while dealing

in securities in order to induce another person or his agent to deal in securities,

whether or not there is any wrongful gain or avoidance

of loss,AND

shall also include -

7

Securities Law Fraud Includes

MisrepresentationSuggestion

Active ConcealmentPromise

RepresentationOmission

Deceptive BehaviorFalse StatementMisinformation

Concealment of material facts or truth

Of facts which are not true

By a person who knows the facts

Without intention of performing it

Made in a reckless & careless manner

Which law specifically declares fraudulent

Deprive people informed consent, full participation

Without reasonable ground of being true

Affecting the market price of securities

8

Regulation 2(1) (c) provides for certain exceptions to ‘fraud’ and states that

nothing contained in the clause shall apply to any general comments made in

good faith in regard to:

1. the economic policy of the government

2. the economic situation of the country

3. trends in the securities market;

4. any other matter of a like nature

5. whether such comments are made in public or in private;

Exceptions important for freedom of speech.

Market trends in securities market understood through press reports and media

opinions.

EXCEPTIONS TO “FRAUD”

9

‘DEALING IN SECURITIES’ “Dealing in securities” includes an act of buying, selling or subscribing

pursuant to any issue of any security or agreeing to buy, sell or subscribe

to any issue of any security or otherwise transacting in any way in any

security by any person as principal, agent or intermediary referred to in

section 12 of the Act.

The term “includes” makes the definition extensive

‘Accessing capital market’ is different from ‘dealing in securities’

‘Dealing in securities normally means transaction in securities” (Sterlite

Industries (India) Limited Vs. SEBI)

Merely agreeing to transact in securities would also qualify such proposed

transaction as ‘dealing in securities’.

10

REGULATION 4Ingredients of regulation 4:

Without prejudice to provisions of regulation 3Dealing in securitiesIs deemed to be a fraudulent or an unfair trade

practice if:It involves fraud and;Includes the following: indulging in an act which creates false or misleading appearance of trading in the securities market;

any act or omission amounting to manipulation of the price of a security;

an intermediary predating or otherwise falsifying records such as contract notes, etc.

11

REGULATION 4

Regulation 3 does not, in any manner, constrict the ambit of Regulation 3

The scope of Regulation 4 would be merely illustrative of the mischief

that Regulation 3 seeks to address. (Academy of Nutrition Improvement

& Ors. Vs. Union of India, Supreme Court 2011)

Regulation 4(2) commences with a deeming provision pursuant to which

any transaction in securities which involves fraud shall be deemed to be

fraudulent or an unfair trade practice.

Illustrative list of activities mentioned in sub-regulation 2(a) to (t).

12

ILLUSTRATIVE LIST OF OFFENCES

1. Scalping2. Puffing Advertisements / Rumour Fraud 3. Front Running / Back Running4. Increasing / Maintaining High Orders5. Synchronized Trades including Circular Trades, Reverse Trades and Cross Deals6. Marking the Close / Ramping7. Churning and Burning8. Pump & Dump 9. Cornering Shares in Public Issues10. Parking & Tax avoidance11. Mis-selling of Mutual Funds12. Ponzi Schemes & Illegal Mobilization of Funds13. Private Treaties14. Unauthorized Electronic Platforms

Copyright © Suvan Law Advisors 2016

13

Defined as “usage of nonpublic 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.” - SEBI Consent Circular

CIR/EFD/1/2012

Covered by Regulation 4 (2) (q) of FUTP Regulations.

Copyright © Suvan Law Advisors 2016

FRONT-RUNNING

14

Hypothetical Examples of Fraud

Aditya has a friend Mihir who is a renowned registered stock broker with SEBI who is also well connected to corporates.

Aditya whatsapps his school friend Dharmendra that Mihir is going to buy 10 lac shares of TCS tomorrow as he thinks it is a good buy especially because entire Tata Group is up for overhaul and it will be good for all Tata Companies.

Dharmendra tell this incident to his wife Seema in the evening when he reaches home after office.

Seema already has an account with Mihir’s renowned broking company and she buys 1000 TCS shares on the next day. Mihir, as stated earlier, also buys 10 lac TCS shares next day.

Is there any Fraud? Copyright © Suvan Law Advisors 2016

15

FRONT-RUNNING 4 (2) (q) particular to intermediaries only. In Dipak Patel vs. SEBI, a Portfolio Manager of an FII passed on

Information to cousins about large trades by the FII. Arranged for personal trades of the same stock through such persons

prior to trade by FII. Subsequently reversed such transaction and made gains of Rs.1.50

crores. Adjudicating Officer (A.O.) held that these transactions were in

violation of Regulation 3(a) to 3(d) of the PFUTP Regulations. SAT held that Front Running is a specific offence under Reg. 4 (2) (q)

of FUTP. Offence only if committed by intermediary.

15Copyright © Suvan Law Advisors 2016

16

FRONT-RUNNING Position reiterated in Sujit Karkera vs. SEBI. Erstwhile FUTP Regulations of 1995 prohibited Front Running by 'Any

Person' vide Regulation 6 (b). Amendment to FUTP Regulations of 2003 by SEBI in September 2013.

SEBI brought amendments Explanation added to Regulation 4 (2) of FUTP :1) Acts an omissions in the regulation not exhaustive.2) Acts and omissions prohibited if within the purview of Regulation 3.

16Copyright © Suvan Law Advisors 2016

17

SELF-TRADES

Considered to be violative of Regulation 4 (2)(b), 4(2) (g) and 4(2) (a).

No change in beneficial ownership May lead to creation of artificial volumes More common with stock brokers account to execute trades

vide various terminals from more than one location, increasing chances of accidental self trades

Brokers using algo-trading, often use separate trading algorithms simultaneously, resulting in accidental matches

Copyright © Suvan Law Advisors 2016

18

LEGAL POSITION OF SELF - TRADES

In H.J. Securities Private Ltd vs. SEBI (11.05.2012), SAT held that “If the appellant was operating through jobbers from different terminals, he should have placed some mechanism in place to ensure that his trades do not result in self trades.”

International trend – difference between bona fide and mala fide self trades

FINRA/SEC rule 5210(.02) states “Transactions in a security resulting from the unintentional interaction of orders originating from the same firm that involve no change in the beneficial ownership of the security, generally are bona fide transactions for purposes of Rule 5210”  

Copyright © Suvan Law Advisors 2016

19

SELF-TRADES PREVENTION The Stock Exchanges, in 2015, put in place mechanisms for the prevention of self

trades across the Equity, Equity Derivatives & Currency Derivatives segments BSE - if an incoming order is likely to match with a passive order belonging to the

same member and client code combination in the same order book, the system cancels such incoming order thus preventing a self trade. The Passive buy order remains active for matching in the call auction session.

NSE- if an active order is likely to match with a passive order belonging to the same member-client or same member-proprietary combination in the same order book originating from same or different trading terminal of the member, either of the active or passive order, as per the instruction set in active order, is cancelled.

SEBI, on the 26th of October 2016, called for a meeting of legal heads of stock exchanges to discuss the issue of accidental self trades and liability of brokers thereof.

Decision is awaited on the same.

  

Copyright © Suvan Law Advisors 2016

20

CIRCULAR AND SYNCHRONISED TRADES

Circular Trading - few stock manipulators trade on a particular stock among themselves at a

price higher than prevailing price creating artificial volume.

Transactions usually cancel out each other and the shares remain within the circle without

any genuine trading transaction.

Synchronized Trading - the buyer and the seller agree on the quantity and price of the

securities they intend to transact at the same time

‘Matching’ of trades can either take place on the stock exchanges or off-market.

May be done through the same broker (termed a cross deal) or through two different

brokers.

Considered to be illegal only if executed with a view to manipulate.

21

Consensual bargaining in which the parties agree on the scrip to be traded, the quantity

to be bought/ sold and the price at which the scrip will be bought and/ or sold.

Timing of trade is synchronized

BULK DEALS are transactions in a script where the total quantity of shares bought or

sold was more than 0.5% of the number of equity shares of the listed company.

BLOCK DEAL is a trade, with a minimum quantity of 5,00,000 shares or minimum value

of Rs. 5 Crore executed through a single transaction on this separate window of the

stock exchange.

On January 14, 2004, SEBI issued a circular requiring disclosures of all bulk deals

immediately upon execution of the trade.

On September 2, 2005, SEBI issued another circular clarifying the 2004 circular as well

as regulating ‘block deals’.

NEGOTIATED TRANSACTIONS

22

ILLEGAL MOBILIZATION AS “FRAUD”

SEBI in its Board meeting on Aug. 12, 2013 has approved the proposal to declare illegal mobilization of funds without obtaining a certificate under the SEBI (Collective Investment Schemes) Regulations, 1999 as a fraudulent and unfair trade practice. This amendment has been made to impose deterrent adjudication monetary penalties on unregistered CIS entities mobilizing money.SEBI had imposed a penalty of Rs 7,269.5 crore under this section 4(2)(t) on PACL recently.

23

SECTION 11C(1), SEBI ACT REGULATION 5, FUTP REGULATION

1. Any transaction in securities being dealt with

in a manner detrimental to investors or the

securities market is sufficient to initiate an

investigation under Section 11C

The transaction in securities being dealt with in a

manner detrimental to investors or the securities

market needs to be necessarily be in contravention

of the FUTP regulations to initiate an investigation

under Regulation 5.

2. Violation by any intermediary or any person

associated with the securities market relates

not just to the provisions of SEBI act or rules

or regulations made thereunder, but also

extends to directions issued by SEBI under

any of the Act or rules or regulations made

thereunder.

Violation by any intermediary or any person

associated with the securities market relates only

to the provision of the SEBI Act and the rules or

regulations made thereunder.

COMPARISON BETWEEEN REG. 5 & SEC/ 11C

24

S. No. SECTION 11C(1), SEBI ACT REGULATION 5, FUTP REGULATION

3. The investigating authority may be any

person as directed by SEBI, in writing.

The investigating authority needs to necessarily

be an officer of SEBI, not below the rank of

Division Chief

4. Section 11C provides for the powers of

the Investigating Authority, including

the powers of search and seizure.

The investigation needs to be undertaken in the

manner prescribed under Section 11C.

COMPARISON BETWEEEN REG. 5 & SEC/ 11C

25

CURRENT ISSUES - REGULATION OF FANTASY TRADING

• SEBI press release (PR No.137/2016) dated August 30, 2016• It has come to the notice of SEBI that various entities are soliciting investors by offering

leagues/schemes/competitions etc. related to securities markets. Some of the schemes may involve distribution of prize monies. Participation in such schemes including sharing of confidential and personal trading data is at investors’ own risk, cost and consequences as such schemes are neither approved nor endorsed by SEBI / SEBI recognized Exchange(s). SEBI is issuing this caution to investors to warn about such schemes offered by third party or group company/associate of stock broker(s) etc. 

• Examples: Indian Trading League, Stock Race etc.?• Which Provision of SEBI Regulations Violated?• Are Playing Games ”Dealing In Securities”? • Are Virtual Securities Under Securities Under SCRA?• Are educational, entertainment or simulation trading covered in the Press Release?

26

UNINTENTIONAL REGULATION OF SOCIAL MEDIA

On 7th October, 2016, SEBI issued a consultation paper proposing stricter regulation of investment advisory and research activity in relation to securities, including the suggested amendments to SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets) Regulations, 2003 :-• No person shall be allowed to provide trading tips, stock specific recommendations to

the general public through short message services (SMSs), email, telephonic calls, etc. unless such persons obtain registration as an Investment Adviser or are specifically exempted from obtaining registration.

• No person shall be allowed to provide trading tips, stock specific recommendations to the general public through any other social networking media such as WhatsApp, ChatOn, WeChat, Twitter, Facebook, etc. unless such persons obtain registration as an Investment Adviser or are specifically exempted from obtaining registration.

• Is this going to be a misguided missile? • Is this reasonable restriction on Constitutional Right on Free Speech?

Copyright © Suvan Law Advisors 2016

27

NEED OF HOLISTIC REVIEW OF REGULATIONS

• SEBI v. Kishore R Ajmera, Supreme Court of India, FEBRUARY 23, 2016.• Before embarking upon the necessary discussions, we would like to record our views

on a somewhat unclear if not a confused picture that emanates from parallel provisions contained in the Act and the Regulations framed thereunder, as referred to above. This is particularly in the context of the power of imposition of penalty on determination of liability either for manipulative or fraudulent practices or for violation of the Code of Conduct Regulation, 1992. The different Regulations including the Regulations that prescribe the procedural course, namely, SEBI (Procedure for Holding Enquiry by Enquiry Officer and imposing Penalty) Regulations 2002 and the successor Regulation i.e. SEBI (Intermediaries) Regulations 2008 contain identical and parallel provisions with regard to imposition of penalty resulting in myriad provisions dealing with the same situation. A comprehensive legislation can bring about more clarity and certainty on the norms governing the security/capital market and, therefore, would best serve the interest of strengthening and securing the capital market.

• FSLRC & Indian Financial Code – Way to go legislatively on Market Abuse?

Copyright © Suvan Law Advisors 2016

2828

THANK- YOUSumit AgrawalPartner, Suvan Law AdvisorsFormer Asst. Legal Advisor, SEBIE: sumit@suvanlaw.comW: www.suvanlaw.com