NISM - Securities Law - Regulating Fraud & Unfair Trade Practices

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.

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.

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
Misrepresentation
Suggestion
Active Concealment
Promise
Representation
Omission
Deceptive Behavior
False Statement
Misinformation
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 4
Ingredients of regulation 4:
Without prejudice to provisions of regulation 3
Dealing in securities
Is 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. Scalping
2. Puffing Advertisements / Rumour Fraud
3. Front Running / Back Running
4. Increasing / Maintaining High Orders
5. Synchronized Trades including Circular Trades, Reverse Trades and Cross Deals
6. Marking the Close / Ramping
7. Churning and Burning
8. Pump & Dump
9. Cornering Shares in Public Issues
10. Parking & Tax avoidance
11. Mis-selling of Mutual Funds
12. Ponzi Schemes & Illegal Mobilization of Funds
13. Private Treaties
14. Unauthorized Electronic Platforms

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.
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?

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

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”

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.

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?

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?

THANK- YOU
Sumit Agrawal
Partner, Suvan Law Advisors
Former Asst. Legal Advisor, SEBI
E: sumit@suvanlaw.com
W: www.suvanlaw.com

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