The Supreme Court has brought more entities within the definition of front-running, a stock market malpractice in which brokers buy or sell shares for personal benefit using information yet to be released to their clients.
According to a ruling on Wednesday, individuals, as well as entities which are not necessarily market intermediaries, will be charged with front-running if they are found to be trading on the basis of such information. So far, only market intermediaries registered with the Securities and Exchange Board of India (Sebi) were covered under front-running.
In addition, any person found conveying confidential information about upcoming large trades will be deemed to be indulging in fraudulent trade practices, if it results in unfair gains for a third party.
The verdict followed the apex court hearing four petitions—two filed by Sebi and two filed by individuals. The court clubbed the petitions since the Securities and Appellate Tribunal had taken two different views on whether “non-registered Sebi intermediaries” could be charged with front-running.
The Supreme Court has set out important jurisprudence with respect to both front-running and insider trading, said Sandeep Parekh, founder, Finsec Law Advisors. “The operative part of the ruling is, however, narrower and focuses on whether the offence of front-running is restricted only to intermediaries registered with Sebi or covers other persons as well. The apex court decided that the prohibition would extend beyond registered intermediaries and would cover all those who indulge in the malpractice of front-running,” he said.
While the intent of Sebi’s prohibition of fraudulent and unfair trade practices (PFUTP) rules is to avoid inequitable gains, provisions related to individual culpability in front-running cases are not explicitly laid down, leading to the Supreme Court going into the legality of “non-intermediary fraudulent trades”.
“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 Supreme Court order said.
“Accordingly, non-intermediary front-running may be brought under the prohibition for being fraudulent or unfair trade practice,” the order added.
“While the Supreme Court of India has upheld the Sebi ruling, it has also observed that ‘unfair’, ‘manipulative’ and ‘fraudulent’ trade practices are not clearly defined by Sebi. This judgement has thrown light that though front running definition is wide enough to include non-intermediaries, the charge cannot be put without strict proof of the volume of securities, proximity of transaction by front runner and the person whose order information is being misused,” said Sumit Agrawal, partner, Suvan Law Advisors.
The court in the 60-page order also said that Sebi would need to prove a person who had provided the tip was under a duty to keep the non-public information confidential.
The regulator will be able to charge an individual with fraud if the person is aware that he is breaching his/her fiduciary duty and still trades based on that information.
“This judgement will be a good benchmark for the Sebi committee on fair market conduct which is looking at rewriting Sebi regulations on insider trading and securities fraud,” said Agarwal.
Sebi on 1 August had formed a committee to review norms pertaining to the Prevention of Insider Trading (PIT) 2015 rules and the PFUTP 2003 rules. The review is aimed at making the definition of fraud under PFUTP leaner and stronger and to remove grey areas in insider trading rules.