Employees type on desktop computer keyboards as they monitor data at a securities brokerage in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)

Synchronisation Of Trades In F&O Segment: Why The Supreme Court Has Overturned SAT’s Ruling

After 11 years of litigation, the Supreme Court of India has upheld securities regulator SEBI’s order to say that synchronised trades in the futures and options segment amount to unfair trade practice - a view that’s contrary to the one expressed by the Securities Appellate Tribunal. But in recognizing this principle, the apex court also concluded that the brokers who facilitated these trades didn’t do any wrong and that the Securities and Exchange Board of India didn’t do enough to prove otherwise.

Background Story

The SEBI View

Back in 2007 SEBI found 3 traders – Rakhi Trading, Tungarli Tradeplace and TLB Securities – guilty of unfair trade practices. The allegation was that these traders indulged in synchronised transactions in the futures segment where one party booked profits and the other party booked losses. Subsequently, SEBI had found, that the trades were reversed in all the cases in a matter of few seconds, showing significant difference between the buy and sell trade prices. Further, the change in positions took place with negligible change in the price of the underlying security.

Three brokers – Indiabulls Securities, Angel Capital, and Prashant Patel – who had facilitated these reversal trades were found to be guilty of violating SEBI regulations for stock brokers.

The modus operandi was that the party and the counter-party to these trades were identical, the trades were carried out within seconds or hours and then reversed very quickly with significant difference between the buy and sell trade, Nirav Shah, a litigation partner at law firm DSK Legal explained to BloombergQuint.

The price difference wasn’t in line with the change in market price. Further, there was no settlement of accounts between the parties to the contract and the most critical aspect, which seems to have been the clincher in this situation, is that there was no transfer of beneficial interest in those securities. 
Nirav Shah, Partner, DSK Legal

The crux of SEBI’s allegations was that the parties were buying and selling securities in the derivatives segment at a price which did not reflect the value of the underlying in synchronised and reverse trades carried out by them. This, the market regulator said, amounts to an unfair trade practice.

The SAT View

But on appeal the Securities Appellate Tribunal disagreed.

The tribunal order pointed out SEBI was insinuating that by executing manipulative trades in the F&O segment, the Nifty index was sought to be tampered with. The argument, SAT had noted, was too farfetched to be accepted.

In its order, the appellate tribunal had explained that the Nifty index is a very large, well-diversified portfolio of stocks which is not capable of being influenced, much less manipulated, by the movement of prices in the F&O segment, particularly by a handful of trades.

Looking at the timings of these trades, SAT had concluded that the arrangement between the parties was that profits and losses would be booked by each of them for effective tax planning and it is for this reason that they had synchronised the trades and reversed them. And so, it had concluded that synchronised and reverse trades that have not resulted in manipulation of the market, or change in beneficial ownership and done for the purpose of tax planning cannot amount to unfair trade practices.

As for the allegations against the brokers, SAT had held that they had merely carried out the directions of their clients, and that the anonymity of the trading system does not allow a broker to know who the counter party or its broker is.

The Supreme Court View

Now, after 8 years, the apex court has overturned SAT’s ruling to say that intentionally trading for loss is not a genuine trade.

The apex court has pointed out that if one party consistently makes losses and that too in pre-planned and rapid reverse trades, it is not a genuine but an unfair trade practice. The Supreme Court has explained that the trade reversals indicate that the parties did not intend to transfer beneficial ownership and through these orchestrated transactions, other investors have been excluded from participating in these trades. Further, the fact that when the trade was not synchronising, the traders placed it at unattractive prices is also a strong indication that the traders intended to play with the market.

The Supreme Court has relied on the principle of market integrity and market abuse but hasn’t examined whether these transactions were manipulative in nature and had impacted investors or the market at large in any way, Sanjay Asher, a partner at law firm Crawford Bayley said. ‘For a violation of SEBI’s regulations on Fraudulent and Unfair Trade Practices, there has to be a result of a synchronised trade,’ he added.

Shah disagreed and opined that the regulations don’t stipulate that a violation has occurred only if there is harm to the market. He pointed out that in fact SAT had deviated from its own precedent in the Ketan Parekh case where it had held that when the beneficial interest isn’t transferred, such a transaction would be deemed to be manipulative of the market. He emphasised that SEBI’s regulations too spell out this principle.

The principles laid down by the apex court in this order will be useful for the Viswanathan committee that has been set up by SEBI on fair market conduct, Yogesh Chande, a securities law partner at law firm Shardul Amarchand Mangaldas said. ‘The order will bolster SEBI’s case in similar ongoing matters,’ he added.

While the apex court has found the traders guilty, it has dismissed SEBI’s allegations against the brokers on lack of evidence that would suggest negligence or connivance. Merely because a broker facilitated a transaction, it cannot be said that there is violation of the regulations, the Supreme Court has concluded. Shah said typically a broker doesn’t go behind the orders of a client and so the apex court has rightly let the brokers off.