A stock market, equity market or share market is the aggregation of buyers and sellers of stocks (also called shares), which represent ownership claims on businesses. Investment in the stock market is most often done via stock brokers and electronic trading platforms. Most of the trading in the Indian stock market takes place on two major stock exchanges: the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). As on April 2020, the BSE had 5,542[1] listed firms, whereas NSE had about 1,795[2] listed firms as on March 31, 2020.
To gauge the performance of stock markets various indices are formulated. An index serves as an indicator of the performance of the overall market or a sub-segment/sector within the market. The two prominent indices in the Indian stock market are Sensex and Nifty. Sensex is the oldest market index for equities, which includes shares of top 30 companies listed on the BSE. Another index is the Standard and Poor’s CNX Nifty; it includes 50 shares listed on the NSE.
Trading at both the exchanges takes place through an open electronic limit order book in which order matching is done. The entire process is order-driven, which means that market orders placed by investors are automatically matched with the best limit orders. As a result, buyers and sellers remain anonymous. The advantage of an order-driven market is that it brings more transparency by displaying all buy and sell orders in the trading system. However, in the absence of market makers, there is no guarantee that orders will be executed. All orders in the trading system need to be placed through brokers, many of which provide an online trading facility to retail customers. Institutional investors can also take advantage of the direct market access (DMA) option in which they use trading terminals provided by brokers for placing orders directly into the stock market trading system.
Equity spot markets follow a T+2 rolling settlement. This means that any trade taking place on Monday gets settled by Wednesday. All trading on stock exchanges takes place between 9:55 a.m. and 3:30 p.m., Indian Standard Time (+ 5.5 hours GMT), Monday through Friday. Delivery of shares must be made in dematerialized form, and each exchange has its own clearing house, which assumes all settlement risk by serving as a central counterparty.
Investment in a Company is basically done by the promoter group or the public investors. The public investors can be further divided into institutional investors and retail investors. The following chart gives a brief overview of the various types of investors in the Indian context:
FPIs/FIIs play an important role in Indian stock market. They would generally include Hedge funds, Foreign mutual funds, Sovereign wealth funds, Pension funds, Asset management companies, amongst others. They have been pivotal in the growth of India’s financial markets over the last two decades. It is estimated that FPIs/FIIs would have invested around Rs 12.5 trillion (USD 180 billion) in India between fiscal 2002-2020 (till March 2020) as per various media reports.
The role of DIIs has dramatically changed over the last 5 years as investors have started looking beyond the traditional gold and real estate as investment options. A rising middle class and a declining interest rate regime has also added to their fortunes. DIIs generally include Mutual funds, Insurance companies and Banks/Financial institutions. It is estimated that MFs alone have invested more than Rs 4.5 trillion in Indian equities over last 5 years as per various media reports.
Strong presence of FIIs/DIIs amongst a listed company’s shareholders is also considered as a proxy for good governance practices being followed by the company.
Supported by strong inflows from the FIIs/FPIs and DIIs, Indian stock markets have seen a healthy growth over the last decade. If we look at the returns just before the markets crashed due to CoVID-19 pandemic, Nifty had grown at 9.7% compounded annual growth rate.
Stocks are priced the same way any commodity is priced globally i.e. governed by the principals of supply and demand. Stock prices are determined by matching buy and sell orders. Each buy order is an offer to buy certain number of shares for a certain price, called bid. Each sell order is an offer to sell certain number of shares at a certain price called ask. The price of any stock at any moment is determined by finding the price at which the maximum number of shares will be transacted based on bids and asks at that time. After that price is determined, the transactions are completed, and that price is shown as the price of the stock at that moment. All this happens real-time with the help of electronic platforms.
The fundamental rule governing securities market is that the parties shall not indulge in any fraudulent activities. Tampering with the price of the security hampers free forces of supply and demand and makes the stock manipulated. Investment fraud occurs when an advisor, stockbroker, or brokerage firm offers inaccurate, incomplete, or biased information to control the market or draw business. A manipulative cartel develops which rigs the liquidity and price and this is called “price rigging”. They actively trade it amongst themselves, to a point where “innocent bystanders” feel the stock is liquid and valuable. This tempts innocent bystanders to step in and buy shares. At this point, the manipulative cartel has made profits because the innocent bystander has been persuaded to part with his money at a falsely elevated price. There are many variations on this theme. Some of the popular variations are circular trading, pump and dump schemes, front running, etc. Another aspect is the unfair trade practice of insider trading by persons in possession of unpublished price sensitive information. Here we discuss them in detail with respect to the regulatory framework and controls in the Indian Securities Market.
The responsibility of protecting the interests of investors in securities and promoting the development of the securities market is vested with the Securities and Exchange Board of India (SEBI)[3]. SEBI ensures the integrity of the markets by making regulations which help in detecting market frauds on a proactive basis, investigating abusive, manipulative or illegal dealings in the securities market and taking punitive action to punish the wrong doers, while simultaneously reviewing policies and procedures to minimize the risk of recurrence of such practices. To fulfil its duty, SEBI has been given legislative, executive, and quasi-judicial powers under the SEBI Act, 1992.
To deal with market abuse related to “market manipulation”, SEBI had framed the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulations in 1995. These Regulations were reviewed and replaced with the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations 2003 (“PFUTP Regulations”) which were notified on 17th July 2003.
To deal with market abuse related to “insider trading”, SEBI had promulgated the SEBI (Prohibition of Insider Trading) Regulations, 1992. The 1992 Regulations were amended in 2002 to strengthen the regulations and bring in the concept of code of conduct for prevention of insider trading, as well as a code for corporate disclosure practices. The entire regulations were reviewed by the Sodhi Committee and were replaced by the SEBI (Prohibition of Insider Trading) Regulations, 2015 (“Insider Trading Regulations” or “PIT Regulations”)
During the financial year 2018-19, 80[4] new cases of market manipulation and price rigging were taken up for investigation by SEBI and 60 cases were completed while 70[5] cases of insider trading were taken up for investigation by SEBI and 19 were completed. Since, several investigation cases involve multiple allegations of violations, water-tight classification under specific category becomes difficult. Therefore, cases are generally classified by SEBI on the basis of main charge / violations. Here we discuss the SEBI regulations governing market abuse related to manipulation and insider trading.
1.1 Scope of PFUTP Regulations:
PFUTP Regulations deal with market abuse such as manipulative, fraudulent and unfair trade practices. Fraudulent and unfair trade practices are prohibited under section 12A of the SEBI Act. Pursuant to the recommendation of Committee on Fair Market Conduct or the T.K. Viswanathan Committee(“Committee”)in its report dated August 2018, SEBI has made amendment to the PFUTP Regulations vide SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) (Amendment) Regulations, 2018 (“Amendment Regulations”). Through these amendments, SEBI has made an attempt to bring the provisions of the PFUTP Regulations in line with several Supreme Court judgements which have dealt with matters related to market manipulation, fraud, and unfair trade practices.
Market manipulation covers a wide variety of practices undertaken to compromise the market’s integrity and efficiency for one’s personal gains. Market Manipulation as defined in Palmer’s Company Law and noted by the apex court[6], “Market manipulation is normally regarded as the ‘unwarranted’ interference in the operation of ordinary market forces of supply and demand and thus undermines the ‘integrity’ and efficiency of the market.”
In SEBI v Rakhi Trading[7] the Supreme Court observed that market manipulation is a deliberate attempt to interfere with the free and fair operation of the market and create artificial, false or misleading appearances with respect to the price, market, product, security and currency. Further the Supreme Court has also defined unfair trade practices in the aforesaid judgement as follows:
“Having regard to the fact that the dealings in the stock exchange are governed by the principles of fair play and transparency, one does not have to labour much on the meaning of unfair trade practices in securities. Contextually and in simple words, it means a practice which does not confirm to the fair and transparent principles of trades in the stock market.”
The term ‘fraud’ has been interpreted by the Supreme Court in, SEBI v Kanaiyalal Baldev Patel[Civil Appeal No.2595 of 2013]to be wider than fraud as used and understood under the Indian Contract Act. In this judgment, front running by a non-intermediary has been brought within the prohibition of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003. The term ‘unfairness’ has been interpreted to be even broader than and inclusive of the concepts of ‘deception’ and ‘fraud’. Unfair trade practices are not subject to a single definition but require adjudication on case-to-case basis. Broadly trade practice is unfair if the conduct undermines the ethical standards and good faith dealings between parties engaged in business transactions.
The Supreme Court of India has, while recognizing that the object and purpose of the PFUTP Regulations is to curb ‘market manipulation’, decided that ‘front running’ by non-intermediaries may be brought under the prohibition prescribed under Regulations 3 and 4(1) of the PFUTP Regulations, for being fraudulent or an unfair trade practice. However, the Supreme Court has liberally interpreted certain provisions of the PFUTP Regulations, where the definition of fraud under regulation 2(c) has been interpreted to include an act, expression, omission or concealment which, even though was not committed in a deceitful manner, but has (or had) the effect of inducing another person to deal in securities. The burden on SEBI in such a case will not be to prove that the inducement was done dishonestly or in bad faith by the person, but only to establish that the person so induced would not have acted the way he did if he was not induced. Thus, it can be inferred that SEBI is not required to prove that the intention of the person was to commit the fraud. However, it has even been expressly stated in the judgment that mens rea is not an indispensable requirement to attract the rigour of regulations 3 and 4, and the correct test is one of preponderance of probabilities.
Further in N Narayanan vs. Adjudicating Officer(SEBI) [Civil Appeal Nos.4112-4113 of 2013], the Hon’ble Supreme Court has noted that manipulation can also be achieved by inflating the company’s revenue, profits, security deposits and receivables, resulting in price rise of the scrip of the company.
Based on the aforesaid judgements and the recommendations of the Committee, the definition of dealing in securities as laid down in regulation 2(1) (b) of the PFUTP regulations was widened to include within its ambit persons providing assistance in such dealing in securities vide the Amendment Regulations. Further based on the recommendations of the committee, regulation 4 of the PFUTP regulations was also amended vide the Amendment Regulations to expand the ambit of PFUTP regulations to restrict new practices that could perpetuate market abuse.
1.2 PFUTP Regulations-Combination of rule based and principle-based approaches:
The committee laid down that these regulations are a combination of rule-based and principle-based approaches. The provisions of Regulation 3 and Regulation 4(1) of PFUTP regulations lay down the underlying broad principles governing fraudulent and unfair trade practices and are intended to cover diverse situations and possibilities whereas Regulation 4(2) lays down specific rules that prohibit certain conduct by deeming them fraudulent activities or unfair trade practice.
Such a combination of rule-based and principle-based approach is appropriate for the present stage of market development, as such an approach not only enunciates the broad principles for ensuring fair markets but also enables rules to be specified to prohibit an illustrative list of identifiable unfair and manipulative trade practices. The committee recommended that rule-based regulation 4(2) to be updated at regular intervals to keep up with the changes in the securities market environment.
Under these regulations the burden of proof is on SEBI to show that the manipulation took place.
2.1 General meaning of the term Insider Trading
‘Insider Trading’ is the unlawful act of trading in securities of the Company by the person who have some information which is not available to the general public in the market and thus allowing them to make unlawful gains. Insider Trading is prohibited under Section 12A of the SEBI Act. Insider trading has been the subject of much regulation world-wide and in the Indian context, SEBI has promulgated the SEBI (Prohibition of Insider Trading) Regulations, 1992, which were reviewed by a High Level Committee and culminated in the SEBI (Prohibition of Insider Trading) Regulations, 2015. Further, in the financial year 2018-19 SEBI appointed T.K. Viswanathan Committee (“Committee”) and, in accordance with the recommendations made by the Committee, these Regulations have been amended by way of SEBI (Prohibition of Insider Trading) (Amendment) Regulations,2018(“Amendment Regulations”) to strengthen transparency, enforcement mechanism and to ensure institutional responsibility.
2.2 Analysis of Insider Trading Regulations:
Regulation 2(1)(g) of the SEBI (Prohibition of Insider Trading) Regulations, 2015, defines insider as:
SEBI’s intent behind coining the term insider was just to differentiate the persons who are connected with the Company or have access to unpublished price sensitive information from the ordinary investors who trade in the securities of the Company on the basis of their financial wisdom, in order to create a level playing field and to safeguard investing public against financial misfortunes. Here it is intended that anyone in possession of or having access to unpublished price sensitive information should be considered an “insider” regardless of how one came in possession of or had access to such information. Unpublished price sensitive information (UPSI) generally relates changes in capital structure, financial results, mergers or demergers or bonus or any other information which may impact the price of the security in the market on becoming generally available in the public.
Another term which forms part of the definition of insider is “connected person”. SEBI has broadened the scope of the definition of connected person in PIT regulations, 2015 wherein any person who is or has been associated with the Company in any manner, directly or indirectly during the last 6 months and is reasonably deemed to have access to the unpublished price sensitive information will be treated as a Connected person. Therefore, even the support staff of the organisation including the office boys, driver, cleaner etc will be included within the purview of the definition. In the matter of Palred Technologies[8], SEBI went down to investigate the social accounts of the accused and held that person connected to each other as mutual friends on facebook, will also be treated as Insider when they have traded in the shares of the Company on the basis of UPSI. Further the Securities Appellate Tribunal (SAT) in the case of Mrs. Sadhana Nabera Vs. SEBI[9]held that an auditor of the company cannot be reasonably deemed to have information relating to merger of one company with another, and will not be treated as an insider until it is shown that the valuation report on the merger prepared by the Chartered accountant was made available to him. Thus we can say that the main element behind considering any person as an insider has always been the possession of UPSI which he has had and in case, the contrary is proved, the said person will not be treated as an Insider.
Regulation 2(1)(e) of the PIT Regulations defines “generally available information” as information that is accessible to the public on a non-discriminatory basis;” This definition grants SEBI the ability to decide, on a case specific basis, whether certain information is available on a non-discriminatory basis, so as to not classify/treat it as a UPSI.
Regulation 3 of the PIT Regulations prohibits the communication and procurement of unpublished price sensitive information, unless such communication / procurement is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations. Further Regulation 3 (2A) lays down that, “The board of directors of a listed company shall make a policy for determination of “legitimate purposes” as a part of “Code of Fair Disclosure and Conduct” formulated under regulation 8.
Regulation 3 (2A) was inserted vide the Amendment Regulations on the recommendation of the Committee wherein the committee noted that the term legitimate purpose is not defined under PIT Regulation and is open to various strict and expansive interpretations[10].
Further Regulation 4 of the PIT Regulations prohibits trading by insiders while in possession of UPSI. However, the regulation allows the insider to prove his innocence by demonstrating certain circumstances.
The PIT Regulations places the burden of proof on the insider to show that he/she did not trade while in possession of inside information (“unpublished price sensitive information” or “UPSI”).
Thus we see that the regulations put restrictions on communication and trading by insiders. However, it provides exception where such communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations. This necessitates all insiders of corporates not to disclose any information to anybody including, even, other insiders which may result into disclosure of UPSI under the new code for insiders. There is a need to imbibe and strict implementation of the need-to-know principle, among all Insiders within the Corporate World.
The penalty for insider trading is prescribed under Section 15 G of SEBI Act which states that any insider who:
“either on his own behalf or on behalf of any other person, deals in securities of a body corporate listed on any stock exchange on the basis of any unpublished price-sensitive information; or communicates any unpublished price-sensitive information to any person, with or without his request for such information except as required in the ordinary course of business or under any law; or
counsels, or procures for any other person to deal in any securities of any body corporate on the basis of unpublished price-sensitive information,
shall be liable to a penalty which shall not be less than ten lakh rupees but which may extend to twenty-five crore rupees or three times the amount of profits made out of insider trading, whichever is higher”.
Insider Trading penalties in India, though having monetary quantification, does not have severe punishments/penalties, as is prevalent in other countries by way of imprisonment, supervised release and substantial payments in form of fines/penalties. The case & decision given by the district court of New York in the matter involving Rajat Gupta, Director of Goldman Sachs and Rajaratnam, Founder of Galleon Group[11] is a testimony to the seriousness of other countries to curb insider trading.
SEBI has made appropriate laws and regulations to ensure market integrity, fair market conduct and protection of interest of investors. To ensure compliance with the aforesaid regulations SEBI has laid down mechanisms for detection of violations through effective surveillance and investigation and punishment thereof by strong enforcement action. Market Surveillance Division was set up in SEBI in July 1995, with a view to keep a proactive oversight on the surveillance activities of the stock exchanges. The stock exchanges apprise SEBI of surveillance concerns and actions at the regular surveillance meetings. The stock exchanges also take punitive actions (suspension of the trading in the scrips, debarment of the suspected entities, etc.)
Lack of liquidity in certain stocks makes it easier to manipulate the price and volumes of stocks with lesser efforts and funds by unscrupulous elements. Liquidity is concentrated around the top 500 odd listed stocks. In order to deter attempts at manipulation in stocks which are illiquid and have low market capitalization 100% dematerialisation of shares has been mandated on the recommendation of the committee on fair market conduct. Further the cost of trading in illiquid stocks has been increased. SEBI also has the powers to seek call data records (list of people in touch with the caller) of those being probed, but it cannot intercept calls.
In a recent case, in the matter of India bulls Ventures Limited, SEBI passed an order impounding Rs. 87.21 Lakhs belonging to Ms Pia Johnson, non-executive director of India bulls Ventures Ltd (IVL), and her husband Mehul Johnson who traded in the scrip of IVL, based on UPSI communicated by his wife to him. The penalty levied here is only the collective alleged gains of the two with an annual 12% interest since the gains were made in the year 2017.
Here we can see that though the regulator has been stepping up the surveillance and other monitoring mechanisms for prevention of Insider Trading and other manipulative practices, a general sentiment that emerges is that the regulator needs to further tighten up on the penalties/punishments, which acts as a deterrent for committing such acts.
[1] https://www.bseindia.com/markets/keystatics/Keystat_Companies.aspx
[2] https://www.nseindia.com/regulations/listing-compliance/nse-market-capitalisation-all-companies
[3] Section 11 of Securities and Exchange Board of India Act, 1992 (SEBI Act, 1992)
[4] Annual report of SEBI for the financial year 2018-19
[5] Annual report of SEBI for the financial year 2018-19
[6] N Narayanan vs. Adjudicating Officer(SEBI) [Civil Appeal Nos.4112-4113 of 2013]
[7] Civil Appeal No. 1969 of 2011, Dod- February 8, 2018
[8] WTM/PS/152/IVD/FEB/2016
[9] Appeal no. 26 of 2007.Dod-19.02.2008
[10] Rakesh Agrawal v SEBI[2003] SCC OnLine SAT 38: [2003] SAT 6 [34]
[11] Securities and Exchange Commission v Rajat K Gupta and Raj Rajaratnam, Civil Action No. 11-CV-7566 (SDNY) (JSR),Dod:27.12.2012