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SC's Ruling on Synchronised Trading

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February 12, 2018

Why in news?

The Supreme Court has recently upheld an adjudication order by SEBI and set aside a SAT order on synchronised trading.

What is synchronised trading?

  • A ‘synchronised’ trade is a pre-negotiated trade.
  • How - Here, the buyers and sellers enter the quantity and price of shares on the screen they wish to transact at nearly the same time.
  • The buy and sale transaction at the same day for the same quantity between the same set of broker/clients is called reversal of trade.
  • Except the parties who have pre-fixed the price, nobody has the position to participate in the trade.
  • This is done with the support of the brokers.
  • Through circular trading between related entities of the company promoter, the price of the stock would be inflated.
  • A year later the investor would sell the shares to promoter entities at the inflated price.
  • The profit gained would then be shown as long term capital gains (used to be tax free till the recent Budget made it taxable).
  • Purpose - The ‘profit’ would be returned to the promoter in either cash or through another set of fake transactions.
  • These transactions may not necessarily happen through the stock exchange platform.
  • It thus serves as a means of converting black money to legitimate income.
  • Market is also manipulated to book artificial losses for tax purposes.
  • Effect - Synchronised trading may at times distort price discovery and affect other investors also.
  • SEBI had no way of proving these offline cash transactions.
  • It found it hard to raise charges of tax evasion and stock manipulation.

What is the present case?

  • SEBI had imposed a penalty of Rs.1.8 crore on Rakhi Trading.
  • This was for indulging in synchronised trading through the ‘reversal of trade’ route in March 2009.
  • Notably, the price did not reflect the value of the underlying in synchronized and reverse transactions.
  • SEBI considered this a violation of the Prohibition of Fraudulent and Unfair Trade Practices Regulations.

What was SAT's order?

  • The case went for appeal before the Securities Appellate Tribunal (SAT).
  • SEBI’s order was struck down by SAT in 2011.
  • SAT admitted that the trades were synchronised.
  • But it held that the trades had no impact on the market and neither induced the investors.
  • As, SAT held that the derivative trades could not influence the market (Nifty index).
  • SEBI however alleged that the fictitious trades created false liquidity in the Nifty options contract, manipulating the market.
  • SEBI then appealed the SAT ruling in the Supreme Court.

What is the SC's ruling?

  • The Supreme Court has now set aside the SAT order.
  • The Court observed that the stock market is not a platform for any fraudulent or unfair trade practice.
  • SC has not mentioned the tax evasion angle in its judgement.
  • However it had made it clear that the synchronized trades did affect market integrity.
  • It held that orchestrated trades, whether in the cash or derivatives segment, are a misuse of the market mechanism.
  • Moreover, protection of interest of investors as per SEBI Act, 1992 necessarily includes prevention of misuse of the market.
  • The bench reiterated the need for a more comprehensive legal framework governing the securities market.
  • It stressed the need for SEBI to keep pace with changing times and develop principles for good governance in the stock market.

What is the significance?

  • SC’s ruling on synchronised trading strengthens SEBI in prosecuting cases of price manipulation in future.
  • It empowers SEBI to impose severe penalty even on the smallest manipulations in the derivative segment.

 

Source: Live Law, Business Line

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