INTRODUCTION
Dealing in equities is subjected to volatility and market risk. The Capital Market in India is at an all-time high with higher retail exposure and investors flocking in with Capital and new strategies. However, specifically, the Securities Market is known to be speculative and manipulative at times which exsanguinates the savings of the retail investors. The Stock Market is highly volatile with stock operators working on specific scripts that can be manipulated by gaining delivery or option leverages. The Securities and Exchange Board of India (“SEBI”) in a Public Order [https://www.sebi.gov.in/media/public-notices/jul-2020/public-notice-in-respect-of-sebi-settlement-scheme-2020_47150.html] vide dated 27th July 2020 has launched a Settlement Scheme for entities who had executed reversal trade (Bogus trades, non-genuine with intent to make a notional profit/loss.) in Bombay Stock Exchange (“BSE”) Future & Option Segment in Illiqudated Stocks (Shares which are not frequently traded in the open market) to derive a notional Profit/ Loss. These transactions are not only manipulative as artificial volume is created but also, in furtherance with a criminal intent to defraud through the sauda book gains/ losses. Therefore, these trades result in artificially creating volume which is a deception and manipulates the bona fide investors.
OPTION TRADING: MEANING
Options are financial derivatives sold by an option writer to an option buyer. The contract offers the buyer the right, but not the obligation, to buy (call option) or sell (put option) the underlying asset at an agreed-upon price during a certain period of time or on a specific date. The factors which influence the Options prices are underlying price, strike price, time until expiration, volatility, interest rates, and dividends. There are various market-based models (Black and Scholes Model) which throw an indicative price of the Option after inputting the various parameters mentioned above.
MODUS OPERANDI OF REVERSAL & NON GENUINE OPTION TRADING
Non-genuine trades through the Exchanges have been in existence since the trading platform was digitized. Since all trades which are executed nationwide and abroad are visible on a screen, it gives more leverage to the stock operators as their moves can attract and disinterest investors both retailers and High Net worth Investors (“HNI”).
Reversal trades have been considered as those trades in which an entity reverses its buy or sell positions in a contract with subsequent sell or buy positions with the same counterparty during the same day, preferably within minutes. The said reversals trades are non-genuine trades as they are not executed in the normal course of trading, lacks basic trading rationale, and lead to a false or misleading appearance of trading in terms of generation of artificial volume, hence were deceptive and manipulative. The entity having a buy position will be connected to the entity subsequently placing a sell position. Therefore, the entities will act in concert and reverse the trade within a few minutes.
The results of these reversal trades are manifold:
For the entity booking profit: It would be a lawful gain, the balance sheet will be positive. The entity can invite new investors by projecting growth and be eligible for new loans, since it is a profit-making entity creditworthiness increases.
For the entity booking Loss: It would be a lawful loss hence the entity can use it by setting off/ carry forward the losses and evade tax. As the loss will be prima facie it would face no income tax scrutiny.
There could be other reasons also since notional profit and loss can be applied in several ways, but the above-mention are few logical deductions as to why an entity would enter in a reversal trade.
ROLE OF SEBI: REACTIONARY
SEBI has sufficient administrative powers and limited judicial powers however it has been a reactionary regulator with respect to the reversal trading issue. SEBI had no specific prohibition on reversal trading in F & O segment particularly. Also, it was only after March 2015 when SEBI realized that 83 % of derivative trade on BSE is in form of reversal trade (ADJUDICATION ORDER NO. Order/JS/DJ/2018-19/2343, In respect of Cellour Commercial Private Limited). Thereafter, SEBI had issued show-cause notices to all entities suspected of such speculative trade practices under Regulations 3 (a), 3(b), 3(c), 3 (d), 4 (1) and 4 (2) (a) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003 (“FUTP”) which are penalized under Section 15HA of the SEBI Act.
Regulation 4 of SEBI (PFUTP) Regulations: -
“Prohibition of manipulative, fraudulent and unfair trade practices
(1) Without prejudice to the provisions of regulation 3, no person shall indulge in a fraudulent or an unfair trade practice in securities.
(2) Dealing in securities shall be deemed to be a fraudulent or an unfair trade practice if it involves fraud and may include all or any of the following, namely:- (a) indulging in an act which creates false or misleading appearance of trading in the securities market;”
In SEBI v. Shri. Kanaiyalal Baldevbhai Patel and Ors. 2017 SCC Online SC 1148, it was held that although unfair trade practice has not been defined under the regulation, various other legislations in India have defined the concept of unfair trade practice in different contexts. A clear cut generalized definition of the ‘unfair trade practice’ may not be possible to be culled out from the aforesaid definitions. Broadly trade practice is unfair if the conduct undermines the ethical standards and good faith dealings between parties engaged in business transactions. It is to be noted that unfair trade practices are not subject to a single definition; rather it requires adjudication on case to case basis. Whether an act or practice is unfair is to be determined by all the facts and circ*mstances surrounding the transaction. In the context of this regulation, a trade practice may be unfair if the conduct undermines the good faith dealings involved in the transaction. Moreover, the concept of ‘unfairness’ appears to be broader than and includes the concept of ‘deception’ or ‘fraud’.
Further in the case of SEBI v. Rakhi Trading (P) Ltd. (2018) 13 SCC 753, the court dealt with similar reversal non-genuine trades it was held that Regulation 4(1) in clear and unmistakable terms has provided that “no person shall indulge in a fraudulent or an unfair trade practice in securities”. Therefore, all reversal trade issues can be a subject matter of inquiry under section 15-I (Power to investigate) of the SEBI Act, and the penalty can be levied under section 15-HA.
However SEBI had failed to prevent such reversal trading manipulation, it was only after April 2015 when the norms were stringent and prohibitory measures were in place.
Further, a very controversial question that is being raised by the entities put to notice in this matter is the ‘lapse of reasonable time’ as of October 2020 SEBI has not issued any Show Cause Notice to the majority of the Noticee(s). The reversal trades were executed primarily in the year 2014-2015, so the delay in initiation of proceedings could be a plausible argument by the Noticee(s) who have refused to settle. However, in the case of SEBI v. Bhavesh Pabari (2019) 5 SCC 90: 2019 SCC, it was held that whenever the period of limitation is not prescribed, such power must be exercised within a ‘reasonable time’. The reasonable time test would depend upon the facts and circ*mstances of the case, nature of the default/statute, the prejudice caused, whether the third-party rights had been created, etc. Hence, the reasonable time will be fettered by the discretion of SEBI.
ABOUT THE SEBI SETTLEMENT SCHEME 2020
The Hon’ble Securities Appellate Tribunal, Mumbai vide its Order dated October 14, 2019 in the matter of R S Ispat Ltd Vs SEBI, had ordered SEBI to consider holding a Lok Adalat or adopting any other alternative dispute resolution process with regard to the Illiquid Stock Options since there were multiple similar cases pending.
A total of 14,720 entities have been identified as involved in the generation of artificial volume by executing non-genuine/reversal trades on the same day. The uniform consolidated Settlement factor of 0.55 has been decided. This rate is decided by keeping the following parameters in place:
·Artificial volume created in the process,
·Number of non-genuine trades,
·Number of contracts resulting in the creation of artificial volume/ non-genuine trades to arrive at an Indicative Settlement Amount.
This is a one-time settlement scheme which has commenced from 1st August 2020-31st October 2020 and the entities which do not settle shall be liable for investigation and penalty under section 15-I of the SEBI Act.
CONCLUSION
The above-mentioned scheme is a one-time settlement scheme SEBI has clarified by stating the entities who do not settle under this scheme shall be liable for action under relevant provisions. Some observation which can be deduced:
i.SEBI has a uniform penalty of 0.55 which means for every bogus trade of Rs. 100 the penalty would be Rs. 55 the rate of penalty is high it is likely that entities would settle.
ii.There a few entities which have had Adjudicating Officer’s order and their penalty was higher than the penalty which they are offered in the Settlement Scheme, these entities may settle.
iii.There are several entities that had executed trades to the tuneless than 5,00,000/-, but due to the minimum fine under section 15-HA even they would have to pay Rs. 5,00,000/- in order to avail the settlement scheme. In all likelihood, these small investors will not settle under the current scheme.
iv.It is also deduced that many entities are shell entities that are bogus. Hence these entities were just created to disgorge money and manipulate the market.
v.If entities do not settle SEBI will be pursuing with 15-I but would face administrative restraints since it would finally come down to proving things in a court of law.
Further, the penalty under section 15-HA for Fraudulent and Unfair Trade practices shall be a minimum of five-lakhs but may extend to twenty-five crores or up to three times the profit made. The penalty is sufficient for the modern notions however when the parties are indulging in reversal trading then practically the parties do not incur a profit. The closing date for the scheme is 31st October 2020.
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DISCLAIMER: The Author is a Registered Mutual Fund Broker with AMFI ARN-14952. This article is only for educational purposes. Fraudulent and Unfair Trading Practice is a punishable offense.
