SC's Ruling on Synchronised Trading

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