Introduction
In an interim ex-parte order last month against the dealers of Reliance Securities Limited (“RSL”) and other related entities (“RSL Order”)[1], SEBI prima facie held over two dozen entities to have engaged in front running the trades of Tata Absolute Return Fund, a scheme of Tata AIF (“Big Client”).
During its preliminary examination, SEBI meticulously pieced together several bits of available circumstantial evidence and alleged an archetypal scheme of front running purportedly employed by three senior dealers (“Dealers”) at RSL, in nexus with various related entities. The RSL Order alleges that once the Dealers at RSL were privy to the non-public information of the impending orders of Big Client, they along with their connected broker or dealer entity would, through multiple trading accounts directly or indirectly controlled by them, place trades either in the Buy-Buy-Sell pattern or Sell-Sell-Buy pattern, around the time of the orders of the Big Client to generate substantial proceeds.
Consequently, while highlighting that the balance of convenience dictated the need for immediate action in order to prevent further harm to the securities market and to ensure a level-playing field for the general investors, SEBI inter alia barred all the 27 entities from accessing or associating themselves with the securities market, until further directions.
The RSL Order was issued as an ex-parte order by SEBI, in exercise of its powers under Section 11 and 11B of the SEBI Act, 1992 (“SEBI Act”), and provides an opportunity to the concerned entities, including the Dealers, to submit their reply. Once the concerned entities have been provided adequate opportunity to reply (through oral and written representations), the RSL Order will be followed by a final order.
In light of the foregoing, below are the key aspects of front running applicable in India, as examined and explored in the RSL Order.
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What is the meaning of front running?
Broadly, front running in the securities market refers to the illegal practice of using non-public information or confidential information, for buying or selling securities ahead of a large order (“Big Client Order”), in order to benefit from the subsequent predictable price movement post the execution of such Big Client Order.
Some of commonly used definitions are as follows:
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- Major Law Lexicon by P Ramanatha Aiyar[2]:
Front running – Buying or selling securities ahead of a large order so as to benefit from the subsequent price move.
This denotes persons dealing in the market, knowing that a large transaction will take place in the near future and that parties are likely to move in their favour.
The illegal private trading by a broker or market-maker who has prior knowledge of a forthcoming large movement in prices. (Investment)
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- Black’s Law Dictionary[3]:
Front running, n. Securities – A broker’s or analyst’s use of non-public information to acquire securities or enter into options or futures contracts for his or her own benefit, knowing that when the information becomes public, the price of the securities will change in a predictable manner. This practice is illegal. Front-running can occur in many ways. For example, a broker or analyst who works for a brokerage firm may buy shares in a company that the firm is about to recommend as a strong buy or in which the firm is planning to buy a large block of shares.
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How is front running dealt with under the Indian regulatory framework?
SEBI recognised front running as an undesirable manipulative practice, in its Consultative Paper dated March 16, 1995,[4] and accordingly brought it within the ambit of the erstwhile SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 1995 (“1995 PFUTP Regulations”).
The erstwhile SEBI (Settlement of Administrative and Civil Proceedings) Regulations, 2014[5], read with the SEBI Circular dated May 25, 2012[6], categorically defined front running as, “‘front running’ means usage of non-public information to directly or indirectly, buy or sell securities or enter into options or futures contracts, in advance of a substantial order, on an impending transaction, in the same or related securities or futures or options contracts, in anticipation that when the information becomes public; the price of such securities or contracts may change.”
Currently, Regulation 4(2)(q) of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (“2003 PFUTP Regulations”), encompasses front running as a fraudulent and unfair practice:
“Dealing in securities shall be deemed to be manipulative, fraudulent or an unfair trade practice… if it involves any order in securities placed by a person, while directly or indirectly in possession of information that is not publicly available, regarding a substantial impending transaction in that securities, its underlying securities or its derivative;”
Pursuant to the landmark judgment of the Supreme Court in SEBI vs. Shri Kanaiyalal Baldevbhai Patel and Ors.[7] (“Kanaiyalal Case”), and the consequent recommendations by the Committee on Fair Market Conduct,[8] the scope of Regulation 4(2)(q) of 2003 PFUTP Regulations was broadened to prohibit front running by non-intermediaries and individuals, w.e.f. February 1, 2019.
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Which are the entities involved in front running?
In the world of financial trading, a front-runner is commonly referred to as someone who gains an unfair advantage with inside information.[9]
Regulation 4(2)(q) of the 2003 PFUTP Regulations envisages front running as a trade practice undertaken by a person in possession (directly or indirectly) of non-public information regarding a substantial impending transaction. Normally, this would apply to a person who trades while being privy to a Big Client Order. Interestingly, the RSL Order identifies two categories of people who can perpetuate front running, viz.:
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- Information carriers: Entities which have direct or indirect access to the non-public information of the Big Client Order, are referred to as ‘information carriers’; and
- Front runners: Entities from whose trading accounts front running trades are executed, are referred to as ‘front runners’.
In the past, although SEBI has held the tippers liable for fraud and manipulative practices, usually, the specific charge of front running was applied to the entities that had actually undertaken the trades. By relying on familial relationships, call records, bank account transfers, social media connections, etc., the RSL Order alleges a nexus between entities who fall in both categories and seeks to bring the ‘information carriers’ within the fold of Regulation 4(2)(q) as well, on the basis that they were responsible for the trades executed through the accounts of the ‘front runners’.
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What are the key elements for classification of trading as front running?
Per the RSL Order, following factors are considered necessary for classifying trading activity as front running:
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- Possession of non-public information regarding the Big Client Order; and
- Placing of order by the alleged front runner in securities (directly or indirectly) in advance of the Big Client Order, while in possession of the aforesaid non-public information. Since, the Big Client Orders are usually placed in smaller tranches, therefore, any order placed by the alleged front runner on or before the time of last tranche of the Big Client Order, would qualify as a front running transaction.
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What are the modes of execution of front running?
Front running activity is normally executed in the following ways:
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- Buy-Buy-Sell (“BBS”) – This pattern denotes ‘Buy’ by the alleged front runner, ‘Buy’ by the Big Client, followed by ‘Sell’ by the alleged front runner.
- Sell-Sell-Buy (“SSB”) – This pattern denotes ‘Sell’ by the alleged front runner, ‘Sell’ by the Big Client, followed by ‘Buy’ by the alleged front runner.
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How is front running different from insider trading?
Conceptually, they are not particularly different. Both front running and insider trading are instances of market abuse that are premised on a person/ entity having access to non-public information that could influence the price of securities. While jurisdictions such as the US and Singapore, have typically identified front running and insider trading as separate offences, the lines do get blurred. In 2019, a Singapore court convicted three individuals who had engaged in front running, for the offence of insider trading; this was the first instance of front running being prosecuted as an insider trading offence in Singapore[10]. Given that the insider trading laws in India treat any person having access to ‘unpublished price sensitive information’ as an insider, the linkage to front running is even more apparent. However, the regulator till date has not chosen to conflate these two offences and has generally dealt with front running cases under the PFUTP Regulations only.
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What are the enforcement powers of SEBI in case of front running?
Under the SEBI Act, any person who indulges in fraudulent and unfair trade practices shall be liable with penalty which may extend to INR 25 crore, or three times the amount of profits made out of such practices, whichever is higher.
In addition to this, SEBI has the ability to initiate parallel civil enforcement proceedings on the same set of facts under the SEBI (Intermediaries) Regulations, 2008, and under Section 11/11B of the SEBI Act. Moreover, Section 24 of the SEBI Act also empowers SEBI to initiate criminal proceedings in court against any person.
[1] SEBI Ad Interim Ex Parte Order, in the matter of Front Running Trading activity of Dealers of Reliance Securities Ltd. and other connected entities, dated August 7, 2020
[2] 4th Edition 2010
[3] Ninth Edition
[4] Reference no. PR 34/95
[5] SEBI (Settlement of Administrative and Civil Proceedings) Regulations, 2014 were replaced by the SEBI (Settlement Proceedings) Regulations, 2018, with effect from January 1, 2019.
[6] Circular CIR/EFD/1/2012
[7] Civil Appeal No. 2595 of 2013, dated September 20, 2017
[8] Report of Committee on Fair Market Conduct, dated August 8, 2018
[9] Nancy Folbre, The Front-Runners of Wall Street, April 7, 2014 (The New York Times).
[10] Available at: https://www.mas.gov.sg/news/media-releases/2019/court-convicts-three-individuals-for-insider-trading-and-orders-forfeiture-of-criminal-proceeds