The Hindu Business Line : SEBI rulings: Case of inexplicable inconsistency

ON SEPTEMBER 10, the SEBI Chairman, Mr G. N. Bajpai, issued separate orders against five entities — ICICI Brokerage Services Ltd (IBSL), Woodstock Securities (P) Ltd, Indsec Securities and Finance Ltd, CSFB Securities Ltd and Mukesh Babu Securities Ltd — which were charged with synchronised trading in the stock of Global Trust Bank.

Indsec and Woodstock were counterparties in transactions with IBSL on the same day in the GTB stock. CSFB and Mukesh Babu were pulled up for different transactions over different periods but in GTB shares. All the entities were charged with violating the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003, known more commonly as FUTP Regulations.

Enquiry officers of the Securities and Exchange Board of India had found all the entities guilty and recommended punitive bans ranging from three months to one year. But the SEBI Chairman absolved IBSL of charges, and let off Indsec and Woodstock with a warning. He affirmed the recommended punishments against CSFB and Mukesh Babu.

In all the cases, SEBI had relied mostly on trading patterns and data to establish synchronised trading. However, while the enquiry officers were consistent in fixing guilt, the Chairman disagreed with them in the case of IBSL, Woodstock and Indsec. \ IBSL sold, on behalf of Asian Development Bank, 50 lakh GTB shares each on the BSE and the NSE on April 11, 2000. The sale was done at a fixed price of Rs 83 per share but in several lots ranging from 2.5 lakh to 7.5 lakh shares. Indsec and Woodstock were among the buyers of the stock that IBSL sold.

One of the guiding principles in proving synchronised trading, as per the SEBI Regulations, is the exactness of the price and quantity of the `buy' and `sell' orders and the closeness in time at which they are placed. In all the four cases the transactions fulfilled that crucial criteria.

Consider the case of Mukesh Babu Securities. The SEBI enquiry officer found six synchronised trades in the GTB scrip on different dates from November 18, to December 3, 2000. On four occasions, Mukesh Babu Securities had purchased 5.2 lakh GTB shares for its sub-broker, Mr Shirish N. Maniar. The client for the sub-broker was Classic Credit Ltd, allegedly a Ketan Parekh investment company. In the last two instances, the member-broker had sold about two lakh GTB shares and the purchasers were Classic Share and Stock Broking, and Triumph International, both entities identified with Ketan Parekh.

In that case Mr Bajpai observed: "I do not accept the contention of the broker. A perusal of the details of the transactions would indicate that the buy order and the sell order in respect of the said transactions were placed in close proximity with each other. The difference in time in buy and sell order ranges from 1 to 6 seconds and the quantity and price of these two orders are exactly the same in all the above transactions. As observed by the enquiry officer the price and order matching mechanism of the stock exchange is a `blind' system wherein the identity of the counter-party to a transaction is not revealed."

As a matter of record, it is accepted even by SEBI that the stock exchanges' order matching system is nearly unbeatable because they recognise time lags of up to 1/164th of a second. Now consider what Mr Bajpai said in the IBSL case.

"The GTB scrip was liquid and there were a large number of traders in the scrip on a given day, including April 11, 2000. The buy and sell orders were placed in close proximity with each other and the price and quantity in the said orders were identical. Thus I find that all the ingredients of synchronised trades were present in the trades by the said broker. However, I also note that the price of the share remained constant at Rs 83 throughout the period in which the said broker had sold the shares. In this regard the enquiry officer has made an observation that the sell orders were not placed at increasing prices, which is expected of a prudent seller."

Mr Bajpai accepted IBSL's contention that it was merely acting on instructions from the ADB. He also did not agree with the enquiry officer's finding that "there was a meeting of minds between ADB and the KP entities, on the one hand, and the said broker and the counterparty brokers, on the other, with the intention of manipulating the price and volume of the share of GTB".

"In addition, I find it highly improbable that an international development financial institution such as ADB would enter into manipulative transactions and also that a reputed Indian financial institution would like to be a party to manipulative transactions," Mr Bajpai said in his order overruling the enquiry officer's recommendation.

However, the Chairman interpreted similar circumstances in Mukesh Babu Securities' case in a different way. "In this regard, I note that a `smoking gun' may be hard to come by in case of offences such as synchronised trading. The plea of coincidence is taken by all those who are parties to the offence. Therefore, a conclusion or finding of violation can only be arrived at by examination of the trading patterns adopted by the entities involved.

"The analysis of the trading patterns and findings of guilt based on the same cannot be called surmises or inferences. They are clear indications of misdeeds by market participants. I find that the analysis of the trades in the present case clearly point finger at possible nexus between the parties involved in the transactions. I further find that upon analysis of the trade details, there is sufficient evidence of synchronised trading in the scrip of GTB," Mr Bajpai said.

In the Nirmal Bang case, the Securities Appellate Tribunal had clarified that synchronised trading is per se not illegal unless the intent to manipulate the price by creating an artificial market is proven. "In my view for the market manipulation stated in Regulation 4 (of FUTP Regulations) if one is to be charged it is absolutely necessary to prove that the person had acted intentionally," SAT had said. In the Videocon case, the Tribunal examined the extent of evidence required to establish the charge of market manipulation and observed: "... in the absence of reasonably good evidence to support, charge of market manipulation, which is a very serious one, cannot stick on the Appellant company, merely on surmises and conjectures."

In the Mukesh Babu Securities case Mr Bajpai said: "I do not accept the explanation of the said broker that they had merely acted on behalf of their clients without any intention to indulge in synchronised trading. I further find that the said broker failed to exercise due diligence while executing the said transactions. A stock-broker is expected to have adequate knowledge of the dynamics of the stock market and take necessary steps to prevent the commission of irregularities/violations by their constituents/sub-brokers. The said broker has failed to do this and thereby violated Clause A (4) of the Code of Conduct of Stock Brokers (Schedule II of Stock Brokers Regulations)."

The SEBI Chairman, however, accepted Indsec's contention that the exactness and proximity of order matching were coincidental. "I have noted the submissions of the said broker (Indsec) that they acted as per the instructions of their clients; however, in doing so, they were also required to comply with statutory requirements such as the Code of Conduct. As intermediaries in the stock market, a duty was cast on them to refrain from facilitating manipulative activities in the market.

The manner and pricing of the transactions should have alerted the said broker to the possibility of market manipulation and they should have advised their clients against continuing the said transactions in the said manner; but they failed to do so."

Another factor that was vital in changing the Chairman's mind in IBSL's case were two letters from the ADB that confirmed that IBSL was indeed acting on its instructions and that they were given under approved procedure. The enquiry officer, however, did not have the benefit of the letters because they were received after he had completed his investigation.

"I am of the view that if the letters were before the enquiry officer for his consideration he would not have come to the conclusion that the orders were placed at a constant price in order to manipulate the trading system," Mr Bajpai said.

It beats reason that if one institution's word on the genuineness of its transaction can be taken as granted, how another entity's testimony rings hollow to the regulator's ears.

Though IBSL was the counter-party to the transactions of Indsec, the Chairman chose to warn the latter but not the former. Perhaps his presumption that reputed financial institutions are unlikely to engage in manipulative practices helped. Also Indsec's client was said to be a Ketan Parekh entity. But at the time of the transaction, even Ketan Parekh's reputation was enviable.

Ketan Parekh became a persona non grata in the eyes of the regulator after mid-2001 when the stock market bubble burst and the high-profile stockbroker was arrested under a cloud of allegations that he siphoned off money from the banking system to fund his equity market operations. Until then, however, he had been a star on Dalal Street with an enviable reputation for his ability to pick stocks.

The SEBI Chairman may also remember that the birth of the institution he heads was forced by a stock scam in 1992 that reduced to dust the reputations of many revered financial institutions, domestic as well as international.

Saying that reputed institutions are unlikely to commit offences is virtually implying that while light evidence could nail a less reputed entity, it would take much more evidence to fix guilt on a reputed one.

It is also curious that Mr Bajpai should chide Indsec for breach of the Code of Conduct but find IBSL innocent in a transaction where the two were alleged to have connived.

Yet another factor that needs to be considered is the number of synchronised trades. While Mukesh Babu is said to have committed the offence six times over 15 days, IBSL struck 11 deals on the BSE and 15 on the NSE within a space of two-and-half hours.

Though 26 deals totalling one crore shares were put through in such a short time, Mr Bajpai did not find it odd that a buyer popped up with the exact quantity and price every time within seconds of IBSL hitting the screen with its quote.Such inconsistencies in approach while making judgments can seriously impair SEBI's reputation as a fair regulator.

Though SEBI has made long strides in the quality of investigation, it must learn to present its case better.

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