SEBI may tighten norms to curb front-running

A recent Supreme Court ruling may nudge SEBI to bring in more clarity with regard to rules on front-running and such other fraudulent trading practices in stock markets.

Front-running is use of non-publicly available information to trade in securities in anticipation that when the information becomes public, the price of such securities will change.

In their recent order, Supreme Court judges, Justices NV Ramana and Ranjan Gogoi pointed to the need for a comprehensive law relating to SEBI’s Prevention of Fraudulent and Unfair Trade Practices (PFUTP) norms. The judgment, in which the apex court said SEBI’s norms fell short of its actual intent, came in the last week of September.

“It is more of an instruction to the regulator than an observation,” said JN Gupta, former Executive Director of SEBI. “When the highest court points out a flaw, it is a direction to reform the law.”

Although SEBI’s PFUTP prohibits such trading practices as wash sales, front-running, price rigging, artificially raiing or lowering prices of the securities, there is a nothing specific in the norms about these practices. Especially, the concept of front-running is understood only in general parlance, experts say.

“The concept of front-running is found more in jurisprudence... but it is not very specific in law,” said Tejesh Chitlangi, Partner, IC Universal Legal.

The Supreme Court ruling said: “SEBI’s PFUTP norms do not explicitly list aspects pertaining to non-intermediary individual’s liability in front-running matters, whilst the front-running is specifically defined under a SEBI circular. The unfair and fraudulent practices have not been adequately defined by SEBI. Since, SEBI recently appointed a committee to review the PFUTP regulations, it would be relevant for the committee to opine on a broader law incorporating SC’s observations.

“SEBI Act does not prescribe or specify as to which practice would be considered to be fraudulent and unfair trade practices. While the fraudulent and unfair trade practices are commonly understood, it would be desirable if these practices are defined specifically. This will bring about clarity among the intermediaries, issuers, investors and other connected persons in the securities markets about the practices that are prohibited, fraudulent and unfair.”

Justice Gogoi said “an unclear picture emerged from undefined concepts contained in the Act and the Regulations framed thereunder, a comprehensive legislation can bring about more clarity and certainty on these aspects.”

Experts said SEBI was finding it difficult to deal with cases of front-running involving mutual fund managers. The regulator has detected instances of several individuals acting as trading fronts for a few mutual fund managers, but has not been able to pin down the charges.

The apex court ruling also expanded the scope of the front-running and insider trading regulation, by bringing in more entities under its ambit. It said individuals as well as entities, which are not necessarily market intermediaries, will be charged with front-running if they are found to be trading on the basis of such information. So far, only market intermediaries registered with SEBI were covered. The court also said any person found conveying confidential information about upcoming large trades will be deemed to be indulging in fraudulent trade practices if it results in unfair gains for a third party.

This makes it easier for SEBI to crack down on individuals acting as fronts for fund managers.

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