SEBI on Penalty for indulging in reversal trading of securities

SEBI on Penalty for indulging in reversal trading of securities

Securities and Exchange Board of India (SEBI) on Penalty for indulging in reversal trading of securities: In the matter of Section 15-I petition filed under Rule 5 of SEBI (Procedure for Holding Inquiry and Imposing Penalties) Rules, 1995, order dated 29/Oct/2021

Brief Introduction of the Order passed by SEBI:

An observation was made by the Securities and Exchange Board of India (SEBI) with respect to the trading made by Nidhi Minni, the ‘Noticee’ herein, represented by its Authorized Representative, Mrs. Ruchika Poddar, with reference to reversal trades made by her through her broker on 06. Aug. 2015. A reversal trade is a non-genuine trade that is not considered normal as it leads to false and misleading appearances of trading volumes and pricing and hence devoid of basic trading rationale.

SEBI noted abnormal trading and initiated adjudicating proceedings against the ‘Noticee’ for violation of Section 3(a) to (d) and Section 4(1) and 4(2)(a) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003, in short, referred to as ‘PFUTP Regulations, 2003’.

SEBI further appointed an Adjudicating office Mr. K.Saravanan as on 26.Apr.2021and due to his transfer appointed Mr. Parag Basu as on 14.Jul.2021. A show-cause notice (SCN) was issued by the ‘Noticee’ under Rule 4(1) of the Adjudicating Rules and to provide an explanation to the reversal trading and why a penalty should not be imposed on the trader.

A reversal trade is where an individual or entity reverses its buy or sell positions in a contract with immediate and subsequent sell or buy positions with the same counterparty on a single day of trading. The given an effect of misleading or false appearances in trading and creates an artificial volume in trades and hence is construed to be manipulative and deceptive. In this case, the ‘Noticee’ had indulged in four reversal contract trades in two stock option contracts. Due to the trades, artificial volumes in units to an extent of 212,000 units were observed. The details of the non-genuine trades made by the ‘Noticee’ are listed below.

S.No.	Contract Name	Avg. Buy rate (INR)	Total Buy Volume (Units)	Avg. Sell rate (INR)	Total Sell volume (Units)	% of non-genuine trades to Notices total trades in contract	% of non-genuine trades to total trades in contract	% of artificial trade volume in contract to Notices total volume in the contract	% of artificial trade volume in contract to total volume in the contract
1	DABU15AUG320.00PE	7	32000	15.5	32000	100	100	100	100
2	DABU15AUG300.00PE	4	74000	8	74000	100	50	100	69.16

It can be seen from the above table that the percentage of non-genuine trades in the stock options contract to total trades of the ‘Noticee’ in the contract raged between 50% to 100% in the aforesaid contracts. Artificial volumes generated by ‘Noticee’ amounted to an entire 100% of total volumes generated by the ‘Noticee’ in both contracts. The percentage of artificial volume generated by the Noticee to the total volume of the market in the contract raged between 69.16% to 100%. The difference between the buy and sell rates was also significant and the party to the buy and sell contract was one party namely ‘Overactive Merchants Private Limited’ to an extent of 32,000 units. The buy rate was INR. 7 per unit and the sell rate was INR. 15.5 per unit for contract DABU15AUG320.00PE. For contract DABU15AUG300.00PE, the buy rate was INR. 4 per unit and the sell rate was INR. 8 per unit and here too there was a significant difference between the buy and sell rates.

Hence SEBI noted significant artificial volumes being generated and also significant price variances which lead to fraudulent trading as per Section 3(a) to (d) and Section 4(1) and 4(2)(a) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003, in short, referred to as ‘PFUTP Regulations, 2003’.

Contention of the ‘Noticee’:

The ‘Noticee’ did not reply to the SCN issue by SEBI and she was called for a personal hearing. In the personal hearing, the ‘Noticee’ replies stating that she was routing all her trades through her stockbroker and was not aware of the reversal trades. She also pleaded that she was party to only a few transactions and hence the adjudicating authority should take a lenient view of the transactions.

Analysis and the final judgment:

The SEBI took note of the reversal transaction which took place on 06.Aug.2015 where the buy transaction took place at 15.02.04 hrs and 32,000 units were priced at INR. 7 per unit and the sell transaction took place at 15.04.04 hrs for 32,000 units which were priced at INR. 15.5 per unit. This generated artificial volumes of 64,000 units.

The contention of SEBI was on the grounds that the reversal transaction was illegal and that the ‘Noticee’ cannot plead ignorance as the transaction was made through her DMAT account. It further stated that the ‘Noticee’ is obliged to comply with the PFUTP Regulations, 2003 and even if the ‘Noticee’ operated through its stock broker, she is responsible for the trades made for her and through her DMAT account. Further, SEBI concluded that the ‘Noticee’ has indulged in pre-determination of prices and substantiated through Supreme Court ruling in the matter of SEBI Vs. Kishore R Ajmera that even though there is no explicit evidence to state that there was meeting of minds and alleged price pre-determination for the trades, it was stated that it cannot be done without some sort of prior illegal intent in meeting of minds. Hence basis proximate facts and circumstantial evidence surrounding the events, the Supreme Court has held that such reversal trades are illegal. In another Supreme Court Case namely SEBI Vs. Rakhi Trading Private Limited, it was held that basis the volumes and price of the stocks traded under reversal trading, it would be too naïve to hold such transactions as screen-based and anonymous. Hence such transactions were held illegal by the Supreme Court and also by Securities Appellate Tribunal (SAT) in its ruling in Ketan Parekh Vs. SEBI.

SEBI further quoted Supreme Court ruling in SEBI Vs. Shri Ram Mutual Fund with reference to the penalty for the illegal trades made by the ‘Noticee’ and further imposed penalty under Section 15HA of SEBI Act, 1992 which would amount to three times profits made by the parties involved.

Hence for the violation of Section 3(a) to (d) and Section 4(1) and 4(2)(a) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003, in short, referred to as ‘PFUTP Regulations, 2003’, the ‘Noticee’ was fined INR. 500,000/- for indulging in illegal reversal trading and was granted 45 days to make the payment. The order further stated that if the ‘Noticee’ fails to comply with paying the penalty, SEBI would initiate recovery proceedings under Section 28A of the SEBI Act, 1992, along with interest, inter alia by attaching movable and immovable properties of the ‘Noticee’ for recovery of the penalty amount.

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