I. Introduction

Capital markets are traditionally an outcome of uninterrupted supply and demand forces. Factors such as anonymity and free flow of information work cumulatively to ensure their stability and efficiency (1). However, there are certain types of transactions on stock exchanges that can work against these factors, impacting price movements and volatility of stock markets. This results in numerous potential threats in regulatory supervision.

An example of such a disruptive transaction is that of synchronised trading. This is a practice characterised by sales from known sellers to buyers at a pre-determined price executed through simultaneous buy and sell orders on the stock exchange (2). In effect, synchronised deals allows unscrupulous market participants to deny investors (other than a select few) a chance to participate in the trading process while also manipulating market volumes and prices. This limitation has consequently raised doubts on legality of such transactions under particular legislation.

So far, Indian courts have differentiated between legitimate and illegitimate synchronised transactions based on ‘manipulative intent’ of parties, by following two differing yet contradictory approaches. By analysing the legal framework and recent judicial decisions on the permissibility of such trades under Indian law (3), this piece attempts to establish that the present view of the Indian regulator as to the statutory validity of such transactions, in absence of surrounding circumstances suggesting manipulative intent, is unclear. It also argues that current intent-focused standard is an insufficient basis to proscribe synchronised dealings. Rather, it proposes a more concrete harm-based approach as a basis to ground determination of illegality.

II. Differentiating Negotiated Deals from Synchronized Transactions

At the outset, it is helpful to clarify an oft-misperceived distinction with respect to such transactions, namely between negotiated deals and synchronised transactions. Traditionally, pre-arranged trades between parties in securities transactions can be executed in broadly two ways: first, through bulk deals (4) or block windows (5) and second, through negotiated deals (6) or synchronised transactions (7). While the former are purely completed on-market, the latter may be pre-arranged off-market but executed on-market.

Given both negotiated deals and synchronised transactions have scope for pre-meditation between parties, the Securities and Exchange Board of India (“SEBI”)(8), the Indian regulator of securities and commodities market, has previously clarified the distinction between the two by highlighting a key difference – based on ‘intent’ of parties. Negotiated deals are permitted “in the manner prescribed” (i.e. on stock exchanges through price and order matching mechanisms) irrespective of the manipulative intent (9), whereas synchronised transactions, while not per se illegal, are prohibited if they had the effect of manipulating the market price.

Illustratively, in the case of ICICI Brokerage Services Ltd. (10), Securities and Exchange Board of India (‘SEBI’) held as follows: “… negotiated deals cannot be equated with synchronised transactions. Initially, negotiated deals were done outside the stock exchange system but such trades were reported to the stock exchange. Thus, negotiated deals were always highly regulated by SEBI and stock exchanges … In sharp contrast, synchronised transactions […] are used as tools for manipulation of price and volume of shares.” (11) As a result, a synchronised dealing may be legal or illegal, depending on what the intent of the party is. (12)

As the section below explains, this distinction – primarily derived from manipulative intent – leaves much scope for error in Indian courts.

III. Examining the Legality of Synchronized Trading: Legal Framework and Case Law

The Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations 2003 (‘PFUTP Regulations’) are the principal regulations governing synchronised dealings. It was brought in force to prevent fraudulent, unfair, and manipulative trade practices relating to the securities market. Among others, two provisions worth noting for our purposes is regulation 3 and 4.

Regulation 3 prohibits dealings in securities that involve fraud, deceit or manipulation, and restrict persons from, inter alia, buying, selling, or otherwise dealing in securities in a fraudulent manner. (13) Regulation 4, on the other hand, prohibits persons from engaging in fraudulent or unfair trade practices in securities, and sets out an inclusive list of instances of fraudulent dealings.(14)

Two terms, fraud and manipulation, used in regulation 3 warrant some scrutiny, as courts have often confused between the two. The term ‘fraud’ has been defined by the PFUTP Regulations in an inclusive manner, and does away with the requirement to demonstrate ‘intention’ to ascertain the existence of ‘fraud’ (15) (as provided by its predecessor in 1993 (16)). Thus, an act can be deemed fraudulent under the PFUTP Regulations even in the absence of any intent to deceive on the part of the accused. (17) However, there is remarkably little guidance in the regulations as to the conduct which manipulation covers. (18) Regulation 3 baldly prohibits use of “any manipulative or deceptive device” in dealings in securities but fail to define what manipulative is.

This is precisely what makes synchronised transactions such a controversial issue. In absence of traditional forms of misconduct (such as fictitious trades, deceit or misstatements), Courts (19) have invoked the vague standard of manipulation under PFUTP Regulations, as against fraud to determine synchronised dealings as illegal – holding that manipulative intent between parties is considered essential to give effect to such transactions. Unsurprisingly though, proving manipulative intent has been of great challenge for Indian Tribunals and Courts. Despite an extensive jurisprudence examining the validity of such trades (see part III. B), the regulatory authorities remain indecisive on their position, especially so in cases lacking determinative evidence of manipulative intent.

Indian Courts have held that synchronised trades undertaken with a manipulative intent can lead to the violation of the PFUTP Regulations’ provisions. Interestingly, these decisions follow two divergent approaches – one observing that synchronised transactions are manipulative by default, whereas the other acknowledging that such practices are not illegal unless carried out with a manipulative intent.

i. Synchronised transactions categorized inherently manipulative

The former set of decisions note that synchronised trading interferes with the price discovery process of the stock exchange, thus leading to manipulation. (20) This implicit intention (21) or understanding between the parties amounts to tampering with the price discovery mechanism. (22) It, therefore, violates ‘all prudential and transparent norms on trading in securities’. (23)

The decisions following this line of reasoning have noted, for instance, that synchronised transactions lead to tampering of the market, or that they result in benchmarking the price. It is crucial to note that a clear manipulative intent was nevertheless found on the basis of facts in these cases, and the synchronisation of trades was, in essence, a means to effect manipulative intent. This might have led the SEBI and the Securities Appellate Tribunal (SAT) (24) to not make any explicit reference to parties’ intention, or even hold manipulative intent to be ‘inherent’ in such practices. (25)

ii. Synchronised transactions categorised as illegal with manipulative intent

Conversely, the latter set of decisions give effect to the intention of the parties and observe that even if synchronised trading is proved, guilt cannot be established if there is no intent to artificially influence the market and induce investors to buy or sell shares. (26) Accordingly, no market manipulation exists based on the fact that buy and sell orders were placed in a short time gap between two unconnected parties with a negligible or no price difference. (27, 28)

A similar conclusion may be drawn from the informal guidance provided by SEBI in 2004 in which synchronised order placements/transactions were held not to be strictly illegal, though any such transaction may be examined in light of the surrounding circumstances for motive or manipulative effect. (29) Additionally, the Supreme Court of India in 2018 cast a positive obligation upon SEBI to provide material evidence to prove ‘intent’ in cases of synchronised trading executed in the futures and options segments of stock exchanges. (30)

iii. A prevailing view?

The divergent views adopted by the Courts create uncertainty whether, in the absence of surrounding circumstances suggesting a manipulative intent, synchronised trades are valid or not. (31) It appears that SEBI, SAT and the Supreme Court have based their determination based on the facts and circumstances of each case, with due regard to the intention of the parties (though not the sole determining factor).

Other indicative factors that have been considered to determine illegality include a change in the beneficial ownership as a result of the transaction, an ability to artificially influence the market and induce investors by creating a misleading appearance of trading, (32) the impact of the transaction on the fairness and integrity of trading on the market, concerted efforts (such as dealing between known persons), (33) and transactions creating pre-planned and intentional trading losses (34), among others. These factors are non-exhaustive and Courts continue to devise new indicators on the basis of facts and circumstances of the cases.

Overall, the two varying approaches give wide scope for unpredictability in an already muddled arena of financial regulations. This disagreement and confusion over an acceptable standard may have serious repercussions on market integrity.

IV. Manipulative Intent: A Confused Standard?

The fractured view of the Indian courts detailed above reflects one of the most fundamental issues in financing through securities market: what constitutes illegal manipulation? While jurists, scholars, academics and economists have often been divided on this front (35), PFUTP Regulations does not offer any relief either (36).

Nonetheless, complexities in proving ‘manipulation’ is an intrinsic characteristic of modern markets. (37) If the view of the Indian courts is to be adopted, everything turns to the manipulative intent of the trader. Is this any different from punishing a criminal for merely having ‘a criminal state of mind’?

An inquiry into a trader’s intent (even if backed by objective acts suggesting malicious intent as listed in Part III) is a futile exercise for two reasons: first, observable acts with an intent to manipulate are often indistinguishable from non-manipulative trading (38), and second, because it is impossible to identify such trades as enforcement costs are very high.(39) Inevitably, discharging the burden to prove ‘intent’ turns out to be highly problematic in such cases.

SEBI’s current intent-driven approach, thus, only exacerbates practical and conceptual difficulties in enforcing such transactions. Mere intent alone can prove to be an incomplete standard with an incoherent basis to determine liability. On the contrary, a ‘market harm’ approach, requiring proof of both a negative impact on the market along with manipulative intent, could protect market efficiency and stability. By grounding inquiry on these twin tests, Courts can be more effective in deterring, detecting and improving enforcement outcomes, without negatively affecting legitimate synchronised transactions. Most importantly, it provides a viable criterion to separate manipulative (and illegal) conduct from permissible dealings.

Beyond the benefits of market integrity and reduced transaction costs, moving to a market harm criterion may however pose a potential risk of ex post regulation, which may be a reactive rather than prescriptive standard. However, an ex post regulation may perhaps be the best approach to tackle synchronised dealings , given the limited scope of ex ante regulatory interventions to hamper free market principle on stock exchanges.

To give effect to the above, Indian legislators and courts should incorporate elements of harm within the definitional elements of market manipulation. This would bring such transactions in line with other conduct deemed manipulative, as well as place a heavier burden to prove illegality – which is less circumstantial than the existing threshold of intent.

V. Conclusion

As demonstrated, intent does not explain why legitimate transactions such as this are manipulative, nor does it provide an adequate basis to determine illegality of such transactions. On the contrary, it has a weakening effect on enforcement, as the inconsistency in Indian courts’ judicial decision-making denotes. This article’s proposal, of moving to a more concrete harm-based criteria, addresses this shortcoming.

Irrespective, as the law stands currently, there remains a legal vacuum on the validity of these transactions in the absence of circumstances suggesting manipulative intent. Consequently, parties should be mindful of the various factors highlighted in Part III.C. to avoid any presumption of illegality. It remains to be seen how the jurisprudence in India evolves over time to provide more clarity on legality of synchronised transactions.

Hatim Hussain is a DPhil Law Candidate at University of Oxford and the President of the Oxford FinTech and LegalTech Society.

Footnotes

(1) Malkiel BG, ‘Is the Stock Market Efficient?’ [1989] 243 Science <www.jstor.org/stable/1703677>

(2) SEBI v Rakhi Trading Private Limited [2018] (2) SCALE 156, < https://www.sebi.gov.in/enforcement/orders/feb-2018/order-of-hon-ble-supreme-court-in-the-matter-of-sebi-vs-rakhi-trading-and-other-connected-civil-appeals-_37831.html>

(3) Unlike in certain other jurisdictions, there is no prescribed regulatory framework in India governing synchronised transactions. Having said that, certain Indian regulatory provisions which have a bearing on the structuring of such transactions include the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to the Securities Market) Regulations 2003 (hereinafter, ‘PFUTP Regulations’); SEBI Circular No. SMDRP/POLICY/CIR-20/98 dated 18 September 1998; SEBI Circular No. SMDRP/POLICY/CIR-32/99 dated 14 September 1999 and SEBI Circular SEBI/MRD/SE/Cir-7/2004 dated 14 January 2004, as well as case law.

(4) See, Securities and Exchange Board of India, Disclosure of trade details of bulk deals, SEBI/MRD/SE/Cir-7/2004 [2004] https://www.sebi.gov.in/legal/circulars/jan-2004/disclosure-of-trade-details-of-bulk-deals_11912.html. The circular defines bulk deals as “all transactions in a scrip (on an exchange) where total quantity of shares bought/sold is more than 0.5% of the number of equity shares of the company listed on the exchange” and provides for certain reporting requirements by brokers.

(5) Such transactions (also called ‘large-in-scale’ deals in UK) are executed through a block window before trading begins every day, usually at a discount (of -/+ 1%) on previous day’s closing price. These deals are useful for private equity investors where large acquisition of shares is required to be made on-market. The window for executing block deals is open two times on daily basis in India. See, Rachael Israel, et al, “India: Completing An M&A Transaction On-Market - Certain Key Considerations” (2020), Mondaq https://www.mondaq.com/india/securities/906756/completing-an-ma-transaction-on-market--certain-key-considerations. For most updated regulatory framework for block deals executed on stock exchanges, see, Securities Exchange Board of India, Review of Block Deal Window Mechanism, CIR/MRD/DP/118/2017 [2017], https://www.sebi.gov.in/legal/circulars/oct-2017/review-of-block-deal-window-mechanism_36338.html.

(6) Securities Exchange Board of India, SEBI Circular No. SMDRP/POLICY/CIR-20/98 [1998], < https://www.sebi.gov.in/legal/circulars/apr-1998/to-e-ds-presidents-m-ds-of-all-stock-exchanges_18575.html> (hereinafter, ‘1998 SEBI Circular’). According to the circular, a negotiated deal is defined as a transaction with either a transaction value of not less than Rs. 25 lakh or volume of not less than 10,000 shares, executed at a price not formed through the stock exchange mechanism. The circular requires, inter alia, that all negotiated transactions result in the delivery of shares and be subject to certain reporting requirements.

(7) Colloquially, synchronised trading is also called “123 trading” based on traders’ practice of counting up to three before selling shares. Unlike block deals where transactions are sold at a predetermined rate of discount, discount on synchronised trades is not regulated by Securities and Exchange Board of India. The market practice for discount on such trades is 3-4% of market price. See, “Shh! Don’t Talk about Synchronised Trading”, International Financial Law Review (2010), https://www.iflr.com/article/b1lv134nvmt962/shh-dont-talk-about-synchronised-trading

(8) For more information, see, Securities and Exchange Board of India https://www.sebi.gov.in/

(9) ibid 5. In a distinction from SEBI’s approach to synchronised transactions, the 1998 SEBI Circular classified all negotiated deals as legal, irrespective of the manipulative intent.

(10) See, ICICI Brokerage Services Limited, Order of the Chairman [2004], https://www.casemine.com/judgement/in/5af1ac0118a681762b08fe32 (‘Order of the Chairman’)

(11) ibid 9, the relevant excerpt is stated in para 4 (Consideration of issues) of the Order of the Chairman.

(12) Subhkam Securities Private Limited v SEBI, Appeal No 73 of 2012, [2012] < http://sat.gov.in/english/pdf/E2012_JO201273.PDF>

(13) PFUTP Regulations, 2003 < https://www.sebi.gov.in/legal/regulations/jul-2003/sebi-prohibition-of-fraudulent-and-unfair-trade-practices-relating-to-securities-market-regulations-2003-last-amended-on-september-6-2013-_34633.html>, r 3 [Prohibition of certain dealings in securities]

(14) ibid, r 4 [Prohibition of manipulative, fraudulent and unfair trade practices]. The acts prohibited by regulation 4 include acts or omissions amounting to manipulation of the price of a security, circular transactions, acts undertaken to cause price fluctuation or price movement in a particular manner and transactions that do not involve a change in beneficial ownership.

(15) ibid 12, r. 2(1)(c) [Definition of Fraud]. Regulation 2(1)(c) provides that the term fraud ‘includes any act, expression, omission or concealment committed whether in a deceitful manner or not by a person or by any other person with his connivance or by his agent while dealing in securities in order to induce another person or his agent to deal in securities, whether or not there is any wrongful gain or avoidance of any loss…’.

(16) i.e. SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to the Securities Market) Regulations, 1995, https://www.sebi.gov.in/sebi_data/commondocs/act11_p.pdf

(17) Pyramid Saimira Theatre Ltd. v. SEBI [2010] 100 SCL 224 (SAT) https://www.sebi.gov.in/satorders/Pyramidsat.pdf. The SAT in this case held that the intention to deceive was not an essential requirement to demonstrate a contravention of the FUTP Regulations.

(18) Nevertheless, courts have extensively analysed manipulative intent, which has been held, in most cases, to be a malafide intention to create a misleading appearance of trading, though the evidence of manipulative intent almost always depends on inferences drawn from a mass of factual data. See, SEBI v Rakhi Trading Private Limited [2018] (2) SCALE 156 (¶ 20); Securities and Exchange Board of India and Ors. v. Shri Kanaiyalal Baldevbhai Patel and Ors. [2017] SCC Online SC 1148 (¶ 31) and SEBI v Kishore Ajmera, AIR 2016 SC 1079 (¶ 26).

(19) Primarily, the Securities Exchange Board of India (SEBI), Securities Appellate Tribunal (SAT) and the Supreme Court of India (SC).

(20) Triumph International Finance Limited v SEBI Appeal No 35 of 2002, [2007], < https://indiankanoon.org/doc/1968025/>

(21) Nirmal Bang Securities Private Limited v The Chairman SEBI [2004] 49 SCL 421 (SAT), < https://indiankanoon.org/doc/1920414/>. The relevant ¶ 249 reproduced as follows: “…I find the scrip, quantity and price for these orders had been synchronised by the counter party brokers. Such transactions undoubtedly create an artificial market to mislead the genuine investors. Synchronised trading is violative of all prudential and transparent norms of trading in securities. Synchronised trading on a large scale, can create false volumes… In a synchronised trading intention is implicit.”

(22) SEBI v Shankar Lal Chokhany, [2007] < https://indiankanoon.org/doc/754691/>; SEBI v Delhi Securities Limited, Order No WTM/GA/13/IVD/5/07 [2007], < https://indiankanoon.org/doc/427598/>

(23) ibid 20

(24) SAT is an appellate body under Securities and Exchange Board of India Act, 1992

(25) ibid 19-21

(26) HB Stockholdings Limited v SEBI Appeal No 114 of 2012 [2013] < http://sat.gov.in/ENGLISH/PDF/E2013_JO2012160.PDF>. In this case, it was held that if an entity has no intent to artificially influence the market and induce investors to buy or sell shares on the basis of artificial transactions, wrongdoing is not established even if it is proved that the entity indulged in synchronised trading.

(27) SPJ Stock Brokers Private Limited v SEBI Appeal No 52 of 2013, [2013] < http://sat.gov.in/ENGLISH/PDF/E2013_JO201352.PDF>

(28) SEBI v Kishore Ajmera AIR 2016 SC 1079, < https://www.sebi.gov.in/enforcement/orders/feb-2016/order-of-the-hon-ble-supreme-court-in-the-matters-of-kishore-r-ajmera-ess-ess-intermediaries-pvt-ltd-and-other-tagged-matters_31815.html>. The Supreme Court held that “circular and synchronised trades are not prohibited per se and are, in fact, regulated by SEBI”. See also, In Re: Samurai Securities Private Limited, Adjudication Order No. EAD/NP/JS/AO/26/2017 [2017]

(29) Securities and Exchange Board of India, Informal Guidance Letter to Ram Kishan Chiripal Stock & Share Brokers [2004] https://www.sebi.gov.in/enforcement/informal-guidance/dec-2004/request-for-informal-guidance-under-clauses-4-and-5-ii-of-the-sebi-informal-guidance-scheme-2003-ram-kishan-chiripal-stock-and-share-brokers_10042.html

(30) SEBI v Rakhi Trading Private Limited [2018] (2) SCALE 156, https://www.sebi.gov.in/enforcement/orders/feb-2018/order-of-hon-ble-supreme-court-in-the-matter-of-sebi-vs-rakhi-trading-and-other-connected-civil-appeals-_37831.html

(31) ibid 19-22 (noting that synchronised trading interferes with the price discovery process of the stock exchange, and thus amounts to manipulation) and 26-30 (noting that even if synchronised trading is proved, guilt cannot be established if there is no intent to artificially influence the market and induce investors to buy or sell shares).

(32) Re: Frontline Biosystems Private Limited and Others, Adjudication Order No EAD-5/SVKM/AO/63-74/2017-18 [2017] https://www.sebi.gov.in/enforcement/orders/jun-2017/adjudication-order-against-12-entities-in-the-matter-suraj-ltd-_35218.html . In reviewing this, the tribunal may scrutinize facts including the liquidity of the traded scrip market volumes before and after the transactions, particulars of the buy/sell orders, the proximity of time between orders, etc. See also ibid 27; In this case, the SC noted that the test is always based on the inferential process adopted by a reasonable/prudent man to arrive at a conclusion.

(33) In Khandwala Securities Limited v SEBI [2017] 141 SCL 77 (SAT), http://sat.gov.in/english/pdf/E2017_JO2015283.PDF. Here, the Securities Appellate Tribunal noted that in circumstances where orders are placed at far-away prices with an objective to manipulate the market, it amounts to a violation of the FUTP Regulations. High quantity orders repeatedly placed at prices far away not resembling the market prices is a sufficient inference for the Court to arrive at this conclusion; See also Re: Gangotri Textiles Limited and Others Order No WTM/GM/EFD-DRA-III/09/MAY/2017 [2017], https://www.sebi.gov.in/sebi_data/attachdocs/may-2017/1494846207855.pdf. SEBI observed that absence of direct proof of connection does not mean the lack of illegal synchronisation. However, where there are large scale repeated transactions with an impact on volume and price on otherwise illegal securities, it may infer illegal synchronisation.

(34) ibid 30

(35) See, Craig P, ‘Squeezes, Corpses, and the Anti-Manipulation Provisions of the Commodity Exchange Act’ (1994) 52(4) Regulation < https://www.bauer.uh.edu/spirrong/pirrong_manipulation_regulation.pdf>; Merritt Fox et al, ‘Stock Market Manipulation and Its Regulation’ (2018) Yale Journal of Regulation 35(1) < https://repository.law.umich.edu/cgi/viewcontent.cgi?article=2978&context=articles>; Daniel Fischel, ‘Should the Law Prohibit ‘Manipulation’ in Financial Markets?’ (1991) Harvard Law Review 105 https://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?article=1554&context=journal_articles

(36) Reg. 4 prohibits “an unfair trade practice in securities” that (a) creates false or misleading appearance of trading or (b) amounts to manipulation of price of security, among others. However, while the second of the two proscriptions listed above target actions that would otherwise form a part of any trading activity, the first is dependent on a vague standard relating to purpose. See, PFUTP Regulations, 2003 < https://www.sebi.gov.in/legal/regulations/jul-2003/sebi-prohibition-of-fraudulent-and-unfair-trade-practices-relating-to-securities-market-regulations-2003-last-amended-on-september-6-2013-_34633.html>, r 4 [Prohibition of manipulative, fraudulent and unfair trade practices]

(37) Mark Hulbert, ‘The Mystery of the Stock Price and the Strike Price’(New York Times, 7 May, 2006) https://www.nytimes.com/2006/05/07/business/yourmoney/07stra.html

(38) Fischel, ibid 35 at 18

(39) Jerry Markham, Law Enforcement and the History of Financial Market Manipulation (1st edn, Routledge 2014) 147 https://ecollections.law.fiu.edu/faculty_books/27/; Gina-Gail Fletcher, ‘Legitimate Yet Manipulative: The Conundrum of Open Market Manipulation’ (2018) Duke Law Journal 68 (479) https://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?article=1554&context=journal_articles