ANALYSIS OF FRONT-RUNNING
UNDER SEBI REGULATIONS, 2003
Securities Law Project
INDEX OF AUTHORITIES
Cases
Dipak Patel v. SEBI.....................................................................................................................5, 6
Surjit Karkera v. SEBI.....................................................................................................................6
Vibha Sharma v. SEBI......................................................................................................................6
Other Authorities
SEBI Circular on Consent Orders as amended by Circular CIR/EFD/1/2012,...............................2
SecuritiesaAnd Exchange Commission (Release No. 34-67774; File No. SR-FINRA-2012-025) 9
Regulations
SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market)
Regulations, 2003.....................................................................................................................3, 8
Securities and Exchange Board of India (Intermediaries) Regulations, 2008.................................5
Online Sources
Another SAT Order on Front Running, Umakanth Varotill.............................................................6
Eight edition of Blacks law dictionary, referred to in Front-running Applicable to non-
intermediaries?, Prachi Pandya...................................................................................................2
Front Running: The definition Conundrum, Hardeep Singh Chawla......................................3, 4, 9
India: SAT Extends Prohibition Of Front Running To Persons Other Than Intermediaries,
Adhitya Srinivasan, Deepak Jodhani, Sambhav Ranka and Nishchal Joshipura........................8
Insider Trading and Front Running Laws In India and Role of Compliance Officers, Ashish
Ahuja............................................................................................................................................2
New Definition of Front Running....................................................................................................9
SAT Extends Prohibition of Front Running To Persons Other Than Intermediaries, Adhithya
Srinivasan.....................................................................................................................................7
SAT now holds front running to be an offence, Jayant Thakur........................................................6
Securities Laws Amendment Ordinance: An Overview, Umakanth Varotill....................................9
Books
P RAMANATHA AIYAR, LAW LEXICON...................................................................................5
AN ANALYSIS OF FRONT-RUNNING UNDER SEBI REGULATION,
2003
1
A. INTRODUCTION
The SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market)
Regulations 2003 (hereinafter SEBI Regulations) prohibits several fraudulent practices. One of
these prohibited fraudulent practices is front running. Front running has been the center of
controversy in the past year with respect to the scope of the offence. It has been defined as A
brokers or analysts use of non-public information to acquire securities or enter into options or
future 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..1
Front running has been defined in a SEBI Circular 2 as 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.3
1 Eight edition of Blacks law dictionary, referred to in Front-running Applicable to non-
intermediaries?, Prachi Pandya, available at
http://corporatelawreporter.com/2014/02/11/front-running-applicable-non-intermediaries/
(Last accessed 26th October, 2016).
2 SEBI Circular on Consent Orders as amended by Circular CIR/EFD/1/2012, dated 25 th May 2012.
3 Insider Trading and Front Running Laws In India and Role of Compliance Officers, Ashish
Ahuja, available at www.imcnet.org/Presentations/Ashish_Ahuja_17-08.ppt (Last accessed
26th October, 2016).
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B. PROVISION OF FRONT RUNNING UNDER SEBI REGULATIONS
Front running has been specifically declared to be an offence under the Regulation 4(2)(q) of the
SEBI Regulations. It states as follows:
Dealing in securities shall be deemed to be a fraudulent or an unfair trade practice if it
involves fraud and may include-
(q) an intermediary buying or selling securities in advance of a substantial client order or
whereby a futures or option position is taken about an impending transaction in the same or
related futures or options contract..
Regulation 3 of the SEBI Regulations is a more general provision that deals with a wide range of
fraudulent4 activities and includes front running within its scope.
Front Running in the securities market: The unethical practice of when a broker trades equity
based on information received from the analyst department even before his/her clients are
provided with the information.5 The Securities Exchange Board of India (Prohibition of
Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 1995
(hereinafter 1995 Regulations sought to regulate front running in India for the first time. The
term front running however, was not used by these regulations. Regulation 6(b) of the 1995
4 Defined under Regulation 2(c) of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices
Relating to Securities Market) Regulations, 2003.
5 Front Running: The definition Conundrum, Hardeep Singh Chawla, available at
http://www.lawctopus.com/academike/front-running-the-definition-conundrum/ (last accessed 1st
November, 2016).
3
Regulations stated, no person shall on his own behalf or on behalf of any person knowingly buy,
sell or otherwise deal with securities pending execution of any order of his client relating to the
same security for purchase, sale or other dealings in respect of securities.6 However, since the
provision stated the words pending execution of any order of his client it was clear that the
provision was only with respect to front running by brokers only even though the beginning of
the paragraph stated no person shall which indicated that person other than brokers were also
prohibited from front running.
The Securities Exchange Board of India (Mutual Funds) Regulations, 1996 (hereinafter Mutual
Funds Regulations) first made a direct reference to front running under Regulation 18(23). The
regulation stated that trustees would have to submit a half yearly certificate to the Securities
Exchange Board of India (SEBI) that stated that the trustees were satisfied that there was no
instance of front running by either the trustees or the directors or any of the key personnel of the
asset management company.7 Thus, what can be inferred from these Mutual Fund Regulations is
that SEBIs understanding of front running was not limited to activities of only brokers but then
again, there was no front running case that SEBI dealt with under the 1995 Regulations.
The Securities Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices
Relating to Securities Market) Regulations, 2003 (hereinafter 2003 Regulations) repealed and
replaced the 1995 Regulations. Even the 2003 Regulations do not directly use the words front
running.8 However, Regulation 3 and Regulation 4 of the 2003 Regulations have a very wide
wording and prohibit dealing in securities in a fraudulent way or dealing in securities in such a
6 Ibid.
7 Ibid.
8 Ibid.
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way so as to be indulging in unfair trade practice. It is specifically provided under Regulation
4(2)(q) of the 2003 Regulations that if an intermediary buys or sells securities before a
substantial client order or in case a futures or option position is taken about an impending
transaction in either the same or related futures or option contract, it shall be deemed to be an
unfair or fraudulent trade practice.9 Whether or not SEBI intended to exhaustively regulate and
cover all cases of front-running under only this provision itself is a question that arises.
With this background, in 2012, the Securities Appellate Tribunal (hereinafter SAT) held that
front running is prohibited under the 2003 Regulations. This gave rise to a lot of debate and
controversy.
C. FRONT RUNNING: THE DEFINITION CONUNDRUM
In order to fully and completely understand the concept of front running and context of the same
holistically as well as the consequences of the SAT decision on the Securities world, it is
important to examine the definitions of both front running and intermediary, as it is around these
two words that the controversial questions of law arise.
Originally, Front running means buying or selling of 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 favor.10
Intermediary means a stockbroker, share transfer agent, sub-broker, trustee of trust deeds, banker
to an issue, merchant banker, portfolio manager, registrar to an issue, underwriter, depository,
9 Ibid.
5
investment adviser, participant, credit rating agency, custodian of securities and any other
intermediaries that SEBI specifies and also includes an asset management company as under the
Mutual Fund Regulations, trading member of a derivative segment or currency derivative
segment of a stock exchange and a clearing member of a clearing house or a clearing corporation
but does not include a foreign venture capital investor, a mutual fund, a foreign institutional
investor, a venture capital fund and a collective investment scheme.11
The SAT, recently, in Dipak Patel v. Securities and Exchange Board of India12 was faced with the
issue as to what exactly constituted front running and whether any person other than an
intermediary could be charged with front running under Regulation 3 of the 2003 Regulations.
The SAT held that in the absence of any other specific provision, a person other than an
intermediary cannot be held guilty of front running and punished for the same even if he engages
in front running activities.
D. THE RECENT DEBATES
Dipak Patel vs. SEBI,13 in 2012, was the first to raise the issue about front
running in the SAT. It was contended that the case of Dipak Patel did not fall
10 P RAMANATHA AIYAR, LAW LEXICON (4TH EDITION 2010).
11 Regulation 2(g) of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008.
12 Dipak Patel v. SEBI Appeal No. 216 of 2011; Date of Decision November 9, 2012. Appeal nos. 74
and 78 of 2012 also combined.
13 [2013] 112 CLA 97 (SAT).
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within the ambit of the provision of front-running as Regulation 4(2)(q), which
prohibited the activity of front-running, was restricted to intermediaries only
and therefore Dipak Patel was not liable to any penalty. 14 The Tribunal applied
literal interpretation to the provision and accepted the contention of Dipak
Patel as it found that scope pf the relevant provisions was limited to
intermediaries and does not apply to any other person, In the absence of
any specific provision in the Act, rules or regulations prohibiting front
running by a person other than an intermediary.
15
Surjit Karkera v. SEBI, reaffirmed this decision of the Tribunal as it was in
one mind with the reasoning that the application of the provision is restricted
to intermediaries only as Regulation 4 (2)(q) clearly states so in explicit
language.16
E. THE DEBATES RESOLVED
17
Finally, in Vibha Sharma v. SEBI , the SAT reversed the decision of the Tribunal in Dipak
Patel. It stated that the no straight jacket formula should be applied to the provision and liberal
interpretation should be applied keeping in mind the harmful nature of the activity of front
14 SAT now holds front running to be an offence, Jayant Thakur, available at
http://indiacorplaw.blogspot.in/2013/09/sat-now-holds-front-running-to-be.html (Last seen on
26th March, 2014)
15 Surjit Karkera v. SEBI Appeal No.167 of 2012.
16 Another SAT Order on Front Running, Umakanth Varotill, available at
http://indiacorplaw.blogspot.in/2012/12/another-sat-order-on-front-running.html (Last seen on 26th March, 2014)
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running. 18 Therefore, any individual connected to the capital markets and guilty of the offence of
front running will face the consequences of violating the provision.
Additionally, in September 2013, SEBI issued a clarification under Regulation 4(2)(q) which
sated that, "For the purposes of this sub-regulation, for the removal of doubts, it is clarified that
the acts or omissions listed in this sub-regulation are not exhaustive and that an act or omission
is prohibited if it falls within the purview of regulation 3, notwithstanding that it is not included
in this sub-regulation or is described as being committed only by a certain category of persons
in this sub-regulation.".19 As a result of this clarification, front running is now applicable to any
person and not only to intermediaries and thereby can be interpreted to come under the
general provision of Regulation 3.
The SAT made an observation about the Dipak Patel case saying that the case has made it clear
that front running always causes detriment irrespective of whether an individual or an
intermediary is an offender. Therefore, the SAT opined that the definition of front-running should
receive a liberal interpretation and the concept should not be put in a straight-jacket formula.
The SAT also held that that Vibha Sharma and Jitender Sharma who were a day trader and an
equity dealer in securities with CBI were related to each other in the capacity of husband and
wife. Exchange of information took place between them regarding future trades by the CBI and
17 Vibha Sharma v. SEBI Appeal No. 27 of 2013.
18 SAT Extends Prohibition of Front Running To Persons Other Than Intermediaries, Adhithya Srinivasan,
available at
http://www.mondaq.com/india/x/264962/Securities/SAT+Extends+Prohibition+Of+Front+Running+To+Persons+Ot
her+Than+Intermediaries (Last seen on 26th March, 2014)
19 Ibid.
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Vibha Sharma used this information to trade in the securities market, thereby making undue
profits in the process.
The SAT held the profits collected by Vibha Sharma cannot be termed as a mere coincidence, as
the trades made by Vibha Sharma matched 100 per cent with that of CBIs purchase order over a
period of two weeks. This decision by the SAT seems to have filled a loophole in the regulatory
framework. In earlier decisions, the SAT has ruled on the perception that the erstwhile Securities
and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to
Securities Markets) Regulations, 1995 had prohibited every person from committing the offence
of front running, while the present Securities and Exchange Board of India (Prohibition
of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulations, 2003 only
prohibit intermediaries from committing the offence of front running. However, this time around,
SAT decided to lend a liberal interpretation to the concept of front running.
It can be argued that the provision of front-running under Regulation 4(2)(q)20 is inclusive and
serves as an illustration only and, whereas the very act of front-running would amount to fraud, 21
and therefore the fact that a person or an intermediary is committing it should be irrelevant.
Therefore, the question that arises is whether circumstances which specifically prohibit
intermediaries from committing such an offence should apply to everyone and not just to
intermediaries. It is important to note that Regulation 4(2) of the Securities and Exchange Board
20 Regulation 4(2)(q) of the FUTP Regulations reads as follows:
"Dealing in securities shall be deemed to be a fraudulent or an unfair trade practice if it involves fraud
and may include all or any of the following, namely:
(q) an intermediary buying or selling securities in advance of a substantial client order or whereby a
futures or option position is taken about an impending transaction in the same or related futures or
options contract."
21
Regulation 2(1)(c) of the FUTP Regulations defines "fraud" as follows:
"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, and shall also include ..."
9
of India (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities
Markets) Regulations, 2003 specifically refers to an intermediary in certain provisions.22
Vibha Sharma decision and the Clarification issued by SEBI also partly resolves the issue of
including Collective Investment Schemes, which are unregistered, within the ambit of front
running. The Security Law Ordinance, 2013, resolved the left over issue of bringing unregistered
schemes under the category of SEBI (Collective Investment Schemes) Regulations, 1999. The
Ordinance amended Section 11A by adding, any pooling of funds under any scheme or
arrangement involving a corpus of Rs. 100 crores, as a Collective Investment Scheme.23
F. THE AMERICAN PERSPECTIVE
The United States recently decided to expand their front-running policy and therefore approved a
plan from the Financial Industry Regulatory Authority (FINRA). 24 Their former front-running
policy applied till the knowledge about the transaction has been made public. The FINRA plan,
while retaining the publicly available information rule, devised a new standard when the
22
India: SAT Extends Prohibition Of Front Running To Persons Other Than Intermediaries,
Adhitya Srinivasan, Deepak Jodhani, Sambhav Ranka and Nishchal Joshipura, available at
http://www.mondaq.com/india/x/264962/Securities/SAT+Extends+Prohibition+Of+Front+Run
ning+To+Persons+Other+Than+Intermediaries (last accessed 2nd November, 2016).
23
Securities Laws Amendment Ordinance: An Overview, Umakanth Varotill, available at
http://indiacorplaw.blogspot.sg/2013/07/securities-laws-amendment-ordinance.html (Last seen on 26th March, 2014)
24
SecuritiesaAnd Exchange Commission (Release No. 34-67774; File No. SR-FINRA-2012-025) available
athttp://www.sec.gov/rules/sro/finra/2012/34-67774.pdf (last accessed 28th October, 2016).
10
information becomes stale or obsolete.25 Therefore, if either of these two standards are met, i.e.,
if the information become publicly available or stale or obsolete, then the restrictions on
front-running will no longer apply. Both of these standards rest on facts and circumstances of
each case including a number of factors like amount of time lapsed post the transaction, radical
change in market conditions, knowledge of such transaction among the members etc.
The suggested expansion of the definition is aimed to apply to, all securities and financial
instruments and contracts (in addition to the existing options and security futures) that overlay
the security that is the subject of an imminent block transaction and that have a value that is
materially related to, or otherwise acts as a substitute for, the underlying security. 26 Such an
expansive and broad definition is required to prevent fraud at the time making open and free
market conditions accessible to all. However, unlike the Indian SAT, the United States S.E.C
does not classify the kinds of people to which these front-running restrictions apply.
G. CONCLUSION
It is necessary to interpret provisions dealing with fraudulent practices such a front-running as
these are serious crimes which have far reaching consequences. They not only affect the
confidence of existing investors but also affect the confidence of prospective investors as such
practices lead to marked fall in faith in the securities market. As it was observed in Surjit
Karkera, that It is of utmost importance that a sense of fair play be maintained in the market so
that innocent investors do not find themselves at the receiving end of irregular conduct by
entities in the market..
25
Supra (n 5).
26
New Definition of Front Running, available at http://www.sec.gov/rules/sro/finra/2012/34-67774.pdf
(last accessed November 2, 2016)
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