What exactly is 'Front Running' in securities market? \
What exactly is 'Front Running' in securities market? Also, whether any third person other than an intermediary can be held liable for front running pertaining to dealings in securities market by SEBI? kindly elucidate both the points aptly.
Front Running in Securities market: The unethical practice of a broker trading equity based on information from the analyst department before his or her clients have been given the information.
In India, front running was sought to be regulated for the first time under the Securities Exchange Board of India (Prohibition of Fraudulent and Unfair trade practices relating to Securities Market) Regulations, 1995 (“ 1995 Regulations”). These regulations do not use the term “front running”. Regulation 6(b) of the 1995 Regulations provided that “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.” However, the reference to “pending execution of any order of his client” indicates that the said regulation purported to cover front running only by brokers, though the initial portion of the regulation used the words ”no person shall” giving an indication as if acts of persons other than brokers are also prohibited.
A direct reference to front running was made in the, Securities Exchange Board of India (Mutual Funds) Regulations, 1996 [Regulation 18(23)] (Mutual Funds Regulations), where it was stipulated that trustees should furnish to Securities Exchange Board of India (SEBI) on half yearly basis, a certificate stating that the trustees have satisfied themselves that there have been no instances of front running by any of the trustees, directors and key personnel of the asset management company. Therefore, it can be inferred from these regulations that SEBI’s understanding of front running was not necessarily limited to dealing in securities by the brokers only. However, no case on front running appears to have been dealt with by SEBI under the 1995 Regulations.
The 1995 Regulations were repealed, and replaced by the Securities Exchange Board of India (Prohibition of Fraudulent and Unfair trade practices relating to Securities Market) Regulations, 2003 (2003 Regulations). The 2003 Regulations also do not specifically refer to the term “front running”. However, Regulations 3 and 4 of the 2003 Regulations were worded very broadly to prohibit dealings in securities in a fraudulent manner or by indulging in unfair trade practices. Regulation 4(2)(q) of the 2003 Regulations [Regulation 4(2)(q)] specifically provides that 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 option contract shall be deemed to be a fraudulent or an unfair trade practice. The question arises as to whether SEBI intended to exhaustively cover and regulate all cases of front running under the aforementioned provision alone.
It is in this background that a recent SAT decision holding that front running only by an intermediary is prohibited under the 2003 Regulations has given rise to controversy and debate.
In a recent ruling of Mr. Dipak Patel vs. Securities and Exchange Board of India(Appeal no. 216 of 2011), the Securities Appellate Tribunal (SAT) while adjudicating on legality of ‘front running’ by a person, other than an intermediary, under Regulation 3 of Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (FUTP Regulations) has held that a person engaging in front running may be committing a fraud against his employer, but in the absence of any specific provision, he cannot be held guilty under Regulation 3 of the FUTP Regulations. However, the latest developments have been such that, on 12'th august 2013, a press release has been issued where, SEBI seemed to have exercised the amendment option. It has decided to clarify that the list under regulation 4(2) (which deals, among various other matters, with front running activities by intermediaries) is not exhaustive and that the general provisions of regulation 3 will override. Hence, the intention seems to be that even where the specific provisions of regulation 4 are not attracted (e.g. when the person involved is not an intermediary), such a front-running case could be brought within the general purview of regulation 3 thereby inviting consequences on the person violating. This “clarificatory” amendment seeks to put to rest the difficulties that arose in the above orders of SAT and SEBI.
In addition, the PFUTP Regulations have been expanded to include another type of activity within its purview. That is the illegal mobilization of funds without obtaining a certificate under the SEBI (Collective Investment Schemes) Regulations, 1999, which will be considered as a fraudulent and unfair trade practice. This is consistent with the regulatory approach (including in the recently promulgated Ordinance) to rein in large mobilization of funds. By including this as a fraudulent and unfair trade practice, the idea seems to be to make the penal consequences more onerous so as to operate as deterrence. These amendments have been approved by SEBI’s board, and the actual text of the amendments is awaited.
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