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ANALYSIS OF CIRCULAR TRADING IN FRAUDULENT AND UNFAIR TRADE PRACTICES RELATED TO SECURITIES MARKETS IN INDIA AND A COMPARATIVE STUDY WITH UNITED STATES
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ANALYSIS OF CIRCULAR TRADING
IN FRAUDULENT AND UNFAIR TRADE PRACTICES
RELATED TO SECURITIES MARKETS IN INDIA
AND
A COMPARATIVE STUDY WITH
UNITED STATES
AUTHORED BY
- NALINI R[1]
ABSTRACT
This article aims to study and analyse
in detail about the circular
trading practice in the Indian Securities Market and to do a
comparative study of fraudulent and unfair trade practices in the United
States. To discuss various kinds of Unfair Trade Practices happening in India
and the measures taken by the regulator (SEBI) to prevent such “Fraudulent and
Unfair Trade Practices” happening in the Securities Market. Participants of
Circular Trading and the measures taken by SEBI to control it. Unfair Trade
Practices in the United States and the related
regulations to control
it. The Doctrinal
Research Method is used in this project
to study about the circular
trading practice in Securities
Markets in India and Unfair Trade Practices
in the United States.
Keywords: Circular Trading, Unfair
Trade Practices, Securities Markets, SEBI, Federal
Trade Commission Act
I.
INTRODUCTION
The Securities Market in India is subject to various fraudulent
activities. It is the duty of the securities market regulator SEBI to regulate
such activities and to save the interests of investors. SEBI has introduced a regulation which is
“Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair
Trade Practices relating to Securities Market) Regulations, 2003” to prohibit
such manipulative, fraudulent and unfair trade practices happening in the securities market. Regulation 4(n) of the
“Securities and Exchange Board of
India (Prohibition of Fraudulent and Unfair Trade Practices relating to
Securities Market) Regulations, 2003” gives
definition for a circular transaction which states “circular transactions in respect of a security
entered into between
intermediaries in order to increase
commission to provide a false appearance of trading in such security
or to inflate, depress or cause fluctuations in the price of such
security[2]”;
Circular trading is one of fraudulent trade practices happening widely in
India, whereas it is banned in all the other countries. Circular Trading is a
type of price manipulation fraud in the securities market in which the sell orders are placed along with
buy orders simultaneously for
the same price and the same quantity to show a huge volume in that particular company to
cheat the investors and make to think that there are changes happening in the
company and prices are expected to move high. Circular trading is done by two
or more persons trading simultaneously in a company between them. Irrespective
of the number of traders
and trades, shares go back to the real owners
at the end of the day.
“Section 5 of the Federal Trade Commission Act, 1914 of the United
States of America
prohibits “unfair and
deceptive acts or practices” in or affecting commerce”. Such practices broadly
include:
·
“an act or practice that causes or is likely
to cause substantial injury to consumers, that cannot be reasonably avoided by consumers and is not
outweighed by countervailing benefits to consumers or to competition[3]”;
and
·
“an act or practice where a material representation,
omission or practice misleads or
is likely to mislead the consumer, who has reasonably interpreted such
representation, omission or practice[4]”.
II.
LITERATURE REVIEW
1. A Study
on Unfair Trade Practices
in India – Sandra N S
2. Unfair Trade Practices – A
Lost Imperative of the Indian Economy – Akshra Mehla
III. SECURITIES AND SECURITIES MARKETS
Financial
products used to raise capital are known as securities. The basic purpose of
the securities markets is to allow capital to move from those who have it to
those who require it. The securities market facilitates the transfer of
resources from people who have them idle to those who require them for
productive purposes. Securities markets serve as conduits for allocating
savings to investments, separating the two activities. As a result, savers and
investors are bound not by their own talents, but by the economy's ability to
invest and save, resulting in an increase in saves and investment in the
economy.
STRUCTURE OF INDIAN SECURITIES MARKETS
The
securities market is the market in which securities are issued, purchased by
investors, and then transferred among investors. The primary market and
secondary market are two interrelated and inseparable parts of the securities
market. Issuers raise capital by selling securities to investors in the primary
market, also known as the new issue market. The secondary market, often known
as the stock exchange, permits the trade of previously issued securities,
allowing investors to exit a position. In the secondary markets, the risk of a
security investment is shifted from one investor (seller) to another (buyer).
The primary market is where financial assets are created, while the secondary
market is where they are sold.
KEY CHARACTERISTICS OF SECURITIES
A security
can be a stock, a bond, or any other financial instrument with value or that is tied to a valuable underlying instrument. A
security is one that can be traded on an exchange, according to the Securities Contracts Regulation Act (SCRA). As it relates
to financial markets, below are some key
characteristics of securities.
·
Securities are the terms of a money exchange between
two parties, in this case a buyer and a seller.
·
Borrowers and equity funders can issue securities to
raise money at a low cost, and investors can own the securities.
·
Businesses use a regulated contract and a controlled
and monitored process to raise money from investors with surplus capital.
·
While the rules for raising cash are set by the
security's issuer, investors have a claim to the rights represented by the
securities.
·
Securities are divided into two categories: equity (risk
participation) and debt (claim on cash flows).
·
Unlike debt securities, which are issued for a set
period of time, equity securities are issued indefinitely. Debt securities pay
interest, and equity securities provide dividends, but neither is guaranteed.
REGULATORS OF THE INDIAN SECURITIES MARKETS
Securities and Exchange Board
of India (SEBI)
The Securities and Exchange Board of India (SEBI), a statutory agency
established by Parliament (SEBI Act, 1992), is India's primary securities
market regulator. SEBI is a government agency that reports to the Ministry
of Finance. SEBI's major goal is to help the
capital markets expand and develop
while also protecting investors' interests4. SEBI is in charge of enforcing the Securities
Contracts Regulation Act of 1956.
SEBI has codified and publicised regulations that apply to all securities
market activities and intermediaries.
The Reserve
Bank of India (RBI)
The money market section of the securities market is regulated by the
Reserve Bank of India. RBI is the government's issue manager because it manages
the government's borrowing programme. It is in charge
of overseeing and regulating the government securities market. The Reserve Bank of India (RBI) is also the Indian banking
system's regulator, ensuring
that banks adhere to
prudential standards in their operations. RBI is also in charge of monetary,
FX, and credit policies, and its activities in these markets have an impact on
the availability of money and credit in the system, which affects interest
rates and borrowing costs for banks, governments, and other debt issuers.
SECURITIES FRAUD
“Section 17 of The Indian Contact Act, 1872 defined Fraud,
"Fraud" means and includes any of
the following acts committed by a party to a contract, or with his connivance, or by his agent,
with intent to deceive another party thereto of his agent, or to induce him to
enter into the contract[5]:-
1. the
suggestion, as a fact, of that which is not true, by one who does not believe
it to be true;
2. the active
concealment of a fact by one having knowledge or belief of the fact;
3. a promise
made without any intention of performing it;
4. any other
act fitted to deceive;
5. any such
act or omission as the law specially declares to be fraudulent”.
Securities fraud, also known as stock fraud or investment fraud, is a
misleading technique in the stock or commodities markets that leads to
investors making purchase or sale decisions based on incorrect information,
often resulting in losses and in violation of securities regulations.
Outright theft from investors
(stockbroker embezzlement), stock manipulation, misstatements on a public company's
financial reports, and lying to corporate auditors
are all examples
of securities fraud. Insider
trading, front running, and other unlawful behaviours on the trading floor of a
stock or commodity exchange are all covered under this umbrella phrase.
Securities fraud, often known as stock or investment fraud, is a sort of
serious white-collar crime that involves misrepresenting facts to investors in
order to influence their decisions.
An individual, such as a stockbroker, could be the perpetrator of the
fraud. It could also be a corporation, brokerage firm, or investment bank. Individuals can commit this form of fraud on their own by using insider trading
strategies.
There are various securities fraud happening in Securities Markets
including Insider Trading, Front-running, Self-Trading and Circular Trading. We
will discuss about Circular Trading in detail in this project.
CIRCULAR TRADING
Circular trading is a deceptive practise in
which a broker enters sell orders knowing that offsetting buy orders for the
exact same amount of shares at the exact same time and at the exact same price
have been or will be entered.
The beneficial ownership of the security does
not change as a result of such a trading arrangement. Circular trading
artificially inflates volumes to demonstrate that a security has liquidity, maintain
a targeted share price, and act as proof that the stock has market
interest. In a few of
countries, the practise is outlawed.
What is circular trading, and how does it work?
The Securities Appellate
Tribunal (SAT) states:
·
When two or more people join hands and begin trading
in a scrip among themselves, this is known as a circular transaction.
·
Despite various participants and exchanges, at the end of the trading session,
the shares are returned to
their original owners, completing the circle.
For example, A sells to B, who then
sells to C, who then sells it back to A. When the shares return to A, the
circle is complete. Multiple players may be involved in the process.
As
a result, trading
volume has increased without
a change in ownership.
In
circular trading, sell orders are countered with buy orders for the same number
of shares and at the same price.
MANIPULATION OF THE SECURITIES MARKETS THROUGH
CIRCULAR TRADING
Circular
trades can create a false sense of activity around a stock, which can influence
its price if they continue. For example, if a security's trading price was on
the verge of falling below levels desired by some shareholders, a circular
trade could help to prop up the price by giving the impression that new owners
are buying the shares at the desired level. This activity may persuade people
who aren't aware of the strategy to invest in the stock, assuming that the
trades reflect a rising interest in the stock. There may even be a suspicion
that the company is about to divulge information that, if made public, will
cause the stock to rise in value.
There is no basis for that assumption because
the circular trade
plan does not introduce any real
change in ownership or represent any actual action about to be announced. If
the stock price rises as a result, the value has been artificially inflated. When the plan is exposed, the artificially
inflated stock price will fall in on itself, destroying the monies invested by
others.
As a
responsible investor and trader, it's critical to be informed about any
unethical trading practises that may affect you.
It is a method of artificially inflating the stock's volume and price without
any real change.
SYNCHRONISED TRADE AND CIRCULAR TRADE
Circular
trading is a synchronised trading strategy.
According to SAT, a synchronised trade is a type of transaction in which
the seller and buyer execute the trade at nearly the same time for nearly the
same quantity and price.
Circular trades, on the other
hand, occur when numerous parties
conspire to buy and sell shares
repeatedly in order to manipulate the stock price.
HOW DO CIRCULAR TRADES
MANIPULATE
THE MARKET?
Due to inflated volume impacting the stock price, circular trading helps generate a misleading
sense of active stock.
Consider the following example from the SEBI document
(see WTM/GA/55/ISD/3/06):
Global Trust Bank's
(GTB) trading volumes
increased dramatically in FY 2000-2001, resulting in a price increase. This is what transpired.
|
Period
|
Average DailyVolume on BSE
|
Stock Price
|
|
01-Sep to 10-Oct,
2000
|
Below 38,000
|
Rs. 57 (On 11-Oct-2000)
|
|
25-Oct to 23-Nov, 2000
|
More than 7,70,000
|
Rs. 114 (On 20-Nov-2000)
|
In just 29 trading sessions, the price climbed by 100%. SEBI discovered the following while investigating the case.
-
During the specified period, transactions were made by
entities linked with a certain entity referred to as 'A.'
-
These entities were fictitious, and the beneficial
ownership of shares remained unchanged. They were simply trading amongst
themselves, using circular trading to artificially raise the volume and price
of GTB scrips.
Because of
the speculative character of the stock market, increasing trading volume gives
the impression of increased demand, prompting retail investors to trade in that
stock and jeopardising the market's integrity.
MEASURES TO CURB CIRCULAR
TRADING
Circular trading is a fraudulent or unfair trade conduct, according to
the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to
Securities Market) Regulations, 2003. Circular transactions involving
securities entered into between intermediaries to increase commissions, provide
the appearance of trading in such securities, or inflate, depress,
or induce price swings are
constituted fraudulent or unfair commercial practises, according to the law.
Under the different sections of the SEBI
Acts and Regulations, SEBI investigates any unusual market
behaviour in a scrip. It also sanctions fines on a case-by-case basis if any
broker or company engages in circular trading.
Depending on the size anomaly
committed, the penalties range from a term of suspension
from trading to a fine.
SEBI has ordered
that all exchanges set a daily price
band and an overall weekly limit for each
stock in order to prevent circular trading and improve market safety and
integrity. The securities have a dynamic price band determined by the
exchanges.
The exchanges have implemented a surveillance mechanism to track price
and volume movements, as well as potential market abuses such as bogus
transactions and circular
trading.
Circular
trading, which deceives investors by generating a misleading sense of stock
activity, disrupts market equilibrium. Circular trading jeopardises the stock
market's integrity and stability, as well as its credibility among
investors. Despite the fact that SEBI and the exchanges have put in place effective
mechanisms to minimise circular trading, some cases continue to arise. Let's
hope that in the future, with active engagement from all market participants,
there are no incidents of circular trade.
PENALTY PROVISION
Penalty provisions for fraudulent and unfair trade practices is provided
in Section 15HA of SEBI Act, 1992 which states “If any person indulges in
fraudulent and unfair trade practices relating
to securities, he shall be liable to a penalty
which shall not be less than five lakh rupees but which may extend to twenty-five
crore rupees or three times the amount of profits made out of such practices,
whichever is higher[6]”.
COMPLAINTS AGAINST
UNFAIR TRADE PRACTICES
Investors can approach SEBI and file a complaint if they come across any
frauds or unfair trading practises in the securities industry. For faster
handling of complaints, SEBI maintains a separate complaint cell called Sebi
COmplaints REdress System (SCORES). Investors can easily make a complaint
through SCORES' online platform[7].
IV.
JUDICIAL
INTERPRETATION
1.
Ketan
Parekh vs. SEBI (2006)
It was observed:
“It would, therefore, follow
that a synchronised trade or a trade that matches
off market is per se not illegal. ……
A synchronised transaction will, however, be illegal or violative of the
Regulations if it is executed with a view to manipulate the market or if it
results in circular trading or is dubious in nature and is executed
with a view to avoid regulatory detection or does not involve
change of beneficial ownership or is executed to create false volumes resulting
in upsetting the market equilibrium.”
2.
Subhkam
Securities Private Limited vs. SEBI (2012)
The principle
was also reiterated in this case in which it has been observed:
“It
is an admitted position that synchronized trades per se are not illegal. It is
only when synchronized trades are executed with a view to manipulate the price
of the scrip that the provisions of the FUTP Regulations will get attracted.”
3.
SEBI vs.
Kishore R. Ajmera (2016)
“In
this case, the Supreme Court recently passed an order on several appeals
involving a common question of law
i.e., what is the degree
of proof required to hold brokers/sub-brokers liable for fraudulent/manipulative
practices under SEBI (Prohibition
of Fraudulent and Unfair Trade Practices) Regulations, 2003
and/or liable for negligence under the Code of
Conduct as specified under SEBI (Stock Broker and Sub-Broker) Regulations,
1992.
The
court stated that it is a cardinal rule of law that proof of an allegation
levelled against a person may be in the form of direct evidence or
circumstantial evidence. In relation to the violations committed by the
brokers/sub-brokers, the court stated that the evidence has to be gathered from
various circumstances such as the volume of the trade effected; the period of
persistence in trading in the particular scrip; the particulars of the buy and
sell orders; the proximity of time between the two etc.
The
court held that there is a dividing line between negligence and deliberate
intention. The difference between Code of Conduct
violations and PFUTP
Regulations violations depends
on the extent of the persistence on the part of the broker/sub-broker.
Upto an extent, where the brokers/sub-brokers failed to alert themselves,
violations can be attributed to negligence and lack of due care and caution.
However, persistent trading either over a long period of time or in respect of
huge volumes would show deliberate intention to play the market. The court
further added that the said dividing line has to be drawn on the basis of the
volume of the transactions and the period of time that the broker/sub-broker
indulged in the conduct.
This
is a landmark decision by the Supreme Court which has shed some clarity on the
determination of liability either for violations of the provisions under PFUTP
Regulations or for the violation of the provisions under the Code of Conduct,
though the question of broker/sub-broker complicity will always be a fact
centric issue”.
4.
SEBI vs.
Shri Kanaiyalal Baldevbhai Patel (2017)
“The Supreme Court observed for the first time in SEBI v. Shri Kanaiyalal
Baldevbhai Patel that terms ‘fraud’ and ‘unfair trade practice’ as provided
under the PFUTP regulations are different. The Court observed that the concept
of unfairness has a broader meaning than fraud, and that trade practice is broadly
unfair if the conduct undermines the ethical standards and good faith dealings between
parties engaged in business transactions. It has to be considered
comprehensively to include any act beyond a fair conduct of business, including
the business in sale and purchase of securities. However,
the Court also observed that a generalised or single definition
of ‘unfair trade practice’ cannot be exist, and it requires adjudication on
case-by- case basis and in accordance with the facts and circumstances
surrounding the transaction”.
5. SEBI vs.
Rakhi Trading Pvt. Ltd.
(2018)
“The Supreme Court of
India in its recent landmark judgement of SEBI v. Rakhi Trading Pvt. Ltd., delivered by
Justice Kurian and Justice Banumathi, has overruled several orders of the
Securities Appellate Tribunal which had held that synchronised trades are
illegal only when they are committed with the intention to impact the market.
The Court has also shed further light on the concept of ‘unfair trade practice’
as provided under the Securities and Exchange Board of India (Prohibition of
Fraudulent and Unfair Trade Practices Relating to Securities Market)
Regulations, 2003”.
V.
UNFAIR TRADE PRACTICES IN UNITED STATES
Unfair commercial practises are prohibited in the United States under
Section 5(a) of the Federal Trade Commission Act, which states that
"unfair or deceptive acts or practises in or affecting commerce" are
prohibited. It extends to all individuals involved in commerce, including
banks, and establishes a legal norm for unfair trade activities, which can be
either unfair or deceptive[8].
Below are lists
of unfair and deceptive practices as per the rule:
An act is
unfair when it meets the following criteria:
·
It injures consumers significantly or is likely to do
so.
·
Consumers will not be able to avoid it.
·
It is not outweighed by countervailing consumer or
competitive gains.
Deceptive Practices
When an act or behaviour fits the following
conditions, it is considered deceptive:
·
A consumer is misled or is likely to be misled by a
representation, omission, or practise.
·
Under the circumstances, a consumer's understanding of
the representation, omission, or conduct is considered fair.
·
Material is a deceptive representation, omission, or
practise.
VI.
CONCLUSION
It is vital to keep any market
free of frauds,
illicit activities, unjust
and manipulative behaviours in order for it to thrive
and grow consistently throughout time. This is also true in the securities market. The Securities and
Exchange Board of India (SEBI) has taken every step feasible to ensure
long-term growth and protect the people who invest in the securities market.
Due to India's population and the vast number of investors entering
the market, there
is a higher chance of
frauds taking advantage of a big number of investors, and India also lags
behind other industrialised countries in terms of cybersecurity. Because most
securities are now handled through online platforms, applications, and other
means, SEBI should establish cybersecurity guidelines and a cyber security wing
to protect the securities market from any potential cyber hacking, thereby
safeguarding and guiding
the securities market in India toward development.
VII.
REFERENCES
1. The Indian
Contract Act, 1872
2. Federal
Trade Commission Act, 1914
3. The
Monopolies and Restrictive Trade Practices Act, 1969
4. Securities
and Exchange Board of India Act, 1992
5. SEBI
(Prohibition of Fraudulent and Unfair Trade Practices relating to Securities
Market) Regulations, 1995
6. The
Competition Act, 2002
7. SEBI
(Prohibition of Fraudulent and Unfair Trade Practices relating to Securities
Market) Regulations, 2003
8. The Consumer
Protection Act, 2019
9. SEBI
(Prohibition of Fraudulent and Unfair Trade Practices relating to Securities
Market) (Amendment) Regulations, 2022
[1] Author is an Assistant Professor at School of Law, Vels Institute of Science, Technology & Advanced Studies (VISTAS), Chennai, Tamil Nadu,
India.
[2] Regulation 4(n) of the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities
Market) Regulations, 2003
Article Information
ANALYSIS OF CIRCULAR TRADING IN FRAUDULENT AND UNFAIR TRADE PRACTICES RELATED TO SECURITIES MARKETS IN INDIA AND A COMPARATIVE STUDY WITH UNITED STATES
Authors: NALINI R
- Journal IJLRA
- ISSN 2582-6433
- Published 2023/11/10
- Issue 7
About Journal
International Journal for Legal Research and Analysis
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