CHAPTER 14 - PROHIBITION OF FRAUDULENT AND UNFAIR TRADE

PRACTICES RELATING TO SECURITIES MARKET

Introduction
The SEBI (Prohibition of Fraudulent and Unfair Trade Practices in relation to the Securities
Market) Regulations, 2003 provide SEBI with the authority to:
- Investigate cases of market manipulation
- Investigate fraudulent and unfair trade practices
These regulations empower SEBI to investigate violations committed by:
- Investors
- Issuers
- Intermediaries associated with the securities market
SEBI (PROHIBITION OF FRAUDULENT AND UNFAIR TRADE PRACTICES RELATING TO
SECURITIES MARKET) REGULATIONS, 2003
 Important Definitions
Dealing in Securities [Regulation 2(1)(b)]
Dealing in Securities includes:
1. Buying, Selling, or Subscribing: An act of buying, selling, or subscribing to any security issue,
or agreeing to buy, sell, or subscribe to any security issue, or otherwise transacting in any
security by any person, including:
- Principal
- Agent
- Intermediary (as referred to in Section 12 of the SEBI Act)
2. Influencing Investor Decisions: Acts that may be knowingly designed to influence the
decision of investors in securities.
3. Providing Assistance: Any act of providing assistance to carry out the aforementioned acts.
Fraud [Regulation 2(1)(c)]
Definition:
Fraud includes any act, expression, omission, or concealment committed by a person or their
agent while dealing in securities, with the intention of inducing another person to deal in
securities, whether or not there is any wrongful gain or avoidance of loss.
Examples of Fraud: or (Fraud Includes)
1. Knowing misrepresentation: Misrepresenting the truth or concealing material facts to
deceive another person.
2. False suggestions: Making false suggestions that are not believed to be true.
3. Active concealment: Concealing facts by a person having knowledge or belief of the fact.
4. False promises: Making promises without intending to perform them.
5. Reckless representations: Making representations in a reckless and careless manner,
whether true or false.
6. Other fraudulent acts: Acts declared fraudulent by other laws.
7. Deceptive behavior: Depriving another person of informed consent or full participation.
8. False statements: Making false statements without reasonable grounds for believing them to
be true.
9. Misinformation by issuers: Issuers providing misinformation that affects market prices,
misleading investors.
Exceptions:
The following are not considered fraud:
1. Good faith comments: General comments made in good faith about:
- Government economic policy
- Country's economic situation
- Securities market trends
- Other similar matters
2. Public or private comments: Such comments are exempt whether made in public or private.
Investigating Authority
“Investigating Authority” means any person authorized by the SEBI to undertake investigation
under section 11C of the SEBI Act.
Securities Law Fraud [Regulation 2(1)(d)]
Securities Law Fraud includes:
1. Misrepresentation: Misrepresenting facts or truth.
2. Concealment of material fact: Concealing material facts or suggesting facts that are not true.
3. Active Concealment: Concealing facts by a person who knows the facts.
4. Promise without intention: Making promises without intending to perform them.
5. Reckless representation: Making representations in a reckless and careless manner.
6. Omission: Omitting facts that are specifically declared fraudulent by law.
7. Deceptive behavior: Depriving people of informed consent or full participation.
8. False statement: Making false statements without reasonable grounds for believing them to
be true.
9. Misinformation: Providing misinformation that affects the market price of securities.
Prohibition of Fraudulent and Unfair Trade Practices Relating to the Securities Market
Prohibition of Certain Dealings in Securities [Regulation 3]
No person shall, directly or indirectly:
1. Buy, sell, or deal in securities fraudulently: Buy, sell, or deal in securities in a fraudulent
manner.
2. Use manipulative devices: Use manipulative or deceptive devices in connection with the
issue, purchase, or sale of securities listed or proposed to be listed on a recognized stock
exchange, in contravention of the SEBI Act, rules, or regulations.
3. Employ fraudulent schemes: Employ devices, schemes, or artifices to defraud in connection
with dealing in or issuing securities listed or proposed to be listed on a recognized stock
exchange.
4. Engage in fraudulent activities: Engage in acts, practices, or courses of business that operate
or would operate as fraud or deceit upon any person in connection with dealing in or issuing
securities listed or proposed to be listed on a recognized stock exchange, in contravention of
the SEBI Act, rules, or regulations.
What is Front Running?
Front running is a type of fraudulent trade practice where an individual uses confidential
information to trade in securities ahead of a larger trade. This allows the individual to make a
profit by taking advantage of the upcoming trade.
Examples of Front Running
1. Ramesh's Case: Ramesh, a finance executive, used confidential information from his boss to
trade in securities. He made a profit by trading in the same securities as his boss.
2. X's Case: X bought shares of a company using confidential information from an employee of
another company. X then sold those shares to the other company for a profit.
# Prohibition of Manipulative, Fraudulent, and Unfair Trade Practices [Regulation 4]
Prohibition:
1. No person shall engage in fraudulent or unfair trade practices in securities.
Manipulative, Fraudulent, and Unfair Trade Practices:
Following information shall be always deemed to have been considered as manipulative,
fraudulent and an unfair trade practice in the securities market:
1. Diversion or misutilization of assets: Diverting, misutilizing, or siphoning off assets or
earnings of a listed company.
2. Concealment of diversion: Concealing such acts or using devices, schemes, or artifices to
manipulate books of accounts or financial statements.
3. Price manipulation: Manipulating the price of securities of a listed company, directly or
indirectly, through the above-mentioned acts.
Manipulative, Fraudulent, or Unfair Trade Practices
The following practices are not allowed in the securities market:
1. Faking trading activity: Creating a false impression of trading in the securities market.
2. Dealing without transferring ownership: Buying or selling securities without actually
transferring ownership, just to manipulate prices.
3. Fraudulently getting investors: Convincing people to invest in securities by giving them
money or other benefits, just to meet the minimum investment requirement.
4. Artificially influencing prices: Paying people to buy or sell securities to manipulate prices.
5. Manipulating prices: Doing something to manipulate the price of a security, including
influencing benchmark prices.
6. Spreading false information: Sharing false information about securities, including financial
results or mergers and acquisitions.
7. Entering into fake transactions: Buying or selling securities without intending to actually
complete the transaction.
8. Dealing in stolen or counterfeit securities: Selling, dealing, or pledging stolen, counterfeit, or
fraudulently issued securities, unless:
- The seller was a holder in due course.
- The securities were previously traded on the market through a bona fide transaction.
9. Disseminating false information: Disseminating false or misleading information through any
media, which is designed to influence investors' decisions.
10. Unauthorized transactions: Entering into transactions on behalf of a client without their
knowledge or instructions, or misutilizing client funds or securities.
11. Circular transactions: Engaging in circular transactions to artificially influence the price of a
security.
12. Fraudulent inducement: Inducing someone to deal in securities to enhance brokerage,
commission, or income.
13. Falsifying Records: - Altering or manipulating documents related to securities transactions.
- Includes contract notes, client instructions, balance statements, and account statements.
14. Insider trading: Placing orders in securities while possessing non-public information about a
substantial impending transaction.
15.. Spreading false news: Knowingly spreading false or misleading news to induce sale or
purchase of securities..
16.. Mis-selling securities: Mis-selling securities or services by:
- Making false or misleading statements
- Concealing material facts
- Concealing associated risks
- Failing to ensure suitability of securities or services for the buyer
17. Illegal mobilization of funds: Illegally mobilizing funds by sponsoring or carrying on
collective investment schemes.
INVESTIGATION
SEBI's Power to Order Investigation [Regulation 5]
The Securities and Exchange Board of India (SEBI) has the power to order an investigation if it
has reasonable grounds to believe that:
1. Transactions are detrimental to investors or the market: Securities transactions are being
conducted in a way that harms investors or the securities market.
2. Intermediaries or market participants have violated regulations: Any intermediary or
person associated with the securities market has violated SEBI regulations, rules, or the Act.
Upon such grounds, SEBI may direct an Investigating Authority to:
- Investigate the affairs of the intermediary, person, or entity
- Report the findings to SEBI in the manner specified in Section 11C of the SEBI Act.
Powers of Investigating Authority [Regulation 6]
The Investigating Authority has additional powers for investigation, beyond what's already
provided in the SEBI Act.
1. Call for information or records: Request information or records from any person, as per
Section 11(2)(i) of the SEBI Act.
2. Inspect books and records: Inspect books, registers, documents, or records of listed public
companies or companies seeking listing, if there are reasonable grounds to believe they've
violated regulations.
3. Require information or documents: Ask intermediaries or persons associated with the
securities market to furnish information, produce books, registers, documents, or records.
4. Keep custody of documents: Keep documents produced during the investigation in custody
for up to 6 months, with the option to recall them if needed.
5. Oral examination: Examine individuals orally, record statements, and take notes as evidence.
The notes will be read over to and signed by the person examined.
6. Examination on oath: Examine managers, directors, officers, or employees of intermediaries
or securities market participants under oath.
7. Call for information and records: Request information and records from any person, bank, or
authority related to securities transactions under investigation.
8. Seizure of documents: Apply to the court for seizure of books, registers, documents, or
records if there's reasonable ground to believe they may be destroyed or altered.
9. Custody of seized documents: Keep seized documents in custody during the investigation
and return them afterward, with the option to place identification marks.
10. Search and seizure procedures: Conduct searches and seizures according to the Code of
Criminal Procedure, 1973.
Submission of Report to SEBI [Regulation 9]
The Investigating Authority must:
- Submit a final report to SEBI after completing the investigation, considering all relevant facts.
- Submit an interim report if necessary, before the investigation is complete.
Enforcement by the SEBI [Regulation 10 and 11]
SEBI may take actions or issue directions, for reasons recorded in writing, in the interests of
investors and securities market, either:
- Pending investigation or enquiry or
- On completion of investigation or enquiry
SEBI's actions may include:
1. Suspend trading: Suspend trading of securities involved in fraudulent activities, if found or
prima facie found to be involved.
2. Restrict market access: Restrict persons from accessing the securities market and prohibit
buying, selling, or dealing in securities.
3. Suspend office-bearers: Suspend office-bearers of stock exchanges or self-regulatory
organizations.
4. Impound proceeds: Impound and retain proceeds or securities from transactions in violation
or prima facie in violation of regulations.
5. Freeze assets: Direct intermediaries or persons not to dispose of or alienate assets related to
fraudulent transactions.
6. Restrict dealings: Require persons to refrain from dealing in securities in specific ways.
7. Prohibit disposal: Prohibit persons from disposing of securities acquired in contravention of
regulations.
8. Direct disposal: Direct persons to dispose of securities acquired in contravention of
regulations, in a manner deemed fit by SEBI, to restore the original state.
Additional Requirements
- SEBI must record reasons for its actions in writing.
- Final orders will be published on SEBI's website.
# Suspension or Cancellation of Registration [Regulation 12]
SEBI can take the following actions against an intermediary:
1. Issue a warning or censure: Warn or censure the intermediary.
2. Suspend registration: Temporarily suspend the intermediary's registration.
3. Cancel registration: Permanently cancel the intermediary's registration.
Conditions
- SEBI must record reasons for its actions in writing.
- Actions must be taken in the interests of investors and the securities market.
- Final orders can only be passed after complying with the procedure specified in the SEBI
(Intermediaries) Regulations, 2008.