Synchronized Trades – their existence in the Stock Market and kinds
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Synchronized Trades – their existence in the Stock Market and kinds

Bar & Bench

Prachi Pande analyses Synchronized Trades and their existence in the stock market and highlights various types of trades / transactions that are undertaken by the investors and market players in the stock market along with the time price anonymity system followed by the Stock Exchange’s software.

The Securities and Exchange Board of India Act, 1992 (“Act”) inter alia, is pre – eminently a social welfare legislation intended to protect the interests of investors. The Hon’ble Supreme Court in the recent judgment of SEBI vs. Ajay Agarwal {[2010] 98 SCL 424 (SC)} has held, “the legislative intent for enacting the said Act, it transpires that the same was enacted to achieve the twin purpose of promoting orderly and healthy growth of securities market and for protecting the interest of investors. The requirement for such an enactment was felt in view of substantial growth in the capital market by increasing participation of the investors. In fact, such enactment was necessary in order to ensure the confidence of the investors in the capital market by giving them some protection.” Thus, the primary responsibility of the Securities and Exchange Board of India (in short “Board” or “SEBI”) is inter alia, to regulate stock market transactions, stock market participants, intermediaries, etc. The Board has come to be the watchdog of the stock market, closely monitoring and regulating scheming activities and whipping miscreants indulging in manipulative activities.

A stock exchange provides a trading platform to a humungous number of buyers and sellers who come to trade their shares. The stock exchange is also a platform for fair price and volume discovery, based on the market forces of demand and supply. A unique feature of stock exchange is, unlike other moveable properties, shares on the stock exchange are generally traded between unknowns. The prices at which trades are determined, is by free market forces of demand and supply. The stock exchanges’ software are designed such that the trades are to be executed on the screens of the exchange in the price and order marching mechanism of the exchange.

Though, the market players and intermediaries are expected to play the game according to the rules, yet they scheme and design various mechanisms in which stock market transactions can be manipulated, as human ingenuity knows no bounds!

Another unique feature of trading through the software of the Stock Exchanges is the anonymity of the buyer and the seller. On a screen based trading, it is not possible for either of the broker (or sub – broker, as the case may be) to know who the counter party or his broker (sub broker) is. The names, codes or other details of the counter party / counter broker do not appear on the screen. Trading system of the stock exchange is essentially anonymous and does not enable either party to know the counter party in the trade (SAT’s order dated 4.11.2009 in Appeal no. 41 of 2009).

Transactions on the stock exchange are determined and consummated on the basis of time price priority system. The time price priority signifies two things. First, is the matching of the price and second is the priority in point of time.

When a buy order is placed on the system, it will be matched with the best sell order (lowest price) available on the system subject to the condition that no buyer will be made to buy at a price more than what he has offered.

Similarly, a sell order will be matched with the best buy order (highest price) subject to the condition that no seller will be made to sell at a price lower than what he has fed into the system.

Once the system has determined the price of a scrip in the aforesaid manner, it can never be described as artificial. This has been dealt in detail by the Hon’ble Securities Appellate Tribunal (“SAT”) in the matter of M/s. Jagruti Securities Ltd. vs. SEBI (SAT’s order dated 27.10.2008 in Appeal no. 102 of 2008).

Trades which are not in consonance with the prescribed time price order mechanism are considered as manipulated and structured for the benefit of few and in order defraud genuine gullible investors. Non genuine, manipulated and fraudulent trades could either be undertaken by stock market investors, stock broker or any other market intermediary. If any person is considered to be circumventing the price, time and order matching mechanism, then inter alia, provisions of Regulation 3 and 4 of the SEBI (Unfair Trade Practices) Regulations , 2003 (“PFUTP”) are attracted.

Regulation 3 of PFUTP, inter alia, states as follows:

No person shall directly or indirectly:

a)      buy, sell or otherwise deal in securities in a fraudulent (The term ‘fraud’ and ‘fraudulent’ has been defined in Regulation 2(c) of the PFUTP Regulation) manner;

b)      use or employ, in connection with issue, purchase or sale of any security listed or proposed to be listed in a recognized stock exchange, any manipulative or deceptive device or contrivance in contravention of the provisions of the Act or the rules or the regulations made thereunder;

c)       employ any device, scheme or artifice to defraud in connection with dealing in or issue of securities which are listed or proposed to be listed on a recognized stock exchange;

d)      engage in any act, practice, course of business which operates or would operate as fraud or deceit upon any person in connection with any dealing in or issue of securities which are listed or proposed to be listed on a recognized stock exchange in contravention of the provisions of the Act or the rules and the regulations made thereunder.

Regulation 4 is an inclusive provision and lists 22 items, which, if found in any dealing, such dealing would be considered as fraudulent or an unfair trade practice. Some of the 22 items are as follows:

a)      indulging in an act which creates a false or misleading appearance of trading in the securities market;

b)      dealing in a security not intended to effect transfer of beneficial ownership but intended to operate only as a device to inflate, depress or cause fluctuations in the price of such security for wrongful gain or avoidance of loss;

c)       any act or omission amounting to manipulation of the price of a security;

d)      entering into a transaction in securities without intention of performing it or without intention of change of ownership of security;

e)      circular transactions in respect of a security entered into between intermediaries in order to increase commissions to provide  a false appearance of trading in such security or to inflate, depress  or cause fluctuations in the price of such security.

Incase the miscreant is a stock – broker or a sub – broker, then Schedule II and III of SEBI (Stock Brokers & Sub – Brokers) Regulations, 1992, which prescribes the Code of Conduct for Stock Brokers and Sub Brokers respectively, would also be attracted. These Schedules amongst others, state as follows:

  • A stock broker shall not indulge in manipulative, fraudulent or deceptive transactions or schemes or spread rumors with a view to distort market equilibrium or make personal gains.
  • A stock – broker shall not create false market either singly or in concert with others or indulge in any act detrimental to the investors interest or which leads to interference with the fair and smooth functioning of the market.
  • A stock – broker shall not involve himself in excessive speculative business in the market beyond reasonable levels not commensurate with his financial soundness.

What are Synchronized Trades?

Synchronized trades are trades which are done between two or more market participant with a premeditated mind and circumventing the time – price mechanism. Such trades occur when two or more people execute trades amongst themselves with a prior understanding vis-à-vis. time, price and quantity of the transaction.

It would be pertinent to mention that synchronized trades per se are not illegal. However, synchronized trades with a fraudulent or deceptive intention to create misleading appearance of trading and to manipulate the volumes of the scrip and tampering with the market equilibrium of stock exchange are considered bad in law.

The Hon’ble SAT in the case of Ketan Parekh vs. SEBI (Date of decisions dated 14.07.2006 in appeal no. 2 of 2004) has held that when any person trades in the shares of a company with the intention to artificially raise or depress the prices of securities he necessarily induces the sale or purchase of such securities by many other innocent investors who may be difficult to be located. Inducement to any person to buy or sell securities is the necessary consequence of manipulation and flows therefrom. In other words, if the factum of manipulation is established it will necessarily follow that the investors in the market had been induced to buy or sell and that no further proof in this regard is required. Synchronized trades are primarily a series of non genuine transactions and SEBI views this as detrimental to the integrity of the securities market and also in violation of PFUTP Regulations.

In the same case, the Oxford dictionary was referred to and relied upon for the meaning of the term, ‘synchronize’, which defined it to mean, “cause to occur at the same time; be simultaneous.”

The Hon’ble SAT further went on to hold recently in the case of M/s. Grishma Securities Pvt. Ltd. vs. SEBI (SAT’s order dated 04.08.2010 in Appeal No. 117 of 2006) that synchronized trades per se are not illegal as they have been sanctified by the Board by its Circular dated September 14, 1999. However, synchronized trades can be executed with a view to manipulated the price or the volumes of the traded scrip or both or with some ulterior purpose and whether the a synchronized trade has been executed with a manipulative intent or not have to be gathered from the intention of the parties and intention will have to be gathered form the surrounding circumstances including the pattern of trading, the frequency of the trades and their volumes. A synchronized trade is one where the buyer and the seller enter the quantity and price of the shares they wish to transact at substantially the same time. This could be done through the same broker (referred to as “cross deal”) or through two different brokers.

Merely because trades were crossed on the floor of the stock exchange with the buyer and the seller entering the price at which they intended to buy and sell respectively, the transactions does not become illegal. Synchronized transactions even on the trading screen between genuine parties who intend to transfer beneficial interest in the trading stock and who undertake the transaction only for that purpose and not for rigging the market is not illegal and cannot be said to be in violation of the PFUTP Regulations. Infact, unless there is matching buy and sell order, trades would not occur. What is condemned is that the matching ought not to be a result of pre – mediation and mala fide intent of artificially disturbing the prices of a scrip or a consequence of tampering with the market mechanism or price discovery mechanism.

A synchronized transaction will, however, be illegal or in violation of the Regulations if:

  •   it is executed with a view to manipulate the market; or
  •   if it results in circular trading; or
  •   if it is dubious in nature and is executed with a view to avoid regulatory detection; or
  •   if it does not involve change of beneficial ownership; or
  •   if it is executed to create false volumes resulting in upsetting the market equilibrium; or
  •   if it is motivated with mala fide intention of artificially jacking up the volume and price.

The Hon’ble SAT in the case of Ketan Parekh vs. SEBI (Supra) has held, “Securities market is so wide spread and in a system of screen based trading various potential investors who track the scrips through the screens of the exchanges only see whether a particular scrip is active or not, whether it is trading in large volumes and whether the prices is going up or down……When a person takes part in or enters into transactions in securities with the intention to artificially raise or depress the price, he thereby automatically induces the innocent investors in the market to buy / sell their stocks.

The U.S. Supreme Court in the case of Ernest & Ernest Vs. Hochfeldev explained the expression ‘manipulation’ as, “It connotes intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities“.

Kinds of Synchronization

Synchronization is of various types and characters. Below in brief are features of some of them:

i.        Cross deals

Cross deals is when the buyer and the seller have a common trading member (read stock broker) and where the buy and sell orders have been entered into within such time, where the prices of both the orders is the same and where the quantity is by and large the same.

When a buyer and seller approach the stock broker for executing their respective trades, it is not always necessary that they shall approach together. Such deals may or may not be a negotiated deal. In any case, while executing a trade on behalf of the buyer and the seller, the broker must ensure that the price and order matching mechanism of the system is not interfered, circumvented or evaded.

In the case of M/s. Bubna Stock Broking Services Limited vs. SEBI (SAT’s order dated 4.11.2009 in Appeal no. 41 of 2009) it was held that cross deal is a trade where the buyer and the seller have the same broker. Such deals ipso facto are not illegal but they have to be executed only on the screen of the Exchange in the price and order matching mechanism of the Exchange just like any other normal trade. In other words, the broker is expected to put buy and sell orders in to the system allowing the system to match the trades at the then prevailing market price.

Relying upon Board’s circular dated September 14, 1999, it has been further held by the Hon’ble SAT in the case of Porecha Global Securities Pvt. Ltd. vs. SEBI (SAT’s order dated 05.08.2010 in Appeal No. 164 of 2009 ), that negotiated deals (including circular deals) executed through the screen of the stock exchange in the price and order matching mechanism is a perfectly valid method of executing such deals and the same stands sanctified by the Board’s circular dated September 14, 1999.

Example – Mr. A and Mr. B are both stock market investors. They both trade through a common broker M/s. Bears & Bulls. A transaction between them in a scrip would be termed as cross trade. If such trade is as per the price and order matching mechanism and on the screen of the Exchange, just like any other normal trade, it would be considered as a bona fide trade.

ii.      Structured deals

The Black’s Law Dictionary (Thomson West Publication, Eighth Edition) defines the term ‘structure’ to mean, “Any construction, production, or piece of work artificially built up or composed of parts purposefully joined together”. Unlike cross deals, in structured deals the trading members on the buy and sell sides of the trade are different. Structured deals are aimed to subvert the fair price discover mechanism. In the case of M/s. Bubna Stock Broking Services Limited vs. SEBI, the Hon’ble SAT has further held, “even in the case of a negotiated deal, it is the duty of the stock broker to ensure that the orders are put into the system at the prevailing market price”.

SAT in the case of Shankar Sharma vs. SEBI (SAT’s order dated 25.06.2001 in Appeal no. 29/2001) has observed, that synchronization of order timing for specific scrips, quantity and rate, is contrary to the accepted principles of screen based trading where anonymity of the counter party is sought to be maintained. Such synchronized orders are necessarily in the nature of structured transactions, which vitiates the transparency and fairness of the working of the market.

Example – Mr. A and Mr. B are both stock market investors. They trade through different stock broker. A genuine, bona fide transaction between with predetermined time, quantity and price per se would be not be illegal, provided the same is as per market mechanism with no mala fide intention to artificially ramp up the price or volume of a scrip. Spot, bulk and block deals are some examples of accepted structured deals.

iii.    Circular trades

A fraudulent trading scheme where sell or buy orders are entered by a group of persons who know that the same number of shares at the same time and for the same price either have been or will be entered by the counter party. These trades do not represent a real change in the beneficial ownership of the security. These trades are entered with the intention of raising or depressing the prices and / or volume of securities.

Circular trades are primarily fictitious in nature with the intent to create artificial volume and artificially ramp up the price of the scrip. In circular trading there is no change in the beneficial ownership of the shares, since the shares are merely rotated amongst a group of people.

Modus operandi of circular trades are – a manipulator targets a scrip and acquires as much of the floating stock as is necessary to ensure he profits and creates an illusion of high trading volumes at the counter. A few of such traders get together and buy and sell large blocks of shares among themselves. Ordinarily, the shares sold to associates are at a price higher than what is prevailing in the market who in turn sells them to another associate for even a higher price (Assuming the group of persons adopt a ‘bullish’ approach). A typical circular trade would appear like A→ B → C → D → A. This implies, A sells 500 shares to B. B sells 500 shares to C. C sells 500 shares to D and D sells 500 shares to A.

Circular trades create an impression that the stock is actively traded and therefore such transactions attract market players outside the circle to buy the stocks. In other words general public gets induced to buy the stock. The manipulators not only increase the volume of the scrip but also raise the bench mark of the prevailing price of the scrip. Retail investors and day traders are most vulnerable to such trading as they follow the herd mentality because they lack market intelligence and experience.  They are usually the ones left holding the parcel when the music stops.

There are several instances wherein the broker gets caught in the crossfire and is considered to be in hand and glove or acting in conduit with its client whilst executing synchronized trades. The question arises – whether a broker could have known at the time of punching orders if his client is indulging in synchronized trades. Mr. Ashish Ajmera, C.E.O. of a leading broking house, Ajmera Associates Ltd. states, “it is not possible based on a few transactions to decipher whether the constituent is indulging in synchronized trades and whether he is using us. However if a similar pattern of trade is seen over a period of time, then one’s alarm bell would start ringing”.

Mr. Ajmera further adds, “Genuine and bona fide brokers after burning their fingers have become cautious and have set up several internal risk management mechanism, whereby scamming constituents can be nailed at the right time. Some brokers have laid an upper percentage cap upto which a scrip can constitute a constituent’s portfolio”.

iv.     Reversal Trades

Reversal trades per se are considered bad in law. A reversal trade is between two people, wherein the seller of the shares ultimately buys the same shares from the original purchaser of the shares.

Example – Mr. A sells 50 shares of XYZ Ltd. to Mr. B and Mr. B later sells 50 shares of XYZ Ltd. to Mr. A. Reversal trades would be between two investors, either having common or different stock broker.

SEBI’s touchstone of synchronized trades

In addition to manipulating trades and circumventing the time price mechanism, SEBI considers the following whilst evaluating the genuineness of transactions:

1.       Relations between the counter party.

2.       Order price difference between the counter parties.

3.       Order time difference between the counter parties.

4.       Order quantity difference between the counter parties.

5.       Price movement of the scrip during the investigation period vis-à-vis. period prior or thereafter.

6.       Price movement of the scrip in comparison to price movement of other scrips in similar sector or movement of the relevant stock exchange.

If on analysis of the trades, Board / SAT concludes that the parties placed buy or sell orders with identical price and quantity, which were executed with the counter parties and had resulted in trades with negligible time difference it would perceived that the parties were involved in synchronized trading. Further, if similar pattern is observed during the entire investigation period, it would also be viewed with an element of doubt.

Conclusion

Human ingenuity knows no bounds! Despite all the checks and balance put forth by the Board, stock exchanges and / or brokers, miscreants just seem to invent new modes of circumventing the market mechanism. However, Board has been keeping a hawk eye on stock market transactions to regulate market manipulation, thereby safeguarding genuine market players, intermediaries and investors.

Prachi is an advocate practicing with the Chambers of Corporate Attorneys, a law firm based in Mumbai. She primarily practices in stock market and capital market related matters. She can be contacted at prachi@ccalex.com. 

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