Mere broking is not 'aiding' and 'abetting'

WITHOUT CONTEMPT

Recent decisions of the Securities Appellate Tribunal (SAT) have come as a welcome respite to professional stock brokers. Despite best standards of diligence and care, stock brokers can find themselves charged with aiding and abetting price manipulation.

At times, it is found that either the same person or a set of related persons execute buy and sell transactions on the screen-based automated trading mechanism of a stock exchange at more or less the same time. Popularly called "1-2-3 trades" these are trades that are executed at exactly the same time with the buy side and the sell side synchronising the timing and price of their trades by co-ordinating over phone, and entering their trades to the count of three.

Such trades could be misused for projecting fictitious volumes in a stock or for manipulating the price upwards or downwards by transacting at successively higher or lower price levels. Trades for fictitious volumes or manipulative transactions necessarily show a repetitive pattern demonstrating their ultimate economic objective.

However, synchronised trades were also used for perfectly legitimate transactions such as bulk deals where, for cleanliness of the transaction, or even due to regulatory reasons, the trade would be effected on the floor of the exchange. Stock exchanges now have a special window in which bulk deals can be legitimately executed provided the price at which the shares are transacted is not at a variance with the previous day's closing price by more than 1 per cent.

The issue that faces many brokers is that despite best intentions, there is no credible means of preventing the occurrence of synchronised trades. To begin with, the screen-based trading system across stock exchanges is completely anonymous i.e. the selling broker and the buying broker are never aware of the identity of each other.

The trading system automatically matches buy orders and sell orders on the basis of the best price then available with the earliest order placed having priority.

When a client requests a broker to execute his buy order or a sell order on the screen of the exchange, the broker is duty-bound to do so with promptitude and immediacy. The broker would have no clue if a corresponding sell order or buy order has already been keyed in by another broker or if it is being keyed in at approximately the same time elsewhere on the nationwide trading system.

A client who is creating fictitious volumes or manipulating price would of course be in league with other persons who would correspondingly be executing the contra orders elsewhere. Even if the volume of such activity is high, by definition, the broker would get to know of it only well after the trades are executed, and any reasons for analysing past trades come up. If the client strictly follows all requirements, does not deviate from his normal past conduct, and is continuously creditworthy, there would be little reason for the broker to suspect that something is amiss.

Against this backdrop, it would be unfair to automatically level an allegation of aiding and abetting the manipulation on the broker.

Observing that the buyer and seller never get to meet in the stock exchange, the SAT has observed that merely because a person has acted as a broker it would not be reasonable to conclude that he must have known about the nature of the transaction.

Dealing with the regulator's argument that the broker should have asked its client as to why he was transacting, the SAT noted: "We do not think that any broker would ask such a question from his clients when he is getting business nor is such a question relevant unless of course he suspects some wrong doing for which there has to be some material on the record."

e-mail: somasekhar@jsalaw.com

(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own)