Synchronised trades are neither illegal nor immoral

WITHOUT CONTEMPT

Recent reports about the Securities and Exchange Board of India (Sebi) and stock exchanges warning brokers to ensure compliance when executing synchronized block deals have unnecessarily confused market intermediaries.

The regulator would do well to assuage investors and stem the spread of confused panic that such announcements bring in their wake.

First, let us examine what is a synchronized trade. A synchronized trade is one where the buyer and seller enter the quantity and price of the shares they wish to transact at substantially the same time. This could be done through two terminals of the same broker (termed a "cross deal") or from the trading terminals of two different brokers.

It is now a settled position that synchronized trades are per se not illegal. Merely because a trade was crossed on the floor of the stock exchange, with the buyer and seller entering the price at which they intended to buy and sell respectively, the transaction does not become illegal.

This is borne out not only by Sebi's stance on the subject with the joint parliamentary committee that looked into the 2001 banking and securities scam and an advance ruling given by Sebi, but also in orders passed by the earlier Sebi chairman.

The Securities Appellate Tribunal too has rightly endorsed this view.

In fact, a circular issued by Sebi requires bulk deals to be executed only on the floor of the stock exchange, and not in the form of off-market deals.

Another circular issued by Sebi requires every bulk deal of above a particular size threshold to be reported by the broker to the stock exchange with full particulars of the deal and the client's identity.

In short, the execution of block trades has always been recognised by the regulator, and the regulator in fact always contemplated that such deals have to be executed on the floor of the exchange and not off-market.

Synchronized block deals are also per se not immoral. They are in fact desirable in the context of block trades. Say, a large shareholder desires to exit a substantial holding in a listed company"" say 10 per cent of the capital.

Such a stake brings with it a size-driven bargain. A buyer for the entire bulk would pay a decent price as a bulk price. If one were to go about buying 10 per cent in the market, there would be avoidable rumours about the buyer amassing shares.

This would lead to a price spiral impacting the interests of small investors who may buy shares at rising price levels, only to burn their fingers when the price falls back to equilibrium.

On the other hand, if the seller were to sell 10 per cent at one go in the market, there would be panic about the supply of the stock in the market being in excess of demand, and the price would crash. The seller would get no benefit of selling a bulk block of 10 per cent.

Here again, the fall in price would risk the fortunes of small investors who may exit the stock in panic only to burn their fingers when the price rises up back to equilibrium.

A block deal prevents all such chaos, and enables execution of such a deal in an orderly manner without disturbing the rest of the market. The seller could scout for large players in the market with an appetite for substantial holding. Once the buyers are identified, the buyer and the seller could synchronise the deal across the floor of the stock exchange.

The buyer and seller get what they want, and the impact on the common investor is minimised.

It could well happen that some portion of the shares get matched with a buy or sell order placed by third parties on the computerised trading platform. Yet, the impact on the small investor would be far lower than having to expose the entire deal to the system.

There are also other complexities in the market environment that are addressed by block trades. Under Sebi regulations, foreign institutional investors can only trade through brokers.

Under exchange controls they can freely trade on the floor of stock exchanges. Similarly, the new capital gains dispensation burdens sales outside the floor of stock exchanges with a 10 per cent tax while a sale on the exchange is taxed under the equitable securities transaction tax system.

Why would the regulators have any basis of being disturbed? The answer lies in differentiating between the baby and the bathwater.

During the 2001 scam, it was found that some market operators had executed a series of synchronized trades to circulate the same stock among one another on the floor of the exchange. This rigged up the volumes and lent false credibility to the price at which the stock was traded.

There were also some instances of synchronized deals among related or un-related parties on a systematic basis at progressively higher or lower prices that led to the price being ramped up or being hammered.

Sebi also found some instances of "positions being shifted" across brokers when the brokers' trading limits prescribed by the exchange got saturated.

The crucial difference in such trades was the absence of any real change in beneficial ownership, pattern of trades to manipulate price and volumes, and non-genuine and fictitious nature of the trades.

That by no stretch can render the very concept of synchronized trades suspect. It is important not to throw the baby out with the bathwater.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed here are personal)