By Rafael Nam and Himank Sharma
MUMBAI (Reuters) - The Securities Exchange Board of India (SEBI) accused Hong Kong-based Factorial Capital Management Ltd of insider trading, saying it suspected the hedge fund had shorted L&T Finance Holdings Ltd
The stock market regulator on Thursday also reserved the option of looking into Credit Suisse's Indian unit, which had been the broker for L&T Finance's share sale, but did not accuse the investment bank of any wrongdoing or announce the start of an actual investigation.
The accusation against pan-Asia multi-asset hedge fund Factorial marks the outcome of an unusually quick investigation by an Indian regulator long regarded as too timid in going after potential insider trading violations.
The claims involving Factorial come as SEBI chairman U.K. Sinha has stepped up the fight against securities fraud in a country where many believe insider trading and share manipulation to be rampant.
The hedge fund returned 2.04 percent in March, its highest monthly gain since Dec. 2012, according to a newsletter obtained by Reuters. Equities and the financial sector contributed the most to the gains in March, the letter showed.
"In secondary blocks, we were up, mainly from positions in India and Korea," the hedge fund told its investors. "The fundamental long-short book was overall up. Key positive contributors were from India," it added.
The fund gained a further 2.62 percent in April, boosting its 2014 returns to 5.8 percent.
Adam Wallace, Factorial's chief operating officer, declined to comment when reached by Reuters. The newsletter did not disclose the amount of money managed by Factorial.
SEBI said Factorial would have 21 days from the date of its order to file a reply and request a personal hearing with the Indian regulator.
A Credit Suisse spokeswoman in Hong Kong declined comment.
"It may prima facie be inferred that Factorial was in possession of the information about the likely floor price of the OFS (offer for sale) and such information was an 'unpublished price sensitive information'," said the SEBI order.
In a seven-page document, SEBI said it had established that Factorial along with more than 70 institutional investors, not identified, were approached by Credit Suisse about their interest in a potential share sale of L&T Finance by its majority owner Larsen & Toubro Ltd
An L&T spokesperson did not answer calls to his phone and email made outside regular business hours.
Such informal gauges of investor appetites are legal and typical ahead of actual transactions.
SEBI said Factorial then aggressively built a big short position in L&T Finance derivatives on March 13 - accounting for 84.15 percent of all its outstanding futures and options positions - and then covered its shorts through purchases in the heavily discounted share offering.
L&T Finance shares subsequently fell 7.2 percent to 79.15 rupees on March 13, and at the close of the session L&T announced it would sell 55.5 million shares in L&T Finance at a floor price of 70 rupees per share.
SEBI said Factorial's transaction on March 13 had netted the hedge fund a profit of around 200 million rupees ($3.37 million), and said it found the transaction "aberrant and suspicious".
The regulator said the fund's massive short positions in L&T Finance's derivatives ahead of the discounted share sale led to suspicion about the fund's access to information on the discounted share sale.
"It is highly unlikely that one who does not have any exposure in the scrip will take such an aggressive short position," SEBI said, "unless it had some definite information about fall in price of the scrip in near future." Scrip is a reference to the company's stock.
SEBI added its examination of chat transcripts provided by Credit Suisse Securities (India) Private Ltd showed that on March 13, before the L&T announcement, brokers at the investment bank had exchanged messages such as "likely to come in at a steep discount about 70 types" amongst themselves.
But SEBI aid it could not determine the extent to which such information had been shared.
"In my view, this aspect needs thorough investigation so as to come to a definite conclusion," wrote the SEBI official who carried out the investigation.
In April, SEBI began a formal investigation into the surge in the stock price of Ranbaxy Laboratories
SEBI last year received enhanced investigation powers from parliament, including the ability to monitor investors' call records as part of its investigation.
The regulator also proposed overhauling its two-decade-old insider trading law, but has not yet issued final rules. ($1 = 59.3100 Indian Rupees)
(Additional reporting by Sumeet Chatterjee in MUMBAI and Nishant Kumar in HONG KONG; Editing by Andrew Roche and Stephen Coates)
