What is the degree of proof required to hold brokers/sub-brokers liable for fraudulent/manipulative practice?

The Supreme Court of India, in its judgement in case of SEBI v. Kishore R. Ajmera delivered on 23 Feb. 2016, dealt with this question.

Facts in brief:
A broker with his sub-broker were allegedly involved in creation of artificial volumes in an illiquid scrip of Malvica Engineering Ltd, who matched volumes for their two related clients. SEBI whole-time member held the broker vicariously liable for conduct of sub-broker and ordered suspension for four months.

Aggrieved Broker filed appeal before Hon’ble Securities Appellate Tribunal (SAT). And SAT by its order dates 05th February 2008 held that in the absence of any direct proof or evidence showing the involvement of the sub-broker in allegedly matching the trades and thereby creating artificial volumes of trading resulting in unnatural inflation of the price of the scrip, the charges are not substantiated. The penalty imposed was accordingly interfered with.

Against this order, SEBI filed appeal before Hon’ble Supreme Court.

The Apex court took up all similar appeals viz. SEBI v. Ess Ess Intermediaries Pvt. Ltd., SEBI v. Rajendra Jayantilal Shah and SEBI v. Rajesh N. Jhaveri where allegations of synchronized trades in Adani Export Ltd. were found and monetary penalties were imposed. And in appeal, SAT had taken the view by order dated 19th June 2013 that the allegations of fraud under the FUTP Regulations, 2003 can be established only on the basis of clear, unambiguous and unimpeachable evidence. The Apex court also took up SEBI v. Networth Stock Broking Ltd.’s appeal, where allegation of circular trading in scrip of G.G. Automotive Gears Ltd. was involved. SEBI held broker liable vide order dated 27th December 2011. In appeal, SAT took the same view as in earlier case.

Applicable legal principle:

The Apex court narrated “It is a fundamental principle of law that proof of an allegation levelled against a person may be in the form of direct substantive evidence or, as in many cases, such proof may have to be inferred by a logical process of reasoning from the totality of the attending facts and circumstances surrounding the allegations/charges made and levelled. While direct evidence is a more certain basis to come to a conclusion, yet, in the absence thereof the Courts cannot be helpless. It is the judicial duty to take note of the immediate and proximate facts and circumstances surrounding the events on which the charges/allegations are founded and to reach what would appear to the Court to be a reasonable conclusion therefrom. The test would always be that what inferential process that a reasonable/prudent man would adopt to arrive at a conclusion.”


Applying above principle of law to facts of the cases before it, Hon’ble Supreme Court opined that while proximity of time between the buy and sell orders may not be conclusive in an isolated case such an event in a situation where there is a huge volume of trading can reasonably point to some kind of a fraudulent/manipulative exercise with prior meeting of minds. Such meeting of minds so as to attract the liability of the broker/sub-broker may be between the broker/sub-broker and the client or it could be between the two brokers/sub-brokers engaged in the buy and sell transactions. When over a period of time such transactions had been made between the same set of brokers or a group of brokers a conclusion can be reasonably reached that there is a concerted effort on the part of the concerned brokers to indulge in synchronized trades the consequence of which is large volumes of fictitious trading resulting in the unnatural rise in hiking the price/value of the scrip(s).

Hon’ble court while agreeing that the screen based trading system keeps the identity of the parties anonymous, however opined that it will be too naive to rest the final conclusions on said basis which overlooks a meeting of minds elsewhere. And it observed that direct proof of such meeting of minds elsewhere would rarely be forthcoming. Hence,

the test is one of preponderance of probabilities so far as adjudication of civil liability arising out of violation of the Act or the provisions of the Regulations framed thereunder is concerned.

However, Prosecution under Section 24 of the SEBI Act for violation of the provisions of any of the Regulations, of course, has to be on the basis of proof beyond reasonable doubt.

Hon’ble Court also observed

“The conclusion has to be gathered from various circumstances like that volume of the trade effected; the period of persistence in trading in the particular scrip; the particulars of the buy and sell orders, namely, the volume thereof; the proximity of time between the two and such other relevant factors.

The fact that the broker himself has initiated the sale of a particular quantity of the scrip on any particular day and at the end of the day approximately equal number of the same scrip has come back to him; that trading has gone on without settlement of accounts i.e. without any payment and the volume of trading in the illiquid scrips, all, should raise a serious doubt in a reasonable man as to whether the trades are genuine. The failure of the brokers/sub-brokers to alert themselves to this minimum requirement and their persistence in trading in the particular scrip either over a long period of time or in respect of huge volumes thereof, in our considered view, would not only disclose negligence and lack of due care and caution but would also demonstrate a deliberate intention to indulge in trading beyond the forbidden limits thereby attracting the provisions of the FUTP Regulations.

The difference between violation of the Code of Conduct Regulations and the FUTP Regulations would depend on the extent of the persistence on the part of the broker in indulging with transactions of the kind that has occurred in the present cases. Upto an extent such conduct on the part of the brokers/sub-brokers can be attributed to negligence occasioned by lack of due care and caution. Beyond the same, persistent trading would show a deliberate intention to play the market. The dividing line has to be drawn on the basis of the volume of the transactions and the period of time that the same were indulged in.”

The transactions were notable in that volume of trading in such scrips was usually minimal. The Court opined in the absence of direct substantive evidence, courts can take note of immediate and proximate facts and circumstances surrounding the events on which the charges are founded to reach a reasonable conclusion. As such, the test would be: “what inferential process that a reasonable/prudent man would adopt to arrive at a conclusion.”

On the facts of the case, though voluminous trading of illiquid scrips was not impermissible per se, the Bombay Stock Exchange had cautioned against the same and asked traders to exercise caution in case of high volume of trading. When over a period of time such transactions had been made between the same set of brokers or a group of brokers a it could be reasonably concluded that there was a concerted effort to indulge in synchronized trades, which resulted in large volumes of fictitious trading, culminating in an unnatural rise in hiking the price of the scrips. By the overall conduct of brokers and their transactions could the court infer not only a lack of due care and caution but also a deliberate intention to indulge in trading beyond forbidden limits.

Accordingly orders of SAT were set aside and orders of SEBI were restored.

Hon’ble Supreme Court observed (Obiter Dicta) “The different Regulations including the Regulations that prescribe the procedural course, namely, SEBI (Procedure for Holding Enquiry by Enquiry Officer and imposing Penalty) Regulations 2002 and the successor Regulation i.e. SEBI (Intermediaries) Regulations 2008 contain identical and parallel provisions with regard to imposition of penalty resulting in myriad provisions dealing with the same situation. A comprehensive legislation can bring about more clarity and certainty on the norms governing the security/capital market and, therefore, would best serve the interest of strengthening and securing the capital market.”