Front running is the act of placing one’s order in front of the orders of others while trading.
How Can This Be Done?
Suppose a market taker passes on information that they will make a sale or a purchase soon. In this case, one could run in front by acting before the market taker. Such a case is mostly trivial unless the taker is a prominent individual like Warren Buffett, CEOs and, so on.
Without being specifically told by a market taker one might execute the front running in another way. For this, one must be between the taker’s order and its execution. This leads us naturally to middlemen like brokers, dealers, market makers in exchanges who are the typical suspects in front-running cases. They have access to what is called ‘order flow’ for their customer base and so they can see all the orders of the market takers as they flow in. It can be either in the form of verbal instructions given to these middlemen or electronic order flow.
However, those associated with dealing /fund management are asked to switch off their mobile phones in the dealing room during trading hours. All phone calls in the dealing room are made from landlines, which are recorded. Such records are stored for periods as long as 7-10 years. The compliance department proactively watches for any irregularity in trades. If an employee is found to indulge in such activity, organizations have the right to take strict action against them, including terminating his/her job.
The Sanghvi Group Case:
In the Sanghvi Group Case, Front Running of HDFC Group’s trades was executed in the form of verbal instructions.
From the call records and transcripts of 30 suspected front running transactions submitted by HDFC, it was observed that the instructions to trade in the scrips were given from the dealer room phone to the mobile number of Rajiv Sanghvi. It was also observed that HDFC’s Executive Director, Chief Investment Officer and, three senior Fund Managers had identified the person’s voice in the dealer room conversations with the mobile number as that of Nilesh Kapadia, Ex-Equities Dealer. He had been the equities dealer for HDFC Asset Management Company Ltd (herein referred to as AMC) from 2000 until 2010.
Observing from the mobile call records of Nilesh Kapadia, it was established that Sanjay Sanghvi and Nilesh Kapadia had been in touch.
The fund managers and portfolio managers of HDFC AMC executed the trades through the dealer Nilesh Kapadia, who had the discretion to execute the orders at any time during the day, depending on the traded volumes/prices.
As a dealer of HDFC, Nilesh Kapadia had the information of HDFC’s sell order details viz., scrip, quantity and, price range and had the discretion of time. Based on this, Nilesh Kapadia had given instructions from the dealer room telephone to Rajiv Sanghvi’s mobile phone to sell the shares of the same scrip which HDFC was going to sell. The shares were sold in one of the trading accounts of Sanghvi Group immediately i.e. before HDFC started selling in the same scrip. Subsequently, Nilesh Kapadia started selling the shares for HDFC in the same scrip through various brokers. The Sanghvi group entities bought the shares in their same trading accounts, to sell. Most of their buy was matched with HDFC’s sell.
SEBI in its investigation period 2000-2010 observed that Nilesh Kapadia, Rajiv Sanghvi, Rajiv Sanghvi HUF, Sanjay Sanghvi, Dipti Mehta and Sonal Sanghvi (collectively referred to as ‘Sanghvi Group‘) and Nilesh Kapadia and Kalpana Kapadia (collectively referred to as ‘Kalpana Group‘) allegedly indulged in front-running of HDFC Group’s trades, and thereby violated the provisions of Section 12A (a), (b) and (c) of SEBI Act, Regulations 3(a), (b), (c), (d) and 4(1) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (hereinafter referred to as the “PFUTP Regulations, 2003“). Also, Penalties were imposed on all the manipulators under Section 15HA of the SEBI Act, 1992, for indulging in front-running of Rs 10 lakhs each. Additionally, a fine of Rs 25 lakh was leveied on Nilesh Kapadia for misusing his position in the capacity of dealer of HDFC AMC.
History of Front Running– Cases & Orders
- In the SEBI orders under FUTP (Prohibition of Fraudulent and Unfair Trade Practices) for ‘Deepak Patel v SEBI’ and ‘Sujit Karkera v SEBI’, the Supreme Court held that Front Running applies to only market intermediaries i.e. anybody connected to the market as an intermediary in any form and not to other entities in the securities market.
- Ultimately, the above was overruled in ‘Kanhaiyalal Patel v SEBI’ where the Supreme Court put a new test saying that anyone having non-public information is not supposed to use it any manner, be it intermediary or market participant. If you have any information which is not in the public domain / which others do not possess that is sufficient for you to be booked under FUTP and be charged accordingly.
- In the SEBI ‘ShareKhan’ order where Sharekhan was the stockbroker for the Vedanta Group earlier known as the Sterlite Group. The family transactions were done by Sharekhan who were the brokers of the Vedanta group and had advance information of what the group was buying or selling and taking advantage of that, they indulged in Front Running, thereby paying an amount of Rs. 2.93 crores as a settlement to SEBI.
- In the case of Shailesh Zaveri v SEBI, the Supreme Court passed an order stating that all interest should be payable on orders of disgorgement from the date of order i.e the interest will be charged after the period given to pay the fine specified in the order. For eg: If SEBI takes ten years to decide a matter, passes an order and, gives 30 days to pay the amount to SEBI, the interest on that order will start from the 30th day.
- However, the above was overruled in Dushyant Dalal v SEBI, where the Supreme Court held that the rate of interest will run from the date on which the ill-gotten gains were earned.
- The April 30th, 2019 order of SEBI on the NSE is another order on Front Running where it was held that certain brokers were given information on the quantity of trade 2-3 seconds before what was given to the other brokers. Taking advantage of the information given to them before others, they performed transactions of more than Rs. 6000 crores in the market. The NSE was thereby fined approx. 687 crores along with the prohibition of (capital market assets) making a public issue of NSE for 6 months. This order has been challenged.
- SEBI is currently also investigating the results of HDFC, Axis, Tata motors which leaked out via Whatsapp and were very close to the actual results of the board meeting.
- In the case of several funds of Fidelity Group and to catch the manipulators, SEBI scanned a profile on a matrimonial website of a trader Vaibhav Dhadda where he used a matrimonial website to establish the link with his family members.
