Sham transactions

A real trade changes who owns a share. A sham transaction is designed to look like a trade while leaving ownership, in substance, where it was — or to be a trade that nobody intends to honour. Its purpose is the appearance it creates: volume that suggests interest, prices that move a chart, a closing price that sets a benchmark.

The PFUTP Regulations deem such dealings manipulative, fraudulent or unfair, because every genuine investor who reads that volume or price is being deceived by it.

The deeming provision (PFUTP Regulations, regulation 4(2)). Dealing in securities is deemed a manipulative, fraudulent or unfair trade practice if it involves, among others:

Clause (g) is the sham transaction in its purest form; (a), (b) and (k) catch the same idea from different angles. The list is expressly not exhaustive: any act within the general prohibition in regulation 3 is prohibited even if not listed.

How it is proved — the Sunita Gupta appeal (Case 8.3). The Securities Appellate Tribunal upheld findings that a group of entities executed synchronised trades, circular trades and reversal trades in the shares of Gangotri Textiles, and placed orders far away from the last traded price. The appellant said synchronisation had happened "just by chance". The Tribunal held that trades matched with other group entities, repeatedly and within a few seconds, are not possible without a prior meeting of minds.

Consequences. Section 15HA of the SEBI Act: penalty not less than Rs 5 lakh, up to Rs 25 crore or three times the profits, whichever is higher. Pending or after investigation SEBI may also suspend trading in the security, restrain persons from the market, impound proceeds, and — against an intermediary — warn, censure, suspend or cancel registration.

The case figures from the workbook. In the Gangotri Textiles matter, the price varied from Rs 43 to Rs 71 during the investigation period (7 April 2005 to 31 May 2006). The group bought 51,98,404 and sold 47,11,903 shares on BSE; the appellant alone bought and sold 3,42,246 shares on BSE.

The Adjudicating Officer first imposed Rs 60 lakh; after remand, a fresh order imposed Rs 25 lakh, which the Tribunal upheld, noting that Section 15HA allowed up to three times the profit or Rs 25 crore, whichever is higher, and that mitigating factors had already been considered.

Illustrative mechanics of a reversal trade. Two accounts under common understanding, X and Y, trade an illiquid share last traded at Rs 50:

Net change in ownership       = 0 shares
Reported volume               = 40,000 shares
Turnover shown to the market  = 20,000 × 54 + 20,000 × 58 = Rs 22,40,000

No share has really changed hands; the price has moved 16% and the volume looks like genuine interest. That is clause (g) — and, because the trades inflate the price, clause (b) as well.

Chapter 8 (SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003), 6% of the paper, lists the deemed practices in regulation 4(2), and Case 8.3 (Sunita Gupta) shows how synchronised, circular and reversal trades are proved. Chapter 2 repeats the list in its overview of the regulations.

Expect a "which of these is deemed manipulative" question built on clauses (a), (b), (g) and (k), and an inference question: repeated matching within seconds implies a prior meeting of minds.

• Two alternatives in clause (g): no intention of performing the transaction, or no intention of changing ownership. Either is enough.
• Beneficial ownership is the test in clause (b) — a trade that transfers legal title between persons acting together may still be a sham.
• Circular trades can involve intermediaries, and the clause says so expressly.
• "By chance" does not survive repeated synchronisation within seconds — the Tribunal inferred a prior meeting of minds.
• The list is not exhaustive. An unlisted practice is still prohibited if it falls within regulation 3.
• Penalty section 15HA: floor Rs 5 lakh; ceiling Rs 25 crore or three times profits, whichever is higher. A loss-making manipulator is still liable.
• Lettering slip. The workbook's list of regulation 4(2) practices uses (p) twice — once for mis-selling and once for illegal mobilisation of funds.