Tippee liability

Front running is trading ahead of a large order you know is coming. When a dealer or portfolio manager does it personally, the wrong is obvious. The harder case is the tippee: a cousin, a family friend or a spouse who is not an intermediary, owes no duty to the client, and simply acts on a phone call.

The Supreme Court, in SEBI v. Kanaiyalal Baldevbhai Patel and connected appeals, held that such a person can be liable under the PFUTP Regulations — but only if specific ingredients are proved. Tippee liability is the name for that test.

Three forms of front running (Chapter 8, Case 8.2).

1. Tippee trading — trading by third parties who are tipped on an impending block trade;
2. Self-front-running — the owner or purchaser of the block trade itself takes an offsetting futures or options position to hedge against the price effect of its own block;
3. Trading ahead — an intermediary with knowledge of an impending customer block order trades ahead of it for its own profit.

The appeals dealt with the first and third. The judgment noted that trading ahead had been explicitly recognised in the PFUTP Regulations as regulation 4(2)(q).

The ingredients for a tippee. To establish charges against a tippee under regulations 3(a), (b), (c), (d) and 4(1) of the PFUTP Regulations, one needs to prove that:

1. the person who provided the tip was under a duty to keep the non-public information in confidence;
2. such breach of duty was known to the tippee; and
3. the tippee still traded, thereby defrauding the person whose orders were front-run, by inducing him to deal at the price he did.

Joint liability. The Court held that the parting of information about an imminent bulk purchase and the transaction that follows are so intrinsically connected that the only conclusion is joint liability of the initiator and the party who knowingly aided it. Non-intermediary front running may therefore be brought within regulations 3 and 4(1) when the ingredients are satisfied.

How it was proved. In the appeals the inference was drawn from the volume of shares bought and sold, the proximity of time between the tippee's trades and the large orders, and the repeated nature of the pattern on different dates.

The penalty. Section 15HA of the SEBI Act (fraudulent and unfair trade practices): not less than Rs 5 lakh, up to Rs 25 crore or three times the profits made, whichever is higher.

The facts in the workbook, with the figure it gives. Dipak Patel was the portfolio manager of Passport India Investment (Mauritius) Ltd. His cousins Kanaiyalal (KB) and Anandkumar (AB) placed orders ahead of Passport's orders and squared off when Passport's orders hit the market. Trades were placed from a phone registered to AB at the address the brothers shared. KB's estimated profit from the alleged trades was Rs 1,56,32,364.

Applying the three ingredients:

The Supreme Court set aside the Appellate Tribunal's orders in KB's appeals and restored the findings and penalty of the Adjudicating Officer.

Scaling the Section 15HA exposure on that profit figure:

Three times the profit ≈ 3 × Rs 1.56 crore ≈ Rs 4.69 crore
Statutory ceiling      = higher of Rs 25 crore and Rs 4.69 crore = Rs 25 crore
Statutory floor        = Rs 5 lakh

Illustrative extension: had a tippee made Rs 12 crore from the same pattern, three times the profit — Rs 36 crore — would exceed Rs 25 crore and become the ceiling.

Chapter 8 (SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003), 6% of the paper, presents the Supreme Court judgment as Case 8.2, including the three forms of front running and the tippee test.

Expect a "which three things must be proved against a tippee" question, and a "name the three forms of front running" question. For a compliance officer the practical lesson is that a dealer's family trading account is not outside the regulations merely because the family member is not registered with SEBI.

• Three ingredients, all needed: tipper's duty of confidence, tippee's knowledge of the breach, and trading anyway.
• A tippee need not be an intermediary. Non-intermediary front running falls within regulations 3 and 4(1) when the ingredients are met.
• Tippee trading ≠ trading ahead ≠ self-front-running. Trading ahead is by the intermediary itself; self-front-running is the block owner hedging its own order.
• The tipper and tippee are jointly liable — the Court found the information and the trade intrinsically connected.
• The penalty section is 15HA, not 15G — this is fraud and unfair trade practice, not insider trading in listed-company UPSI.
• Stale reference. The judgment cites trading ahead as regulation 4(2)(q); the list of practices in the workbook's current text of regulation 4(2) runs only to clause (p). Treat "4(2)(q)" as the judgment's citation of an earlier version of the list.