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Class Report: Front Running

The document summarizes key points from a class about insider trading: Front running involves a broker entering trades before a large order to profit from the price movement. Circular trading artificially inflates volumes by moving the same shares between accounts to maintain price levels. The class discussed an Indian Supreme Court case related to front running regulations. Fraud in securities markets includes deceitful actions like misinformation that mislead investors and affect prices.

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abbishek
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73 views3 pages

Class Report: Front Running

The document summarizes key points from a class about insider trading: Front running involves a broker entering trades before a large order to profit from the price movement. Circular trading artificially inflates volumes by moving the same shares between accounts to maintain price levels. The class discussed an Indian Supreme Court case related to front running regulations. Fraud in securities markets includes deceitful actions like misinformation that mislead investors and affect prices.

Uploaded by

abbishek
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Abbishek.

R BC0140003
Class report
11.09.2018
On this day, the class was about the different types of insider trading. In this
class, we learnt about Front Running and Circular Trading. We finished the class
with what fraud means under the SEBI Act.

A summary of the lecture is as follows

Front Running:

There are three parties involved in Front Running, A seller, intermediary and a buyer. Front-
running is when a broker enters into an equity trade with foreknowledge of a block transaction
that will influence the price of the equity, resulting in an economic gain for the broker. It also
occurs when a broker buys shares for their account ahead of a firm's strong buy
recommendation to clients. Front-running is also known as tailgating. Front-running is a
prohibited practice for brokers.

Brokers have access to information about crucial transactions even before they have taken
place, which can be misused for personal benefit in trading. Front-running is the practice of a
broker or trader stepping in front of large orders to gain an economic advantage. For example:
‘A’ wants to buy 10000 shares of ABC Ltd and he is the first person to buy it through stock
broker and ‘B’ purchases the shares and transfers it to ‘C’ and ‘C’ transfers it to ‘D’ and ‘D’
might either transfer it to ‘A’ or keeps the shares. Front Running in the securities market leads
to:

 Creation of Artificial liquidity


 Bulk trading
 Artificial Scarcity (If ‘B’ keeps it for long and inflates the price and then sells it)

He holds the client's order until after personally executing an order for the same stock for his
account. Later when he places the client's request, there is a rise in share price, due to the size
of the order. This rise creates an instant profit for the broker. This is an example of Front
Running by stockbroker ‘B’ & thus it is a ‘fraudulent’ trade practices as per FUTP Regulations.
This form of front-running is not only unethical; it is illegal, as it gives an unfair advantage to
the broker. Front-running, much like insider trading, provides unfair advantages to the broker
who has non public information about a company.

Also, we discussed the case of SEBI v. Kanaiya Lal Baldev Patel. In this case, Regulation 6
and 4(2)(q) of the SEBI Regulations were discussed. The 1995 Regulations prohibited Front
Running being done by “Any Person”. But in 2003 Regulations they substituted “Any Person”
to “Intermediary”. So, it was argued by Plaintiff that there was a shift in regulations because
any person was substituted with intermediary and hence any person cannot be made liable. But
the Supreme Court gave a negative interpretation to the wordings and said nowhere it said in
regulations that front running by any person is permitted with the help of Regulation 3.
Circular Trading:

Circular trading is a fraudulent scheme where sell orders are entered by a broker who knows
that offsetting buy orders for the exact same number of shares at the same time and, at the same
price, have either been or will be entered. Such a trading scheme does not represent a real
change in the beneficial ownership of the security. Circular trading artificially inflates volumes
as a way to show that a security has liquidity, maintain share price at a desired level, and to act
as proof that there is market interest in the stock. The practice is banned and illegal in numerous
countries.

If the trading price of a security was on a trajectory to fall below levels desired by certain
shareholders, a circular trade could serve to buttress the share price by giving the impression
that new owners are buying the stock at the desired level. This activity might convince others,
who are not privy to the scheme, to buy into the stock as they assume the trades indicate there
is growing interest in the stock. There may even be some presumption that the company is
about to release news that, once made publicly known, would drive up the price. However,
since the circular trade scheme does not introduce any real change in ownership nor represent
any actual action about to be announced, there is no basis for that perception. If the shares do
rise in price as result, the value is fraudulently inflated. Once the scheme is discovered, that
artificial escalation of the stock price will collapse in on itself, taking with it the funds invested
by others.

For example, if XYZ company’s shares had 10000 shares no takers for it and ‘A’ has 10000
shares and he transfer/sold it to’B’ and then ‘B’ sells it to ‘C’ and then ‘C’ sells it to ‘D’ and
then again ‘D’ sells it back to ‘A’. For circular trading to happen the following points are to be
noted:

 Shares are freely moving


 Repeatful transfer of beneficial ownership
 Synchronization between all 5 investors (not beneficial to investor outside
synchronization because of this circular trading
 Positive sentiment is created
 Inflation of shares prices

Some bonafide purchaser will buy 10000 shares from ‘A’ at inflated price.

Fraud:

Fraud means anything done in a deceitful manner and enjoys a wrongful gain.

The FUTP Regulation, 2003 defines fraud in the securities market as:

 Misinformation
 Affecting the market prices of security
 Investors being misled

General Comments will not fall under the definition of Fraud:


1. Economic policy of the Government
2. Economic situation of the country
3. Trends in the securities market
4. Any other matter of a like nature

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