The curious case of definition and adjudication of front running in India

by Natasha Aggarwal, Amol Kulkarni and Bhavin Patel.

One of the core legislative mandates of the Securities and Exchange Board of India (SEBI) is to prohibit fraudulent and unfair trade practices (FUTP) relating to securities markets. A practice commonly classified as FUTP is front running. It is generally understood as a set of two trades or positions: first, a trade or position taken in advance of a large order, and second, a squaring off of the initial trade or position after the large order, to benefit from the price movement it causes.

SEBI issued the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (the PFUTP Regulations) to deter and sanction front running and other FUTPs.

Neither the SEBI Act nor the PFUTP Regulations define front running. SEBI has, however, defined it elsewhere: in guidelines, glossaries, master circulars and consultation papers, and in a number of adjudicatory orders.

In our working paper, Front running: The law and enforcement of an ill-defined violation, we set out the legal elements that a violation under the PFUTP Regulations requires: fraud, manipulation and unfair trade practice. These elements should inform any definition of front running. We find that the characteristics of front running laid down by SEBI in its other regulatory instruments and adjudicatory orders are inconsistent with these legal requirements.

Through an empirical study of 33 SEBI adjudicatory orders on front running between 2019 and 2024, we show that SEBI's enforcement practice is also disconnected from the codified law, and does not engage with its key requirements.

This proliferation of inconsistent definitions and interpretations causes a range of problems:

• It creates confusion, and weakens the certainty and predictability of the law.
• It gives the regulator untrammelled discretion in deciding whether a violation has taken place.
• It raises concerns about separation of powers: the boundary between the regulator's law-making and adjudicatory functions is erased and re-drawn erratically, at cost to the integrity of each function.

The result is a lack of doctrinal clarity about what front running means, and a set of conflicting articulations of the violation with no clear grounding in the codified law.

We suggest that the term be defined clearly, either in the parent statute or in the PFUTP Regulations. There is now a nearly three-decade history of enforcement, which should be enough to identify the ingredients of this violation.

The Securities Markets Code Bill, 2025 (the SMC) is an opportunity to write such a definition into the parent law. This would take the power to define the violation away from the regulator, restore the integrity of SEBI's separate functions, and meet the requirements of separation of powers. In its present form, though, the SMC may fall short: we show the gaps and confusions that remain in its treatment of fraud, and its failure to define fraudulent or unfair trade practice, or front running, explicitly.

Part of the problem may lie in the absence of separation of powers within SEBI. The regulator can write subordinate legislation, investigate alleged violations, and adjudicate and sanction them, all without a strict separation between its quasi-legislative, investigative and adjudicatory arms.

This may incentivise SEBI to write broad, all-encompassing regulations in its quasi-legislative capacity, and then to widen their scope further to suit its quasi-judicial needs.

The regulator might defend this by pointing to the constantly changing methods used by fraudsters. International experience suggests otherwise: methods change, but the key constituents of securities fraud stay broadly constant.

In India, a lasting solution may require Parliament, not SEBI acting under its delegated powers, to define terms such as front running in the parent legislation.

Front running is only one example of an inconsistently defined and adjudicated practice within the broader category of FUTP. There are likely others. This points to the need for a wider review of how fraud, manipulation and unfair trade practice are defined and adjudicated under Indian securities law, with the aim of achieving consistency and certainty in interpretation and enforcement.

References

Front running: The law and enforcement of an ill-defined violation, TrustBridge working paper.

SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003, Securities and Exchange Board of India.

Securities Markets Code Bill, 2025, Bill No. 200 of 2025.

Natasha Aggarwal, Amol Kulkarni and Bhavin Patel are researchers at TrustBridge Rule of Law Foundation.

What happens when arbitration deadlines are missed

by Prashant Narang and Renuka Sane.

Section 29A of the Arbitration and Conciliation Act 1996 was introduced to deal with delays in arbitration. It sets a time limit for making an award. If that time runs out, parties have to go to court to extend it. The court can also impose consequences for delay, such as reducing fees, awarding costs, or replacing the arbitrator.

Our new working paper studies how this works in practice. It looks at 202 reported orders of the Delhi High Court between 2015 and 2024.

It finds that the Court almost always grants extensions and almost never imposes sanctions.

What the data shows

Out of 202 cases, the court granted extensions in 198 (98%). Only 4 cases were dismissed, and those were on technical grounds. Sanctions were rarely imposed.

• Fee reduction: 0 out of 202 cases
• Adverse costs: 6 out of 202 cases (about 3%)
• Replacement of arbitrators: 4 out of 202 cases (about 2%)

Repeat extensions are not unusual. There are 30 cases where parties came back for a second or later extension. The court granted 29 of them (96.7%). There are no sanctions in these repeat cases.

These petitions also move quickly.

• Median time to decide: 3 days
• Median number of hearings: 1
• About 63% of cases are decided in a single hearing

So the delay is not in the court process. Courts dispose of these matters quickly. But they usually extend time without imposing any consequence.

Why extensions are common

Part of the answer lies in how Section 29A is structured.

For the Court, giving an extension is easy if both parties agree. The court can dispose of the case quickly.

Imposing a penalty is harder as the Court has to find out who caused the delay. It may have to look at the record in detail. It also has to hear the arbitrator before cutting fees. All this is likely to take more time and effort.

It is not surprising that consensual extensions are more common.

What this means for the law

Over time, this pattern shapes how the law works.

Section 29A was meant to push arbitrations to finish on time. It often works as a way to formally extend time after the deadline has passed.

If parties expect that extensions will be granted without much difficulty, the deadline may lose its force.

This does not mean the provision has no value. But it suggests that deadlines work best when consequences are easy to apply.

Looking ahead

If deadlines are not backed by predictable consequences, do they change behaviour?

The paper does not answer this fully. It focuses on what courts do once parties come for an extension. But the pattern is clear. Extensions are routine and sanctions are exceptional.

That may matter for how arbitration timelines are taken in practice.

You can read the working paper here.

The authors are researchers at TrustBridge Rule of Law Foundation.

From Statute to Zero-Cost: Section 31A and the Bombay High Court's Zero-Cost Culture

by Prashant Narang and Vishnu Suresh.

Why this matters now

In 2015, Parliament rewrote Section 31A of the Arbitration and Conciliation Act to make loser-pays the default i.e., compensate the winner and deter abuse. A decade on, our mixed-methods study of the Bombay High Court's arbitration docket(2023-24) shows a stark gap between that legislative design and courtroom reality. Out of 102 decisions under Sections 11 (appointment) and 34 (set-aside), costs were imposed in only four (3.9%). Even then, costs were framed as exceptional sanctions for egregious conduct - not as routine reimbursement that follows the event.

Parliament's 2015 insertion of Section 31A followed the 246th Law Commission Report (2014), which condemned India's token-costs culture under the Code of Civil Procedure and urged a structured, outcome-linked "costs-follow-the-event" rule for arbitration. Section 31A sought to import the English loser-pays norm to ensure both indemnity and deterrence. Yet, a decade later, the provision functions largely as a dead letter.

This reluctance is not harmless. When weak Section 11 or Section 34 petitions carry no real downside, the expected cost of delay collapses onto the opponent and the taxpayer. The result is a deterrence gap: fewer incentives to screen out speculative filings, more tactical adjournments, and a credibility problem for India's "arbitration-friendly" promise.

In our new paper (publicly available), we build the first mixed-methods baseline for any Indian High Court on post-2015 costs in arbitration-related litigation. We combine a complete corpus of BHC decisions in 2023-24 with 22 confidential stakeholder interviews (judges, arbitrators, and counsel) to explain the pattern and to propose targeted reforms.

What we did

Prior commentary (and court exhortations in Salem and Uflex) diagnosed India’s token-cost culture but largely at the Supreme Court or in international arbitration. So, we chose to focus on a major High Court post-2015. We identified every Bombay High Court decision under Sections 11, 34 (and related Section 37 appeals where relevant) in calendar years 2023–24; after deduplication and exclusions, 102 reasoned decisions remained (54 in 2023; 48 in 2024). We coded each decision for whether costs were awarded, quantum, reasons, and whether judges engaged with Section 31A’s statutory factors. Interviews (22 conducted) supplied explanatory mechanisms behind judicial practice.

What we find

3.9% of decisions imposed costs; 96.1% did not. Where imposed, costs were justified as punishment for delay/illegality - not as routine indemnity. In 60 decisions, the court itself recorded conduct that maps onto Section 31A triggers. Costs were imposed in 4; in the remaining 56, no cost order followed. This selective enforcement blunts deterrence. With no articulated scale or factors applied, lawyers cannot advise clients on realistic exposure.

Why the default drifts to "zero-cost"

One, Section 31A(1) gives courts/tribunals discretion to determine costs. Section 31A(2) supplies a loser-pays presumption, but only if the decision-maker chooses to engage. Written reasons are required for departing from the presumption - not for declining to consider costs at all. This creates a one-way gate.

Two, interviewees repeatedly flagged a cultural aversion to "appearing punitive". For judges approaching retirement, the post-retirement arbitration market sharpens this caution: visible toughness on costs can be perceived as party-unfriendly, potentially affecting future appointments. That behavioural preference often persists into arbitral roles.

Third, Section 31A lists factors but lacks practical scales. In our four cost-imposing cases, sums ranged from Rs. 1 lakh to Rs. 40 lakh - with thin links to documented outlay. Practitioners consequently cannot price risk ex ante; costs become a lottery, not a calculable exposure.

How reasons are (not) written

Most orders end with a formulaic "no order as to costs", even when the judgment itself records behaviour that Section 31A treats as cost-triggering: obstruction, delay, frivolous claims, wasted hearings, or refusal of reasonable settlement.

Two of the four cost-imposing judgments offer only a one-line figure; two provide a brief narrative (e.g., "taking a chance") and sometimes cite one cost figure from the record, but none works through Section 31A's checklist or ties quantum to documented expense and deterrence. The resulting spread (Rs. 1-40 lakh) looks unanchored. For users, this reads like gesture, not governance.

What needs to be done

Our proposal aligns with the 246th Law Commission (2014) and the T.K.V. Committee (2024). One, create a rebuttable default: award reasonable, receipted costs to the successful party. Require brief reasons (even 1-2 sentences) when withholding costs. This small change collapses the one-way gate that currently rewards inaction. Two, keep indemnity as the baseline and add calibrated uplifts for documented delay tactics, non-disclosure, wasted hearings, or unreasonably rejected settlement offers - all already listed in Section 31A(3). Three, consider importing a narrow, high-threshold wasted-costs power (on the UK model) against improper or negligent conduct that needlessly increases expense. This targets the source of delay when it lies with representatives rather than clients.

Limitations

We included only one jurisdiction (Bombay), a two-year window, and interviews that exclude sitting judges and in-house counsel. Arbitral awards and proceedings were out of scope (confidentiality), though interviews illuminate arbitral practice.

Conclusion

Section 31A promised efficient, fair, and predictable cost allocation. In the Bombay High Court's arbitration-related litigation, it has largely delivered neither indemnity nor deterrence - except at the margins of overt misconduct. A rebuttable default in favour of reasonable costs, brief reasons for exceptions, receipt-anchored scales, and conduct-linked uplifts would realign daily practice with Parliament's indemnificatory intent and close the deterrence gap that now fuels speculative petitions.

Read the full working paper "From Statute to Zero-Cost: Section 31A and the High Court's Zero-Cost Culture", here.

The authors are researchers affiliated with TrustBridge Rule of Law Foundation.

A guide to writing good regulatory orders

by Natasha Aggarwal, Bhavin Patel and Karan Singh.

India has several regulators that are vested with quasi-judicial powers and that play a pivotal role in economic governance. In exercising their quasi-judicial functions, regulatory orders must: (i) demonstrate compliance with the principles of natural justice, (ii) establish legitimacy by showing how they are taken strictly in accordance with, and to the extent authorised by the governing law, and (iii) be accountable, by ensuring that all the information an appellate authority may require for its evaluation of the regulatory action is clearly documented.

Regulatory orders significantly impact market participants and public trust. In particular, four sets of stakeholders are impacted by regulatory orders: (i) parties involved in the enforcement proceedings, (ii) the regulator itself, (iii) appellate and review fora, and (iv) the market and the general public. However, deficiencies in reasoning, structure, and clarity in quasi-judicial orders often undermine regulatory legitimacy and efficiency, leading to diminished stakeholder confidence. Moreover, arbitrary orders that do not demonstrate application of mind can be challenged or overturned or remanded in appeal. Such challenges, overturns, and remands lengthen the enforcement process and increase costs for all those involved. They also take away from the certainty of regulatory orders and affect the predictability of the law. Regulatory certainty and predictability are important requirements of the rule of law and are critical for the smooth functioning of markets.

The need for regulatory orders to be well-reasoned is recognised in Indian law. In a recent paper, titled "A guide to writing good regulatory orders", we propose a method of structuring regulatory orders that would aid readability, strengthen the logical flow of arguments, and enhance the accessibility and transparency of regulatory orders. In particular, we identify four sets of requirements for better order writing: informational, structural, substantive, and stylistic. Broadly, the information requirements relate to identificatory and citatory information that should appear in orders, and to information that helps establish that procedural requirements have been complied with, such as dates of Show Cause Notices. Structural requirements relate to the logical arrangement of the contents of orders in a manner that aids reading and comprehension, and which strengthens regulatory arguments. The substantive requirements help establish that all the requirements of the substantive law applicable to the matter discussed in the order have been addressed. Finally, our suggestions on stylistic requirements include the use of plain language and writing styles that are accessible and comprehensible to all affected persons.

We propose to conduct further studies on how the suggestions in this paper may be implemented through tools and technologies that could augment regulatory capacity for order writing.

The authors are researchers at the TrustBridge Rule of Law Foundation.

Reducing challenges to arbitration awards: lessons from court data

by Madhav Goel, Akshay Jaitly, Renuka Sane and Anjali Sharma.

Contracts form the bedrock of economic activity in the formal economy. As an economy grows, so does its reliance on contracts. Delays and friction in contract enforcement erode trust in contracts and inhibit the pace of economic growth. In India, contract enforcement generally falls in the jurisdiction of the civil court system, which, according to the National Judicial Data Grid, has more than 11 million pending cases and takes, on an average, more than three years to dispose of a case. One of the solutions to an increasingly overburdened court system in India has been to move certain types of matters to a different judicial forum, either a specialised court or tribunal or by using an alternate dispute resolution (ADR) mechanism. Arbitration is one such alternative mechanism, the framework for which is provided by the Arbitration and Conciliation Act, 1996 (A and C Act).

Contract enforcement by private persons against the state in India brings its own set of problems. Increasingly, government contracts provide for dispute resolution by arbitration. However, anecdotal evidence suggests that the state consistently challenges adverse arbitration awards. In this article, we use Delhi High Court data on challenges to arbitration awards for matters in which the National Highways Authority of India (NHAI) was a party. We analyse the grounds on which these awards were challenged and the manner in which the court dealt with these challenges.

Our main finding is that both the NHAI and the private parties challenge adverse arbitration awards, most often on the merits, even though the A and C Act specifically prohibits this. We also find that the court generally does not interfere with arbitral awards, which is in line with the legislative intent. However, this does not deter such challenges. This may be for a variety of reasons, such as the relatively low cost of litigation vis-a-vis the award value or the incentives of decision makers within the state.

Our analysis adds to the intersection of two growing bodies of recent work in India on the subject. The first that studies government contracting, both from a public administration lens and from the lens of how the government impacts ease of doing business and business outcomes (Chitgupi and Thomas (2023), Burman and Manivannan (2022), Mehta and Thomas (2022), Manivannan and Zaveri (2021), Shah (2021), Roy and Sharma (2020)). The second studies the functioning of courts and the manner in which they deal with a variety of matters (Manivannan et. al. (2021), Damle et. al. (2021), Sharma and Zaveri (2020), Gulati and Sane (2021), Bhatia et. al. (2019)).

The organisation of this article is as follows. We first provide an overview of the legislative and judicial framework to challenge an arbitral award, i.e., Sections 34 and 37 of the A and C Act. We then describe our data set and our methodology for analysis. This is followed by our findings and some recommendations on the way forward.

An overview of Sections 34 and 37 of the A and C Act

The design of the A and C Act allows for a two-stage sequential challenge to outcomes of arbitration proceedings, first under Section 34 and then under Section 37 of the Act. Section 34 provides 5 procedural and jurisdictional grounds, along with 3 additional grounds to set aside an arbitral award. These are:

• Procedural and Jurisdiction:
• The party was under some incapacity while entering into the arbitration agreement;
• The arbitration agreement was not valid under the law to which the parties have subjected it;
• The party making the application was not given proper notice of appointment of arbitrator or of arbitral proceedings, or was otherwise unable to present its case;
• The arbitral award dealt with a dispute not contemplated by or not falling within the terms of the submission to arbitration, or it contained decisions on matters beyond the scope of the submission to arbitration; or
• The composition of the arbitral tribunal or the arbitral procedure was not in accordance with the agreement of the parties or the A and C Act, as the case may be.
• Additional Grounds:
• The subject matter of the dispute was not capable of settlement by arbitration;
• The award is in conflict with the public policy of India, i.e., award is affected by fraud or corruption, or is against the fundamental policy of Indian law, or is in conflict with the most basic notions of morality or justice; or
• The award is vitiated by patent illegality appearing on the face of the award.

It is useful to note that Section 34 proceedings are not appeals (Delhi Airport Metro Express (P) Ltd. v. DMRC (2022)), and the grounds for challenge are limited by the A and C Act itself (Union of India v. Annavaram Concrete Pvt. Ltd. (2021)). Under the scheme of Section 34, an arbitral award cannot be set aside on merits, that is, on the grounds of erroneous application of law or by re-appreciation of evidence (MMTC Limited v. Vendanta Limited (2019); PSA SICAL Terminals (P) Ltd. v. Board of Trustees of V.O. Chidambranar Port Trust Tuticorin (2021)). Therefore, unless an arbitral award is set aside under the grounds laid down in Section 34, it is ready for execution as a civil court decree against the award debtor. Section 37 of the A and C Act, on the other hand, is an avenue of appeal against an order under Section 34 of the Act. Accordingly, proceedings under Section 37 are governed by the Code of Civil Procedure, 1908 (CPC) and are in the form of an appeal. However, through consistent judicial pronouncements, the grounds for appeal under Section 37 have been restricted, even as compared to the grounds under Section 34 (Mahanagar Telephone Nigam Limited vs. Applied Electronics Ltd. (2014)).

While the A and C Act is, to a large extent, modeled on the UNCITRAL Model Law on International Commercial Arbitration, 1985, it deviates from the Model Law in two important ways. First, it introduces an additional ground to challenge an arbitral award: patent illegality appearing on the face of the award. Second, it provides for a two-stage appeal process, where Section 37(1)(c) of the Act allows an appeal against an order under Section 34 setting aside or refusing to set aside the arbitral award. These two deviations from the Model Law have implications for the efficacy of the arbitration framework in India. The ground of patent illegality introduces ambiguity and discretion in the otherwise procedural nature of the process of challenging awards. The two-stage appeal process adds to this ambiguity and discretion, and introduces delays in the enforcement of the award. Section 36 of the A and C Act, under which an award is enforced as a decree, adds to these challenges. Section 36(2) specifically gives the court the power to stay the enforceability of an award. Section 36(3) specifies the conditions under which the court may grant such a stay.

Data and methodology

For our analysis, we collected judgments from Delhi High Court for the years 2018 and 2019 pertaining to matters where the NHAI is a party. Our choice of Delhi High Court is due to its importance as a court for arbitration matters, as well as because NHAI matters are likely to be brought before it.

Our choice of the years 2018 and 2019 is driven by three factors. First, the arbitration framework has undergone significant legislative change since 2015 and more recent data reflects the current framework. Second, the period from 2020-2022 was marked by disruptions in the judicial system due to the COVID-19 pandemic, and therefore, may not represent the ordinary course of dispute resolution. Finally, the choice of 2018 and 2019 allows for the possibility of extending our analysis to studying the entire life-cycle of such litigation all the way to the Supreme Court.

We focus on the NHAI because of its status as an autonomous, specialised statutory body that has been tasked with development, maintenance and management of India's national highways. NHAI is also one of the largest contracting bodies within government, accounting for nearly 10 percent of the total union government expenditure on public procurement (Sharma and Thomas (2021), Chitgupi, Gorsi and Thomas, (2022)).

We find 96 judgments in Delhi High Court where NHAI is a party. Of these, 82 pertain to matters under Sections 34 and 37 of the A and C Act (details can be found by clicking here) From these 82 judgments, we collect the following details:

1. The nature and quantum of claims filed before the arbitral tribunal;
2. The party that won the arbitration;
3. The time taken between filing the petition under Section 34 or 37 of the A and C Act to the final judgment;
4. The nature of disputes and grounds for the petition under Section 34 or 37; and
5. Which party won, and the quantification of the claims that were upheld/set aside by the Court.

Findings

Our main finding is in regards to the win-loss record for a challenge to an arbitral award under Sections 34 and 37 of the A and C Act, i.e., the likelihood of success in challenging the arbitral award (Table 1).

Table 1: Outcome of Section 34 and 37 Challenges

Categories	2018	2019	Total
Petitioner won	4	4	8
Petitoner lost	44	30	74
Total	48	34	82
Source: Delhi High Court judgments

We find that in 74 of the 82 cases (90.2%) involving NHAI, the court refused to interfere with the arbitral award, irrespective of whether the party challenging the award was the NHAI or the private party. This suggests two things. First, the Delhi High Court's action of ordinarily not setting aside the arbitral award is in line with the legislative intent of Sections 34 and 37 of the A and C Act. Second, despite the court not interfering with the award, parties continue to mount such challenges. This is especially so for NHAI, which is the petitioner in 67 out of the 82 matters.

When we look at the grounds under which awards are being challenged in court (Table 2), we observe that the bulk of the challenges, 77 out of 82 (93.9%), are under Section 34(2A), which is unlike the provisions of the UNCITRAL Model Law, and is an Indian innovation that allows the award to be reviewed on the basis of the substantive merits of the case. Patent illegality is a subjective formulation whose treatment may change from case to case and from court to court.

Table 2: Nature of Section 34 challenges

Provision	2018	2019	Total
S. 34(1)	2	1	3
S. 34(2)	-	-	-
S. 34(2A)	45	32	77
S. 34(3)	1	1	2
Source: Delhi High Court judgments

The findings from Tables 1 and 2 together indicate that award debtors routinely challenge arbitral awards on substantive merits, even though the courts routinely turn down such challenges.

We also find that, on average, it takes the court 805 days (2.2 years) to dispose of a Section 34 challenge and 208 days (0.6 years) to dispose of a Section 37 challenge. A matter in which both Section 34 and 37 challenges are brought will be in court for about 3 years after the award has been made by the arbitral tribunal.

In 36 of the 82 matters, we get data for the size of the claim. The total value of claims, across these 36 cases, is Rs. 17.5 billion and the average per case claim value is Rs. 485 million. While these may not be significant for an entity of NHAI's scale, for private parties dealing with NHAI, these may be consequential. And so may be the additional time of three years and the cost of litigation to secure these claims.

Some simple calculations also give us a sense of what these challenges with minimal chance of success mean for the government. At an interest rate of 8% per annum (MCLR during 2018 and 2019 was in this range), compounded annually, after the three year litigation challenging the arbitral award, the government will have to bear an additional interest cost of Rs. 4.5 billion on these awards. This does not take into account the cost and time consumed by the litigation.

Why do parties challenge arbitral awards?

There may be two main reasons why parties continue to appeal even though the chances of the award being overturned are low:

• Low costs: for large value awards, the cost of the litigation challenging the arbitral award is lower than the expected benefit to the award debtor even at low probability of the award being overturned (Mehta and Thomas (2022) supra). Additionally, for the government, the economic considerations around litigation costs may not be as relevant as for private litigants. Empanelled lawyers for the government and its agencies are often remunerated far less than lawyers representing private parties. Further, incentives of the bureaucracy are often such that they do not accept adverse outcomes in contractual disputes and litigate till the last available forum, regardless of cost.

• Delaying the enforcement: parties may resort to challenging the award to delay enforcement. Filing a petition under Section 34 of the A and C Act often forces the award holder to delay an execution petition under Section 36 of the Act. This could be because of the uncertainty regarding the outcome of the challenge, and due to potentially wasteful litigation costs, should the award be stayed or overturned. Anecdotal evidence shows that the executing court is often cognizant of the filing of a petition under Section 34 while taking substantive decisions under Section 36 of the Act. The executing court typically awaits the outcome of proceedings under Section 34 or 37 before taking any coercive action against the award debtor. Therefore, it is likely that much of the litigation under Sections 34 and 37 is a means of delaying enforcement of the award, and not because the litigants expect to succeed.

Legislative solutions

Disincentivising litigants from challenging arbitral awards on merits, especially if the litigant is the government, is important to ensure that the A and C Act remains relevant as an alternate dispute resolution mechanism. This can be achieved through two levers. First, that courts take up Section 34 challenges only in cases where there is a high likelihood of the challenge succeeding. Second, the cost of challenging the award either under Section 34 or Section 37 are high enough to alter the economic incentives of the award debtor. To this effect, we suggest three legislative solutions:

1. Amending Sections 34 and 37 of the A and C Act to introduce a prima facie test of satisfaction: As the law stands currently, the courts must hear petitions under Sections 34 or Section 37 and decide them on merits, irrespective of the grounds of challenge and the chances of success. This takes up significant resources. Introducing a prima facie test of satisfaction will enable the Court to dismiss the petition at the pre-notice stage itself, unless the petitioner is able to satisfy the court that it has a good case on merits. This will be similar to the procedure adopted by the Supreme Court while hearing fresh special leave petitions under Article 136 of the Constitution of India. The decision of the court to entertain a petition under Section 34 or Section 37, based on a prima facie view of the merits, has cost advantages to the litigants as well as the court. Dismissal at the pre-notice stage means that the litigants do not bear the cost of a full appeal and the court also spends less time and resources in deciding the petition on merits (Shavell (2010)). Further, deciding the merits at the pre-notice stage may also reduce time and costs during the full appeal as part of the assessment of the merit will already have been done by the court.

2. Amending of Sections 34 and 37 of the A and C Act to introduce a mandatory pre-deposit of fees proportionate to the arbitral award for the admission of petitions to set aside arbitral awards: As pointed out earlier, the economic incentives are stacked in favour of a challenge to the award. One way of counteracting this would be to increase the cost of a challenge. This can be achieved by adopting a mandatory pre-deposit of a proportion of the award value with the court before a challenge can be instituted. Such a pre-deposits can be tiered, with a higher proportion being required under Section 37 as compared to Section 34.

Another way of achieving this outcome will be to amend Section 82 of the Act to introduce a clarification that empowers the courts to frame rules to introduce barriers to unmeritorious challenges. These could include, as suggested above, a prima facie test or a mandatory pre-deposit of a proportion of the award value under challenge. This method leaves the discretion of framing such rules, and the substance of these rules with each High Court which could take into account local conditions while framing them. Further, the desired objective will be achieved without hard coding too much detail in the statute itself, which might make it inflexible and require more amendments going forward.

In October, 2021, the General Financial Rules, 2017 (GFR), the procurement rules for union government and its agencies, were amended to introduce Rule 227A which requires government departments challenging arbitral awards to pay 75% of the award value into an escrow account, to be used sequentially for the settlement of lender's dues, project completion and then as payment to the contractor. However, the impact of this change is in respect of of government challenges to arbitral awards. Our analysis shows that even private parties routinely challenge arbitral awards, and hence an amendment to the A and C Act introducing a pre-deposit may be desirable.

3. Amending Section 37(1)(c) to remove the second challenge avenue for the award debtor: Section 37(1)(c) of the A and C Act permits an appeal of the order of the court either setting aside or refusing to set aside an arbitral award under Section 34. This affords the award debtor a second avenue to continue litigation and stave off enforcement of the award. Our analysis shows that while courts generally uphold the award even during this challenge, both time and resources of the court and the litigants are consumed. Further, even at this stage courts may adjudicate the matter on merits, despite this already having been done at the award stage and at the Section 34 stage. Further, as mentioned earlier, no analogous provision to Section 37(1)(c) exists even in the Model Law as well as the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards.

   One possibility is to completely remove Section 37(1)(c) from the A and C Act and align the framework for challenging an arbitral award with the Model Law. Alternatively, Section 37(1)(c) could be amended to remove the appeal available to the award debtor, but retain the appeal available to the award holder. This will protect against frivolous appeals by the award debtor, while providing adequate remedy in matters where an award has been erroneously overturned under Section 34.

Conclusion

In India, delays of the court system have increasingly led both government and private parties to opt for ADR mechanisms such as arbitration to resolve contractual disputes. However, for arbitration to be used effectively, it is important that challenges to the outcome of arbitration are limited to the procedural and jurisdictional grounds laid down in the A and C Act. Our analysis shows that this may not be so, and that both government and private parties routinely challenge arbitral awards on merits. Challenges to arbitration awards appear to have become a way of delaying enforcement. The Delhi High Court has been sanguine in the manner of its dealing with these challenges, most often refusing to interfere with the arbitration outcome. However, this does not seem to have deterred challenges, especially from government agencies.

One way of disincentivising such challenges is to amend the A and C Act to remove the legislative loopholes. These include: (i) introducing a prima facie test of the merits of the challenge, (ii) seeking a pre-deposit of a part of the award value before allowing a challenge, and (iii) removing the second challenge permitted under the Act. These changes could go a long way in curbing the litigious behaviour of parties to delay enforcement of high value awards.

Contract enforcement is hard when there exists an imbalance of power and resources between the parties to a contract or where the incentives of one of the parties are not driven entirely by commercial considerations, as in the case of government contracting with private parties. Creating legislative boundaries against strategic actions by parties, whether government or private, is one way of dealing with this challenge. There are other ways, that seek to change the behaviour of government departments and agencies, through measures such as a National Litigation Policy or the government procurement rules.

References

Aneesha Chitgupi and Susan Thomas, Learning by doing for public procurement, XKDR Working Paper No. 22 (2023).

Pavithra Manivannan, Susan Thomas, and Bhargavi Zaveri-Shah, Helping litigants make informed choices in resolving debt disputes, The Leap Blog (2023).

Anirudh Burman and Pavithra Manivannan, Delays in government contracting: A tale of two metros, The Leap Blog (2022).

Aneesha Chitgupi, Abhishek Gorsi, and Susan Thomas, Learning by doing and public procurement in India, The Leap Blog (2022).

Charmi Mehta and Susan Thomas, Identifying roadblocks in highway contracting: lessons from NHAI litigation, The Leap Blog (2022).

Pavithra Manivannan and Bhargavi Zaveri, How large is the payment delays problem in Indian public procurement?, The Leap Blog (2021).

Ajay Shah, The bottleneck of government contracting, Business Standard (2021).

Anjali Sharma and Susan Thomas, The footprint of union government procurement in India, XKDR Working Paper No. 10 (2021).

Devendra Damle, Karan Gulati, Anjali Sharma, and Bhargavi Zaveri-Shah, Litigation in public contracts: some estimates from court data, The Leap Blog (2021).

Karan Gulati and Renuka Sane, Grievance Redress by Courts in Consumer Finance Disputes, The Leap Blog (2021).

Anjali Sharma and Bhargavi Zaveri, Judicial triage in the lockdown: evidence from India's largest commercial tribunal, The Leap Blog (2020).

Shubho Roy and Anjali Sharma, What ails public procurement: an analysis of tender modifications in the pre-award process, The Leap Blog (2020).

Surbhi Bhatia, Manish Singh, and Bhargavi Zaveri, Time to resolve insolvencies in India, The Leap Blog (2019).

Steven M. Shavell, On the Design of the Appeals Process: The Optimal Use of Discretionary Review versus Direct Appeal, 39 J. Legal Stud. 63 (2010).

Delhi Airport Metro Express (P) Ltd. v. DMRC, (2022) 1 SCC 131.

Union of India v. Annavaram Concrete Pvt. Ltd., (2021) SCC OnLine Del 4211.

MMTC Limited v. Vendanta Limited, (2019) 4 SCC 163.

PSA SICAL Terminals (P) Ltd. v. Board of Trustees of V.O. Chidambranar Port Trust Tuticorin, (2021) SCC OnLine SC 508.

Mahanagar Telephone Nigam Limited vs. Applied Electronics Ltd., AIR (2014) Delhi 182.

Madhav Goel, Renuka Sane and Anjali Sharma are with the TrustBridge Rule of Law Foundation. Akshay Jaitly is the co-founder of TrustBridge Rule of Foundation and Partner, Trilegal. We thank Karan Gulati, Ajay Shah and two anonymous referees for their inputs and comments.

How are securities laws enforced in India: some facts from a new data-set of SEBI orders

by Devendra Damle and Bhargavi Zaveri Shah.

Introduction

The Securities and Exchange of Board of India (SEBI) is one of the most powerful regulators in India. As the regulator of one of the world's largest stock markets by market capitalization, SEBI has a variety of enforcement tools at its disposal. These include the imposition of monetary penalties, license cancellation and pursuing criminal proceedings against violators. The law empowers SEBI to issue directions to intermediaries, and more broadly, to persons associated with the securities market. Such directions may be of a prohibitory nature, such as restricting companies from raising capital in the public markets, disqualifying persons from acting on the board of publicly traded issuers and restricting access to the capital market altogether. They may also be of a remedial nature such as disgorging illegal gains made by violators or directing restitution to wronged investors. The grounds for issuing such directions are wide.

How has SEBI used these enforcement powers over time? Has it prioritized enforcement against some kinds of misconduct over others? If yes, have the priorities stayed static or changed over time? Do certain types of violations consistently entail certain types of sanctions? How efficient are the enforcement proceedings in terms of the time taken, and what is the success rate for enforcing such sanctions? Unlike some Indian financial sector regulators, SEBI follows a due process before issuing such orders, involving the issuance of a show cause notice and a hearing and publishes each enforcement order passed by its officials systematically on its website. This transparency in enforcement allows us to establish some basic facts on securities laws enforcement in India over a long observation period. In a new paper, we analyse over 8,000 enforcement orders passed by SEBI over a span of ten years to answer some of the questions we mentioned above. In this article, we summarize the key findings of our work.

Data description

In our study period beginning 1st January, 2011 and ending on 31st December, 2020, SEBI passed 9048 enforcement orders, of which we were able to sucessfully download and parse 8032 orders. We then analysed these orders, using text-mining software we designed ourselves, to arrive at some summary statistics on the frequency and type of enforcement undertaken by SEBI during the study period. To answer more detailed questions on the nature of enforcement, we manually analysed a stratified random sample of about 10% of these orders. The sample was drawn from the set of orders involving four regulations, which are most frequently enforced by SEBI (as per our data), namely, orders pertaining to fraudulent and unfair trade practices in the Indian securities market (FUTP), violations of the Insider Trading regulations, the Takeover Code and Broker regulations.

As mentioned above, the SEBI Act empowers SEBI to pass two types of orders, namely, orders imposing monetary penalties and orders issuing directions. Such orders can be issued against intermediaries, market participants, issuers of capital or persons generally associated with the securities market. Until 2019, monetary penalty orders could be passed only by adjudication officers and directions would be issued by whole time members of the SEBI board. With effect from 2019, the members of the SEBI board have also been empowered to pass orders imposing monetary penalties. In addition to these, the law also empowers SEBI to settle violations upon the payment of a settlement fee, without passing a guilty verdict against the violator. Basis this scheme of the SEBI Act, we categorize the enforcement orders in our data set into three categories shown in the Table. On an average, SEBI issues 250 enforcement orders with directions and double the number of orders imposing monetary penalties each year. The SEBI Act also empowers SEBI to initiate criminal prosecution against persons accused of having violated the SEBI Act or the regulations made by it, but we do not take account of this typology of enforcement proceedings in our study.

Table: Enforcement orders (2011-20)

Type of order	Type of sanction	Total^
Orders by Adjudicating officers	Monetary penalties	4911 (61)
Orders by Chairperson/member	Non-monetary sanctions	2484 (31)*
Settlement orders	Settlement fee	637 (8)
Total		8032 (100)
^Numbers in brackets are a percentage of the total. *We estimate that not more than 30 orders may involve a monetary penalty.

As is evident from the Table, securities law enforcement is largely undertaken in India through monetary penalties, but the proportion of enforcement undertaken through non-monetary sanctions is not trivial. Settlements account for less than 10% of the total enforcement orders in our data. The annual distribution of these types of orders is shown in the Figure. The Figure shows that from 2018 onwards, there has been a sharp increase in the intensity of enforcement, with the number of monetary penalty orders nearly doubling from the previous years. The proportion of settlements has also increased over time, particularly after 2016. While the growth in the size of the market, an increase in the intensity of regulation and enforcement capacity are intuitive explanations for this jump, more precise, causal explanations require further research.

Figure: Year-wise types of enforcement orders (2011-2020)

Findings

SEBI draws its substantive powers from a set of three laws, over and above the SEBI Act, namely, the Companies Act, 2013 (and its preceding legislation), the Securities Contracts (Regulation) Act,1956 (SCRA) and the Depositories Act, 1996. While the Companies Act largely deals with the incorporation of Indian companies and the governance of their affairs, it also governs primary issuances, the requirements to be met by public offer documents and some aspects of the governance of listed companies. These matters under the Companies Act are administered by SEBI. The SCRA governs the conceptual definition of securities and securities contracts, regulates some types of securities contracts and governs the licensing and affairs of stock exchanges. The Depositories Act, 1996 deals with the regulation of depositories and depository participants. Under each of these laws, and in particular under the SEBI Act, SEBI has issued regulations defining the registration and reporting requirements for intermediaries, the kinds of misconduct that will elicit penalties, and so on.

We find that orders against fraudulent and unfair trade practices (FUTP) are the single largest group (15%), followed by orders dealing with violations of the provisions of the Companies Act (11%), insider trading regulations (10%) and the takeover code (9%). The enforcement actions (i.e. the number of orders) under the remaining regulations are few, with some of them having witnessed enforcement not more than once during the study period. Some of these seemingly rarely-enforced regulations, such as the regulations governing alternative investment advisors, are relatively new, which may explain why they do not appear more often in our data. However, others, such as the regulations governing venture capital funds, stock exchanges and clearing corporations, are older, but we see fewer orders issued under these regulations as compared to other regulations. Whether this is because the regulations themselves are not violated as frequently by market participants, or because SEBI chooses not to enforce them, requires further study.

To answer more specific questions of these enforcement orders, we manually analysed a random sample of 818 orders (approximately 10% of the total sample) from amongst the orders against the following types of violations: (1) FUTP, (2) insider trading, (3) violations of the takeover code and (4) violations of brokers' regulations. Some findings from this micro-study are summarised below:

1. Duration of the enforcement proceedings: The formal enforcement process at SEBI begins with the appointment of an investigating authority who investigates the facts and reports her findings to the SEBI board. If the findings are adverse, a show cause notice is issued to the accused by the adjudication officer (where the proposed sanction is a monetary penalty) or a whole time member of the SEBI board (where the proposed intervention is a direction). We find that the median time for the issuance of a show cause notice is a little more than three years from the date on which the violation was committed. Further, the median time from the date of issuance of a show cause notice to the date of an order imposing monetary penalties is a year and a half. It is a little more than two years for orders issuing directions. A regulation-wise analysis of the duration suggests no relationship between the complexity of the violation involved and the duration of the enforcement proceeding.
2. Subject and outcome of enforcement: A bulk of the enforcement actions are in respect of unregulated entities, that is, entities that are not SEBI-licensed intermediaries. This phenomenon could be attributed to the type of violations that are most often enforced against, namely FUTP and insider trading. Both these practices would likely involve traders and market participants that are not SEBI-licensed intermediaries. Further, in nearly 80% of the cases, SEBI found the person(s) guilty of all the violations that they were charged with, with a marginally higher conviction rate for unregulated entities compared to regulated entities. The conviction rate for violations of the Takeover Code is also marginally higher, compared to violations under the three sets of regulations. It is hard to comment on the optimality of this high conviction rate as these enforcement proceedings are undertaken and decided by SEBI officers themselves. All orders of SEBI, except those rejecting an application for settlement, are appealable to the Securities Appellate Tribunal (SAT). The rate of appeals and the outcome of appeals before the SAT could be a rough proxy to evaluate the optimality of this conviction rate and would be a good direction for further research.
3. Proportionality of sanction: We find a lot of variation in the amount of penalty levied across cases. While the median (i.e. typical) size of the penalty is in the range of Rs 5,00,000, the average is in the range of Rs. 57,00,000. This difference indicates that while there are few cases where large penalties are issued, the size of these penalties is very large compared to the typically-imposed penalties. One explanation that could account for this variation is the amount involved in the violation. The SEBI Act requires an Adjudicating Officer to take into account, among other factors, the amount of disproportionate gain or unfair advantage made as a result of the default or the amount of loss caused to investors as a result of such default. However, we find that in a vast majority of the cases in our sample (90%), the size of the violation was not calculated.

   We similarly find a lot of variation in the orders that impose sanctions other than monetary penalties. Out of 118 such orders, 82 orders restricted the market access of the accused. The duration of such restrictions varied from 15 days to 4 years, and we could not discern any relationship between the duration of the restriction on the one hand and the violation or the purpose of the restriction on the other. Further, courts have repeatedly held that SEBI's direction making powers are remedial and preventive in nature, and not punitive. However, it is unclear at what point an order that operates to restrict market access starts to become punitive in nature, since none of the orders in our data clearly draw the line between remedial and punitive measures.

Conclusion

In India, the field of securities laws is often studied from the perspective of a specific case, individual legislative amendments or specific judgements of courts. While such analysis is useful, a slightly different, more quantitative approach is necessary to gain a systematic understanding of the manner in which the regulator uses the wide variety of enforcement tools available to it, the manner in which it seeks to enforce against different kinds of misconduct and the efficiency of its enforcement functions. The consistent publication of easily accessible enforcement orders by SEBI on its website makes it possible to undertake such systematic research on securities laws enforcement in India. This paper is one such effort to begin developing more systematic knowledge on enforcement of private law in India.

The data used for this analysis can be found here. The data-set can be cited as Zaveri Shah, Bhargavi; Damle, Devendra (2022), "Securities law enforcement in India", Mendeley Data, V1, doi: 10.17632/ppdk9pzfdp.1.

Devendra Damle is an independent researcher. Bhargavi Zaveri Shah is a doctoral candidate at the National University of Singapore.

Reconsidering SEBI disgorgement

by Renuka Sane and S. Vivek.

SEBI disgorgement is a regulatory remedy to recover wrongful gains from entities that have violated securities laws. It is justified based on the equitable principle that no one should benefit from their own wrong. This seems like a non-controversial, even obvious, ground for regulatory action that has 'compelling intuitive appeal'. However, there are basic conceptual issues that are not clearly settled, not just India but in other jurisdictions as well. For example, the U.S. Supreme Court has considered three cases on disgorgement over the last few years - in one case, it held that disgorgement was beyond the powers of the Federal Trade Commission, overruling decades worth of practice, and in another, upheld Securities and Exchange Commission's power to seek disgorgement but with important conceptual restrictions.

These are trends that the Securities and Exchanges Board in India (SEBI) should be watching carefully. Lack of conceptual clarity about the remedy can put years of regulatory action at risk, if the basis of the remedy is questioned in a case before superior Courts. Further, a study of how SEBI orders are interpreting disgorgement powers and if they are consistent with the conceptual justifications is critical. SEBI disgorgement does not have any statutory limit - the order can direct recovery of all the wrongful gain, whatever they may be. This exercise of of vast discretion by SEBI Whole-Time Members (who are executive members of the regulator and typically do not have substantial judicial training), without transparent statutory or conceptual guidance, raises regulatory governance concerns.

In a new working paper, Reconsidering SEBI disgorgement, we study disgorgement from three perspectives:

1. The theory of disgorgement: Disgorgement is a distinct remedy that must be distinguished from other remedies such as compensation, restitution, and penalties. Disgorgement is different from compensation because compensation is focussed on the loss suffered by claimants whereas disgorgement is focussed on the gains made by the wrongdoer. While disgorgement and restitution are both gain-based remedies, there is a subtle yet important difference. Restitution is focused on reversing a wrongful gain of the defendant based, for example, on a wrong or incorrect transfer from the plaintiff. Here, the (wrongful) gain made by the defendant is equal to the loss suffered by the plaintiff - the property in question (money, for example), is returned to status quo. Disgorgement, on the other hand, strips the defendant of its gains, even if such gains are not made from the plaintiff, and even if the plaintiff does not suffer any loss. Accordingly, the loss suffered by the plaintiff need not correlate to the defendant's gain that is clawed back through disgorgement. The objective for disgorgement is to have a deterrence effect, and not to merely reverse an illegal transfer. Penalties are also generally imposed for the purpose of deterrence, among others. However, while disgorgement amounts must be equal to the gains made by the wrongdoer, penalties can be imposed merely on the basis of the violation and need not correlate exactly to the gains, if any, made by the wrongdoer.

2. The evolution of disgorgement at SEBI: SEBI had even in the early years tried exercising powers to claw back illegal gains (disgorgement), or compensate victims in insider trading cases, with mixed success at appellate fora. Subsequently, parliamentary and expert committees over the years have recommended providing SEBI with clear powers to trace the illegal gains made by wrongdoers and return such gains to their victims. Before such powers could be formalised through statute, disgorgement was used by SEBI Whole-Time Members (WTMs) as a quasi-judicial innovation in their orders,and received approval from the Securities Appellate Tribunal. Since, at that time, SEBI WTMs did not have the power to impose monetary penalties, SEBI disgorgement was justified as a 'remedial' power which only returns the wrongdoer to status quo, and hence can be distinguished from a punishment. Further, as there was no express statutory provision at the time for SEBI disgorgement, it was traced back to 'equitable' powers of SEBI WTMs.

   In 2014, the Securities and Exchange Board of India Act, 1992 (SEBI Act), was amended to clarify that SEBI disgorgement was part of SEBI's remedial powers. The amendment also stated that the amounts so clawed back are not to be deposited with the Consolidated Fund of India as in the case of penalties; instead, they are retained by SEBI's Investor Protection and Education Fund, to be used in terms of SEBI's own regulations. Interestingly, despite tracing its origins to Parliamentary and expert committees which discussed disgorgement powers in the context of using the proceeds to compensate victims, the amendment did not require SEBI to even attempt to distribute the amounts to victims. Since then, SEBI's power to direct disgorgement without clear statutory limits has been entrenched. Gradually, SEBI also received judicial recognition for its power to impose interest on the disgorgement amount. These rates are calculated from the date of the violation, sometimes going back 10 years or more (as opposed interest on penalties which is typically calculated from the date of non-payment after the SEBI order). Further, the initiation of proceedings for disgorgement or penalties, remains with SEBI and it is unclear how it is exercised.

   These vast powers are conferred on the regulator on the basis that SEBI disgorgement is only 'remedial' and is returning the wrongdoer to status quo. The use of the term 'disgorgement' while at the same time emphasising the return to status quo creates some confusion between the related albeit distinct remedies of disgorgement and restitution. In this context, we study whether in practice what kind of remedy SEBI disgorgement actually is, regardless of its nomenclature. Further, as a legal matter, returning the wrongdoer status quo is critical as a point of distinction from SEBI penalties; if the wrongdoer is left worse-off, it could be argued that SEBI disgorgement is a penalty by another name.

3. The practice of disgorgement at SEBI : If SEBI's case for disgorgement is based on clawing back illegal gains and returning the wrong-doer to status-quo, do they actually do so? We use all the SEBI disgorgement orders between January 1, 2018, and July 15, 2021, and find that in 9% of the cases there is no finding that the noticee has made a benefit or avoided a loss, and yet noticees have been ordered to disgorge. In none of the cases is there a finding that the direction brings the noticee back to status-quo and does not leave them worse off - a critical element in the justification for SEBI disgorgement and its characterization as a remedial power. Further, it is interesting that SEBI disgorgement is usually used for insider trading, and fraudulent trading offences, for which the SEBI Act allows penalties to be issued up to three times the profits made. Why is disgorgement, and not penalties, being used in these cases?

Our results suggest that lawmakers and the SEBI Board must review how SEBI disgorgement is conceptualised and what goals it serves. It should scrutinise how disgorgement orders are being issued under the existing framework so that they are consistent with the justifications for remedial measures (such as, allowing deductions for legitimate expenses and a transparent and careful system to determine causation of the gains from the wrong). A holistic look at remedies available for securities law violations is required so that they serve all the goals required for stakeholders - deterrence, compensation, and restitution.

S. Vivek is a researcher with the Regulatory Governance Project at the National Law School of India University, Bengaluru. Renuka Sane is a researcher at NIPFP. Author names are in alphabetical order.

Problems with evidentiary standards for proving securities fraud in India

by Nidhi Aggarwal and Bhargavi Zaveri.

Introduction

Did O.J. Simpson kill his wife? A criminal jury said no, a civil jury said yes. The standard of proof applied by the two juries made all the difference to the outcome of the case (Vars 2010).

In India, the securities regulator adopts a very low standard of proof for cases involving wrongdoing in the securities market. For many people, standard of proof related questions are procedural and semantic exercises in the dispensation of justice. However, the standard of proof adopted by a judge has direct impact on the outcome of the case and over time, the quality of the investigation conducted by the investigative agency. When the standard of proof is low, there is a high chance that initiating an investigation will induce an adverse order. This creates substantial discretion in the hands of the investigator, to choose the persons against whom State power will be directed. This runs against a basic theme of liberal democracy, of containing executive discretion. The ability of the executive to direct punishment upon chosen ones is inconsistent with the rule of law. It creates policy risk for persons who may consider participating in the Indian financial markets, and creates a bias in favour of participation by politically connected persons.

There are three reasons why the standard of proof in securities fraud cases in India are low. First, the Supreme Court has held that the standard of proof which SEBI must meet to establish securities fraud is the 'preponderance of probability' standard. This is lower than the standard of proof required to establish a crime under criminal law. In civil proceedings, there are usually two versions of the facts. The court, on the basis of the evidence before it, chooses that version which it thinks is 'more probable', that is, it will accept a version which a prudent man will act upon the supposition that it exists. On the other hand, in criminal cases, the prosecutors must satisfy the court that the existence of a fact is not only probable, but that its existence is beyond reasonable doubt. Simply put, the prosecution must satisfy the court that 'a reasonable alternative version is not possible' (185th Report of the Law Commission). Courts have explicitly acknowledged that it is not possible to mathematically define the degree of probability for meeting a certain standard of proof and there is an inherent subjective element within each of these standards. (State of UP v. Krishna Gopal and Anr.)

The other two reasons are inter-connected. SEBI exercises regulation-making, executive and quasi-judicial powers in connection with the securities market. It defines what conduct would constitute fraud for the purpose of exercising its enforcement powers. The concept of fraud under the SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003 (PFUTP Regulations) - a regulation that defines fraudulent conduct in the securities market - is wider than what is understood as fraud in common law and the codified law applicable to fraud in India. It dispenses with critical elements such as intent, deceit and damages. A wider definition of fraud sets the bar very low for establishing securities fraud before a court or tribunal. SEBI is also responsible for conducting investigations of suspected fraud and makes decisions on whether the conduct investigated meets its definition of fraud. This violates the constitutional scheme of the separation of powers that applies to areas of public administration which are not governed by a technocratic regulatory agency. As an example, the Indian Penal Code defines what constitutes theft, the investigation is conducted by the executive agencies and the decision on whether the investigated conduct amounts to theft (as defined in Parliamentary law) is made by the judiciary.

The concentration of all three powers in a single body creates scope for bias towards a lower standard of proof. Empirical work done on the cases investigated by the Securities Exchange Commission, the securities regulator in the United States, is indicative of such bias. The SEC is empowered to choose whether to pursue a proceeding before one of its own internal administrative law judges or an independent federal court. Reportedly, while the SEC enjoyed a 90% success rate in its own hearings, it had only a 69% success rate against defendants in federal court. (here and a perma link here)

In February 2018, a judgement of the Supreme Court further diluted the standard of proof for securities fraud in India in a case involving synchronised and reverse trades executed on the exchange. The Supreme Court reversed the decision of the Securities Appellate Tribunal which had held that although the trades in question might have been synchronised, they were not manipulative and "market manipulation of whatever kind, must be in evidence before any charge of violating these Regulations could be upheld." The Supreme Court dispensed with the need to show manipulation and relied on the notion of "market integrity" as a standard for adjudging the conduct of market participants. SEBI has extensive powers to sanction wrongdoing in the securities markets, such as the power to bar access to the market, suspend professional licenses and impose hefty monetary penalties. The Supreme Court's ruling has serious implications for the manner in which these powers are exercised as it effectively introduces a new standard of proof of 'market integrity' to be met by persons accused of securities market fraud.

What is market integrity?

The notion of market integrity is both un-defined and hard to measure. World over, there is considerable debate on its meaning in the context of financial regulation (Austin, 2016). Given the subjectivity of the concept, using market integrity as a standard of proof is equivalent to using 'public interest' or 'public good' as a standard for establishing wrongdoing. It leaves tremendous scope for discretion and creates the potential for differential standards of enforcement across a range of practices, depending on the adjudicator's view of whether or not a particular trading practice affects market integrity. This creates uncertainty in the manner in which the law will be applied and enforced and has adverse implications for the rule of law. Ambiguity in the grounds of enforcement and the standard of conduct that could invite legal sanctions, is detrimental to the development of the market as well.

In this article, we advocate the use of empirical approaches for establishing wrongful conduct in the securities markets. We do this by demonstrating the empirical evidence that should have been used to support a claim of fraud in the very same case where the Supreme Court lowered the standard of proof by relying on the vague and problematic ground of market integrity. In a world of electronic trading, empirical evidence of fraud and its impact on the market is not hard to collect and investigators and courts must rely on such evidence instead of holding market participants to a vague and subjective notion of market integrity and unfairness, which the world at large is struggling to define.

Judgement of the Supreme Court in Rakhi Trading

In February 2018, the Supreme Court in the case of Securities and Exchange Board of India v. Rakhi Trading Private Ltd. upheld an order passed by the Securities and Exchange Board of India (SEBI) that levied a penalty on some traders who had synchronised their trades off the exchange before placing them on the exchange. The trades in question were a series of orders placed on the F&O segment of the Nifty index. The modus operandi was to place an order for Nifty options, which matched with a particular party and subsequently reverse the position taken by placing an opposite order, which also matched with the same party. SEBI penalised the party placing such orders on the ground that these "transactions were in the nature of fictitious transactions resulting in creation of misleading appearance of trading in these options." The SEBI order did not elaborate the manner in which the synchronised trades sought to manipulate the price of either the option itself or the underlying securities, which in this case, was the basket of securities included in the Nifty index.

The parties against whom this order was passed appealed against the order before the Securities Appellate Tribunal (SAT). SAT confined its review to whether the synchronised trades in the F&O segment of the Nifty index artificially manipulated the underlying cash segment, which in this case is the Nifty index itself. It observed that:

"To say that some manipulative trades in Nifty options in the F&O segment could influence the Nifty index is too farfetched to be accepted. The only way Nifty index could be influenced is through manipulation of the prices of all or majority of the scrips in the cash segment that constitute Nifty."

This in line with precedent case-law laid down by SAT on the requirement to show manipulative conduct to demonstrate that the synchronised trades constituted fraud under the PFUTP Regulations. On an appeal by SEBI against this order of the SAT, the Supreme Court reversed the order of the SAT without explaining how the synchronised trades in question affected the price discovery system or created a misleading impression of volumes, but emphasised the notion of market integrity as under:

"According to SAT, only if there is market impact on account of sham transactions, could there be violation of the PFUTP regulations. We find it extremely difficult to agree with the proposition...SAT has missed the crucial factors affecting the market integrity, which may be direct or indirect (emphasis supplied) ...By synchronization and rapid reverse trade, as has been carried out by the traders in the instant case, the price discovery system itself is affected."

The problem with synchronised trades

Synchronised trading involves pre-negotiating the trade off the exchange and subsequently placing the order on the exchange such that it matches with the counterparty with whom the trade was pre-negotiated. To synchronise trades on an exchange platform, the buyer and seller of the pre-negotiated trade will enter their respective orders at the same time (with same price and quantity) to maximise the chance of matching their orders against each other. To ensure that the order does not match against another counterparty, the first order may be placed away from the touch, that is, at a price significantly different from the ongoing bid / ask price.

By itself, synchronised trading is not a harmful practice. In fact, block trades for which exchanges have a block trading window are synchronised trades. It is difficult to synchronise trades on liquid securities on the exchange because such orders run the risk of matching against other counterparty(ies). However, even on relatively illiquid securities, synchronised trading is not risk-free. The probability of getting hit by another order (especially a market order) on the opposite side of the book is low, but not zero.

How can synchronised orders be used to manipulate the market? Synchronised trades could create misleading, artificial trading interest in a security. High volumes and significant price changes on an otherwise illiquid security may cause participants to believe that there is some news on the security. This may induce them to buy those securities based on unexplained changes in prices and volumes. This is especially possible in an illiquid scrip, which may be perceived to be suddenly liquid if a series of transactions are executed on such a scrip. While the SEBI order levying the penalty does not specify exactly what was manipulated, evidence of manipulation could be demonstrated in either or all of the following ways:

1. Manipulation of Nifty index: One way of determining manipulation in the Rakhi Trading case is by analysing the changes in the value of the underlying security, the Nifty index. The SAT order almost exclusively focused on the possibility of the synchronised trades having manipulated the value of the Nifty index. The order rightly concludes that price manipulation on the index can happen only if an equivalent position is taken on the spot market on all the 50 constituent stocks of the index. Neither the SEBI order nor the Supreme Court order show any evidence of a position by Rakhi Trading on the spot market. This leaves the scope of manipulation on the Nifty index value to the price transmission from derivatives market to the spot market. Empirical evidence on price transmission from derivatives market to spot market suggests that such transmission is subject to the liquidity of the derivatives instrument (see Fleming et al, 1996, Aggarwal and Thomas, 2019). We examine the liquidity of the relevant Nifty options and also examine if the volumes traded by Rakhi Trading in the options segment were significant enough to impact the value of the underlying Nifty index.
2. Volatility in option premium: Manipulation of stock price increases the volatility in returns on such stocks (Aggarwal and Wu, 2006). If the synchronised trades on the Nifty options were manipulative, we would expect that the real price discovery process on option premium would be hampered, resulting in higher volatility in the premium of the Nifty options in question. This manipulation can be established by examining the volatility of the premium on the Nifty options on which the synchronised trades were executed.
3. Jump in traded volumes: Similar to price efficiency, manipulative trades on a security create a misleading impression and induce other market participants to buy the security. This misleading impression will manifest itself through higher traded volumes on that security on the days of such trades. We examine if this was the case by examining the traded volumes of the Nifty options traded by Rakhi Trading around the dates on which such trading occurred.

Size of the market for the relevant Nifty options

Rakhi Trading executed synchronised trades on 13 specific Nifty option contracts (hereafter referred to as "the relevant Nifty options") on four days of the year 2007, namely, on March 21, March 22, March 23 and March 30 (hereafter,"the event days").

We begin by a simple comparison of the liquidity and volatility of the relevant Nifty options on the event days and compare it with other days between March 15, 2007 and March 31, 2007 (hereafter, "non-event days"). Such a comparison should be the beginning of the court's enquiry when dealing with an order punishing a market participant for securities market fraud. Table 1 provides basic summary statistics on the traded volumes (a measure of liquidity) and volatility of the relevant Nifty options.

Table 1: Volumes and volatility of the relevant Nifty options on event days and non event days

	Event days			Non Event days
	Total Volumes	Volatility	Rakhi Trading Volumes	Total Volumes	Volatility
		(%)			(%)
Min	9,550	0.97	2,000	50	0.10
Mean	26,142	6.19	10,015	7,712	2.25
Median	25,750	5.08	10,700	3,925	0.37
Max	38,600	14.85	11,900	50,050	17.62
SD	7,752	3.86	2,477	10,718	4.39

The key observations from Table 1 are as follows:

1. First, the traded volumes of the relevant Nifty options fluctuated significantly on a daily basis on the event and non-event days, ranging from 9,550 to 38,600 on the event days, and 50 to 50,050 on the non-event days.
2. Second, in comparison to the average daily traded volumes on a liquid Nifty option, Table 1 shows that the relevant Nifty options were relatively illiquid. For a frame of reference, the maximum traded volumes on one single Nifty option in March 2007 was 9.2 million.
3. Third, the volatility (measured by the Parkinson's range measure) of the relevant Nifty options was in the range of 1-15% on the event days, while it was in the range of 0-18% on the non-event days.

Did the synchronised trades manipulate the Nifty index?

Table 2 gives a picture of the size of the overall Nifty options market on the event days and compares it for non-event days based on traded volumes. It also shows the traded volumes of the stocks which constitute the Nifty index for these dates. The last column of the table shows the volumes and contracts traded by Rakhi Trading on the event days to provide a perspective on the possible influence of its trades on the overall options and underlying spot market.

Table 2: Size of overall Nifty options market and proportion of synchronised trades

		Non-event days	Event days	Rakhi Trading volumes
All Nifty Options	Traded volumes (in Rs. millions)	49,978	61,041	277
	Contracts (in `000s)	262	316	1.35
Nifty stocks	Traded volumes (in Rs. millions)	36,228	37,932	NA

The key observation from Table 2 is that on the event days, the volumes traded by Rakhi Trading on the Nifty options were less than one percent of the average traded volumes on the stocks that constitute the Nifty index on the spot market. The minuscule proportion of the volumes traded by Rakhi Trading in the Nifty options market relative to the total traded volumes on the stocks constituting the Nifty index on the spot market, re-affirms the finding of the SAT that the synchronised trades executed by Rakhi Trading could not have possibly manipulated the underlying Nifty index.

However, Table 2 also shows that the volumes and number of contracts on the Nifty options segment on the event days were higher than on non-event days. This might or might not have been due to the synchronised trades executed by Rakhi Trading. In the next few paragraphs, we zoom in our analysis on the specific Nifty options which were involved in the synchronised trades executed by Rakhi Trading and examine if those trades did manipulate the individual options traded by Rakhi Trading.

Did the synchronised trades manipulate the option premium?

To test the claim of manipulation of option premium, we examine the volatility of the premium of the relevant Nifty options, and compare it with the volatility of the premium of other Nifty options with similar liquidity. We call the former as the treated set, and latter as the control set. We identify the control set as the options on which the traded volumes were in the same range as that on the ``treated" set, to ensure comparability across the two sets. If there was indeed manipulation on the treated options, we expect the volatility of the treated set to be higher than that of the control set.

We obtain a total of 50 unique options in the control set which we compare with data on the treated set on the event days. Table 3 presents summary statistics on the volatility of the premium for the options in the treated set and control set for our period of analysis.

Table 3: Summary statistics on volatility of options premium on the treated and control sets (in %)

	Treated	Control
Min	0.97	0.25
Mean	6.19	4.78
Median	5.08	2.91
Max	14.85	35.17
SD	3.86	5.09

We observe that the average volatility of the treated set was slightly higher than that of the control set. However, a simple t-test of comparison of means of the treated and control set volatility shows that the difference between the volatility of the two sets is not statistically significant. In a regression analysis (not shown here), we also control for other factors that affect volatility of the option premium of the treated and control sets. We do not find any evidence of significant difference across the two sets even after controlling for other factors such as strike price, days to expiry, value and volatility of the underlying. The analysis finds that the price range in which the option premium varied for the treated set was similar to that of the control set. Thus, we find that the option premium on the Nifty options that were traded by Rakhi Trading was not manipulated.

Did the synchronised trades manipulate the volumes?

We also examine the question whether the synchronised trades in the relevant Nifty options led to higher volumes in these options thereby creating a possibly misleading impression of volumes. For this, we analyse the traded volumes on the relevant Nifty options, after excluding the volumes arising out of synchronised trades themselves. We compare the traded volumes of the relevant Nifty options on the event and non-event days (Table 4). If the synchronised trades did result in higher trading activity from other market participants, we expect to see significant difference in the traded volumes on the event and non-event days.

Table 4: Summary statistics on traded volumes of options traded by Rakhi Trading

	Event days	Non-event days
Min	0	50
Mean	5,342	5,170
Median	4,500	2,450
Max	15,400	21,350
SD	5,736	5,762

Table 4 shows that the traded volumes on the Nifty options involved in the Rakhi Trading case were, on an average and on a median scale, slightly higher on the event days compared to the non-event days. However, a statistical test (t-test) of the comparison of means finds no significant difference across the two sets. A regression analysis on the event and non-event set confirms this finding. This indicates that Rakhi trading trades did not lead to any jump in volumes in the options so traded.

Trading for tax evasion or tax planning

An ancillary concern expressed by the Supreme Court was that Rakhi Trading conducted the trades in question for tax planning or avoidance. While this may or may not be true, the securities markets regulatory framework should not be used for punishing tax evasion. Cases of trades that SEBI has reason to believe were meant for tax avoidance, must be reported to the tax authorities, which is the appropriate forum for addressing questions of tax evasion. The objective of the securities market regulatory regime is not to deal with tax evasion, but to protect investors and develop the securities markets. More importantly, a regulator has scarce resources and dedicating investigative and adjudicatory capacity for dealing with tax evasion cases is not the best use of these resources.

Conclusion

Our empirical analysis finds that the synchronised trades did not manipulate the underlying Nifty index, the premium on the relevant Nifty options or the traded volumes of the relevant Nifty options. However, we recognise that our analysis is limited to daily data. An analysis of this kind must be underpinned by examining the intra-day data around the time of synchronised trades. By using such data, the regulator can further make a case for whether the trades in question were indeed manipulative.

The objective of this article is not to establish the guilt or innocence of any specific market participant. By using publicly available inter-day trading data on the security involved in the Rakhi Trading case, we make a case for using empirical strategies to establish fraudulent conduct under the Indian securities regulatory regime. As demonstrated above, the advanced nature of the securities market infrastructure in India and the availability of data ensures that this is not difficult. The use of empirical evidence to substantiate charges of fraudulent conduct will ensure that enforcement orders pass the muster of the appellate forums without having to compromise on evidentiary standards for establishing guilty conduct. More importantly, backing enforcement with robust underlying evidence will help the regulator build the trust of the regulated and testify to the high standards of proof that our society should place for the deprivation of liberty.

References:

Stock market manipulations by Aggarwal R and Wu G, The Journal of Business, 2006.

When stock futures dominate price discovery by Aggarwal N and Thomas S, Journal of Futures Markets, 2019.

What exactly is market integrity? An Analysis of One of the Core Objectives of Securities Regulation by Austin J, William and Mary Business Law Review, Vol.8(2), 2017.

Trading costs and the relative rates of price discovery in stock, futures, and option markets by Fleming J, Ostdiek B and Whaley R, Journal of Futures Markets, 1996.

State Of U.P vs Krishna Gopal & Anr 1988 AIR 2154.

185th Report of the Law Commission of India on a Review of the Indian Evidence Act, 1872.

Toward a General Theory of Standards of Proof, Frederick E. Vars, Catholic University Law Review, Vol. 60(1) (Fall 2010).

 

Nidhi is faculty at IIM-Udaipur and Bhargavi is a researcher at IGIDR.