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2                                                               SECURITY LAWS UPDATES

The ingenious ways to outsmart regulators


It is a cat and mouse game being played out on the bourses with market regulator Sebi acting the cat’s part and the manipulators as the mice. Although the cat is now armed with more teeth than before, the mice are getting even more ingenious. In the last few years, the Sebi has banned several prominent market operators for various malpractices. But while the process of establishing guilt and barring the offender are rather straight forward, ensuring that the offender stays away is turning out to be a challenge.


Several banned entities continue to actively trade (and ramp up) stocks, using front entities for their operations. Loopholes in the regulatory framework, the vast size of the market (nearly 3000 stocks traded on a regular basis), and Sebi’s manpower limitations, often give manipulators the upper hand. These players are in demand with corporates who want to ‘improve’ their market valuations through bulk trades, and financiers who are looking for a better return on their investments.


Stock manipulation is as old as the stock market itself. Over the years, technology has made it easier for exchanges and the regulator to zero in on any suspicious activity. But, manipulators too have come up with newer ways to avoid being caught out. And while it may not always be possible to escape detection, these players complicate matters for the regulator so that they are through with their ‘operations’ by the time the Law catches up with them.


At the heart of any price manipulation is circular trading. The operators have to generate volumes in a stock so as to draw investors to the counter. Usually few players come together and start trading among themselves, thus building up volumes. This attracts new players to the counter. Once there is sufficient liquidity in the stock, thanks to increased participation from retail investors, the operators offload their positions at a profit and move on to some other stock. In the 90s, it was easier for Sebi to crackdown on circular trading. That is because there were just a handful of players involved in each stock. But of late, operators have been covering up their tracks rather well.


An operator looking to ramp up the price of a certain stock, ties up with a dozen odd brokerages. In each of these brokerages, there are another dozen odd clients, which are fronts for this operator. This way, there is little concentration of volumes at any single brokerage house, or in the account of any one client. Through a series of off-market deals, shares from the company promoter’s demat account are transferred to the demat account of the front entities controlled by the operator. This mode of transfer of shares is directly from one demat account to the other, and does not show up in the trading volumes on the stock exchanges. After the share change hands, the front entities, who have signed up as clients at different broking houses, then start trading in the shares among themselves.


The most difficult part for the investigator is to prove that all these entities are related. At times, there may be a careless transfer of money between accounts, which is evidence of that these clients know each other and are acting in concert. At other times, there may be telephonic conversations between the clients, which prove that they know each other, and hence the transactions could have been pre-planned. But here too, the manipulators have found a way out. The numbers that these clients mention in the KYC form is not the phone they use for sensitive conversations.  


The strategy of these operators is simple – use as many entities as possible and make the chain of transactions so long that it becomes difficult for the regulator to prove a link between the entities. Many of these so-called clients are not regular market players. They are well compensated by the operator for lending their names. So even if they are banned from trading, it means little for them. The operator will then find another set of players for the next stock he plans to manipulate.


Published by

CA Lalit Mohan Agarwal
(EDITOR & Practicing CA)
Category Corporate Law   Report

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