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In the Grey Zone

By Mahesh Nayak     July 17, 2007

They've been accused of unusual trading practices, which might just be a euphemism for stock manipulation and price rigging. The penalty? A sharp rap on the knuckles from the market watchdog. Last fortnight, the Securities and Exchange Board of India (SEBI) hauled up 15 brokers and 10 investors or entities for what would appear as clear violations in the futures & options (F&O) segment of the stock market. The brokers (registered with the National Stock Exchange) and their clients were found to be transacting in a synchronised manner, and buying and selling in illiquid counters at a price far different from those of the underlying securities.

In fact, most of the trades were reversed on the same day to book profit or losses on such transaction. Reversal of trade implies that when a buy transaction has been initially entered into by a broker for a particular client for a specific quantity, there is a corresponding sale transaction which takes place during the day for the same quantity between the same set of brokers or clients, and vice versa. However, the difference in the prices at which the above two trades were executed was very significant whereas such differences were not observed in the price of the underlying shares.

As a result, one of the parties to the transactions apparently had substantial gains while the other party suffered a loss. The motive of such transactions was not a genuine purchase and sale but rather seemed to be to create an artificial market for trading in F&O and booking profits or losses from such transactions. The loss can be offset against profits resulting in lower tax incidence or where the entity which books profits is an entity which is either exempted from paying tax or is a low-tax paying entity.

The regulator ruled that the entities and brokers have indulged in non-genuine trade transactions to create a false and misleading appearance of trading. The brokerages for their part have their defence. Says Gagan Banga, Executive Director, Indiabulls Financial Services, one of the brokers pulled up: "We are just a medium for executing a deal that has taken place through the internet. Our involvement is zero and the system could not capture such activity as the client has not traded more than a couple of times in the last one year with us." Adds Amit Majumdar, Executive Director (Operation & Risk Management), Angel Broking, another of the firms that's earned SEBI's ire: "In April, we had already informed NSE of such stray transactions and even discontinued the clients' accounts." He agrees that such synchronised trades are a part of price manipulation, "but how do you tackle such issues when you're a part of one leg, while the other party transacts through other brokers."

If SEBI hasn't been tempted to take stricter action it's because of such grey areas. Industry experts say "till SEBI establishes a clear link between both the parties, they don't stand a chance of debarring the investors or brokers. On the basis of buying losses or profit one can't be punished." Players are clearly taking advantage of the loophole in the systems, as stocks in the F&O segments do not have circuit filters. One solution: Just get rid of illiquid stocks from the F&O list.


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