This compilation discusses an adjudication order dated December 3rd, 2024 (“Order”) in the matter of Mahesh Agrawal HUF (PAN – AAJHM3103K) (“Noticee”) with respect to dealing in illiquid stock options at BSE. This Order discusses certain non-genuine trading practices under the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003, as amended (“PFUTP Regulations”). The fundamental objective of the PFUTP Regulations is to safeguard the integrity of the securities market and protect investor interests. These regulations aim to prevent fraudulent, manipulative, and unfair trading practices that distort market transparency and create false impressions of market activity. In the current case, Regulations 3(a), (b), (c), (d), 4(1), and 4(2)(a) of the PFUTP Regulations, were invoked to address reversal trades in illiquid stock options, which created artificial trading volumes and misled investors. Moreover, enforcement of such regulations, by regulators like the Securities and Exchange Board of India (“SEBI”), ensures fair trading practices, accurate price discovery, and withholds confidence in the securities market.

Factual background:

• Observations by SEBI
  The SEBI observed widespread reversal of trades in the Illiquid Stock Options (“ISO”) segment on the BSE. These reversal trades occur when an entity reverses its buy or sell positions with a subsequent sell or buy position involving the same counterparty. Such trades are deemed non-genuine as they lack valid trading rationale and create artificial trading volumes, giving a false or misleading impression of trading activity. SEBI identified these trades as deceptive and manipulative in nature.
• Details of the Investigation
  Following the same, SEBI conducted an investigation into the trading activities in the ISO segment of BSE during the period from April 1, 2014, to September 30, 2015 [referred to as, the Investigation Period (“IP”)]. The investigation revealed that 81.38% of the trades in the ISO segment during the IP were reversal trades, amounting to 2,91,643 trades. These trades involved 14,720 entities that participated in executing non-genuine trades.
• Allegations Against the Noticee
  As part of the investigation, Noticee, one of the entities identified as being engaged in the no-genuine trades, was found to have engaged in reversal trades in the stock options segment of BSE during the IP. These trades were alleged to be pseudo/non-genuine trades and contributed to creating a false impression of trading activity, thereby being classified as manipulative and deceptive.
• Initiation of Adjudication Proceedings
  In light of these findings, SEBI initiated adjudication proceedings against the Noticee. The proceedings alleged violations of Regulations 3(a), (b), (c), (d), 4(1), and 4(2)(a) of the PFUTP Regulations.
• Appointment of Adjudicating Officer
  In pursuant of the same, SEBI initially appointed Shri Rohit Dubey as the Adjudicating Officer (“AO”) on May 28, 2021, under Section 19 and Section 15-I of the Securities and Exchange Board of India Act, 1992 as amended (“SEBI Act”) read along with Rule 3 of the SEBI (Procedure for Holding Inquiry and Imposing Penalties) Rules, 1995, as amended (“Adjudication Rules”), to inquire and decide as according to Section 15HA of SEBI Act. After subsequent transfers, the role of AO was assigned to various officers. Most recently, the undersigned was appointed as AO on September 13, 2024, following the transfer of the previous AO, Shri Shashi Kumar Valsakumar.

Key highlights of the SCN:

The SCN, inter alia, alleged the following:

• Following the investigation, as mentioned above, and observations thus made, SEBI issued a Show Cause Notice (“SCN”) dated July 27, 2021, under Rule 4(1) of the Adjudication Rules, requiring the Noticee to explain why:
  1. An inquiry should not be held, and
  2. Why the penalties imposed for alleged violations of Regulations 3(a), 3(b), 3(c), 3(d), 4(1), and 4(2)(a) of the PFUTP Regulations should be cancelled.

• The SCN alleged that the Noticee executed four non-genuine trades in one stock options contract, creating an artificial trading volume of 9,000 units during the IP. The contract in question, identified as ‘LUPL15MAR1920.00CE,’ recorded an average buy rate of ₹71.55 per unit for a total buy volume of 4,500 units and an average sell rate of ₹116 per unit for a total sell volume of 4,500 units. The artificial volume created by the Noticee constituted 100% of their total volume in the contract and 2.2% of the total market volume during the investigation period.
• SEBI illustrated the reversal trade in the contract on March 25, 2015, the details of the same are as follows:
  1. A sell trade for 4,500 units at ₹71.55 per unit with counterparty Suyash Malu at 11:55:39.586962 hours.
  2. A buy trade for 4,500 units at ₹116 per unit with the same counterparty at 11:50:01.390774 hours.
  3. These trades created artificial volume, accounting for the entire market volume (100%) in the contract during this period.
• Henceforth, an SCN was served on the Noticee via Speed Post Acknowledgement Due, and proof of service is on record.

Reply to the SCN:

The Noticee failed to respond to the SCN or provide any explanation for the alleged violations

SEBI settlement proceedings:

• Background of Settlement Recommendation: The Securities Appellate Tribunal (“SAT”), in its order dated May 13, 2022, recommended SEBI to create a one-time settlement scheme under Regulation 26 of the SEBI (Settlement Proceedings) Regulations, 2018, as amended (“Settlement Regulations”). The aim was to resolve pending penalty proceedings, reduce litigation, and attract entities to settle cases with favorable terms.
• SEBI Settlement Scheme 2022: Following the same, SEBI introduced the SEBI Settlement Scheme 2022 (“2022 Scheme”), effective from August 22, 2022, to January 21, 2023. This scheme provided entities facing pending proceedings or appeals an opportunity to settle their cases.
• Notice about the 2022 Scheme: On August 1, 2022, SEBI informed the Noticee about the 2022 Scheme via Post SCN Intimation (“PSI”), and the same was acknowledged by the Noticee on August 5, 2022.
• Extension of 2022 Scheme: The scheme’s deadline is extended by the SEBI to January 21, 2023, vide a public notice dated November 21, 2022.
• Noticee’s response: On November 25, 2022, the Noticee informed that he could not pay the settlement amount due to financial difficulties, and requested SEBI for a rebate and installment options. However, the adjudication proceedings were resumed as the Noticee did not avail of the 2022 Scheme.
• Opportunity of Hearing in 2023: In good faith and interests of natural justice, SEBI granted the Noticee a hearing on July 10, 2023. During the hearing, the Noticee has:
  1. reiterated his earlier submissions (November 21, 2022), and
  2. expressed his willingness to settle if SEBI introduced a new scheme. Otherwise, requested the matter to proceed based on its merits.
• Introduction of SEBI Settlement Scheme 2024: Post-hearing, the Noticee emphasized his limited financial capacity and inability to pay a high settlement amount. Following the same, SEBI launched Settlement Scheme 2024 from March 11, 2024, to June 10, 2024, (“2024 Scheme”) under Regulation 26 of the Settlement Regulations. The Noticee was informed via a second PSI dated March 6, 2024, and acknowledged receipt on April 28, 2024.
• Extension of the 2024 Scheme & Noticee’s non-participation: While, the scheme’s deadline was extended to June 10, 2024, through a public notice dated May 8, 2024; the Noticee failed to participate in the 2024 Scheme, citing the high settlement amount as the reason.
• Resumption of Adjudication Proceedings & hearing: On Noticee’s failure to participate in the 2024 Scheme SEBI has resumed the adjudication proceedings. A hearing notice was issued to the Noticee on October 7, 2024, scheduling a hearing on October 14, 2024. Thereafter, the Noticee appeared and reiterated his earlier submissions (from November 2022), and had additionally requested leniency, highlighting his financial limitations and inability to afford the high settlement amount.

Observations of SEBI:

The key issues for consideration and the observations for each of the issue respectively is as follows:

I. Whether the Noticee is in violation of Regulations 3(a), (b), (c), (d) and 4(1) and 4(2)(a) of PFUTP Regulations?

• SEBI’s investigation into the stock options segment of BSE revealed a pervasive pattern of non-genuine trades conducted by multiple entities during the relevant IP from April 1, 2014, to September 30, 2015. These trades were aimed at artificially inflating trading volumes and misrepresenting the true state of the market. As part of its adjudicatory proceedings, SEBI initiated action against the Noticee for alleged fraudulent and manipulative activities, specifically reversal trades, which fall under the purview of Regulations 3 and 4 of the PFUTP Regulations.
• An interim order was issued on August 20, 2015 by SEBI after a preliminary look into the suspicious trading in the illiquid stock options matter. And this order was confirmed with further orders in 2016. SEBI later conducted a detailed investigation, completing it in 2018, and found 14,720 entities involved in fake trades on the BSE. Following which, the interim order was closed with a final order on April 5, 2018, as SEBI started taking phased action against these 14,720 entities. SAT, vide it’s order dated October 14, 2019, suggested that SEBI can consider alternative dispute resolution methods like Lok Adalat to settle the matter.
• Settlement Schemes Introduced:
  Meanwhile, SEBI has launched a few settlement schemes, mentioned hereunder;
  1. First Scheme (2020): It was launched under the Settlement Regulations from August 1 to December 31, 2020.
  2. Second Scheme (2022): It was launched following an order by SAT dated May 12, 2022.
  3. Third Scheme (2024): It was introduced on March 11, 2024.

• Allegations against the Noticee: The Noticee was found to be engaging in ‘reversal trades’ (buying and selling the same stock options with the same counterparty on the same day), which created fake trading volumes and misled the market. It was found that the Noticee executed 2 reversal trades for a stock option contract called ‘LUPL15MAR1920.00CE,’ and bought 4,500 units at ₹116 and later sold the same number of units at ₹71.55, creating a total artificial volume of 9,000 units.
• Reason for non-genuine trades: These trades lacked a genuine trading purpose, as they involved reversing positions with the same counterparty on the same day with significant price differences, as a result indicating a prior agreement (pre-determined prices) between the two parties. Moreover, since these trades occurred in an illiquid market (with low activity), they were determined to be manipulative in nature.
  These significant price differences within a short time showed no actual price discovery, and the trades were done to create artificial volumes. Thus, the fact that the trades were consistently matched with the same counterparty strongly suggests deliberate coordination between the Noticee and the counterparty, which was planned to deceive the market.
• Judgements and principles relied upon:
  1. Supreme Court rationale in SEBI v. Kishore R Ajmera (AIR 2016 SC 1079): The Court, in this case, has observed that the anonymity provided by screen-based trading systems does not eliminate the possibility of pre- arranged trades. Even if the identities of the parties are hidden, the nature and pattern of trades can reveal a “meeting of minds” elsewhere. Since direct evidence of such pre-arrangement is rare, civil liability can be decided based on a “preponderance of probabilities.” Moreover, certain indicators of collusion like
     1. High trade volumes.
     2. Repeated trading in specific securities.
     3. Similarity in the timing, quantity, and price of buy and sell orders, etc. must also taken into consideration.

     Courts must infer intent logically by examining all relevant circumstances rather than relying solely on direct evidence. In light of the same, the judgment emphasized that while direct evidence is ideal, in its absence, courts and regulators must analyze the facts and surrounding circumstances. Courts should adopt a “reasonable and prudent person” approach to draw inferences from observed trading behavior.
     Observation: The specific observation in the present case noted that the accused trader/Noticee consistently matched trades with the same counterparty, demonstrating a meeting of minds to execute pre-arranged transactions.

  2. SAT decision in Ketan Parekh v. SEBI (Appeal No. 2 of 2004): SAT has stated that manipulative trading inherently misleads investors, who are induced to buy or sell based on false impressions of demand or supply, and thus it is not the duty of regulators like SEBI to prove that specific investors were misled; it is sufficient to establish the manipulation itself.
  3. Supreme Court in SEBI v. Rakhi Trading Private Limited (2018): The Court, in this case, examined reversal transactions with high volume, significant price variations, and repeated dealings between the same parties, and has concluded that such patterns indicate pre-arranged trades, not genuine market activities. These manipulative practices are deceptive and violate the transparency required in securities trading.

Observation: In the current case, the Noticee executed trades with precise coordination in timing, price, and quantity. These trades were reversed with the same counterparty, thereby, confirming a prior agreement. And it is clear that the wide price variations within short periods could not have occurred naturally, pointing to predetermined prices and collusion.

• Henceforth, the trades by the Noticee were non-genuine and artificially created misleading trading volumes. Based on the principles from the cited judgments, the Noticee’s actions clearly involved prior collusion, violating Regulations 3(a), (b), (c) and (d), 4(1), 4(2)(a) of the PFUTP regulations; thereby, undermining the integrity of the securities market, reaffirming the Noticee’s liability.

II. If issue 1 is established in affirmative, would it attract any monetary penalty under Section 15HA of the SEBI Act?

• The Noticee, as established, has been found to have engaged in non-genuine trades, which created artificial volume in the market, thereby violating Regulations 3(a), (b), (c), (d) and Regulation 4(1) and 4(2)(a) of the PFUTP Regulations. Placing reliance on the Supreme Court’s decision in SEBI v. Shri Ram Mutual Fund (2006), it was thus decided that once a violation of statutory obligations is proven, a penalty must be imposed.
• While the intention behind the violation does not count; a mere breach of the rules shall trigger the penalty; meaning that, even if the violation was unintentional, a fine would still be applicable.
• It is thus clear, that this case is appropriate for imposing a monetary penalty under Section 15HA of the SEBI Act; which specifies that anyone involved in fraudulent or unfair trade practices related to securities can be fined anywhere between five lakh rupees and twenty-five crore rupees, or up to three times the profits gained from such practices, whichever amount is higher.

III. What would be the quantum of penalty that can be imposed on the Noticee according to Section 15J of the SEBI Act?

• Before deciding on the quantum of the monetary penalty under Section 15HA of the SEBI Act, it is important to take into account certain factors listed in Section 15J of the SEBI Act. These factors include:
  1. The amount of unfair gain or advantage made due to the wrongdoing, if it can be measured.
  2. The loss caused to investors because of the wrongdoing.
  3. Whether the wrongdoing was repeated.
• The law makes it clear that these factors should always be considered when determining penalties for violations under various sections, including Section 15HA of the SEBI Act. In the current case, the trades carried out by the person involved were not genuine and created a false impression of trading in a particular stock. However, it was difficult to directly measure how much unfair gain was made or the exact loss caused to investors from these false trades.
• Additionally, there was no evidence to show that the person had repeatedly committed similar violations. Despite this, the false trades still distorted the market and harmed the integrity of the securities market. Given the serious nature of these violations, the penalty should reflect the seriousness of the wrongdoing, even if some factors, like the exact gain or loss, can’t be fully quantified.

Order:

The AO, exercising its powers conferred under Section 15-I of the SEBI Act, has thereby declared that a monetary penalty of ₹5,00,000 (Five Lakh Rupees) on the person for violating Regulations 3(a), (b), (c), (d), 4(1), and 4(2)(a) of PFUTP Regulations. This penalty is deemed appropriate, given the seriousness of the violations committed.

The Noticee is required to pay the penalty within 45 days from the receipt of this order. And, if the Noticee fails to pay the penalty within 45 days, recovery proceedings may be initiated under Section 28A of the SEBI Act. Such a failure could include actions such as attaching and selling the person’s movable or immovable properties to recover the penalty amount along with interest.