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2014 (12) TMI 1438 - Board - SEBIViolation of securities laws - fraudulent and manipulative trading practices - buyers are related /connected entities of preferential allottees - HELD THAT -Preferential allotment was used as a tool for implementation of the dubious plan device and artifice of First Financial group and allottees. One could argue that in the order to make LTCG the preferential allottees in question could have bought in secondary market and waited for a year before selling the shares. In the instant case probably the preferential allotment route was preferred over secondary market route because the share capital of First Financial prior to preferential allotment was very small i.e. 3, 74, 760 equity shares (face value Rs. 10) to accommodate the required fictitious LTCG of Rs. 172 crore approximately. As such the capital expansion through preferential allotment and sock split provided much bigger source to the persons involved in terms of volume and price manipulation to facilitate the whole operation. Since prior to the trading in its scrip during the Examination Period First Financial did not have any business or financial standing in the securities market in my view the only way it could have increased its share value is by way of market manipulation There was no change in the beneficial ownership of the substantial number of traded shares as the buyers and sellers both were part of the common group and were acting in league/concert to provide LTCG benefits to the allottees. I prima facie find that First Financial group and allottees used securities market system to artificially increase volume and price of the scrip for making illegal gains to and to convert ill-gotten gains into genuine one. Schemes plan device and artifice employed in this case apart from being a possible case of money laundering or tax evasion which could be seen by the concerned law enforcement agencies separately is prima facie also a fraud in the securities market in as much as it involves manipulative transactions in securities and misuse of the securities market. The manipulation in the traded volume and price of the scrip by a group of connected entities has the potential to induce gullible and genuine investors to trade in the scrip and harm them. As such the acts and omissions of First Financial group and allottees are fraudulent as defined under regulation 2(1)(c) of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations 2003 ( PFUTP Regulations ) and are in contravention of the provisions of Regulations 3(a) (b) (c) and (d) and 4(1) 4(2)(a) (b) (e) and (g) thereof and section 12A(a) (b) and (c) of the Securities and Exchange Board of India Act 1992. SEBI strives to safeguard the interests of a genuine investor in the Indian securities market. The acts of artificially increasing the price of scrip misleads investors and the fundamental tenets of market integrity get violated with impunity due for such acts. Acts and omissions of First Financial group and allottees as described above is inimical to the interests of participants in the securities market. Therefore allowing the entities that are prima facie found to be involved in such fraudulent unfair and manipulative transactions to continue to operate in the market would shake the confidence of the investors in the securities market. In this case it is noted that as on December 01 2014 the allottees are still holding 65, 98, 810 shares of First Financial that were allotted to them in the aforesaid preferential allotments. The entities that were buyers in Patch-2 and Patch-3 have gradually started selling shares after the price rise from August 2014 onwards i.e. from Rs.9 to Rs.23 almost 155% increase. The price of the scrip is currently around Rs.23 per share and the holders including preferential allottees and buyers (exit providers) who are holding around 7, 70, 00, 000 shares (post split) may potentially gain around Rs.177 crore. Unless prevented they may use the stock exchange mechanism in the same manner as discussed hereinabove for the purposes of their dubious plans as prima facie found in this case. In my view the stock exchange system cannot be permitted to be used for any unlawful/forbidden activities. Considering these facts and the indulgence of a listed company in such a fraudulent scheme plan device and artifice as prima facie found in this case I am convinced that this is a fit case where pending investigation effective and expeditious preventive and remedial action is required to be taken by way of ad interim ex -parte in order to protect the interests of investors and preserve the safety and integrity of the market. Thus in order to protect the interest of the investors and the integrity of the securities market in exercise of the powers conferred upon me in terms of section 19 read with section 11(1) section 11 (4) and section 11B of SEBI Act 1992 pending inquiry/investigation and passing of final order in the matter hereby restrain the following persons/entities from accessing the securities market and buying selling or dealing in securities either directly or indirectly in any manner till further directions.
The core legal questions considered in this judgment relate to whether the entities involved engaged in manipulative and fraudulent trading practices in violation of securities laws, specifically:
Issue-wise Detailed Analysis: 1. Use of Preferential Allotment for Price and Volume Manipulation The legal framework includes the SEBI Act, 1992, particularly section 12A prohibiting manipulative and deceptive devices, and the PFUTP Regulations prohibiting fraudulent and manipulative trading practices. The Court examined the price-volume behavior of the scrip during three distinct patches within the examination period from May 2012 to March 2014. The company had made preferential allotments to 83 entities, whose shares were locked-in for one year, yet the scrip price rose dramatically by 5160% during this lock-in period (Patch 1), with negligible genuine trading volume. The Court found that a small group of entities, connected to specific brokers, were responsible for creating artificial price highs through minimal quantity trades, contributing disproportionately to price rise. This was not supported by any material corporate announcements or fundamental improvements in the company's business, which was limited to financing and investment activities with meager profits and no expansion as claimed in shareholder resolutions. The Court noted that the preferential allotment was used as a tool to inflate share capital and facilitate manipulation, as the company's share capital increased substantially post-allotment and stock split, enabling a larger volume of shares to be manipulated. 2. Connection and Concerted Action Amongst Entities Using KYC data, bank statements, off-market transactions, and MCA records, the Court identified a large group of entities ("First Financial group") connected through common directors, shareholders, addresses, and fund transfers. These entities acted as net buyers during Patch 2, providing exit to preferential allottees who were net sellers, thereby creating artificial demand to absorb the large supply of shares sold by allottees at inflated prices. The Court observed significant layering of funds among these entities, indicating pre-planned arrangements to route money and obscure the ultimate beneficial owners. The preferential allottees and First Financial group entities were found to be acting in concert, with no genuine change in beneficial ownership, merely facilitating fictitious LTCG exempt from tax. The Court relied on precedents that connection/relations can be established based on common addresses, directors, and shareholders, reinforcing the finding of concerted manipulation. 3. Misuse of Securities Market and Fraudulent Trading The Court held that the acts and omissions of the preferential allottees, First Financial, and connected entities constituted fraudulent and manipulative trading under the SEBI Act and PFUTP Regulations. The relevant provisions prohibit use of manipulative or deceptive devices, schemes to defraud, and acts creating false or misleading appearances of trading, including matched trades without change of beneficial ownership. The Court emphasized that the manipulation had the potential to mislead genuine investors and harm market integrity. The scheme involved artificial price inflation during the lock-in period with minimal volume, followed by massive volume increases post lock-in to facilitate profitable exits for connected entities. 4. Responsibility of Directors and Promoters The directors controlling the company's day-to-day affairs were found prima facie responsible for the violations, as they had knowledge of and failed to prevent the manipulative activities. The Court noted their obligation to ensure compliance with securities laws and found that they abetted the fraudulent scheme. 5. Need for Investigation and Interim Relief The Court noted the necessity for a detailed investigation to identify other involved parties, connections, and ultimate beneficiaries of the fund flows and manipulative trades. It directed SEBI to investigate and recommended referral to other enforcement agencies for possible tax evasion and money laundering. Given the prima facie findings of fraud and the risk of continued market abuse, the Court exercised its powers under sections 11(1), 11(4), 11B, and 19 of the SEBI Act to impose an ex-parte ad-interim restraint on the company, its promoters, preferential allottees, and connected entities from accessing the securities market or dealing in securities until further orders. This was deemed necessary to protect investors and preserve market integrity pending investigation and final adjudication. Significant Holdings: The Court held:
The Court concluded that the entities involved had misused the securities market to generate fictitious profits and evade taxes, thereby committing fraud. It imposed immediate market access restrictions on all identified entities to prevent further harm to investors and market integrity.
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