Column : Legitimate fraud?

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Yash Bansal, Sandeep Parekh: Nov 26 2012, 03:10 IST

In 1942, at a meeting of the commissioners of the US securities regulator, the SEC, one of them asked rhetorically, “Well, we are against fraud, aren’t we?” And thus was drafted the famous rule against fraud in US securities regulations. For a humble rule, which must live under the tutelage of a section of an act, it is quite a prima donna. Mention Rule 10b-5 or just 10b-5 and lawyers and laymen the world over often recognise the massive jurisprudence that came out of this brief conversation. The SEC unanimously adopted Rule 10b-5, prohibiting any person from employing any device, scheme, or artifice to defraud investors including making any untrue statement of a material fact or omitting to state a material fact in connection with the purchase or sale of any security.

This story is interesting given the recent ruling of our Securities Appellate Tribunal (SAT), which held that front-running (a form of fraud) is illegal only if committed by an intermediary. In other words, front-running is legal if committed by a non-intermediary. The facts in brief were as follows: The portfolio manager of a foreign institutional investor (FII), who made investment decisions for the FII, before buying stocks for the FII bought those stocks in his personal account. Thereafter, the manager sold those shares through the exchange mechanism to the FII and made huge gains in the process. When one buys large quantities of shares over a period of time resulting in a large acquisition of shares, clearly the price

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