Frontrunning has been a significant issue in the stock market, and SEBI has taken a strong stance against it. The regulator has been imposing penalties on frontrunners, including disgorgement of unlawful gains, penalties, and debarment from the securities market. However, the way SEBI calculates frontrunning gains has raised concerns. It overlooks profits made through grey market positions and ignores gains made in a broker’s proprietary accounts. In this article, we will explore the issue of frontrunning and the calculation of unlawful gains in light of recent SEBI orders.
The Menace of Frontrunning: Frontrunning, in simple terms, refers to the act of making a trade based on non-public information to gain an unfair advantage. In the stock market, it occurs when someone buys shares ahead of a large institutional order, anticipating that the price will rise once the order is executed. This allows the frontrunner to sell the shares later at a higher price. Frontrunning can take various forms, such as buying stocks before a stock recommendation is broadcast by an expert, purchasing shares before the rebalancing of an index, buying shares before a research paper is published by a major brokerage firm, or acquiring stocks before their inclusion in a derivatives segment.
Calculation of Unlawful Gains from Frontrunning: The calculation of unlawful gains made through frontrunning is a crucial factor in penalizing offenders. In most cases, SEBI only considers the trades executed through the trading accounts of the culprit, their family members, and associates. However, in many instances, positions taken through mule trading accounts, proprietary accounts of other brokers, and options market positions are overlooked. This could be due to difficulties in data segregation and the lack of market intelligence.
Large brokers and their representatives, who are often featured on TV channels, sometimes extend margin facilities to reporters and anchors through proprietary accounts. The profits made from such tips are then shared among the stakeholders. Many brokers also facilitate mule trading accounts, where option-based positions are placed to circumvent surveillance mechanisms, such as those used by the NSE. SEBI has not considered these positions in calculating unlawful gains.
SEBI’s Blind Spot Regarding Grey Market Positions: SEBI has acknowledged the existence of the grey market in several of its circulars. The recent SEBI circular regarding the grey market trading of unlisted shares and price manipulation through the grey market confirms that the regulator is aware of its existence. The grey market offers margins of up to 20 times the trading amount, allowing individuals who are confident in their predictions of stock price movements to make substantial profits based on price-sensitive information.
Despite the potential for significant gains, SEBI has consistently ignored profits made through grey market trading when calculating unlawful gains from frontrunning. The recent cases of TV anchor Hemant Ghai and market operator Ketan Parekh can be cited as examples of this oversight.
While it may be difficult for SEBI to precisely quantify grey market profits due to its covert nature, a link between regulated market and grey market trading could be established. For example, if someone makes an unlawful gain of Rs 100 in the regulated market, it is likely they are making two to three times that amount in the grey market. Applying this multiplier to the disgorgement calculation would increase the amount to be disgorged and act as a stronger deterrent against frontrunning.
The Consequences of Ignoring Grey Market Gains: By ignoring the unlawful gains made through the grey market, SEBI inadvertently encourages frontrunners. If the penalty for frontrunning only requires disgorging 20% of the profits made in the regulated market, why would anyone choose to forgo frontrunning? Turning a blind eye to this issue knowingly constitutes a form of complicity.
