[By Palash Varyani]
The author is a student of Institute of Law, Nirma University.
Introduction
Recently, the Securities and Exchange Board of India (SEBI) has made a significant breakthrough by explicitly addressing and defining the practice of “spoofing” in its recent order. Spoofing, a method employed by traders worldwide to extract illegitimate profit from the stock market, has been a longstanding concern. This article focuses on the SEBI’s order concerning Nimi Enterprises, highlighting the concept of spoofing and recent developments in its regulation within India’s financial landscape. By examining the implications of the SEBI’s action and the measures taken to combat spoofing, this article sheds light on the evolving dynamics of market integrity and investor protection.
The Practice of Spoofing
Spoofing entails a manipulative strategy employed in financial markets, wherein a trader deliberately places deceptive buy or sell orders, without genuine intent for their execution within the market. This deceptive practice frequently relies on the deployment of algorithms and automated bots, with the objective of distorting market dynamics and asset prices by fabricating a false impression of supply or demand. In simple terms, spoofing refers to the act of a trader initiating orders to purchase or sell a specific security, only to subsequently alter or cancel those orders with the aim of extracting profits.
For example, Mr. A submits a purchase request for 5000 shares of XYZ company, which will lead to an increased demand for the stock. Consequently, the price of the stock will escalate. Later on, he cancels the order and proceeds to sell his existing shares. By doing so, he aims to generate an artificial demand and achieve a higher selling price than originally anticipated. This practice is also known as “Layering” which encompasses the utilization of a disruptive algorithmic trading strategy. This particular approach can potentially instigate either excessive “optimism” or “pessimism” within the market.
It constitutes a form of illicit market manipulation that is prohibited in the majority of countries worldwide. Within the USA, engaging in such conduct is deemed unlawful and classified as a criminal offence according to the Dodd-Frank Act of 2010. In the UK, spoofing is governed by Article 15 of the Market Abuse Regulation, and sections 89 and 90 of the Financial Services Act, 2012.
SEBI and the Nimi Enterprises case
The SEBI has recently passed an order against “Nimi Enterprises” and has ruled that it was involved in spoofing of shares in the Indian securities market. The firm was involved in securities trading and was subject to an investigation regarding its trading operations to determine whether it violated the regulations outlined in the SEBI Act and the Prohibition of Fraudulent and Unfair Trade Practices Regulations, 2003.
Throughout the probe, SEBI uncovered evidence indicating that the firm engaged in a trading scheme designed to artificially manipulate the perception of demand or supply for specific stocks. As an illustration, the firm placed substantial buy orders for a security, offering a price significantly distinct from the current market value. Subsequently, the firm would place another order for the same stock, but at a price in line with market rates, although for a lower number of shares. After this order was executed, they would cancel the initial order, which consisted of a higher quantity of shares. As a result of the public disclosure of these activities, the parties concerned received a “Show Cause Notice”.
The firm asserted that its approach of placing many large purchase and sell orders, some of which were executed at prices higher or lower than the current market price, was driven by the anticipated price changes caused by a variety of causes. Certain big orders, however, were not fulfilled and were subsequently cancelled in order to free up the “margin” for trading in alternative equities. Furthermore, they claimed ignorance of the word “spoofing” used in the “Show Cause Notice”, emphasising that it was not defined by SEBI. Moreover, they asserted that their actions evidenced a genuine intention to carry out the orders, as they openly disclosed them to participants of the market. According to their argument, a trader who harbours no intention of executing an order would refrain from making such disclosures. Consequently, they contended that there was no substantiated proof indicating any fraudulent motives behind the activities in question.
SEBI’s investigation determined that there was a brief time interval, often just seconds, between the fulfilment of “small orders” and the subsequent cancellation of “large orders”. On multiple days, a similar trend was observed for several stocks. This information revealed the firm’s recurrent mode of operation as a usual trade practice. SEBI also emphasised the rules of the stock exchanges, which require traders to reveal to market participants either the complete quantity of their order or at least 10% of the overall quantity. A further amount equal to 10% of the total quantity then becomes publicly viewable in the “Order book” once the revealed quantity has been traded. According to SEBI’s inquiry, the firm purposefully disclosed all of their significant orders in the “Order book”. They chose to report only a portion of shares, however, while making deals involving significantly lower amounts for the same stocks.
Based on this factual investigation, SEBI reached the conclusion that the firm had placed “large orders” with no genuine motive of executing them. Instead, they harboured a “malicious intent” to rig the price of the stock. By capitalizing on the non-authentic demand or supply generated within those stocks, the firm was able to purchase or sell shares at the price that was influenced by these artificial market conditions. This unethical practice ultimately affected the interests of sincere investors trading in the stock market.
In this order, the SEBI also defined spoofing for the first time as:
“The unlawful practice of placing orders containing a large number of shares on one side of the market (buy/sell) and eventually executing orders containing relatively smaller quantities of shares on the opposite side (sell/buy) and cancelling the orders containing large orders.”
According to SEBI, the firm was involved in the act of spoofing and its trading strategy violated both the PFUTP Regulations and the SEBI Act. Thus, for a period of 2 years, SEBI restrained the firm from accessing the securities market and prevented it from engaging in any transaction related to purchasing, selling, or dealing in stocks, either directly or indirectly. In addition, a hefty penalty was also levied on the firm.
SEBI’s 2021 Circular Against Spoofing
SEBI established various parameters and regulations for penalizing individuals engaged in spoofing, as outlined in its circular issued on March 26, 2021. Starting from April 5th, 2021, stock market traders who try to modify their orders repeatedly without actually placing the orders face the consequences imposed by SEBI. Upon detection of such violations, their trading accounts are temporarily disabled for a duration ranging from 15 minutes to 2 hours, depending on the extent of the violation.
The newly implemented measures apply to daily trading activities. Three significant parameters are taken into account:
- a) “High order to trade ratio”
- b) “High number of order modifications”
- c) “High percentage of order modifications”
When all three conditions are violated, it will be considered as a single instance. However, even if these parameters are not entirely fulfilled, SEBI acknowledges that any entity consistently modifying and cancelling orders without execution, causing unnecessary disruption, will also face regulatory action.
Concluding Remarks
SEBI’s recent order against Nimi Enterprises and its comprehensive circular on spoofing reflect a significant step forward in curbing the deceptive practice in India’s financial markets. By explicitly defining spoofing and taking decisive action against violators, SEBI demonstrates its commitment to ensuring market integrity and protecting the interests of genuine investors. Its order not only penalized Nimi Enterprises for its involvement in spoofing but also set a precedent for future cases.
The regulatory body’s clear stance on spoofing and its implementation of strict measures will undoubtedly serve as a deterrent for others who engage in similar practices. Its proactive approach in combating spoofing and protecting market integrity is commendable. This will foster confidence among investors, enhance market transparency, and contribute to the overall growth and stability of India’s financial markets. By taking concrete actions and implementing stringent regulations, SEBI reaffirms its commitment to upholding market integrity, protecting investors, and fostering a fair and transparent securities market in India.