Every Budget reaction is not market manipulation

Shortly after this piece gets published, the Finance Minister would be making the budget speech in Parliament. Expectations from the speech vary. Some expect “market-friendly” measures in the Budget speech while others expect a lacklustre spectacle. Stock brokers wait with bated breath for the aftermath of the market reaction – not just for the contents of the speech, but also for what can follow from the regulators.

The post-budget period is when many a price manipulation investigation has been launched. After budget speeches, stock prices swing one way or the other. Finance ministers who perceive the stock market index to be a barometer of how good they are, are known to have been offended by a crash in market prices. When newly-elected governments, formed by popular public perception, present budgets, they also get very sensitive about market perception of their policies. The pressure on regulators to investigate price manipulation for every post-budget price fall is immense, and generally governments like to draw some blood rather than acknowledge that there was indeed no manipulation.

It is against this backdrop that stock brokers can be easy prey. Regardless of whether the alleged manipulator who traded is brought to book, the stock broker through whom he transacts gets picked up and thrashed easily. Stock brokers, being registered with the regulator are within striking distance of regulatory action. Historically, stock brokers have been penalised whenever there has been an alleged manipulation.

It is often seen that brokers are picked up for investigation and accused of manipulation. The brokers through whom maximum trade orders were placed get investigated. Indeed, an allegation that a particular broker accounted for a large percentage of trades is often treated by the Securities and Exchange Board of India (SEBI) as a pertinent fact to infer manipulation. If allegations of manipulation fail, the allegation shifts to one of aiding and abetting manipulation. If that fails, the allegation then shifts to lack of deployment of skill and care – typically, SEBI’s argument is that the broker was not vigilant enough to prevent the occurrence of manipulation by the client.

When a client trades through a broker, the broker cannot be expected to grill the client on why he is trading in a particular stock, or to even seek self-certification from the client that he is not colluding with some other broker’s clients and indulging in manipulation. If a broker had to put a client to such a test every time the client trades in any stock, not only would genuine clients legitimately run away, but such a test would be blatantly unfair and against investor interest. Investors could get stuck without being able to transact because their brokers make such unreasonable demands, and therefore the approach would only hurt the interests of investors in securities rather than protect the market for investors.

It is important for people in government to accept that every single time the market crashes, there need not be an element of manipulation in price discovery. SEBI would do well to adopt an approach of not presuming that the stock broker would per se be deemed to have participated in the conspiracy to manipulate price or volumes.

Price or volume manipulation involves an element of artificiality in price discovery or market volumes. A successful presentation of a misleading picture to the market would necessarily involve the contracting parties having colluded or conspired. Even if a market player misleads or attempts to mislead the market, it does not necessarily follow that the broker through whom he transacted is a fellow-conspirator.

Often regulators simply pick up the traded volumes in a time slot when prices fell, and go after brokers and their clients who sold the most in percentage terms in that time slot. Such an approach runs the risk of mistaking effect for cause.

Market behaviour is to often follow the herd. SEBI is also known to argue that in bringing a charge of manipulation, it does not have to prove intention of the party to manipulate. However, the very term “manipulation” can only involve a conscious attempt to distort the picture and create a price that is not a true.

Some of the manipulation charges do not succeed in court. Some others do. In the fear of being charged with heinous crimes, brokers seek to settle the dispute by filing consent terms. A new trend is that SEBI insists on extracting an equivalent of the brokerage that a broker may earn for the period for which the regulator believes it could suspend his business. Such an approach can prove to be very expensive and unreasonable. It would instill a feeling of injustice about the legal system rather than a sense of regard and respect for the might of the law. More importantly, a charge wrongly levelled and lost in court can inflict far greater harm to the credibility of the regulatory system. (The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own)

somasekhar@jsalaw.com