Decided on October 26,2010

Indiabulls Securities Limited Appellant


Samar Ray, Member - (1.) THIS order will dispose of four Appeals No. 51, 57, 168 and 214 of 2009 as they raise identical questions of law and fact and originate from the same investigations and the consequent ad interim ex -parte order passed by the Securities and Exchange Board of India (for short the Board). We shall take the main facts from Appeal No. 51 of 2009 and refer to the other appeals thereafter. The appellants in Appeal numbers 51, 168 and 214 are stock brokers and the appellant in Appeal No. 57 is a market trader.
(2.) WHETHER the appellants had aided and abetted their clients in executing non genuine transactions in collusion with counter party clients and brokers in the Futures and Options (F & O) segment of the National Stock Exchange of India Limited (NSE) and misused the stock exchange mechanism in violation of Regulations 3(a), 3(b), 3(c), 4(1), 4(2)(a) and 4(2)(b) of the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003 (FUTP Regulations) and Regulations 7A(1), (2), (3) and (4) of the Securities and Exchange Board of India (Stock Brokers and Sub -Brokers) Regulations 1992 (Stock brokers Regulations) is the short question that arises for our consideration in the appeals filed by the stock brokers. (F&O) contracts are traded in the derivative segment of the Indian Capital Market. Derivatives are actually financial instruments whose values are derived from the other, more basic, underlying variables like the share price of a particular scrip in the cash segment of the market or the stock index of a portfolio of stocks. Derivative trade is governed by Section 18A of the Securities Contracts Regulation Act, 1956 which was recently inserted with effect from February 22, 2000 and is legal only when such contracts are traded on a recognized stock exchange and settled through the clearing house of that exchange. Futures contract is a contract that obligates the holder to buy or sell an asset at a predetermined delivery price during a specified time period. An options contract, on the other hand is a derivative contract between a buyer and a seller where the seller gives a right but not an obligation to buy from or sell to the seller the underlying asset on or before a specific date at an agreed price. We have discussed the nature of an options contract in detail in the case of Rakhi Trading Private Limited v. Securities and Exchange Board of India, Appeal No. 70 of 2009 decided on October 11, 2010. Since the present appeal deals mostly with futures contracts, let us notice the parameters of such contracts before coming to the facts and issues involved in this case.
(3.) A futures contract is standardized by the stock exchange. All the terms of a futures contract like the stock/index to be traded in F & O segment, the expiry date of the futures contract, the contract size etc are determined by the stock exchange where the contracts are traded. The only constituent of the contract which is determined by the trading parties is the price of the contract. Unlike the options contract where the buyer has the right and not the obligation and the seller is under the obligation to fulfill the contract, in futures contracts both the buyer and the seller are under an obligation to fulfill the contract. If two investors agree to trade an asset in futures for a certain price there are obvious risks. One of the investors may regret and try to back out. Alternatively, the investor simply may not have the financial resources to honour the agreement. One of the key roles of the exchange is to organize trading so that contract defaults are avoided. Both the buyer and seller of the futures contracts are protected against counter party risk by an entity called the Clearing Corporation. The Clearing Corporation provides this guarantee to ensure that the buyer or the seller of futures contracts does not suffer as a result of the counter party defaulting of its obligation. To be able to guarantee the fulfillment of the obligation under the contract, the Clearing Corporation holds an amount as a security from both the parties. This amount is called the margin money and can be in the form of cash or other financial assets. NSE collects margins from the brokers which are recalculated six times a day on the basis of the value of the underlying in the cash segment and the same or the differential is directly debited/credited to the broker's account. This margin has to be collected by the broker from the concerned client. The brokers are exposed to regulatory action if they fail to ensure adequate margins from their constituents. Unlike an options contract, both the buyer and the seller have potential to make unlimited gains or losses. The parties in the futures contract have the flexibility of closing out the contract prior to its maturity by squaring off the transaction in the market by closing the contract. Alternatively, a reverse position can also be taken i.e. a buyer can take a sale contract for the same scrip/contract for the same quantity, in which case, his obligation is squared off and he will only get the difference between the buy and sell price. It must be remembered that in F & O segment, only a contract is traded without involving any delivery of the underlying asset or change of beneficial ownership of the asset and all trades are settled in cash through the exchange mechanism.;

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