.png)
The authors are Hamza Jawed Khan and Vanshika Sharma, second year students at NALSAR University of Law, Hyderabad.
Introduction
An important question of law has been pending before the Hon’ble Supreme Court for the last four years. In an appeal filed by the SEBI, SEBI asked the court to clarify the position of law regarding the requirement of looking into intention while holding a party liable for PFUTP violations, and whether fraud in securities law has to be preceded by a guilty intention or not. It is an important question as companies usually take the defence of a bona fide mistake whenever the regulator holds them guilty for deceiving the investors.
This article seeks to analyse the definition of fraud in the PFUTP Regulations, the various precedents that have interpreted the provision in diametrically opposite manners. The author then compares the two approaches of courts, one penalizing every action which could disrupt the market whether it be bona fide or mala fide and the other seeking to establish intention before penalizing. The author then concludes the article by suggesting a reformed understanding of fraud for the Indian securities regime.
The definition of fraud in Indian Securities Law
Market abuse is generally understood to include market manipulation and fraud, and such activity that erodes investor confidence and impairs economic growth. Thus, the definitions of fraud, market abuse and market manipulation are used interchangeably by the courts. Market abuse and market manipulation have not been defined in the Statute but fraud has been defined.
While the PFUTP Regulations, 1995 2(c) defined fraud as acts committed by a party to a contract, or with his connivance, or by his agent, with intent to deceive another party thereto or his agent, or to induce him to enter into the contract.
However, the PFUTP Regulations, 2003 2(c) amended the definition of fraud which now states:
““fraud” includes any act, expression, omission or concealment committed whether in a deceitful manner or not by a person or by any other person with his connivance or by his agent while dealing in securities in order to induce another person or his agent to deal in securities, whether or not there is any wrongful gain or avoidance of any loss.”
Though, the introduction of the expression “whether in a deceitful manner or not” might give a prima facie impression that intention has become totally irrelevant to establish fraud under the post-2003 PFUTP regime a closer look at the definition will highlight its inherent ambiguity with respect to the same. The words “in order to induce” can be interpreted to mean that any act which led to the inducement but was not done in order to induce would not fall within the ambit of the fraud, thus reading in intention as a requirement in the provision. Hence, though the earlier definition clearly required the presence of intention, the new definition is ambiguous and could be construed to include or exclude the requirement of intention for fraud.
Interpretation of fraud by the Courts
The Supreme Court (SC), the Securities Appellate Tribunal (SAT), and the Securities and Exchange Board of India (SEBI) have through the years interpreted fraud under PFUTP differently. Thus, judgements explicitly excluding the requirement of mens rea to establish fraud coexist alongside, other judgments that have involved the court/tribunal inquiring into the deliberateness or default, the knowledge on part of the abusers, and the motive or intention before affixing liability.
SAT held in the case of Pyramid Saimira Theatre Ltd. v. Securities and Exchange Board of India (2010) that: A bare reading of regulation 3(b) of PFUTP regulations makes it clear that the words “any manipulative or deceptive device or contrivance” do not require any state of mind. But SAT in S Gopalkrishnan v. SEBI, (2011) held that SEBI must prove that the parties had willfully with intent and knowledge induced the investors in taking a wrong decision.
The SC also in the case of N. Narayanan v. SEBI (2013) impliedly brought in the requirement of mens rea for a case of fraud or market abuse by defining market abuse as: “the use of manipulative and deceptive devices, giving out incorrect or misleading information, to encourage investors to jump to conclusions on wrong premises, which is known to be wrong to the abusers.”
This was overlooked by the subsequent SC judgment in the case of SEBI v. Kanaiyalal Baldevbhai Patel (2017) which completely did away with the requirement of looking into intention or motive, holding that: No element of dishonesty or bad faith in the making of the inducement would be required.
However, the next SC judgment in the case of SEBI v. Rakhi Trading (P) Ltd (2018) held that, “Market manipulation is a deliberate attempt to interfere with the free and fair operation of the market.”
Two approaches to fraud
The above conflicting judgments from the SC and the SAT reflect two different understandings of fraud. The first understanding of fraud is victim-centric; according to which, the courts look into the effect of the acts on the investors rather than the underlying intent behind these acts. Hence, strict liability would apply and purposeful deception is not required, as long as harm was caused to the investor. The alleged violator needs to be penalized to set a deterring effect on others.[1] Thus, for instance, presenting wrong financial statements even if made after due care and in bona fide belief would make the person liable for fraud if the investors were induced to purchase the shares based on financial misstatements.
The second approach would imply that Fraud requires deception because fraud is the intentional misrepresentation of facts in order to gain an advantage. Deception, in turn, requires purpose; it is not simply lying or telling an untruth. It is the willful alteration of another's mental processes,[2] thus fraud requires purpose. But fraud cannot be solely characterized by purposeful deception. In order for fraud to occur, the person committing the fraud must have a specific goal in mind. This goal, or purpose, is what motivates the person to deceive others. Without a goal, there is no fraud.
Towards a more balanced approach:
It must be noted that the SEBI Act was enacted with the dual aim of protecting the interests of the investors in the market and promoting the development of the securities market as per the preamble of the Act. An overemphasis on protecting the investors by expanding the definition of fraud and removing the requirement of intent or knowledge could inadvertently implicate well-intentioned individuals as serious offenders. Bona fide players, even if they made judgment errors or believed their information to be accurate, might be at risk of being treated as fraudulent actors. This will have a “chilling effect” on the market and be detrimental to the purpose of the SEBI Act.
However, including the requirement of mens rea as exists in the criminal law for establishing fraud law, and holding that SEBI can take any action against the violator only after proving intention would be harmful to the investors.
Thus, it is necessary to create a distinction between fraud and misrepresentation. While punitive measures should be taken against a person who knowingly manipulates the price shares or abuses the market with a dishonest intention under Section 15HA of the SEBI Act, an order of disgorgement of undue gains under Section 11(4) of the SEBI Act or other such remedial measures should suffice in the case of a bona fide player in the market, who did not intend to distort the price or the market play, but ended up doing so. To pass an order of penalty, though SEBI should not be asked to prove mala fide intention, it should prove scienter, to protect the bona fide players from being unduly penalized. Taking such a stance will serve the dual purpose for which the SEBI Act had been enacted and create a uniform jurisprudence in the Indian Securities Regime.
[1] John C.P. Goldberg, Anthony J. Sebok & Benjamin C. Zipursky, The Place of Reliance in Fraud, 48 ARIZ. L. REV. 1001, 1011 (2006).
[2] James Edwin Mahon, A Definition of Deceiving, 21 INT’L J. APPLIED PHIL. 181, 181 (2007)