The New Kid on the Block - Industry Standards Forum

Aniket Singh Charan and I have a piece in today’s Financial Express on the newly introduced ‘Industry Standards Forum’. Below is the full pieces:

SEBI recently introduced the Industry Standards Recognition Manual (“ISF Manual”), which is a set of guidelines that governs the formation and functioning of forums known as Industry Standards Forums (“ISFs”). While the ISF Manual came out only recently, the journey of ISFs began in 2023 with a pilot project, that sought to involve listed companies and stock-brokers for formulating standards based on regulatory instructions issued by SEBI.

In furtherance of representations from different market participants, similar forums were set up on a pilot basis for other stakeholders/participants of the securities markets. The concept of ISFs, however, is not new; the UK has similar provisions allowing industry groups to create codes that help their members implement existing financial laws. The securities market regulator of the UK, the Financial Conduct Authority (“FCA”) recognizes these codes to ensure compliance. Thus, trade associations or industry bodies develop standards, and the FCA reviews and endorses them if they meet certain criteria.

In the Indian context, the ISF Manual has clarified that the role of ISFs is to identify regulatory directives that require implementation standards. Once such directives are identified, ISFs will, through a consultative process, draft appropriate standards. These standards would primarily be in the form of specifics, checklists, or Standard Operating Procedures (SOPs) that would assist industry participants in compliance. ISFs will not be considered self-regulatory organizations and will not have any powers to undertake regulatory actions against any industry participant for failure to comply with the formulated standards.

ISF’s are expected to develop standards by seeking inputs from members and/or by setting up working groups chaired by members to provide comments. SEBI has further clarified that, throughout the process of formulating standards, consultation with SEBI is a sine qua non. It is only with the ultimate consent of SEBI that a standard is taken up for formulation and ultimately, implementation. While standards are expected to be formulated by consensus, in some matters where no consensus can be arrived at, ISFs are expected to submit all proposals received on the matter to SEBI, along with the respective pros and cons. In these matters, SEBI at its option, may choose to independently issue or not to issue relevant circulars, in part or in whole.

SEBI has also provided details of the structure/composition of ISFs. Essentially, ISFs will consist of a committee comprising of members of the concerned industry or regulated entities, with adequate representation from all segments of the entities required to comply with the regulatory directions. This will include a mix of large stakeholders, small and medium sized participants. Interestingly, SEBI has directed that 75% of the membership of the ISF will comprise of current practitioners i.e. persons who have to implement regulatory directions in their respective organizations. The remaining members can comprise of lawyers, consultants and regulatory advisors. Each member generally has a term of 2-3 years but in order to avoid all member posts vacating at the same time, SEBI has proposed to reconstitute at least one-third of the composition of the ISF every year, starting from the third year of its functioning.

SEBI’s approach to ISFs is commendable. It shows regulatory maturity and a willingness to create a structured regulatory environment that benefits all market participants. However, one of the biggest challenges these forums will face is in ensuring that they do not become an exclusive “big boys club”, where only large financial institutions, major market players end up dictating the agenda, leaving smaller participants unheard. For ISFs to be truly representative, small and mid-sized players must have an equal voice. Notably, SEBI has made efforts to address this issue by mandating representation from small and mid-size participants. However, ISFs must endeavour to select issues that affect all participants in the industry and not just the bigger players. If ISFs focus solely on the perspectives of dominant firms, the very purpose of fostering fair, competitive, and inclusive markets could be undermined. For ISFs to be a success diverse stakeholders—big and small—must contribute meaningfully. Structured consultations, representation quotas for smaller firms, and open feedback mechanisms are useful methods for achieving this. The importance of the above cannot be stressed enough, as the very effectiveness of ISFs will ultimately depend on their ability to balance the interests of all market participants, creating a regulatory ecosystem that promotes both innovation and investor protection. This should also include efforts to rationalise the current over-prescriptive laws. To give one example the mutual fund regulations and master circular run into over a thousand pages.

Another key priority for ISFs is incorporating industry feedback and conducting periodic reviews to keep standards relevant and manageable. Engaging with a diverse set of stakeholders will help in identifying unnecessary complexities and ensuring that compliance remains feasible for all participants.

Another major challenge ISFs will face is ensuring that the standards they formulate are effective. ISFs should focus on crafting crisp, concise, and practical standards that address key industry challenges without becoming onerous. Lengthy, vague, or overly prescriptive guidelines can lead to unnecessary bureaucracy, making compliance more about paperwork rather than real impact. Standards formulated by ISFs should be principles-based, allowing for flexibility in implementation while ensuring the regulatory intent is met. ISFs must avoid the pitfall of creating standards merely for the sake of it and should always remember that the primary goal of formulating standards is to reduce regulatory confusion, not to add to it.

Another aspect of the recent ISF Manual that merits further discussion is the manner in which the standards formulated by various ISFs will be published. Present practice suggests that SEBI merely notifies the recognition of standards, and the actual standards themselves are available on the website of the concerned ISF or participating entities of the ISF. It is advisable that such standards, in addition to being displayed on the concerned ISF’s website, must also be available on SEBI’s website. This will make these standards, that have the factual, if not legal, force of law, more accessible to practitioners and regulated entities.

While ISFs are still in their nascent stages, their introduction helps us in understanding what the future of securities market regulation would look like. It is too early to comment on whether ISFs will be a resounding success or a compliance burden, however, the underlying motive for their introduction is a noble one. For ISFs to truly emerge as valuable tools to ensure sustainable growth it is important that they maintain a balanced approach that fosters ease of doing business while upholding market integrity.

Fraud, Manipulation and Insider Trading in the Indian Securities Markets, 5th Edition

Delighted to bring the 5th edition of my book to you, published by LexisNexis. All books are labours of love, so do buy and leave a rating (please leave it on the official page of Amazon as there are multiple sellers). Link to Amazon.in micro-page.

Running Ahead and Running Amok

I have a piece in yesterday's Financial Express on front running with Rashmi Birmole and Manas Dhagat.

Many will recall the morning of 1^st March 2001 when the proverbial penny, long waiting in the shadows of the tech boom, finally dropped, triggering one of the most significant crashes in Indian stock market history. This canonical event, that went on to inform sweeping structural reforms in the years to come, also exposed an insidious and extensive pump and dump scheme orchestrated by one Ketan Parekh, no relative of the first author, a former broker, and several major players in India’s financial ecosystem. Nearly 23 years later, history seems to be repeating itself with another fraud masterminded by Ketan Parekh, uncovered by SEBI after a months-long investigation into trading records, mobile communications, IP address mappings and statements from key individuals.

The findings, released by SEBI in an interim order on January 2, 2025, expose a fraudulent scheme orchestrated to exploit sensitive, non-public information for illicit gains. This time around, though equally fraudulent, the modus operandi is fundamentally different from the last. SEBI’s investigation has identified several individuals, including Rohit Salgaocar, Ketan Parekh and others, who are found to have colluded to front-run the trades of an overseas institutional client, or ‘Big Client’, of two Indian stock brokers. For the uninitiated, front-running, is a form of market abuse where individuals trade securities based on advance knowledge of large, market-moving transactions by other investors. It allows the perpetrators to profit from predictable price movements, often at the expense of the original investor’s interests and to the prejudice of the public. The investigation also revealed the involvement of individuals who can be categorized into information carriers, front runners, facilitators, who played pivotal roles in enabling this malpractice.

The information about impending trades flowed from Rohit Salgaocar, a Singapore resident, whom the Big Client often consulted on trading decisions in the Indian markets. Salgaocar leveraged this role to access non-public trade information (as contrasted with non-public inside information), which was relayed to the front-runners. To add to this, traders of the Big Client, familiar with Salgaocar, interacted with him while executing trades in Indian securities. These communications typically took place over Bloomberg chats and calls. SEBI’s investigation revealed that Ketan Parekh played a central role in orchestrating the operation and coordinating between the individuals involved. Ketan Parekh and connected entities exploited sensitive trade information from the Big Client’s impending transactions in various securities to generate profits to the tune of roughly 65 crore rupees.

The operation involved three distinct groups. Rohit Salgaocar, based in Singapore, acted as a conduit for non-public information (NPI). By leveraging his role as a director of Strait Crossing Pte. Ltd. and MoUs with brokers, Salgaocar obtained detailed information about the Big Client’s substantial market transactions. Using this information, Ketan Parekh directed employees of stockbrokers, as well as certain individuals who executed trades through private companies. These entities positioned themselves to benefit from price movements triggered by the Big Client’s large orders. The frontrunners used their access to trading accounts and networks to ensure seamless operations, directly communicating with Ketan Parekh. A notable aspect of the operation was the use of novel trading strategies termed as BBSB (Buy-Buy-Sell-Buy) and SSBS (Sell-Sell-Buy-Sell). To illustrate, in the BBSB approach, the perpetrators would purchase shares before the Big Client’s buy order was placed in the market, which they would consistently match in terms of timing, pricing, and quantity, providing strong evidence of prior knowledge and coordinated execution, and then also go on to sell the remaining shares in the open market.

Privileged access to non-public information (NPI) distorts market fairness, which lays the foundation for investor trust. When trust diminishes, individuals and institutions become wary of investing, perceiving the market as inherently unsafe. In this case, the Big Client’s transactions, aimed at executing legitimate investment strategies, were compromised. The illicit profits were found to have been shared among the perpetrators, with Ketan Parekh orchestrating the scheme and distributing trade-related instructions. These coordinated trading patterns were critical to masking the front-running activities and misleading market observers.

The data released by SEBI for 2022-24 reveals a concerning rise in front running cases, with numbers tripling every consecutive year. Between 2020 and 2024, nearly 116 front-running cases have been taken up by the regulator. This highlights a troubling trend of escalating violations emphasizing the need for more vigil. At the centre of these cases lies the information leaker, who, based on past data, has predominantly been a dealer servicing the broker’s institutional clients. While the exponential rise in front-running cases may reflect more pro-active surveillance and enforcement, it is equally important to consider scenarios and systemic issues that make front-running possible and erode trust in the market. The broader policy implications are also significant and any questions around market integrity impacts private investment and capital formation, ultimately weaking economic growth. The lack of adequate oversight has made it easier for front-runners to leak sensitive information, allowing those with access to exploit it for personal gain.

It is time to adopt a more targeted approach to front-running that addresses its root causes. Brokers and other fiduciaries must re-imagine its compliance strategy and contemplate measures that minimize the possibility of front-running in the trading process by design. At the client end such measures, could include rotation of specific brokers by institutional clients, splitting up of large institutional orders between multiple dealers and systematic checks to closely monitor broker activities. Furthermore, introducing stringent accountability frameworks for brokers, accompanied by enhanced oversight of employees engaged in large-volume trading, can also strengthen preventive measures. The broking community, needs to collectively adopt a higher standard of monitoring and surveillance over dealer activities. Additionally, brokers, whose dealers are often the primary source of such leaks, should face stricter liabilities. Restrictions on access to communication channels during critical trading activities, such as proper implementation of dealing room restrictions, should be reviewed periodically to ensure that such restrictions don’t merely exist on paper. Separate dealers can be assigned for institutional trades, subject to a higher level of monitoring. These measures would help reduce the risk of sensitive information leaking and ensure greater integrity in trading operations.

The growing prevalence of front-running cases highlights the urgent need for an innovative strategy that addresses systemic flaws, enforces accountability and fosters a fair trading environment and SEBI’s improved surveillance and heightened enforcement action bode well. But mere enforcement action by the regulator will not suffice and the industry must come up with stringent best practices in internal surveillance and supervision which are adopted industry-wide and become a benchmark before any institutional clients approaches them.

Legal500 ranking of Finsec Law Advisors

Delighted and honoured that Finsec Law Advisors is recognised as a distinguished law firm in the space of financial services regulatory for 2025 by Legal500, London an international agency which ranks law firms globally based on client feedback. Grateful for the kind words by clients.

Cut all that flab from reg laws: Why SEBI's securities laws need a revamp

I have a piece in today's Economic Times on the need to eliminate 80% of all regulatory laws and how precision and brevity are important in designing law, specially law which is easy to pass without parliamentary approval. Below is the full piece:

It’s a Doge eat regulation world

 

Regulators think of introducing new regulations from two lenses. First in terms of errors. Whether the law will harm innocents or let the guilty get away. Second, in terms of cost-benefit analysis because every law has a cost on the market. In addition, for good process, they look at views of expert committees and exposing draft regulations to public comments. 

 

Students of criminology (with its origin in logic and later statistics) will immediately recognize the two error types. Type I error occurs when a guilty person escapes because the law is too lax. This error prioritizes protecting the innocent at the risk of letting some guilty individuals go free. Type II error occurs when an innocent person is found guilty. This reflects an overly stringent or biased system that compromises individual rights and undermines justice. 

 

Sadly, a lot of current regulations falls within these errors. In fact, the SEBI law against fraud is drafted so sloppily that it simultaneously creates both type I and type II errors at the same time. While it is easy to blame SEBI, many of these laws were created by market experts from the industry. The law against fraud, the law against insider trading and the takeover law are the most egregious examples (and also the cornerstone of securities laws).

Let’s take the example of the securities law against fraud. Fraud has been well understood for centuries under common law, even before a formal legislation came in. Based on the common law, five ingredients were identified: intent, materiality, mis-statement, causation and harm. These ingredients with minor modifications for the anonymous securities markets have created the US rule against fraud commonly called rule 10b-5 never modified since its introduction in 1942. There are now tens of thousands of US court rulings chiseling each of the requirements of the ingredients. That’s how the law becomes more sophisticated and nuanced.

Take the Indian law now, in what is called the Fraudulent and Unfair Trade Practices regulations of SEBI or FUTP. None of the five ingredients are required to prove fraud. I had written an article in this paper in Sept 2018 that under securities law I can prove that walking, running and swimming were all fraud. These kind of laws may sound fair to a layman, but if you put a lot of random people in jail for murder, likely-some-will-be- murderers kind of logic is not really a good way to draft law and puts the common law system of ‘innocent till proven guilty on its head’. Yes, it indeed makes the task of the prosecutor easy to put everyone they see in jail.

The other, somewhat related problem is prolixity. We love to write laws. With a lot of words. It may not make any qualitative difference in liberal arts subjects whether you describe an object with a thousand words or ten thousand. However, law is more akin to STEM subjects. At the cost of sounding pompous, I would go so far as to say, it is akin to surgery. Every single comma is like a millimeter while conducting surgery. Ask the insurers how the 9/11 insurance contract was drafted and whether the ‘event’ included two plane attacks or one, decided whether they paid an extra 3.5 billion dollars or not. With laws, the consequences can be alarmingly more serious than with drafting contracts. 

 

Let’s just start with one comparison and two examples from the same domain of fraud and insider trading laws in the securities markets. First, the anti-fraud rule in the US has 124 words. The insider trading law has 0 additional words as it is subsumed in the anti-fraud Rule. The Indian equivalent FUTP has over 4,400 words and the insider trading regulation has over 20,000 words. These additional 24,000 words are not just surplusage, but cause harm to innocent people, and let the guilty free. And no, we didn’t try to create a better definition, Regulation 3 of FUTP is a virtual lift off of the US rule. We just chose to write another 24,000 words and stuck a long tail on what matters.

 

Just look at one example where the Supreme Court had to intervene in a case where a person who had good news sold in the markets and was accused of insider trading. In its argument, SEBI relied on the fact that the regulation does not mention the direction of trading and thus the person will be found guilty. Even a high school student will note the absurdity of this argument, buying while holding unpublished bad news or selling while in possession of good news is irrefutable proof that insider trading did not happen. 

 

Even worse is the deeming provisions of these laws. For example, if a woman were to share the closure of a large M&A deal with her husband for going out on a celebratory dinner is a criminal according to SEBI laws on ‘need to know’ basis of sharing information even where no mis-use of the information occurs. The deeming provisions of insiders would deem almost any semi-random communication with any other person as refutable proof that the person illegally passed on information. If I were to give a legal opinion to a company on matters of intellectual property, and bought a few thousand shares contemporaneously, there could be a deemed provision that the company passed on illegal information (say quarterly earning) to me. The only way I will be able to disprove it would be for me to record every conversation had with company officials, and if I were to meet them, put a GoPro camera on my head while having dinner with them. The insider trading laws require no element of being an insider, no need to show trades and even no need to show any inside information. There is a need to take Elon’s scalpel, and cut down regulations and the overly broad laws. By my estimate, the existing laws of SEBI and other regulators could easily be improved by cutting them by 80% and bringing in precision. And we could see a real ease of doing business in India for public companies. 

 

The author’s book Fraud, Manipulation and Insider Trading in the Indian Securities Markets fourth edition will be published by LexisNexis next month. 

 

Decoding with Finsec - Episode 1 (December SEBI board meeting analysed)

 Introducing the first episode of ‘Decoding with Finsec’ on Youtube. We dive into the key proposals which were greenlit by the Securities and Exchange Board of India (SEBI) on 18th December 2024.

From stricter norms for SME IPOs to classifying material events as unpublished price sensitive information (UPSI) under the insider trading regime, join us as we dissect the recent changes and explore whether these reforms are geared towards enhancing the ease of doing business for market participants or designed to ease SEBI’s regulatory responsibilities. __________________________________________________________ Time Stamps: 0:00 - Introduction 1:21 - Stricter norms for SME IPOs 8:36 - Permitted activities by merchant bankers 17:36 - Agency for verification of past returns 22:31 - Events deemed as 'unpublished price sensitive information' 29:41 - Draft PUSTA Regulations 31:31 - Skin in the game by AMC employees

The future of Algo Trades

I have a piece with Parker Karia and Pragya Garg on the future of algo trading and its regulations in today's opinion page of Financial Express. Please see below the full piece:

"Among the flurry of consultation papers issued by the securities market regulator over the past few months, in December 2024. SEBI proposed significant changes to its framework governing algo trading. To recap quickly, algorithmic trading, or algo trading, refers to any trading activity that automates trades, and does not require manual intervention to place any orders, or monitor prices.

There are two ways in which one can carry out algo trading. The straightforward method is to use the algorithms provided by the stock broker, if that is a facility your broker provides. The other route is through APIs (Application Programme Interface), which enable electronic systems to connect with each other.

Think of it as a data pipe which carries your algorithm. APIs enable the transmission of information, and as a result, a third party can create a code that will execute itself on the broker’s platform. APIs are what enables you to book an Air India flight on Goibibo or avail a loan from a bank through a distributor.

In the context of algo trading, third parties provide their algo on say, Platform X, which is connected to the broker’s platform through an API. Thus, orders placed by the client on Platform X get passed on to the broker. Now, while a broker can identify that an order is coming in through an API, it cannot verify that the order is an algo order.

In 2021, being concerned with the rise of unregulated and unapproved algos, SEBI had proposed to treat all API orders as algo orders. This was a flawed approach, and a departure from SEBI’s mission to encourage innovative and digital solutions in securities market, as the regulator’s proposal would have retarded connectivity between brokers and other sophisticated players connecting to them for non-algo purposes.

It appears that the proposal has been scrapped, and after extensive consultations with the industry, a more practical approach has been proposed.

With respect to API orders, SEBI has suggested that an ‘Order per second’ threshold be specified, and that all API orders above such threshold would be treated as algo orders.

Secondly, SEBI has proposed to bring ‘algo providers’ within the regulatory ambit. These algo providers would be agents of stockbrokers, similar to the present ‘Authorised Person’ or the erstwhile sub-broker concept. Algo providers would also have to register with the stock exchange, and also get their algos approved by the exchange. This would ensure that the broker is responsible for customer grievances, and the redressal mechanism deployed by SEBI would be available to clients of algo providers.

Individuals who design their own algos would also have to get them approved by the stock exchanges through their broker. These can then be used by the investor’s immediate family as well.

The regulator has also sought to categorise algos into ‘White Box’ and ‘Black Box’ algos. White Box algos, also known as ‘Execution Algos’, are those which execute orders based on fully transparent algorithms, where the logic, decision making processes and underlying rules are accessible and understandable to users and is replicable. On the other hand, Black Box algos are algos whose logic is not known to the user and is not replicable, or where the user cannot see the internal workings and rationale of the algo. For providing Black Box algos, one would be required to register as a research analyst, and for each algo, a research report would have to be maintained, and in case of any change in the logic governing such algo, it would have to be registered afresh, along with a new research report.

The proposed framework places significant responsibilities on stock brokers. Brokers would have to put in place systems and procedures to detect, identify and categorize all orders above the specified ‘order per second’ threshold as algo orders. They would also have to make sure to have the ability to distinguish between algo and non-algo orders. Further, brokers would no longer be permitted to offer open APIs, to ensure identification and traceability of the vendor and end user. Whether such severe restrictions are required or not, in view of the measures such as the ‘order per second’ threshold, may require some more thought. APIs have uses beyond algo trading. The proposed circular should not stand in the way of such non-algo trading use case scenarios.

There is a fair bit of work that the stock exchanges would also have to do. First, they have to define the roles and responsibilities of brokers and empanelled vendors, and lay down the criteria and process of empanelment of vendors. A turn-around-time has to be specified for registration of algos, including a fast-track registration for certain algos, such as White Box algos.

Further, the stock exchanges would have to deploy additional resources as well. The exchanges would be required to conduct post trade monitoring of algo orders and trades and put in place a Standard Operating Procedure for testing of algos. Further, they must have the ability to use a ‘kill switch’ to stop malfunctioning algos.

Additionally, they would have to supervise/inspect that stockbrokers have the ability to distinguish between algo and non-algo orders, and issue detailed operational modalities, regarding the roles and responsibilities of stock brokers and algo providers including risk management system of stockbrokers for API orders.

The present proposal thus seems to be more carefully thought out, and seeks to adopt an approach that strikes a balance between the interests of the stakeholders and concerns of the regulator. In another positive move, in its last board meeting of 2024, SEBI’s board granted approval for the recognition of a ‘Past Risk and Return Verification Agency’ (PaRRVA), which shall carry out the verification of risk-return metrics inter alia in relation to algo trading.

There are still some points which may require a re-think as algo trading picks up. For instance, SEBI’s earlier question of whether an algo should be a facility provided by a research analyst or an investment adviser, or a separate class of regulated entities altogether. With the proliferation of AI, the roles, responsibilities, risks and liabilities are getting redefined.

However, there are few items that may require consideration soon, if not now. For instance, algos may be designed by artificial intelligence. The risks and liabilities that may arise out of such instances must also be deliberated upon carefully, along with the roles and responsibilities of the elements involved. While there may never be one right answer, and regulation of something as innovative as algo or AI based algos is bound to create some unnecessary bureaucracy in the process, it is important for the regulator to at least have some grip on something which could have systemic impact on the markets."