Faced with tech-savvy crooks, Sebi proposes new regulations to probe ‘suspicious trading activity’

The market regulator has released a consultation paper on regulations to stop unexplained suspicious trading activity

The market regulator is seeking to regulate unexplained, suspicious trading activity through a new set of regulations as the “use of innovative, vanishing and encrypted methods of private communication, as well as complex and untraceable funding arrangements” allow people/entities to do fraudulent activities while masking their identities and connections.

Therefore, Sebi put out a consultation paper on May 18, inviting public comments on the draft of the Sebi (Prohibition of Unexplained Suspicious Trading Activities in the Securities Market) Regulations, 2023.

It outlines a framework where the regulator can start an investigation if it detects suspicious activity and can penalise if no effective counter is presented.

Also read: Listed companies fail to categorise UPSI instance in 95 percent of cases: Sebi study

Under it, unusual trading pattern (UTP) when combined with the existence of material non-public information (MNPI) points to suspicious trading activity (STA). Further, when this suspicious trading activity (STA) is combined with the absence of an effective rebuttal or explanation, it can be seen as an unexplained suspicious trading activity (USTA).

Once USTA is established, the persons/entities responsible will face action as “deemed appropriate” by Sebi.

System so far

The regulator stated that it has always relied on the principle of “preponderance of probability”, which means a high probability of violation, to act against people who are flouting the law.

But modern technology seems to be making this a difficult proposition. Despite its surveillance systems detecting insider-trading and front-running activity repeatedly, the consultation paper stated, “use of innovative, vanishing and encrypted methods of private communication, as well as complex and untraceable funding arrangements, makes it impossible to establish the preponderance of probability”.

It stated that one of these surveillance mechanisms generated 5,000 alerts of 3,588 entities in 2022. Of these 3,000-plus entities, 97 were showing up on their radar repeatedly, even five or more times. But action could not be taken against them because connections or communications could not be established.

Even for cases that were taken for detailed investigation, the existing regulatory framework seemed poorly equipped. Around 60 percent of these cases could not proceed from lack of “adequate evidence” and in the remaining 40 percent establishing communication of unpublished price-sensitive information (UPSI) was difficult.

Therefore, it has proposed a new framework.

Under it, an unusual trading pattern (UTP) shall include the repetitive pattern of trading activity by a person or a group of connected persons, which involves either a substantial change in risk-taking in one or more securities over short periods of time or activity that consequently delivered abnormal profits or averted abnormal losses.

Material Non-Public Information (MNPI) shall include information about a company or security, which was generally not available, and upon becoming generally available had a reasonable impact on the share price; or information about any impending order in security, which when executed reasonably impacted the price of that security; or information about an impending recommendation, advice by name, etc., in a security, by an influencer, to the public/followers/subscribers, etc., and which when became generally available to the public/followers/subscribers, reasonably impacted the price of that security.

A suspicious trading activity would be decided if UTP and MNPI come together. Once this is established, proceedings against a person/entity would begin.

If the accused is not able to provide an effective rebuttal, as defined by the regulations, then the trading activity would be deemed unexplained suspicious trading activity or USTA.