SEBI
Topic37 PFUTP Prohibition Regulations 3 4
Prohibition of Fraudulent & Unfair Trade Practices
Topic 37 — PFUTP Regulations 3 & 4: Connected Persons, Market Manipulation & Unfair Practices | SEBI Law Officer
Regulations 3 and 4 of the PFUTP Regulations, 2003 are the core prohibition provisions. Regulation 3 targets 'connected persons' — those with access to unpublished price-sensitive information who deal in securities using that advantage. Regulation 4 is the comprehensive anti-manipulation provision — it lists specific prohibited practices and adds a residuary prohibition on any 'manipulative, fraudulent or unfair trade practice'. Together, Regulations 3 and 4 cover the entire spectrum of securities market misconduct, from insider dealing to price rigging to spoofing to misleading research reports.
1. Regulation 3 — Prohibition on Connected Persons
Regulation 3: No person shall directly or indirectly — (a) buy, sell or otherwise deal in securities of a body corporate listed on any stock exchange on the basis of any unpublished price-sensitive information; (b) communicate or counsel or procure directly or indirectly any person to deal in securities on the basis of unpublished price-sensitive information; (c) induce any other person to deal in securities on the basis of such information. |
Regulation 3 creates three separate offences:
- Clause (a) — Trading on UPSI: Dealing in securities of a listed company while in possession of unpublished price-sensitive information. This overlaps directly with the PIT Regulations 2015.
- Clause (b) — Communicating UPSI: Communicating, counselling, or procuring another person to deal on UPSI — covers tippers (those who pass on UPSI) and their associates.
- Clause (c) — Inducing others: Inducing any person to deal on UPSI — broader than communication; covers subtle inducement (e.g., a wink, a hint) not amounting to explicit communication.
⚠️ Regulation 3 PFUTP vs PIT Regulations 2015 Regulation 3 PFUTP and the PIT Regulations 2015 both prohibit insider trading — but PFUTP applies to all 'connected persons' as defined in Regulation 2(1)(b), while PIT applies to 'insiders' and 'connected persons' as defined under PIT. SEBI typically invokes both simultaneously in insider trading enforcement actions. The PIT Regulations are more detailed; PFUTP provides an alternative/additional enforcement route. |
2. Regulation 4 — Prohibition of Market Manipulation & Unfair Practices
Regulation 4(1): Without prejudice to the provisions of Regulation 3, no person shall indulge in a fraudulent or an unfair trade practice in securities. |
Regulation 4(2): Dealing in securities shall be deemed to be a fraudulent or an unfair trade practice if it involves fraud and includes — [extensive list of prohibited practices follows]. |
Regulation 4(2) enumerates 13 specific practices deemed to be fraudulent or unfair. These are examined below:
2.1 Category A — Price and Volume Manipulation
Regulation | Practice | Explanation |
|---|---|---|
4(2)(a) | Effecting transactions creating false/misleading appearance of trading | Wash trades, circular trades — transactions that create artificial volume without genuine change of beneficial ownership |
4(2)(b) | Dealing in securities at a price below/above market price to cause decline/rise | Painting the tape — executing trades to artificially move the price without genuine investment intent |
4(2)(c) | Colluding to fix prices | Agreements among brokers, institutions, or investors to fix the opening/closing price of a security |
4(2)(d) | Entering into transactions that are not intended to be performed (fictitious transactions) | Matched/fictitious orders — entering buy and sell orders in concert to create false trading activity |
2.2 Category B — Information-Based Manipulation
Regulation | Practice | Explanation |
|---|---|---|
4(2)(e) | Disseminating information or causing publication of information through any media for inducing purchase/sale of securities | Pump-and-dump using social media, WhatsApp groups, Telegram channels, news portals — spreading false positive/negative news to move stock prices |
4(2)(f) | Publishing misleading information about security, company, or management | False analyst reports, fake company announcements, manufactured due diligence reports |
4(2)(g) | Misrepresenting to any person entrusted with funds for investing | Portfolio managers/investment advisers misrepresenting the nature of investments to clients |
4(2)(h) | Unreasonable delay in transferring securities after payment | Broker delaying delivery of securities to extract additional charges or manipulate settlement |
2.3 Category C — Front-Running & Misuse of Position
Regulation | Practice | Explanation |
|---|---|---|
4(2)(q) | Front-running by connected persons | Dealing ahead of client orders — e.g., broker buying stock before executing large client buy order, then selling after price rises |
4(2)(r) | Misuse of client information for own benefit | Investment adviser/portfolio manager using client-disclosed information to trade for their own account |
4(2)(s) | Circular trading / matched orders | Group of persons systematically buying/selling among themselves to generate artificial turnover |
3. The 'Unfair Trade Practice' Concept
Beyond specifically enumerated practices, Regulation 4(1) contains a general prohibition on any 'unfair trade practice' in securities. This residuary clause enables SEBI to take action against new forms of market misconduct not specifically listed in Regulation 4(2). Key examples of practices treated as 'unfair' even without being explicitly listed:
- Spoofing — placing large fake orders to move prices and then cancelling them before execution.
- Layering — placing multiple orders on one side of the book to create false depth, then trading on the other side.
- Churning — an investment adviser excessively trading a client's account to generate commissions, against the client's interests.
- Mis-selling — recommending unsuitable investments to retail investors for personal financial benefit.
4. Landmark Cases on Regulations 3 & 4
📖 SEBI v. Rakhi Trading Pvt. Ltd. (2018) 13 SCC 1 Facts: SEBI alleged Rakhi Trading engaged in synchronised algorithmic trading — placing buy and sell orders simultaneously through different entities, creating artificial volume. SEBI found a pattern of coordinated trading. Held: The Supreme Court upheld SEBI's findings. Synchronised trading that creates artificial volume and misleading price signals violates Regulation 4(2)(a). The fact that orders were placed through algorithmic systems does not exempt them from PFUTP. Trade pattern analysis — timing, price impact, order matching — is sufficient evidence. SEBI need not prove communication between the parties. Ratio: Algorithmic trading is not exempt from PFUTP Regulations. Pattern-based evidence of coordination — timing, order matching, price impact — is sufficient to establish a Regulation 4(2)(a) violation. SEBI does not need to prove communication between the coordinating parties. |
📖 SEBI v. Shri Kanaiyalal Baldevbhai Patel (2017) 15 SCC 1 Facts: Stock operators were found to have manipulated the prices of certain listed securities through circular trading — repeatedly buying and selling among connected entities to create artificial turnover and mislead other investors. Held: The Supreme Court upheld SEBI's order of debarment and disgorgement. Circular trading — even without explicit communication between parties — violates Regulation 4(2)(a) when the trading pattern shows coordinated activity creating a misleading appearance. SEBI established the violation through statistical analysis of trading patterns. Ratio: Regulation 4(2)(a) is violated when trading creates a misleading appearance — proof of coordination can be inferred from trading patterns. Debarment and disgorgement are valid remedies for market manipulation under Section 11B SEBI Act. |
5. Model Examination Questions
Q1. Discuss the prohibition on market manipulation under Regulation 4 of the PFUTP Regulations, 2003 with reference to leading cases.
Regulation 4 — Prohibition on Market Manipulation Model Answer — Regulation 4(1) prohibits any fraudulent or unfair trade practice in securities. Regulation 4(2) deems specific practices as fraudulent/unfair: (a) transactions creating false/misleading appearance of trading — wash trades, circular trading (most important provision); (b) dealing to cause artificial price rise/fall; (c) price fixing through collusion; (d) fictitious transactions not intended to be performed; (e) dissemination of misleading information (pump-and-dump); (f) publishing misleading information; (q) front-running; (r) misuse of client information; (s) circular/matched trading. The Supreme Court in SEBI v. Rakhi Trading (2018) upheld SEBI's PFUTP action against algorithmic circular trading — holding that algorithmic trading is not exempt; trade pattern analysis is sufficient evidence; SEBI need not prove communication. In SEBI v. Kanaiyalal Patel (2017 SC), circular trading established through statistical pattern analysis — debarment and disgorgement upheld. The 'misleading appearance' standard from Regulation 2(1)(g) is the benchmark: trading that does not reflect genuine supply and demand forces violates Regulation 4(2)(a). Regulation 4(1)'s residuary prohibition covers new forms of manipulation (spoofing, layering) not specifically listed in Regulation 4(2). |
🎯 EXAM POINTERS — Topic 37: PFUTP Regulations 3 & 4
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← Topic 36: PFUTP Definitions [Regulation 2] | Next → Topic 38: Market Manipulation — Price Rigging, Circular Trading & Churning
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