Order in Respect of Factorial Master Fund

WTM/RKA/ISD/125 /2014 BEFORE THE SECURITIES AND EXCHANGE BOARD OF INDIA ORDER UNDER SECTIONS 11 AND 11B OF THE SECURITIES AND EXCHANGE BOARD OF INDIA ACT, 1992 IN RESPECT OF FACTORIAL MASTER FUND IN THE MATTER OF L&T FINANCE HOLDINGS LIMITED. Appearances: For Noticee: Mr. Somasekhar Sundaresan, Advocate Mr. Paras Parekh, Advocate Mr. Barun Agarwal, Director, Factorial Master Fund 1. Vide ad interim ex-parte order dated June 5, 2014 (hereinafter referred to as the 'interim order') Factorial Master Fund (hereinafter referred to as the 'noticee') has been restrained from accessing the securities market and prohibited from buying, selling or dealing in securities, in any manner whatsoever, till further directions. 2. The interim order was passed on the basis of prima facie findings that the noticee had taken unusual and aggressive short position in the F&O segment in the scrip of L&T Finance Holdings Ltd. („LTFH‟) ahead of the Offer For Sale („OFS‟) of 5,55,05,755 shares (amounting to 3.23% of the total share capital) and with an option to sell further 2,77,52,878 shares (amounting to 4.845% of total share capital) of LTFH on March 14, 2014 by L&T Limited („LT‟) while in possession of and on the basis of unpublished price sensitive information regarding the likely floor price of the scrip in the impending OFS. Based on these prima facie findings, the noticee was alleged to have contravened section 12A (d) and (e) of the Securities and Exchange Board of India Act, 1992 (the SEBI Act), regulation 3(i) of the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 (the PIT Regulations) and regulations 3 (a), 3 (b), 4(1) of the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practice relating to Securities Market) Regulations, 2003 (the PFUTP Regulations).

3. Pursuant to the interim order, the noticee filed its reply vide letter dated June 23, 2014 and also availed opportunity of personal hearing on August 7, 2014. The replies and submissions of the noticee inter alia are as under: (a) SEBI has passed the interim order without any notice to the noticee and without an opportunity to present its perspective on the points referred to in the ex-parte interim order. In this regard, the noticee has placed reliance on various judgments including Golak Patel Volkart Ltd. vs CCE (1987 (28) ELT 53 (S.C.)), Municipal Board Pushkar vs State transport

Order in respect of Factorial Master Fund

Authority (AIR 1965 SC 458: 1963 Supp (2) SCR 373) and East India Commercial Company vs Collector of Customs (AIR 1962 SC 1893:(1963) 3, SCR). (b) The trades in question were based on high conviction, and fundamental and technical analysis in the scrip of LTFH. The equity share of LTFH was over-priced - from a fundamental research as well as from technical view-point. In support of its arguments, the noticee also submitted various brokerage/analyst reports and literature which pointed that the average target price of the LTFH shares ought to be 20% below its prevailing market price. (c) As a part of its fundamental research, the noticee had met senior management of LTFH on March 11, 2013 and had formed a negative view on the stock. Hence, when the shares of LTFH were included in the F&O segment on March 13, 2014, it presented an opportunity to sell the derivative contracts in the scrip of LTFH. (d) The noticee would have sold the derivative contracts in the scrip of LTFH had it listed earlier than March 13, 2014, irrespective of the market gauging exercises conducted by various stock brokers.

(e) It was well known in the market that the promoters of LTFH were required to reduce their stake in it so that LTFH becomes compliant with the minimum public shareholding norms as stipulated under rules 19(2)(b) and 19A of the Securities Contracts (Regulation) Rules, 1957 (the SCRR). In view of this expected dilution of shareholding by the promoters of LTFH, there would be supply overhang in the scrip of LTFH. (f) The interim order alleges that the noticee built a short position of 5,309 derivative contracts of LTFH on March 13, 2014 which is equivalent to 2,12,36,000 shares, i.e., 84.15% of market wide open interest built during the day in the scrip of LTFH. This reference to 84.15% of market wide open interest built during the day in the scrip, indicating a high percentage of the open interest position is flawed. (g) The price discovery and volumes for price discovery are contributed to by the F&O segment as well as the cash segment. The reference to “open interest” is misplaced since this computation has been made on the basis of net position in the F&O segment only, which purports to throw up an inflated percentage mark.

The denominator should be the total trades effected in the F&O segment as well as cash segment rather than open interest which only portrays the closing position in the F&O segment. (h) If holistic value of shares traded in the cash and F&O segment is considered, the noticee sold only approximately 1 in 5 units. Further, if only F&O volume is considered, the noticee‟s sale was approximately 1 in 3 units. The noticee ended up with 84.15% open interest despite being only 21.8% of holistic volumes as many participants closed their short position intraday while the noticee stuck to them. Some other instances where the noticee‟s open interest was high relative to its trading volume were cited to highlight that there was nothing extra ordinary about the LTFH trades. (i) In the instant case, the noticee was not alone in figuring out the fact that the share price of LTFH was overvalued. Further, the information regarding impending OFS of LTFH was available to everyone because SEBI‟s seriousness to ensure compliance by listed companies, including LTFH, of MPS requirements was extensively covered in the press.

(j) There is no trace of any reasonable evidence that the noticee was in possession of any unpublished price sensitive information in relation to the OFS as alleged or otherwise. During the market gauging exercise by Credit Suisse Securities (India) Private Limited („CS‟), the noticee had given its feedback to CS. Even CS has not stated that it mentioned any unpublished price sensitive information to the noticee. Further, CS did not undertake any “wall-crossing” exercise (the process of putting someone on notice that unpublished price sensitive information may be communicated and that one should not trade any more in those securities) when it corresponded with the noticee in the course of its market gauging exercise. This also points to the fact that there was nothing sensitive at all to convey regarding the scrip of LTFH. (k) The references to the likely floor price in the internal correspondence referred to in the interim order are to those of correspondence within CS and not with the noticee. (l) The noticee has strict compliance procedures and all actions by the noticee were in line with these procedures.

(m) The bidding for shares of LTFH by the noticee during the OFS was through a transparent auction process and based on the price that the noticee felt was reasonable. (n) Till date, not a single query has been put to it by SEBI after the interim order. Thus, it shows no emergency to intervene by way of interim order. 4. In view of its aforesaid submissions the noticee has contended that the facts and circumstances do not warrant intervention by the interim order and, therefore, though the investigations may continue, the interim order should not continue during pendency of the investigations. The noticee has further submitted that in view of its aforesaid submissions, the prima facie case is in its favour and the ban imposed vide the interim order is disproportionate even if the noticee is prima facie found guilty. Alternatively, the noticee has pleaded that the restraint, if any, against it may be limited to the scrip of LTFH or to OFS of any company. 5. I have carefully considered the allegations/charges against the noticee, its replies and relevant material available on record. In the instant case, it is observed that the directions issued vide interim order against the noticee were interim in nature and were issued on the basis of prima facie findings.

I note that the investigation in the matter is still in progress. Therefore, the limited issue to be considered at this stage is whether the interim directions issued against the noticee vide the interim order need to be confirmed, vacated or modified in any manner, during pendency of investigation in the matter. 6. I note that the noticee has raised preliminary objection that no show cause notice was issued to it and the directions issued by way of the interim order was in violation of the principles of natural justice. In this regard, I note that the power to pass interim orders is specifically permitted under section 11 and 11B of the SEBI Act which empowers SEBI to pass appropriate order/direction in the interests of investors or securities market, pending investigation or inquiry or on completion of such investigation or inquiry. It is not always necessary to pass orders under those sections only after affording opportunity of personal hearing. Considering the facts and circumstances of a particular case, ad-interim ex-parte orders may be passed in the interests of investors or the securities market.

This position has also been settled by various judgments such as the matter of Anand Rathi & Others Vs. SEBI (2002 (2) Bom CR 403, wherein the Hon'ble Bombay High Court has held as under:

"31. It is thus clearly seen that pre decisional natural justice is not always necessary when ad-interim orders are made pending investigation or enquiry, unless so provided by the statute and rules of natural justice would be satisfied if the affected party is given post decisional hearing. It is not that natural justice is not attracted when the orders of suspension or like orders of interim nature are made. The distinction is that it is not always necessary to grant prior opportunity of hearing when ad-interim orders are made and principles of natural justice will be satisfied if post decisional hearing is given if demanded. 32. Thus, it is a settled position that while ex parte interim orders may always be made without a pre decisional opportunity or without the order itself providing for a post decisional opportunity, the principles of natural justice which are never excluded will be satisfied if a post decisional opportunity is given, if demanded." 7. Further, the Hon'ble High Court of Judicature for Rajasthan at Jaipur in the matter M/s. Avon Realcon Pvt. Ltd. & Ors Vs. Union of India & Ors (D.B.

Civil WP No. 5135/2010 Raj HC) has held that: “…Perusal of the provisions of Sections 11(4) & 11(B) shows that the Board is given powers to take few measures either pending investigation or enquiry or on its completion. The Second Proviso to Section 11, however, makes it clear that either before or after passing of the orders, intermediaries or persons concerned would be given opportunity of hearing. In the light of aforesaid, it cannot be said that there is absolute elimination of the principles of natural justice. Even if, the facts of this case are looked into, after passing the impugned order, petitioners were called upon to submit their objections within a period of 21 days. This is to provide opportunity of hearing to the petitioners before final decision is taken. Hence, in this case itself absolute elimination of principles of natural justice does not exist. The fact, however, remains as to whether post-decisional hearing can be a substitute for pre-decisional hearing. It is a settled law that unless a statutory provision either specifically or by necessary implication excludes the application of principles of natural justice, the requirement of giving reasonable opportunity exists before an order is made.

The case herein is that by statutory provision, principles of natural justice are adhered to after orders are passed. This is to achieve the object of SEBI Act. Interim orders are passed by the Court, Tribunal and Quasi Judicial Authority in given facts and circumstances of the case showing urgency or emergent situation. This cannot be said to be elimination of the principles of natural justice or if ex-parte orders are passed, then to say that objections thereupon would amount to post-decisional hearing. Second Proviso to Section 11 of the SEBI Act provides adequate safeguards for adhering to the principles of natural justice, which otherwise is a case herein also…"

8. In view of the above, I find that the interim order in this case has been passed within the scope and ambit of the powers conferred by section 11 and 11B of the SEBI Act and the principles of natural justice has also been observed by affording the noticee an opportunity to file its reply and avail the opportunity of personal hearing. I, therefore, reject the contention of the noticee in this regard. 9. Coming to the merits of the case, I note that the facts and circumstances that are basis of the interim order and also admitted or not disputed by the noticee are briefly as under:- (a). As per the SEBI order, LTFH was required to be compliant with minimum public shareholding requirements stipulated under rules 19(2)(b) and 19A by August, 2014. The noticee was aware that LT were required to reduce their stake in LTFH so that LTFH becomes compliant with the minimum public shareholding norms as stipulated under rules 19(2)(b) and 19A of the SCRR. (b). The noticee had met some officials of LTFH on March 11, 2013 and had formed a negative view on the stock. (c). During the market gauging exercise (prior to March 13, 2014) by CS regarding the OFS of LTFH, the noticee had given its feedback to CS regarding the impending OFS of LTFH.

(d). On March 13, 2014, 5 FIIs, namely, Macquarie Bank Limited, Goldman Sachs Singapore Pte., Merrill Lynch Cm Espana Sa. Svb., Citigroup Global Markets Mauritius Private Limited and Nomura Singapore Limited, cornered around 86% of the market open interest in the derivative contracts of LTFH of which around 84% was on behalf of the noticee. (e). These FIIs had created short positions at the instructions of the noticee. (f). On March 14, 2014, LT, the promoters of LTFH diluted their shareholding in LTFH through OFS of 5,55,05,755 shares (amounting to 3.23% of the total share capital) with an option to sell further 2,77,52,878 shares (amounting to 4.845% of total share capital) of LTFH on March 14, 2014 by LT. (g). After creating a short position in the derivative contracts of LTFH on March 13, 2014 and had subscribed to the shares of LTFH in the OFS on March 14, 2014. In this manner, the noticee locked in a profit of approximately `20 crores through this trade. (h). After the OFS on March 14, 2014, LT was further required to dilute its shareholding in LTFH by 1.7% so that LTFH becomes compliant with the minimum public shareholding norms as stipulated under rules 19(2)(b) and 19A of the SCRR.

10. The noticee has contended that it had a long-standing fundamental negative view on the share price of LTFH and the same view was held by several other brokers/analysts. In this regard it has also submitted certain brokers/analysts reports. It is pertinent to note that it is only the noticee who took substantially large and aggressive position in the futures of LTFH. It cannot be just a coincidence that it is only the noticee who could take such position based on the negative fundamentals as contended by it. I, therefore, do not find that the contention of the noticee that its trades in the scrip of LTFH were solely based on fundamental and technical analysis and its high conviction not plausible. Considering the facts and circumstances described in the interim order, I prima facie find that the noticee created such an aggressive position on the basis of some privileged information with regard to the scrip in question, which other investors did not have access to. 11. As regards the contention of the noticee that the price sensitive information of impending OFS of LTFH was known to world at large on March 13, 2014 when the noticee had traded in the derivatives of LTFH, I note that the in terms of regulation 2(1)(k) of the SEBI (Prohibition of Insider Trading) Regulations, 1992 said price sensitive information remained unpublished till the same was disclosed on the stock exchange on March 13, 2014 after the close of the market hours.

Admittedly, the noticee had traded in the derivatives of LTFH prior to such publication of the price sensitive information. Though at this stage it is yet to be ascertained during the ongoing investigation as to who communicated this unpublished price sensitive information (UPSI), it is proved with reasonable certainty that the noticee traded in the derivatives of LTFH and created substantially large position in the futures of LTFH when the said price sensitive information was unpublished. The question that remains to be determined is as to whether, in the facts and circumstances of this case, the noticee can be said to be in possession of the said UPSI when it created such position.

12. I note that the noticee was involved as a potential investor in the market gauging exercise undertaken by CS (prior to March 13, 2014). It is undisputed fact that, during the market gauging exercise by the CS with regard to the OFS of the LTFH, the noticee had been contacted by CS team as a prospective investor. This strengthens the prima facie finding that the noticee was in possession of unpublished price sensitive information about the discounted floor price of impending OFS of LTFH. Even if CS did not undertake any “wall-crossing” exercise, as contended by the noticee, it cannot be said that that the noticee was not in possession of this unpublished price sensitive information while it traded in the securities of LTFH. I, therefore, am of the prima facie view that the noticee was in possession of unpublished price sensitive information, based on which it took such aggressive positions as alleged in the interim order.

13. According to the noticee, it created such position since the impending OFS of LTFH would have led to supply overhang and consequent effect on the share price of LTFH. In this regard, I note that LTFH was required to be compliant with minimum public shareholding norms stipulated under rules 19(2)(b) and 19A of the SCRR by August, 2014. On March 14, 2014, LT (the promoter of LTFH) diluted its 3.23% shareholding in LTFH by way of OFS and it had to further dilute its 1.7% shareholding in LTFH by August, 2014. Admittedly, the noticee created short position in 5309 derivative contracts (for 2,12,36,000 shares) in the scrip of LTFH on March 13, 2014. It is pertinent to note that supply overhang and its impact on the share price of LTFH as contended by the noticee was reasonably foreseeable with regard to the subsequent dilution of 1.7% shareholding by LT. If such was the view of the noticee the normal prudence would be to hold the positions to earn more profits rather than squaring off immediately after creating the positions as was done by the noticee. 14. As prima facie found in the interim order the noticee took an aggressively short position i.e. equivalent to 84.15% of the total open interest in the scrip of LTFH on March 13, 2014. This implies that for every one unit of short position carried forward by the rest of the traders in the futures of LTFH, the noticee was carrying forward 5 units. The noticee has disputed the basis of computation of its open interest (i.e., 84.15%) in the scrip of LTFH on March 13, 2014 i.e. on the basis net position in the F&O segment as described in the interim order. According to the noticee, the denominator should be the total trades effected in the F&O as well as cash segment and not the net position in the F&O segment only. I note that in the interim order, “open interest” has been calculated on the basis of the net position of the noticee in the F&O segment as at day end. In my view, it would be illogical to include the trades in the cash segment since the open interest has been clalculated in the interim order with regard to the position created by the noticee in the futures of LTFH on F&O segment. I, therefore, find that the denominator used in computing the open interest of the noticee in the interim order is logical, and not flawed as has been contended by the noticee.

15. In this case, there is no dispute as to the fact that after taking such an unusually aggressive short position in the F&O segment, the noticee took a reverse position of 2,75,10,484 share in the cash market by subscribing to the OFS at a price of ₹71.50 on March 14, 2014. By taking the said position, the noticee locked-in a profit of approximately ₹20 crores based on the difference between the average price at which the short position was created and the OFS subscription price of ₹71.50. Thus, the noticee had built unusually aggressive short position in the F&O segment i.e. 84.15% of the market wide position ahead of the impending OFS, taking a view which was quite contrary to the view of the most of other participants, understandably on the basis of the unpublished price sensitive information and took reverse position of nearly same number of shares in cash segment by subscribing to OFS on the very next day thus locking a profit for itself.

16. It is also undisputed fact that the noticee did not have any previous exposure in the securities of LTFH and that it used five different FIIs for its trades in derivatives contracts of LTFH. These facts make its trades even more aberrant and suspicious. It is highly unlikely that the noticee who did not have any exposure in the scrip will take such an aggressive short position - which is quite contrary to the market behaviour on that day - unless it had some definite information about fall in price of the scrip in near future. The facts that the noticee covered its entire position the next day by subscribing to the OFS of LTFH and then gradually wound up his positions in cash and derivatives together show a behaviour that is contrary to what was depicted by noticee's aggressive short position built up in the securities of LTFH, which would not have been undertaken unless the noticee was in possession of UPSI. These facts and circumstances further substantiate the prima facie finding that the noticee employed a device or artifice to deceive the investors in securities market and make profit in a manner which was quite disruptive to the market equilibrium. 17. In view of the above, I find that the noticee has not been able to show sufficient and plausible reason to draw any inference other than those drawn in the interim order with regard to its activities in the securities market. The noticee has failed to make out a prima facie case and to establish balance of convenience in its favour at this stage. The facts and circumstances, as alleged in the interim order indicate a device or artifice to deceive the investors in the securities market and make profit in a manner which was quite disruptive to the market equilibrium. I, therefore, am of the considered view that no intervention is called for, at this stage, in either vacating the interim directions or modifying it. 18. I, therefore, in exercise of the powers conferred upon me under section 19 of the Securities and Exchange Board of India Act, 1992 read with sections 11(1), 11(4) and 11B thereof, hereby confirm the directions issued in respect of Factorial Master Fund vide ad-interim ex-parte order dated June 5, 2014. 19. This Order shall continue to be in force till further directions.

DATE: OCTOBER 16th, 2014 RAJEEV KUMAR AGARWAL PLACE: MUMBAI WHOLE TIME MEMBER SECURITIES AND EXCHANGE BOARD OF INDIA