Will SEBI ban on Reliance from derivatives trading impact the market?

The case

As part of fund raising, the board of Reliance Petroleum Limited (RPL, which was merged with RIL in 2009) decided to offload 5% of the promoters' stake in the market, but trades were executed in the month of November.

During the investigation, it was found that RIL executed the share sale in the cash segment of the NSE and another dozen entities (hired by RIL) started taking positions in the derivatives market. These dozen entities were connected directly or indirectly with RIL.

As the position in the derivatives contract rose to alarming levels, SEBI launched an investigation in the case, and found that entities hired by RIL had held a large position in the RPL shares ahead of the stake sale by RIL in the cash market.

What is derivatives trading?

The derivatives (or futures and options) segment of the market is used by market participants to hedge their positions in the cash market. Buying or selling futures would be considered as an investment strategy that hedges the risk of a falling or rising market. Put options and call options are used to hedge the risk of gaining profit for falling or rising price of a share.

In theory, when a large quantity of shares are sold in the open market, the price of the security falls. The position taken in put options (an option to sell assets at an agreed price on or before a particular date) is a strategy where the buyer of the put option gets a profit if the price falls to a particular level.

Illegal gains

As per the investigation conducted by SEBI and the notice issued to RIL, just ahead of the stake sale, entities hired for a commission payment booked positions in the derivatives segment to the extent of 9.92 crore shares. Trades in derivatives were ordered by an employee of the group entity of RIL.

When prices started falling for RPL shares, these entities allowed to expire their position to the extent of 7.97 crore shares in the derivatives market. Meanwhile, 1.95 crore shares were sold in the cash segment ahead of the expiry of contracts.

SEBI alleges that RIL earned illegal profit of Rs447 crore due to the trading activity.

SEBI's ruling

“This is not a normal case of price manipulation or volume manipulation. This is a case of a unique strategy of per se not manipulating the price or volume in a single market, but manipulating the settlement price in one market to gain across the volumes accumulated in the other market. The actual manipulation has happened with respect to the convergence price of the spot with the futures,” the SEBI order states.

As per the SEBI order, the very act of appointment of entities by RIL, coupled with the act of assuming separate position limits by these entities in the derivatives segment, was fraudulent. Further, the order states: “RIL was not genuinely hedging the risk, but was aiming at reaping huge speculative profits by cornering futures positions and playing a fraud on the general investors and the market.”.

It added that cornering position in open interest by RIL would amount to a well-planned, fraudulent and manipulative trading scheme.

What next?

The legal battle is almost 10 years old, but is not over yet.

All efforts during the period by RIL, the company with largest number of shareholders in the country, have been shot down by SEBI and SAT. Even a request by RIL for settlement of charges (consent order) in this matter was dismissed in 2014.

Looking at the reactions from RIL, however, the battle looks set to shift again to the SAT or higher courts.