PFUTP Regulations | Fraud Requires Proof of Inducement to Trade; Market Cornering Alone Is Insufficient : SC

The Supreme Court has clarified that market cornering and breach of position limits, without proof of inducement to deal in securities, cannot constitute fraud under the PFUTP Regulations. This judgment redefines the boundaries of regulatory enforcement in securities markets, emphasizing that intent and causation are indispensable elements of fraud.

Background & Facts

The Dispute

The dispute arose from trading activities by Reliance Industries Limited (RIL) in the shares of its subsidiary, Reliance Petroleum Ltd. (RPL), during November 2007. RIL, holding a 75% stake in RPL, planned to divest 5% of its holdings - 22.50 crore shares - in the cash segment to raise funds for its projects. Anticipating a price correction due to analyst reports deeming RPL shares overvalued, RIL sought to hedge its exposure by taking short positions in the November 2007 futures segment.

Key Facts

• RPL’s IPO price in May 2006 was Rs. 60 per share; by October 2007, the price had risen to Rs. 247.90.
• On 29.03.2007, RIL’s board resolved to raise Rs. 87,000 crore, including through divestment of RPL shares.
• Between 01.11.2007 and 06.11.2007, RIL entered into agency agreements with twelve independent entities to take short futures positions of 9.92 crore RPL shares.
• The agreements stipulated that all profits and losses would accrue to RIL, while the entities received fixed commissions.
• RIL sold 20.29 crore RPL shares in the cash segment between 01.11.2007 and 29.11.2007, including 1.95 crore shares in the last 8 minutes 20 seconds of trading on 29.11.2007.
• The settlement price for futures was determined by the 30-minute volume-weighted average price (VWAP) in the cash segment on 29.11.2007.
• RIL realized Rs. 5,013 crore from cash sales and futures settlements, with Rs. 513 crore attributed to futures gains.
• The 12 entities collectively held 93.63% of the open interest in the November 2007 RPL futures, exceeding the 1.01 crore client-level position limit under the 2001 SEBI Circular.

Procedural History

• 29.04.2009: SEBI issued a show cause notice to RIL.
• 08.10.2009: A corrigendum was issued.
• 16.12.2010: A fresh show cause notice was issued.
• 2010: SEBI’s Whole Time Member (WTM) held RIL guilty of fraud and manipulation under the PFUTP Regulations, ordering disgorgement of Rs. 447.27 crore.
• 05.11.2020: Securities Appellate Tribunal (SAT) delivered a 2:1 majority judgment upholding the WTM’s order.
• 04.12.2023: SAT upheld a penalty of Rs. 25 crore under Section 15HA of the SEBI Act.
• 17.12.2023: Supreme Court ordered RIL to deposit Rs. 250 crore with the Investor Protection and Education Fund (IPEF).
• 29.05.2026: Supreme Court delivered judgment on Civil Appeal No. 4015 of 2020 and Civil Appeal No. 4723 of 2024.

The Parties' Positions

Appellant (RIL): Argued that the futures positions were legitimate hedges against the risk of price decline in the cash segment. Contended that the use of 12 entities was not fraudulent, as the 2001 SEBI Circular did not prohibit positions taken through persons acting in concert. Asserted that the sale of 1.95 crore shares on 29.11.2007 was a genuine attempt to realize value during a price spike, not manipulation.

Respondent (SEBI): Alleged that RIL used the 12 entities to circumvent position limits, cornered the market, and artificially depressed the settlement price by dumping shares in the final minutes of trading. Argued that the conduct constituted fraud under Regulation 3 and 4 of the PFUTP Regulations.

Relief Sought

RIL sought:

• Setting aside of the SAT’s order dated 05.11.2020 and 04.12.2023.
• Refund of Rs. 250 crore deposited with IPEF.
• Refund of Rs. 25 crore penalty paid under Section 15HA of the SEBI Act.
• Declaration that its actions did not constitute fraud or manipulation.

The Legal Issue

The central question was whether breach of position limits under the 2001 SEBI Circular, coupled with market cornering, constitutes fraud under the PFUTP Regulations in the absence of proof that the conduct induced another person to deal in securities.

Arguments Presented

For the Appellant/Petitioner

Mr. Harish Salve, Senior Counsel for RIL, argued that:

• The 12 agency agreements were lawful and disclosed upon inquiry.
• The 2001 SEBI Circular did not prohibit positions taken through persons acting in concert, nor did it require disclosure of such arrangements.
• The 9.92 crore futures positions were a bona fide hedge against the risk of price decline on the sale of 22.5 crore RPL shares in the cash segment.
• The 40.10% open interest (calculated across all derivatives, not just November futures) was justified by the scale of the cash market exposure.
• The sale of 1.95 crore shares on 29.11.2007 occurred during a price spike and was not an attempt to depress the settlement price.
• The definition of fraud under Regulation 2(1)(c) of the PFUTP Regulations requires inducement, which SEBI failed to prove.
• Reliance on SEBI v. Rakhi Trading was misplaced, as that case involved non-genuine transactions creating artificial volumes.

For the Respondent/State

Mr. Arvid P. Datar, Senior Counsel for SEBI, contended that:

• The use of 12 entities to aggregate positions beyond the client-level limit was a fraudulent device to circumvent regulation.
• The principle that what cannot be done directly cannot be done indirectly applied.
• The retention of 7.97 crore open positions after selling 18 crore shares in the cash segment constituted a "naked hedge" and speculative intent.
• The sale of 1.95 crore shares in the last 10 minutes, with orders placed below the Last Traded Price, demonstrated intent to depress the settlement price.
• Inducement need not be separately proved once manipulation is established, as per SEBI v. Rakhi Trading.
• The conduct violated Regulation 3(b) and 4(2)(e) of the PFUTP Regulations.

The Court's Analysis

The Supreme Court undertook a rigorous analysis of the PFUTP Regulations, the 2001 SEBI Circular, and the nature of hedging in derivatives markets.

The Court first examined the definition of "fraud" under Regulation 2(1)(c) of the PFUTP Regulations, which requires an act, omission, or concealment that induces another person to deal in securities. The Court emphasized that inducement is a sine qua non for fraud, even if deceitful intent is not required.

"The definition of fraud under Regulation 2(1)(c) of the PFUTP Regulations requires proof of inducement. Without it, even the most aggressive trading strategy cannot be termed fraudulent."

The Court rejected SEBI’s argument that cornering the market by holding 93.63% of open interest in the November 2007 futures series amounted to fraud. It held that the calculation was flawed because the 2001 SEBI Circular required position limits to be assessed across all derivatives of the underlying stock - not just one futures series. When recalculated, RIL’s open interest was 40.10%, still above the limit but not indicative of manipulation.

The Court further held that the use of 12 entities did not constitute fraud. The 2001 SEBI Circular did not prohibit persons acting in concert from taking positions, nor did it mandate disclosure of such arrangements. The absence of a prohibition meant that RIL’s conduct, while potentially a regulatory breach, did not rise to the level of fraud.

"What cannot be done directly cannot be done indirectly is a sound legal principle, but it cannot be stretched to convert a regulatory violation into fraud without proof of inducement."

Regarding the sale of 1.95 crore shares on 29.11.2007, the Court found no evidence of manipulation. RIL had consistently sold shares at or above Rs. 208 per share. The price spike to Rs. 224.70 in the final minutes created an opportunity to sell, and RIL’s orders at Rs. 210 were not below its historical floor. The Court noted that 1.06 crore shares were sold by others during the same period, and SEBI failed to investigate their conduct.

The Court also rejected the notion of a "naked hedge." It held that hedging does not require a perfect 1:1 match between futures positions and cash exposure. The absence of a hedging policy in 2007 meant that RIL’s actions were commercially reasonable. The Court distinguished Pankaj Oil Mills as inapplicable to equity derivatives.

The Court reaffirmed the principle from SEBI v. Kanhaiyalal Baldevbhai Patel that inducement is essential. It clarified that SEBI v. Rakhi Trading applied only to non-genuine, circular trades creating artificial volumes - not to legitimate hedging.

The Court concluded that SEBI had failed to discharge the burden of proving fraud under the PFUTP Regulations. While RIL violated the disclosure requirement under the 2001 SEBI Circular, that breach attracted only a monetary penalty under the SCRA, not fraud under the SEBI Act.

The Verdict

The Supreme Court allowed the appeals in part. It set aside the SAT’s order dated 05.11.2020 and 04.12.2023 insofar as they found fraud under the PFUTP Regulations. The order of disgorgement of Rs. 447.27 crore was quashed. RIL is entitled to a refund of Rs. 250 crore deposited with the Investor Protection and Education Fund. The penalty of Rs. 25 crore under Section 15HA of the SEBI Act for violation of the 2001 SEBI Circular was upheld. The Court directed compliance within four weeks.

What This Means For Similar Cases

Inducement Is Non-Negotiable

• Practitioners must now prove inducement to establish fraud under Regulation 2(1)(c) of the PFUTP Regulations.
• Mere market concentration, high open interest, or price movement alone cannot substitute for proof that third parties were induced to trade.
• SEBI’s reliance on Rakhi Trading is now limited to cases involving artificial trading volumes or circular trades.

Hedging Is Legally Protected

• Hedging does not require a board resolution, written policy, or perfect hedge ratio.
• Anticipatory hedging - taking positions before the underlying exposure is fully sold - is lawful.
• The absence of a hedging policy in 2007 means such conduct cannot be retroactively deemed fraudulent.

Regulatory Breach ≠ Fraud

• Breach of position limits under SEBI circulars attracts penalties under the SCRA, not fraud under the PFUTP Regulations.

• Agencies and front entities are not inherently fraudulent if they operate within the regulatory framework.

• SEBI must distinguish between regulatory non-compliance and intentional market manipulation.

• Practitioners should document all hedging rationale and disclose agency arrangements promptly to avoid regulatory ambiguity.

• In future cases, focus on whether the conduct induced market participants - not whether it was aggressive or unconventional.

• SEBI must now conduct granular analysis of market-wide open interest, not single-series positions, when alleging cornering.

• The judgment reinforces that securities regulation must be grounded in statutory text, not hindsight or conjecture.