Sebi Bars Hedge Fund in L&T Finance Insider Trading Case

Unearthing a major insider trading case in shares of L&T Finance, capital market regulator Securities and Exchange Board of India (Sebi) on Thursday barred a Cayman Islands-based hedge fund from the Indian securities markets.

The role of other entities including some employees of investment banking major Credit Suisse was also put under scanner.

This hedge fund - Factorial Master Fund - traded in derivative contracts of L&T Finance with offshore derivative contracts (commonly known as P-Notes) through five different foreign institutional investors (FIIs) - namely Macquarie Bank, Goldman Sachs Singapore, Merrill Lynch CM Espana, Nomura Singapore and Citigroup Global Markets Mauritius Ltd - in an "aberrant and suspicious" manner.

Besides, a probe by the capital markets regulator found that Factorial was involved as potential investor in the market gauging exercise undertaken by Credit Suisse as 'seller broker' of L&T Finance for its offer for sale (OFS) in March.

The order does not affect L&T Finance or its promoters as such.

Finding Factorial prima facie guilty of having violated various regulations including those for prevention of insider trading and prevention of fraudulent and unfair trade practices, Sebi said the fund traded on the basis of its access to 'unpublished price sensitive information' (UPSI).

It, however, added that the entire channel for flow of 'unpublished price sensitive information' in this case needs to be further investigated.

"It may be mentioned in this regard that as per its submissions, investment banking team of Credit Suisse had contacted Factorial in relation to the OFS of L&T Finance," the Sebi order said.

"On examination of Bloomberg chat transcripts provided by CS, it is observed that on March 13, 2014, information like, 'likely to come in at a steep discount about 70 types' was being circulated amongst the members of Equity team of Credit Suisse," it said.

In this chat, '70' apparently referred to the price for sale of shares in the OFS, the floor price for which was actually later fixed at Rs 70 per share.

"It is noted that this message from one CS employee to another in the Equity team was sent at 09:21:24 much before the formal announcement of OFS and the floor price at 21:22:00 on the same day," it said.

"At this stage, however the channel of communication of the 'unpublished price sensitive information' is not ascertainable as various stakeholders such as seller, Seller Broker, their employees, potential investors, etc are involved in the whole process."

"In my view, this aspect needs thorough investigation so as to come to a definite conclusion," Sebi whole-time member Rajeev Kumar Agarwal said in his seven-page order.

Sebi has restrained Factorial from dealing in securities in Indian securities market (including through offshore derivative instruments), as also from accessing the Indian markets, directly or indirectly, till further orders.

The fund has been asked to file its reply, if any, to Sebi within 21 days.

Sebi said that the dealings of Factorial "are prima facie inimical to the interests of participants" in the securities market.

"It is noted that Factorial still has open position of 62.08 lakh shares in cash market and the same quantity in F&O segment on the short side in 1552 derivative contracts.

"In the facts and circumstances of this case, it is incumbent to intervene promptly in the interests of investors and to safeguard the market integrity," it stated.

Sebi had begun its probe in this case after it observed abnormal movement in the share price of L&T Finance Holdings Limited.

Sebi observed that on March 13, 2014 - the day on which the shares of L&T Finance were included in the F&O segment - the future contract price dropped by more than 10 per cent.

In cash segment, the scrip opened at Rs 86, rose to Rs 88 and then dropped by more than 10 per cent close at Rs 79.20.

It was also observed that in the late evening on March 13, the company's promoter, L&T, made announcements with regard to its planned offer for sale exercise and appointment of Credit Suisse as 'seller broker'.

As per requirements under minimum public shareholding norms, L&T was obligated to reduce its shareholding in L&T Finance to 75 per cent by August 2014.

It had disposed of one per cent of its shareholding in L&T Finance on December 23, 2013 (through a market sale), and it had to further offload a total of 6.46 per cent stake to meet the norms after expiry of requisite 12 weeks cooling-off period that was expiring on March 17, 2014.

L&T had sought exemption from the 12-week mandatory cooling-off period which was allowed by Sebi through a letter dated March 13, 2014.

During preliminary inquiry, L&T submitted that on March 10, Credit Suisse was mandated by it to launch the OFS within the next 2-3 days based on the market conditions and potential investor interest for the proposed OFS.

L&T later submitted before Sebi that Credit Suisse had given updates on general pulse of the market and the trends over four days from March 10-13 and and also informed that investors would seek a good discount to buy shares.

On its part, Credit Suisse submitted before Sebi that in order to gauge market sentiment for the scrip, between March 10 and 13, its team held discussions with over 70 institutional investors which included their direct clients and potential investors which typically invest in India through ODI route.

On examination of order book and trade data in cash and derivative segments, Sebi found that on March 13 - when the shares of LTFH were included in F&O segment - four FIIs had taken substantial short positions which contributed around 86.83 per cent of the market wide open interest (OI) on the short side.

These short positions were built on March 13 much before the formal announcement of OFS and floor price at 21:22:00 hours on the same day.