Insider trading is understood as trading in a business’s stocks based on confidential knowledge about the company or its securities in order to benefit or prevent loss. This secret, unpublished information unknown to the general public is known as unpublished price-sensitive information (hereinafter ‘UPSI’). Insider trading has been practised by investors since the inception of securities trading. The expanding size of the securities markets has exacerbated the difficulties of authorities’ across the world. The Prohibition of Insider Trading (hereinafter ‘PIT’) Regulations aim to reduce the disproportionate and unfair access to information present with traders, non-transparency in deals, repair the eroded trust of the investor owing to unfair gains accrued from such insider trading and increase market efficiency. Insider trading can undermine investor trust and must be curtailed by regulatory action and sufficient oversight. Insider trading laws in India have progressed a great deal and have been tightened by revisions over the years. However, in what has become more of a common occurrence recently, the regulatory body, i.e., the Securities and Exchange Boards of India (hereinafter ‘SEBI’), and its appellate authorities such as the Securities Appellate Tribunal (hereinafter ‘SAT’) and the Supreme Court, have been found lacking in interpreting such laws and this shows a dire need for uniformity and consistency.
Through this piece, the authors seek to highlight the issues and limitations that are plaguing SEBI and preventing it from becoming an effective regulatory body. They seek not only to spell forth the legislative interpretations and consequences of some important ideas under insider trading legislation but also to expound on the fundamental issues that we have detected in the attitude of the quasi-judicial body. They further aim to show how only via adequate statutory advice can such problems be addressed. In this part, we aim to explain the obstacles imposed by statutes and appellate bodies on SEBI.
Statutory limitations on SEBI
The Impossibility of Absolute Evidence
It is well-settled law that quasi-judicial bodies are entitled to act on material that may not be accepted in a court of law, meaning that they are not bound by strict rules of evidence. But the Supreme Court has time and again set the demarcations with respect to the use of evidence by quasi-judicial bodies, such as SEBI, stating that the authorities have to be unswerving of the substantive rules of evidence while conducting and concluding their investigations.
For instance, In the case of SEBI v. Shruti Vora & Ors, the Supreme Court of India ruled in favour of Shruti Vora, who was accused of forwarding unpublished price-sensitive information (UPSI) via WhatsApp. It was claimed that she distributed UPSI regarding the financial results of Bajaj Auto Ltd before they were made public, in violation of PIT Regulations. The Securities Appellate Tribunal, however, overturned the SEBI order. In light of the preceding decisions, Mr Sumit Agrawal, Managing Partner of Regstreet Law Advisors and a former SEBI Officer, believes that “Gathering evidence of ‘connection’ and ‘communication’ in insider trading cases is a daunting task for regulators worldwide, but it cannot be done without ‘assumption’ and speculation’. Furthermore, in the recent PC Jeweller Ltd., the Supreme Court of India again reversed the order of SEBI and held that trading patterns in absence of material on record to establish communication of UPSI cannot lead to the imposition of penalty under PIT Regulations. It implies that the trading pattern in itself, would just be classified as circumstantial evidence and there would then be a need for additional material to indict an alleged violator. Given the restraints imposed upon SEBI, which shall be elaborated upon further, gathering ‘absolute evidence’ to prove the communication of UPSI beyond reasonable doubt is near impossible. This very loophole is the saving grace for most violators as they realize that SEBI cannot access the damning evidence which shall prove their guilt beyond reasonable doubt.
The Paradox of Mens Rea
Some recent Supreme Court decisions serve as a reminder to consider the elements of “knowledge” and “motive” when facing serious charges of insider trading, which is both a civil and criminal offence.” Supreme Court of India’s decision comes just days after its decision in the Gammon Infrastructure Projects Limited insider trading case in which it held that motive is essential in determining whether a person engaged in trade in violation of PIT Regulations. However, this is in contradiction to the landmark judgement of the Apex Court in SEBI v Shriram Mutual Fund, where it stated that:
imputing mens rea into the provisions of Chapter VI A is against the plain language of the statute and frustrates entire purpose and object of introducing Chapter VIA to give teeth to the SEBI to secure strict compliance of the Act and the Regulations.
All the above-cited judgements point towards the obvious conclusion that the power of SEBI to establish the crime of insider trading based on circumstantial evidence is very inconclusive and is also being overridden by higher authorities of the law.
Contradictions within the Court judgments
Various contradictions and ambiguities within judgements of superior authorities further hamper the ability of SEBI to effectively monitor and hold violators liable for insider trading offences. The observation of Lord Denning, that ‘law is only the last interpretation of the last judge’ is the aptest description of the state of the law in insider trading cases. The SAT has repeatedly changed its stance regarding the standard of proof in insider trading cases, from stating that ‘in offences relating to the securities market, it is not necessary for the regulator to prove the case beyond reasonable doubt’ to then going on to say, ‘the charge of insider trading is one of the most serious charges in relation to the securities market and having regard to the gravity of this wrongdoing, higher must be the preponderance of probabilities in establishing the same’. The Supreme Court highlighted the principle for the evaluation of insider trading cases as “one of preponderance of probabilities”.
It is important to first understand the meaning of “Preponderance of Probabilities” in the context of the burden of proof. Preponderance is defined as the largest part or greatest amount and probability as the level of possibility of something happening or being true. It is critical to emphasise that the core concept of this word has neither negative nor positive connotations associated with it. However, it appears that SEBI relies on this approach in most cases to hold the noticee accountable on the basis of preponderance and assumptions, but the same facts and underlying replies can equally be used to hold the noticee innocent under the same principle. In an attempt to establish a connection between two persons, SEBI had started employing aggressive measures and interpretations of the regulations, such as in the Palred Technologies Limited case where two individuals had mutual friends on the social media website, Facebook, was deemed sufficient by SEBI to establish the required connection. This case broadened the requirements used by SEBI to prove a link and, as a result, be designated an “insider.” SEBI extended such interpretation to several matters, such as the case of Deep Industries Limited where additional evidence in the form of frequent interactions including liking posts on social media was also relied upon by SEBI and then in the matter of insider trading in the scrip of Lux Industries Limited, wherein connections were established between the entities merely on the basis of Facebook relations.
After such instances, such connections by SEBI were considered the norm. The landmark case of Balram Garg overturned a number of such judgements of SEBI while the law on which SEBI had relied for such judgements has seen no change. In the said case, even members of a family were not called ‘connected persons’ since they were estranged and it was held that allegations of insider trading and fraud require a very high standard of proof and preponderance of probabilities; in contradistinction to an earlier judgment where the apex court stated that a reasonable expectation to be in the know of things can be “based on reasonable inferences drawn from foundational facts and there is no requirement of establishing of guilt beyond a reasonable doubt. In several other cases, SAT took cognizance of the trading patterns and the relations between the insider and the trader and concluded that merely this circumstantial evidence is not sufficient to establish that UPSI had been communicated and trades were undertaken on basis of such UPSI.
The presence of motive or mens rea has also been a matter of contention and confusion. In this context, the landmark ruling of the Supreme Court in the case of SEBI v. Shriram Mutual Fund is also useful to note, where the Apex Court stated that “imputing mens rea into the provisions of Chapter VI A(penal provisions for Insider Trading) is against the plain language of the statute and frustrates entire purpose and object of introducing Chapter VIA to give teeth to the SEBI to secure strict compliance of the Act and the Regulations”. However, in Rakesh Agrawal v. SEBI, the appellate tribunal ruled that the motive must be taken into account. This view had been held in at least three other cases. Therein lies the confusion because even precedents of the Supreme Court bear little to no relevance and the adjudicating bodies insist on analysing every case on only its facts, foregoing consistency in the process.
Such inconsistencies in the findings of the appellate authorities have marred the decision-making process of SEBI and further convolutes a field of law which already has no uniform method of application. Such obstacles showcase the dire need to increase the scope of regulatory oversight of SEBI and rethinking of the nature of the offence of insider trading as well which shall be done in the second part of this article.
(This post has been authored by Aditya Singh and Shubhendra Mishra, third-year law students from Dr. RMLNLU, Lucknow)