Foundation research

Insider Trading Rules May Need Another Update to Avoid Arbitrary and Contradictory Rulings

The United States made insider trading illegal in 1934; yet an academic study in 2020 showed that only about 25% of these are detected and prosecuted. Despite continued efforts by policymakers around the world to tighten rules and close loopholes, people continue to take advantage of advanced stock or earnings information from price-sensitive companies because insider trading is extremely difficult to detect. and to prove.

India only introduced insider trading regulations in 1992 after the Securities and Exchange Board of India (SEBI) got its statutory bite. Since then, he has worked to tighten the rules. In 2013, Judge Sodhi Committee was put in place to make insider trading regulation “more predictable, precise and clear by suggesting a combination of principles-based regulations and rules”. This led to a major regulatory overhaul in 2015. Earlier this month, a report said that SEBI was looking to introduce artificial intelligence (AI) methods used by casinos, to boost its ability to crack down on insider trading.
How does this effort translate into successful insider trading prosecutions by SEBI and legal precedents set by court orders? A study of Moneylife Foundation delved into the matter to conclude that insider trading law, through precedents set by SEBI orders and other judgments, evolves randomly, sometimes due to new situations and cases, but often due to positions contraries taken by SEBI, as well as an appellate court. Therefore, insider trading verdicts, except in standard and brazen breaches, are subject to arbitrary results.
This insider review Business cases was mentored and guided by the expert in securities law, lawyer Ravichandra Hegde, partner of Parinam Law Associates, assisted by his colleague Mitravinda Chunduru with the help of two law school interns. The study analyzed SEBI’s interpretation of its own rules as well as various judgments rendered by the Securities Appeals Tribunal (SAT) and the courts in historic insider trading cases, particularly after the changes to 2015.

The problem, we find, starts with SEBI but is not limited to the regulator; The SAT has also issued contrary orders in similar cases, adding to the confusion. For starters, instead of adopting a one-size-fits-all approach to deciding similar cases, SEBI Full-Time Members (WTMs) often analyze cases, previously decided by other WTMs, to make fine distinctions in which cases they hear. This results in divergent orders that require further determination by the appellate forum on whether or not these distinctions are justified and which interpretation is correct.

This confuses investors and leads to more litigation and embarrassment when many SEBI orders are overturned by courts and tribunals. In the last instance, on April 19, 2022, an order of the Supreme Court (SC) in the case of Balaram Grag versus SEBI also known as the PC Jewelers case, overturned “a plethora of cases decided by SEBI, while limiting the regulator’s ability to establish insider trading based on circumstantial evidence.” More on that later.

The study examines how SEBI defines the key concepts of insider trading, as crystallized by its own orders and various precedent-setting appellate decisions. For example, what is generally available information (GAI) as opposed to possessing “unpublished price sensitive information” (UPSI). And, whether mere possession of UPSI amounts to insider trading or must it be established that a person acted “on the basis” of UPSI (Chandrakala case) to be found guilty of insider trading. He concludes that the legal provisions are incompatible with the decisions and need to be clarified.

The use of social media has posed a new set of challenges. The SEBI orders have expanded the definition of “connected person” by exploring social media connections leading to insider trading (Palred Technologies Limited, Deep Industries Limited and Lux ​​Industries Limited). The ease of transmission has further created the need to distinguish between sharing “insider” information and merely transmitting what is generally available or published in research reports or media columns.

Another series of high profile cases involves transactions related to corporate actions (sale of shares by an investment company, preliminary discussion of a rights issue or information that would normally be disclosed to stock exchanges) would lead to a charge of insider trading.

The study identified two key issues where SEBI may need to re-examine the regulations to achieve a streamlined and consistent approach. One is the importance of the pattern or mens rea and the second is the “preponderance of probability” (or the role of circumstantial evidence and burden of proof) in converting his allegations and conclusions into a conviction that withstands appellate review. Let’s examine each of them.

Reason or mens rea

SEBI rules state that an insider’s motive or state of mind is not relevant to establishing a charge of insider trading. However, the recommendations of the Sodhi committee included some well reasoned caveats when assigning responsibility. SEBI chose to ignore them and adopt an “absolute liability” principle to determine guilt. This led to several contradictory judgments. To Rakesh Agrawal versus SEBI, the appeals tribunal ruled that the motive should be considered. This view had been supported in at least three other cases (Chandrakala, PVP Ventures and Shreehas Tambe). On the other hand, the Bombay High Court (in the case of Cabot International Capital) as well as SC (SEBI versus Shriram Mutual Fund) ruled that mens rea cannot be an essential factor in determining insider trading. As it stands, due to the SC ruling, a person can be punished for insider trading even if it is done inadvertently or unknowingly and the motive of the accused person is irrelevant . The Sodhi Committee had intended that motive and intent play a role in establishing insider trading, particularly in cases where the person who traded is different from the person whose securities were traded. This would also apply when a person receives information from someone who is not “connected” to the company and therefore unaware that it is UPSI, and should not be punished. for acting accordingly. The study concludes that adopting an “absolute liability approach is not sacrosanct and makes it impossible to have a clearly established law. Therefore, SEBI must revise its regulations to make intent or motive a determining factor when establishing guilt.

Balance of probabilities

Another key issue is the role of all of the circumstantial evidence or what is described as the “balance of probabilities” in establishing insider trading. SEBI’s market surveillance software generates system-based alerts that trigger an insider trading investigation, often resulting in ex-parte orders that result in the imposition of severe hardship, restriction of business and livelihood. The study indicates that in such cases, the arbitration reveals that there is little evidence to confirm the charges or a series of contradictory decisions, even at the level of the appeal.

The Moneylife Foundation study argues that SEBI has consistently relied on a negative connotation of this phrase to decide cases; but all of those cases could be overturned by the SC’s landmark order in the PC Jewelers (Balram Garg) case in April this year. In this case, despite an official partition in 2001, SEBI relied on a family connection based on a common residential address to establish insider trading and impose a severe penalty. The Supreme Court ruled that the allegation should be supported by a higher burden of circumstantial evidence or, to use regulatory jargon, the degree of “balance of probabilities” must be much higher.

The study of historical insider trading orders suggests that SEBI’s insider trading regulations need another much-needed overhaul to ensure consistency and reduce unintended harassment and litigation. But even before that, the regulator may need to put in place an internal framework to ensure that its officials have a consistent and uniform approach to cases, instead of interpreting the regulations according to the desired outcome.