Introduction
Information is the most relevant piece of tool in the functioning of the Capital Markets. Every share or stock that has been traded of a listed company has been based on some type of information. That is why to ensure a fair and efficient market all the securities regulators focus on the fact that everyone has the same information available to them. Information is ideally revealed through disclosures like offer document Red Herring Prospectus, Letter of Offer, continuous disclosures etc., however, there is certain information that is not always available to the public but only to a few specific people of a company. There can be instances that these people sometimes act on this non-public information. This instance is what is essentially called Insider Trading.
What is Insider Trading?
To elaborate, Insider trading is any insider i.e., a connected person or a person who is in possession of Unpublished price sensitive information (“UPSI”),[1] participating in a transaction based on that UPSI to gain some profit. The key part here is, “Connected persons” and “UPSI”. According to the SEBI (Prohibition of Insider Trading) Regulations 2015 (“PIT Regulations”), (i) connected persons are people who are likely to possess UPSI for example-Directors, employees, clients, immediate relatives of employees etc.,[2] and (ii)UPSI can be any information like mergers, new policies, financial results etc which can likely effect the price shares in the stock market.[3][4] In one of the first cases of Insider Trading i.e. India Hindustan Unilever (HUL) Vs SEBI, HLL which was a subsidiary of HUL had bought Rs 8 lakh shares of BBLIL which is another subsidiary of HUL. Two weeks after the transaction it was announced that there is going to be a merger of the two subsidiaries. SEBI charged HLL with insider trading. HLL argued that it was an independent trade, however, SEBI held that as HLL had common directors with BBLIL and a common parent in HUL it was a connected person and is reasonably expected to be privy to the information of the merger.[5] Therefore there was misuse of UPSI for a gain. This is one example of insider trading.
Why is Insider Trading Regulated?
SEBI has powers under section 11 and 30 of SEBI Act, 1992 to intervene in matters of insider trading and also implement restrictions to limit these activities.[6] Further, there are also specific regulations for the prohibition of Insider Trading i.e. PIT Regulations 2015. The questions is, Why is insider trading considered wrong and hence regulated?, First, the aspect of trading on information that is not publicly available to gain an unfair advantage raises moral concerns. However, most of all it is the damaging effect that insider trading can have on the markets. Efficient Capital Market Hypothesis denotes that a buyer of even one share not just impacts the seller but the entire market. If one person has more information than the other persons and misuses that information for personal gain then the markets can fluctuate drastically.[7] Insider trading can potentially lead to the collapse of the market as it will create an unfair tilt in favour of the insiders and if there is no protection then people, especially, retail investors will be deterred from investing and trading knowing that the corporate personnel always possess more information and hence in a position to reap more profits. This will leave the market with only insiders as participants with no other non-insiders to trade shares with leading to collapse of the company as well as it would be very hard to raise capital.
Rakesh Agrawal Vs SEBI
In the controversial case of Rakesh Agrawal vs. SEBI, the insider trading regime was extensively discussed along with the requirement of mens rea. Rakesh Agrawal (appellant) was the managing director of a company called ABS Industries which had negotiations going on for a deal with a German Company Bayer AG. During those negotiations the appellant was buying shares of ABS through his brother-in-law. It is important to note that it was known through Bayer AG’s past ventures that they prefer acquiring a majority stake in the company they are entering into a deal with. Following the announcement of a deal between the ABS and Bayer, the shares owned by Rakesh through his brother-in-law were sold to Bayer.[8] The case was investigated by SEBI anticipating a case of insider trading. SEBI was of the view that the brother-in-law was connected person as he was the relative of an insider who was also a part of the negotiations and was in possession of UPSI regarding the deal. Therefore, SEBI held that Mr. Rakesh Agrawal was guilty of Insider Trading and fined him Rs 34 lakhs. The decision was appealed to the Securities Appellate Tribunal (SAT). The tribunal overruled SEBI’s decision holding that even if the trades were made while in possession of UPSI Rakesh cannot be held guilty because the trading was done to promote the interests of the company and not for his own personal benefit. Bayer AG wanted 51% of the shares of ABS for the deal to fall through and Mr. Agrawal helped in accomplishing that goal through indulging in the trades beforehand and then selling the shares when needed.[9]
The basis of SEBI’s ruling was that on the literal interpretation of Regulation 3 of SEBI (PIT) 1992 there is no requirement of mens rea to make profits to prove insider trading. SAT rejected SEBI’s argument stated that the objective of the regulation is to prevent any unfair gains by an individual and for that motive has to be taken into account. Further stating that mens rea is not specifically mentioned as a part of insider trading but that does not mean it shouldn’t be taken cognizance of.[10]
‘Proving Intent’ in Insider Trading
Even after the above judgement, the amended SEBI (PIT) Regulation 2015 do not explicitly mention the need for proving intent. It has instead become more arbitrary as Regulation 4 states that to prove a person guilty of insider trading only consideration that is required is that the person was in possession of UPSI while trading in securities. Explanation to this regulation mentions that the purpose for which the trade is applied is not relevant to determine whether the person has violated the regulation. This raises question as to if proving intent is/should be the basis of proving insider trading or not.[11]
According to established jurisprudence proving intent to make profit or act on the basis of UPSI should be the basis of insider trading as the most basic goal of establishing the regulations were to get rid of any unfair advantage that insider may have over the investors to make profits but if the intent to make profit is only not being considered then what is the basis of these regulations. In the case of Rakesh Agrawal Vs SEBI, it was stated that these regulations are not formed to outright ban on trading, transactions that have been undertaken to discharge a fiduciary duty or in the interest of public shareholders in a company without any intent to make personal profit should not be hit by the prohibitions. The intention behind the regulation is to prevent any misuse of information so that there is no unfair advantage obtained by a person and market remains fair.[12] All directors, officers, employees are in possession of UPSI at all times, does that mean they cannot engage in trades at all under the current regulation even if they are not diverting from their fiduciary duties. Moreover, it was presented in the arguments that under the SEBI Act, insider trading is considered a statutory offence and is punishable with imprisonment under section 24. Any statutory crime requires the aspect of Mens Rea to hold the person guilty even if the statute lacks the express definition of it.[13][14]Attention should be paid to the US jurisprudence on Insider Trading as well as it is one of the first countries to develop a regulation on insider trading. Whole US insider trading regulation is based on the importance of mens rea which is recognised by way of a misappropriation theory i.e. an act becomes unlawful when the fiduciary duty is breached.[15] In the case of United States Vs Chiarella, supreme court stated that merely trading on UPSI was not enough to declare a breach of fiduciary duty.[16]In the case of United States V O’Hogan, fiduciary duty was looked into, it was held that to impose a criminal charge it is important to conclude that there was a wilful violation of the securities regulation. The person in possession of UPSI should violate the fiduciary duty owed to the company in order to be held guilty.[17]
One can look at the recent case of PC Jewellers case as well to determine that the basis of insider trading is to prove intent. In this case three people connected to the company were held to be guilty of insider trading by SEBI just based on circumstantial evidence that there was a possibility they might have access to UPSI but the supreme court overruled SEBI stating that there had been no application of mind by SEBI as according to the facts, timing of the transaction there wasn’t possibly any communication of UPSI that took place and people cannot be charged just on the basis of circumstantial evidence.[18] This is why insider trading works on the basis of proving intent because if intent or wilfulness is not looked into then all cases of trading by connected person would have to be concluded based on circumstantial evidence which is not conclusive enough to hold someone justly liable. If mens rea to make profit or to act on UPSI is not taken into account, then many more people like the three appellants in PC Jewellers will be unfairly charged.
Conclusion
Therefore, to conclude Insider Trading is a conundrum that is trying to be dealt globally. The main purpose behind Insider Trading Regulation is to prevent any misuse of UPSI and breach of the fiduciary duty towards the companies. Any insider transaction has potential to adversely affect the market and hence regulation is required so that investors feel protected and the markets are provided with a fair environment to function. The managers and promoters of a company are its Key Managerial Personnel that the shareholders rely on, therefore there is need to regulate their behaviour, however there cannot be a legal threat looming over their head all the time as it is irrational and can hamper the company’s growth. A Just legal system does not punish without cause. Proof of intent needs to be a criterion in the regulation as it continues to be a guiding factor in the jurisprudence around the world. Jurisprudence of USA and precedents set by Indian courts should be used to provide a clear idea to market of what attracts insider trading prohibition and get rid of any ambiguity, thereby instilling confidence in the investors.
[1] Prohibition of Insider Trading Regulation 2015, 2(g)
[2] Prohibition of Insider Trading Regulation 2015, 2(d)(i)
[3] Prohibition of Insider Trading Regulation 2015, 2(n)
[4] Prateek Bhattacharya, India’s Insider Trading Regime: How Connected Are You?, 16 N.Y.U.J.L. & Bus. 1 (2019)
[5] (1998) 18 SCL 311 (AA).
[6] SEBI Act 1992, Section 11 & 30
[7] Eugene F. Fama, Efficient Capital Markets. 24 Journal of Finance, 383-417
[8] Rakesh Agrawal Vs SEBI, (2004) 49 SCL 351 (SAT)
[9] Id
[10] Id
[11] Prohibition of Insider Trading Regulation 2015, Reg. 4
[12] Rakesh Agrawal Vs SEBI, (2004) 49 SCL 351 (SAT)
[13] Id
[14] SEBI Act 1992, Section 24
[15] STEPHEN M. BAINBRIDGE, SECURITIES LAW: INSIDER TRADING, 164-169 (1999)
[16] United States v Vincent F. Chiarella, 445 U.S. 222 (1980) at 233-34
[17] United States Vs James O’ Hogan, 521 U.S. 642, 665-66 (1997).
[18] Indu Bhan, PC Jeweller Case: Supreme Court Sets Aside SAT Order, FINANCIAL EXPRESS (April 21, 2022, 6:00 AM), https://www.financialexpress.com/industry/pc-jeweller-case-supreme-court-sets-aside-sat-order/2498556/
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