Analysis of SEBI Vs. Abhijit Rajan (Supreme Court of India)

SEBI Vs. Abhijit Rajan (Supreme Court of India)

Introduction: In a significant judgment on insider trading, the Supreme Court of India delivered a ruling in the case of Securities Exchange Board of India (SEBI) v. Abhijit Ranjan. This ruling addresses the crucial test for establishing insider trading, focusing on whether the insider sought to gain from unpublished price sensitive information (UPSI).

ABSTRACT

In a landmark decision on insider trading, the Supreme Court of India (“Supreme Court”) held in Securities Exchange Board of India (“SEBI”) v. Abhijit Ranjan (“Respondent”) that the critical test for establishing a charge of insider trading is whether the ‘insider’ attempted to profit or gain from unpublished price sensitive information (“UPSI”).

Differentiating among mens rea and profit motive, the Supreme Court held that, while mens rea is not an essential requirement in matters governed by the SEBI (Prohibition of Fraudulent and Unfair Trade Practices in the Securities Market) Regulations, 1995, the test to be applied in matters governed by the SEBI (Prohibition of Insider Trading) Regulations, 1992 (“PIT Regulations”) is that of profit motive, i.e., whether the insider’s action

Using this test, the Supreme Court determined that because the Respondent sold his shares before the UPSI became public and before it could have had an advantageous effect on the price of the shares, the sale was akin to a distress sale that was not done with the intent to take advantage of or redeem the benefit of the information, and thus the Respondent’s action did not amount to the mischief of insider trading.

While insider trading allegations will always be resolved on the facts and circumstances of each case, the ruling in this case will have a far-reaching impact on how regulators and courts decide insider trading charges in the future.

FACTS

Until September 20, 2013, Abhijit Rajan (“Respondent”) was the chairman and managing director of Gammon Infrastructure Projects Limited (“GIPL”). Following that, he stepped down as chairman and managing director, but remained a director of GIPL.

The National Highways Authority of India (“NHAI”) granted GIPL a contract in 2012. GIPL established a special purpose vehicle called Vijayawada Gundugolanu Road Project Private Limited (“VGRPPL”) to carry out the project. Similarly, NHAI awarded a contract to Simplex Infrastructure Limited (“SIL”) in Jharkhand and West Bengal. SIL established a special purpose vehicle called Maa Durga Expressways Private Limited (“MDEPL”) to carry out the project.

GIPL and SIL signed into two shareholder agreements. These agreements called for GIPL to make investments in MDEPL and SIL to invest in VGRPPL for each of their projects. The mutual investments were to be structured in such a way that GIPL and SIL would own 49% of each other’s projects.

However, on August 9, 2013, the GIPL board of directors approved the cancellation of both shareholders agreements. On the 22nd of August 2013, the Respondent sold approximately 144 lakh shares (approx.) in GIPL. On August 30, 2013, GIPL informed the National Stock Exchange of India (“NSE”) and the Bombay Stock Exchange (“BSE”) that two shareholder agreements had been terminated.

Following an input from the NSE regarding the aforementioned transaction and the likelihood of trading on the foundation of unpublished price sensitive information (“UPSI”), the Securities and Exchange Board of India (“SEBI”) initiated a preliminary investigation. Following the completion of the preliminary investigation, SEBI issued an ex parte interim order concluding that the Respondent infringed the regulations of The Securities and Exchange Board of India Act, 1992 (“SEBI Act”) and prohibiting the Respondent from buying, selling, or dealing in securities or accessing the security markets directly or indirectly. This ex-parte interim order was further confirmed by a confirmatory order issued after the Respondent was given an opportunity to be heard.

During the interim period, SEBI finished the investigation and issued specific orders on the 21st of March 2016, which was followed by a show cause notice on March 29, 2016. The show cause notice was sent not just to the Respondent, but also to a different firm, ‘Consolidated Infrastructure firm Private Limited’ (“CICPL”) and two of its directors. The noticees filed their replies, and after providing the noticees an opportunity to be heard, the Whole-Time Member (“WTM”) issued an order holding the Respondent liable of insider trading and so accountable to disgorge the number of illicit gains gained by him. The show cause notices issued to the others, namely, CICPL and its directors were closed without any directions, on the ground that no case was made out against them.

The Respondent filed a statutory appeal with the Securities Appellate Tribunal (“Tribunal”), challenging the WTM’s order. The Tribunal granted the appeal by order, and it is against that order that SEBI has filed the above-mentioned appeal in the Supreme Court.

ISSUES

• Whether the information regarding the decision of the board of directors of GIPL to terminate the two shareholders’ agreements can be characterized as ‘price sensitive information’ within the meaning of Section 2(ha) of the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 (“PIT Regulations”).
• Whether the sale by the Respondent of the equity shares held by him in GIPL, under peculiar and compelling circumstances in which he was placed, would fall within the mischief of ‘insider trading’ in terms of Regulation 3(i) read with Regulation 4 of the PIT Regulations.
• Whether SEBI should have taken into account the last trade price of the day on which information was disclosed instead of the trade price of the next day.

ARGUMENTS

CONTENTIONS BY SEBI:

SEBI contended that in matters involving insider trading, proportionality is a dangerous and subjective ground, particularly since one-third of the total number of directors of a listed company are independent directors and even transactions involving thousands of crores may be a minor proportion to the turnover if the company is very large in size. SEBI also argued that Regulations 3 and 4 of the PIT Regulations contain an absolute prohibition on insider trading, and that such a statutory prohibition cannot be diluted by claiming that the total value of the contracts terminated by the company was a minor percentage of the order book value and total turnover of the company. The de minimis syndicate has no application to insider trading, as it introduces an element of subjectivity.

Furthermore, the total value of the contracts cancelled on both sides was roughly INR 2,600 crores, and thus the information relating to contract termination was definitely likely to materially affect the price of the company’s stocks under Regulation 2(ha).

SEBI also stated that explanation (vi) under Section 2(ha) which speaks about “significant changes in policies, plans, or operations of the company” cannot limit the scope of the main part of the definition, and in this case, the price of the share dropped in just one day, saving the Respondent INR 85 lakhs. SEBI argued that genuine intentions or grounds of necessity, such as those pleaded in this case, cannot defeat the goal of a strict ban on insider trading, especially since the phrase “lawful excuse,” which is used to justify noncompliance in approximately 88 central statutes, is conspicuously absent from the PIT Regulations.  Also, that in any case, SEBI took note of the situation in which the Respondent was placed, warranting the necessity to sell the shares and hence confined the final order only to disgorgement, which is merely in the nature of restitutionary relief.

Furthermore, the notification of contract termination was given to the BSE at 1.05 p.m. and the NSE at 2.40 p.m. on September 3, 2013, and trading ended at 3:30 p.m., so using the closing price on September 3, 2013 would not accurately determine either the gains made or the losses avoided. As a result, the issue of SEBI using the closing price on September 3, 2013 did not arise.

CONTENTIONS BY THE RESPONDENT:

The Respondent contended that the primary goal of insider trading regulations around the world is to prevent insiders from taking advantage of asymmetrical access to UPSI over others who do not have such access, and that whether an information is price sensitive or not is determined by its ability to materially impact the price of the securities upon publication.

The Respondent also asserted that, by definition, the matter is a mixed question of fact and law, and so does not fall within the purview of Section 15Z (Appeal to Supreme Court) of the SEBI Act, necessitating intervention by this Court.

Furthermore, one of the major criteria that courts consider when evaluating the circumstances surrounding transactions like the one in question is the purpose for which the transaction was carried out. Aside from the transaction’s intent, courts have also considered other factors such as the transaction’s size, trading pattern, and honesty in responses during the proceedings.

In the case at hand, the information in question, namely the termination of the shareholders’ agreements, led to GIPL gaining total control of a larger project, and thus what was lost by the termination was far less than what was gained, and thus the information related to the termination of the agreements was actually favourable rather than adverse.

The Respondent noted that GIPL’s investments in the SIL project represented 0.05% of GIPL’s order book and 0.7% of its turnover, and that a project with such a small percentage of the order book and such a small proportion of the company’s revenue cannot ipso facto become material for UPSI information.

The Respondent contended that if the Respondent had failed to meet its obligations under the Corporate Debt Restructuring (“CDR”) package, GIL would have declared bankruptcy. Furthermore, the Respondent transferred every penny of the share sale profits to the implementation of the CDR package, which SEBI has accepted. As a result, it is a mistake to believe that he made illegal gains that should be repaid.

Furthermore, SEBI exonerated the co-noticee, CICPL, on the grounds that its sale of shares was necessary to pay a margin shortfall to its stock broker. Thus, SEBI adopted two separate yardsticks in the same process, one for the Respondent and one for the co-noticee, necessitating intervention by the Tribunal.

OBSERVATIONS OF THE SUPREME COURT

The Supreme Court remarked that an appeal under Section 15Z (Appeal to Supreme Court) of the SEBI Act concerns ‘any matter of law arising out of the Tribunal’s ruling. Section 15Z focuses on “any question of law,” not “any substantial question of law.”

The Supreme Court stated that in order to determine whether a person is guilty of violating Regulation 3 of the PIT Regulations, the courts should ask the following questions:

• is he an insider?
• did he possess or have access to any information relating to the company?
• whether such information was price sensitive?
• whether the information was unpublished?
• whether he dealt in securities by subscribing, buying, selling,

The SC highlighted an essential point, namely, that the price sensitivity of an information is directly related to the materiality of the influence that it can have on the price of the company’s stocks. A piece of information can have a significant impact on the price of a company’s stock, either positive or negative. The impact should be substantial and not negligible.

Keeping the above parameters in mind and coming to the facts of the case on hand, it was clear,

• that the Respondent was certainly an insider, as he was a chairman and managing director of GIPL till September 20, 2013 and was a party to the resolution of the board of directors authorising the termination of the shareholders’ agreements
• that the information relating to the termination of both the shareholders’ agreements that the Respondent had, would certainly fall under the category of “significant changes in policies, plans or operations of the Company” under Regulation 2(ha)(vii) of the PIT Regulations
• that the Respondent dealt in securities by selling 144 lakhs shares, a month before his resignation as chairman and managing director
• that the termination of the shareholders’ agreements was disclosed to the NSE and BSE after the sale of the shares, which made the information relating to the termination of the agreements unpublished as on the date of the sale.

As a result, it may appear at first sight that the Respondent, who was an insider with unpublished and price sensitive information, was guilty of insider trading because he obviously engaged in securities.

While it is true that actual profit or loss in the transaction may not provide an escape route for an insider from the charge of breach of Regulation 3 of the PIT Regulations, natural human behavior cannot be ignored. If a person engages in a transaction that is almost certain to end in a loss, he cannot be charged of insider trading. In other words, the actual gain or loss is unimportant, but the motivation for creating a profit is critical.

The revocation of the shareholders’ agreements resulted in a massive gain in terms of order book value for GIPL. In such conditions, a prudent investor would anticipate a growth in the value of GIPL shares and would wait for the market trend to manifest itself before engaging in insider trading. However, the Respondent did not wait for the knowledge regarding the market trend to become public since he needed to sell his shares as well as certain other properties to honor a CDR package.

As a result, the Tribunal was correct in concluding that the Respondent had no motivation or purpose of making unjustified gains by cashing in on the UPSI that he owned. In fact, the Tribunal determined that the closing price of shares increased following the dissemination of the information. This demonstrates that the UPSI was designed in such a way that it was expected to be more beneficial to shareholders once the disclosure was made. Anyone who wanted to engage in insider trading would have waited until the knowledge became public before selling his assets. The Respondent did not do so, evidently due to a pressing need.

The Supreme Court stated that the charge of insider trading cannot be measured in terms of the value of contracts cancelled and the percentage of shares sold, and that the proportionality approach cannot be applied in such circumstances. The magnitude of what an insider did in relation to the size of the company may not have an impact on whether someone engaged in insider trading or not, but the information sought to be encashed by the insider should be information that, if published, is likely to materially affect the price of the company’s securities. True, the de minimis rule does not apply to insider trading since it involves an element of subjectivity. Hence, the SC did not go on the basis that GIPL’s investments in the project of SIL represented 0.05% of GIPL’s order book value and 0.7% of its turnover.

The Supreme Court reasoned that the termination of both agreements put GIPL in a better position, and that the price of the securities would have risen as a result. Normal human behaviour would be to wait for this event to occur. This incident could have occurred only after the dissemination of the relevant information. The fact that the Respondent did not wait to exploit the situation persuaded the SC that the Respondent’s objective was not to engage in insider trading.

The allegation that SEBI took note of the Respondent’s predicament and the urgent necessity for him to sell the shares, and that as a result, SEBI limited the final decision to disgorgement, is neither here nor there. The argument is simply a convenience argument. According to SEBI, the closing price of the stock on September 3, 2013 demonstrated a favourable position for the Respondent, and SEBI calculated that the Respondent made a profit.

DECISION OF THE SUPREME COURT

On problem number. 1, the Supreme Court ruled that the information about the termination of the two shareholders’ agreements was price sensitive information since it was likely to put the existing shareholders in a better position once the information became public. In such circumstances, the SC held on issue no. 2 that the Respondent’s sale did not constitute insider trading because it was analogous to a distress sale, made before the information might have a favourable influence on the price of the shares.

As a result, there was no need to go into issue number three, and the Tribunal’s order was not subject to interference. Hence, the appeal was dismissed.

Conclusion: The Supreme Court’s decision in SEBI v. Abhijit Ranjan marks a pivotal clarification on insider trading regulations, emphasizing the necessity of assessing profit motive over mens rea. By scrutinizing the facts of the case and highlighting the importance of price sensitivity and market behavior, the court sets a precedent that will influence future decisions on insider trading allegations.