Case Note on Securities and Exchange Board of India vs. Abhijit Rajan

ABSTRACT

The Supreme Court ruling in a significant insider trading case underscores the necessity of a profit motive for an insider trading charge. The case involved Mr. Rajan, former Chairman of Gammon Infrastructure Projects Limited (GIPL), who sold shares before disclosing contract termination information. The court deemed the termination as price-sensitive but exempted Mr. Rajan due to his lack of profit motive, viewing his actions as a necessity to prevent bankruptcy. This decision introduces subjectivity, complicating insider trading adjudication. The court’s emphasis on profit motive diverges from the “parity of information” approach, shifting focus from information possession to intent. This ruling pertains to the 1992 SEBI regulations, raising questions about its impact on current regulations. The verdict highlights the complexity of insider trading cases and reflects a departure from previous regulatory approaches.

INTRODUCTION

In the significant case it was ruled that the motive on the part of the insider to seek profits is an essential precondition for a successful insider trading charge. Such a directive from the Supreme Court is likely to have implications for insider trading cases currently within the regulatory system, and on the manner and extent to which the Securities and Exchange Board of India (SEBI) is likely to initiate actions for insider trading.

FACTS

The facts of the present case are rather straightforward. Mr. Rajan was the Chairman and Managing Director of Gammon Infrastructure Projects Limited (GIPL). In 2012, GIPL was awarded a contract by the National Highways Authority of India (NHAI). Similarly, another company, Simplex Infrastructure Limited (SIL) received another contract from the NHAI. Both GIPL and SIL entered into shareholders’ agreements to implement their respective contracts. However, on 9 August 2013, the board of GIPL passed a resolution authorizing the termination of the contracts, which information was disclosed to the stock exchanges on 30 August 2013. In the meanwhile, on 22 August 2013, Mr. Rajan had sold about 144 lakhs (14,400,000) shares he held in GIPL, which became the subject matter of investigation by SEBI.

The securities regulator eventually passed an order holding Mr. Rajan to be in violation of the insider trading regulations, and thereafter also pronounced him to be liable to disgorge the number of unlawful gains to the extent of Rs. 1.09 crores. On appeal, the Securities Appellate Tribunal (SAT) overturned SEBI’s order, against which SEBI preferred the present appeal to the Supreme Court.

Two primary issues arose for consideration by the Supreme Court. The first was whether the information regarding the GIPL board decision to terminate the contracts amounted to “price sensitive information”. The second was whether Mr. Rajan’s sale of equity shares in GIPL “under peculiar and compelling circumstances in which he was placed” would amount to “insider trading”, thereby inviting legal consequences.

SECREACY IN REGARD TO PRICE

At stake is item (vii) of the explanation above. The Supreme Court did not display any hesitation in concluding that the termination of the agreements by GIPL fell within item (vii), as it indicated a significant change to the business plans of the company. Nevertheless, the Court inexplicably went on to draw a wedge between item (vii) of the explanation and the other items. It noted that while items (i) to (vi) “are likely to have an impact directly upon the financial strength of the company”, item (vii) stands apart “in that it is very broad and general in nature”. It observed that while the information listed in items (i) to (vi), without more, is likely to materially affect the price of the company’s securities, the same is not true of matters in item (vii).

In case of item (vii), “one may have to see whether there was any likelihood of the said information materially affecting the price of the securities of the company”. This would involve a consideration of whether the insider purchased (sold) shares when their prices were going up (down). The Court stated: “… one cannot ignore human conduct. If a person enters a transaction which is surely likely to result in loss, he cannot be accused of insider trading. In other words, the actual gain or loss is immaterial, but the motive for making a gain is essential”.

With due respect, such a reasoning could be subject to incongruences. First, the Court draws an artificial distinction between items (i) to (vi) of the explanation on the one hand and item (vii) on the other. The fact that item (vii) appears more general than the others is insufficient of its own strength to bear the weight of that distinction.

Second, when the text of the regulation is clear, the Court has sought to introduce a distinction that might perhaps have never been the intention of the regulator. Any departure from the plain meaning of the regulation would require adoption of the principles of statutory interpretation, which the Court did not seek to invoke.

Third, the Court’s treatment of item (vii) as a standalone provision creates a circularity problem. The explanation in regulation 2(ha) creates a deeming fiction by which the items set out there in automatically amount to matters that materially affect the price of the securities, that too whether they actually do. By reading in the requirement in item (vii) of a profit motive and the requirement of whether there was a likelihood of price being affected, the Court effectively renders item (vii) redundant, as one effectively has to fall back on the main portion of the regulation 2(ha) rather than the explanation. It is questionable whether this is consistent with the regulatory intention.

Fourth, and relatedly, the Court has artificially introduced profit motive as a precondition to item (vii) (and its impact on price sensitivity) when none ought to exist.

FOR INSIDER TRADING, PROFIT MOTIVE IS SINE QUA NON.

The Supreme Court agreed with SAT’s finding that Mr. Rajan “had no motive or intention to make undeserved gains by encashing on the unpublished price sensitive information that he possessed.” In doing so, the Court paid heed to circumstances involving Mr. Rajan’s sale of GIPL’s shares. At the outset, it was persuaded by the fact that Mr. Rajan sold shares when the termination of the contracts by GIPL was beneficial to it, thereby raising the likelihood of an increase in its share price. In that sense, the trade was contrary to what a profit-seeking insider may have undertaken, i.e., to purchase shares before the information regarding the termination of contracts was revealed to the market. Another important supporting factor was the fact that the sale of shares by Mr. Rajan was occasioned by the need to utilise the proceeds thereof to stave off the bankruptcy of the parent company of GIPL. In that sense, divestiture of shareholder to meet a necessity found favour with the Supreme Court in cushioning the impact of an insider trading charge.

While the broader logic of the Court’s analysis is understandable, the conclusion could lead to significant unintended consequences. The insertion of profit motive will make a fact-based determination crucial in insider trading cases. While the Court has itself sought to eschew the element of subjectivity (for instance, by declining to invoke the de minimis principle for materiality – at paragraph 37), the requirements of profit motive and necessity reintroduce a great deal of subjectivity through the back door. This may enhance the difficulty of adjudicating insider trading cases.

OBSERVATIONS OF THE SUPREME COURT

The SC noted that an appeal under Section 15Z (Appeal to Supreme Court) of SEBI Act concerns appeals with ‘any question of law arising out of the order of the Tribunal’. The focus of Section 15Z is on ‘any question of law’ and not ‘any substantial question of law’.

The SC observed that in order to find out if a person is guilty of violation of Regulation 3 of the PIT Regulations, the courts should address the following questions namely: (i) is he an insider?; (ii) did he possess or have access to any information relating to the company?; (iii) whether such information was price sensitive?; (iv) whether the information was unpublished?; and (v) whether he dealt in securities by subscribing, buying, selling or agreeing to do any of these things in any securities.

The SC noted that one important fact namely, that the price sensitivity of an information has a correlation directly to the materiality of the impact that it can have on the price of the securities of the company. An information may materially affect the price of the security of a company either positively or negatively. The effect should be material and not completely insignificant.

Keeping the above parameters in mind and coming to the facts of the case on hand, it was clear, (i) 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; (ii) 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; (iii) that the Respondent dealt in securities by selling 144 lakhs shares, a month before his resignation as chairman and managing director; and (iv) 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.

Therefore, it may appear at first blush, that the Respondent, who was an insider and who possessed information which was both unpublished and price sensitive, was guilty of the charge of insider trading as he undoubtedly dealt in securities.

While it is true that the actual gaining of profit or sufferance of loss in the transaction, may not provide an escape route for an insider against the charge of violation of Regulation 3 of the PIT Regulations, one cannot ignore normal human conduct. If a person enters into a transaction which is surely likely to result in loss, he cannot be accused of insider trading. In other words, the actual gain or loss is immaterial, but the motive for making a gain is essential.

The cancellation of the shareholders’ agreements resulted in GIPL gaining very hugely in terms of order book value. In such circumstances an ordinary man of prudence would expect an increase in the value of the shares of GIPL and would wait for the market trend to show itself up, if he actually desired to indulge in insider trading. However, the Respondent did not wait for the information about the market trend, after the information became public because he had to dispose of his shares as well as certain other properties for the purpose of honouring a CDR package.

Therefore, the Tribunal was right in thinking that the Respondent had no motive or intention to make undeserved gains by encashing on the UPSI that he possessed. As a matter of fact, the Tribunal found that the closing price of shares rose, after the disclosure of the information. This shows that the UPSI was such that it was likely to be more beneficial to the shareholders, after the disclosure was made. Any person desirous of indulging in insider trading, would have waited till the information went public, to sell his holdings. The Respondent did not do this, obviously on account of a pressing necessity.

The SC observed that the allegation of insider trading cannot be measured in terms of the value of the contracts terminated and the percentage of shares sold, and that the theory of proportionality cannot be applied in such cases. The magnitude of what an insider did, in relation to the size of the company, may not have a bearing upon the question whether someone indulged in insider trading or not, but what is sought to be encashed by the insider should be an information which if published is likely to materially affect the price of the securities of the company. It is true that the de minimis rule has no application to insider trading, as it introduces 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 SC had gone on the basis that the termination of both the agreements put GIPL in a more advantageous position, in which one would have expected the price of the securities to rise. The normal human conduct would be to wait for this event to happen. This event could have happened only after the publication of the information in question. The fact that the Respondent did not wait to take advantage of the situation, convinced the SC that the Respondent’s intention was not to indulge in insider trading.

The contention that SEBI took note of the situation in which the Respondent was placed, and the dire need that he had to sell the shares, and that therefore SEBI confined the final order only to disgorgement, is neither here nor there. The argument is an argument of convenience. It so happened that according to SEBI the closing price of the stock on September 3, 2013, showed favourable position for the Respondent and SEBI was able to calculate as though the Respondent made a profit.

DECISION OF THE SUPREME COURT

The SC, on issue no. 1, held that the information regarding the termination of the two shareholders’ agreements can be characterized as price sensitive information, in that it was likely to place the existing shareholders in an advantageous position, once the information came into the public domain. In such circumstances, on issue no. 2, the SC held that the sale by the Respondent would not fall within the mischief of insider trading, as it was somewhat like a distress sale, made before the information could have a positive impact on the price of the shares.

Accordingly, there was no necessity to go into issue no. 3 and that the impugned order of the Tribunal did not call for any interference. Hence, the appeal was dismissed.

CONCLUDING REMARKS

The jurisprudential evolution clearly demonstrates that adjudicating insider trading cases bears considerable complexity. The regulator and courts over the years have sought to streamline the application of insider trading regulation, especially given the daunting task of the regulator in discharging the burden of proof. Depending on one’s vantage point, the present ruling of the Supreme Court can be considered a setback or a much-needed respite. However, some final observations are in order.

First, although the Court began by delineating the two issues of whether (i) the information in the present case constituted “price sensitive information”, and (ii) the sale by Mr. Rajan amounted to “insider trading”, in the end the analysis surrounding the two issues were conflated. The profit motive and necessity of circumstances pervaded as the common reasoning across the two otherwise distinct issues.

Secondly it was discussed, several jurisdictions (India including) have adopted the “parity of information” approach to insider trading, whereby the focus is on the information that the insider had in possession while trading in securities of the company, and not on whether the insider in fact intended to violate the law. While the “parity of information” approach does call for exceptions in specific circumstances, the present Supreme Court ruling has the effect of a broader erosion of the theory by specifically requiring a mental element as a precondition to insider trading. To that extent, the judiciary has moved the needle away from parity of information approach that the regulator has sought to construct.

Thirdly, the direct applicability of the judgment is confined to the erstwhile 1992 version of the SEBI regulations on insider trading. It remains to be seen whether (and to what extent) the ruling will have a play on the interpretation of the 2015 version of the regulations currently in force.

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