ROLE OF SEBI IN CURBING INSIDER TRADING
Tamil Nadu National Law University
The Securities and Exchange Board of India acts as a watchdog and regulator of the securities market. It protects the interest of investors and ensures the growth of the stock market. The Indian stock exchange has grown significantly which has led to the practice of insider trading. The term insider trading means when a person has potential access to confidential information that relates to the sale and purchase of securities in a company and such information is not yet available to other people. The SEBI (Prohibition of Insider Trading) Regulations, 1992 was introduced to prevent the act of insider trading. An amendment was made to strengthen these regulations and a code of conduct to prevent insider trading was introduced in the year 2002. To curb the offence of insider trading, Sodhi Committee reviewed these regulations and SEBI (Prohibition of Insider Trading) Regulations, 2015 replaced the existing regulations. These regulations were again recently amended in 2019to strengthen the regulations. In this paper, the powers exercised by SEBI and the penalties imposed to curb insider trading will be studied. The element of mens rea as a deciding factor to impose liability for insider trading will be dealt with in this paper. This paper will also examine the defences available against insider trading.
The Black’s Law Dictionary has defined the term Insider Trading as “the use of material non-public information in trading the shares of the company by a corporate insider or any other person who owes a fiduciary duty to the company.” The trading of securities is misconduct when it is done by persons who have accessibility to non-public information just because of the virtue of their position and work, and such kind of information is very vital for decisions relating to the investment.
To prevent and punish for using unpublished price sensitive information (UPSI) concerning the securities of the company, regulations have been formulated by SEBI.It was based on the rationale that directors and key managerial persons have a duty that is fiduciary towards the company and should work for its betterment rather than their self-interest. Insider trading prohibition is embedded in the fairness theory which deals with the use of non-public material information as fraudulent and dishonest due to the fiduciary duty owed towards the common investor by the insider or due to unequal access of inside information.
The SEBI (Prohibition of Insider Trading) Regulations, 1992 has been introduced by SEBI to prevent insider trading by abusing the market. An amendment was made to strengthen these regulations and a code of conduct to prevent the offence of insider trading was introduced in the year 2002. To curb insider trading, Sodhi Committee reviewed these regulations and SEBI (Prohibition of Insider Trading) Regulations, 2015 replaced the existing regulations. In 2019, an amendment was made to the existing regulations.
The provision for prohibiting insider trading of securities had been dealt with under section 195 of the Companies Act, 2013. But due to the Companies (Amendment) Act, 2017 an omission was made to this section. The rationale for this omission is that those public and private companies which do not propose to list their securities, such restrictions would be of limited use on account of lack of public involvement in the price discovery of their securities. Hence by looking at the dynamic nature of the stock exchange, a review of existing regulations assumes extreme significance so that the objectives of SEBI can be discharged effectively.
POWERS AND PENALTIES TO CURB INSIDER TRADING
The commission of insider trading is difficult to prove by using direct evidence due to the very nature of the offence. In numerous cases, a person trading based on UPSI or communicating UPSI or procuring UPSI would be punished or prosecuted based on evidence of circumstance revolving around the transaction.The Apex Court in N.Narayanan v. Adjudicating Officer, SEBI,held that there is a need for a transparent share market and emphasized that SEBI being a regulator of the market, must strictly deal with the directors and companies involving in insider trading, else it would mean that it has failed in its duty to encourage healthy and orderly development of the stock market. Concerning this, the scope and exercise of SEBI’s power to investigate have gained significance.
SEBI is empowered to investigate those transactions which are suspected to be violating the insider trading norms under the wide scope of powers granted to it by the SEBI Act.Under Section 11 of the SEBI Act which deals with the functions of SEBI, it has the power to take action for the prohibition of insider trading of securities, to call for information and records, conduct inquiries, audit the stock market, and inquire those persons who are related with the stock market or intermediaries. It has been granted powers to inspect any register, books, records or documents if it has any reasonable ground to believe that the company has been engaging in insider trading only when it is a listed company or a company that is proposed to be listed. Its powers relate to the discovering, production and inspecting of accounts books and documents, summoning and enforcement of attendance of a person and examining those persons on oath.
In K.Venkateswarlu v. SEBI, the Delhi High Court dismissed a writ petition seeking direction to SEBI for an investigation into alleged Insider Trading and held that SEBI being a specialized body knows when an investigation is to be done.
If SEBI has reasonable grounds to believe that in the stock exchange the transactions are done in such a way that it is harmful to investors or persons related to the stock market or intermediaries and has been in violation to the provisions of any regulation or SEBI Act, then it has the power to form an investigative body to initiate an investigation on the person involved in those transactions and investigate such transactions. When those persons fail to provide any information or non-cooperate with the authority who is investigating, then this kind of action would lead to fines or imprisonment.
An issue arose regarding whether SEBI has the power to access individual’s data of call records in the Indian Council of Investors v. Union of India. The High Court of Bombay observed that under the provisions of the SEBI Act, the powers granted to SEBI were very vast to include the power to call records from telecommunication providers. It was held that these kinds of information were static and different from the interception of calls. It was also emphasized by the court that this power of SEBI cannot be used for the purpose to conduct a fishing inquiry. Such powers can only be implemented by an officer authorized for this purpose only when there is a pending investigation or inquiry.
Section 15G of SEBI Act,1992 punishes insider trading. The insider shall be liable to pay an amount of at least Rs.10,00,000/- and can exceed up to Rs.25,00,00,000/- or 3 times the sum of profit generated due to insider trading, whichever is greater. The SAT in Rakesh Agrawal v. SEBI,observed that under the provisions of the SEBI Act there is no other section except section 15G which allows SEBI to charges for insider trading in form of monetary penalty.
STANDARD OF PROOF REQUIRED TO ESTABLISH INSIDER TRADING
The past decisions of SEBI and SAT provide an insight into the implied standards of proof since there is no explicit mention of the standards in the Insider Trading Regulations. The SAT in the case of Samir Arora v. SEBI, observed that“it is very difficult to gather adequate evidence in respect of charges relating to conflict of interest, market manipulation, and insider trading. While we appreciate the difficulty, we can’t let mere suspicions, conjectures, and hypotheses take the place of evidence as described in the Indian Evidence Act.”
InDilip.S.Pendse v. SEBI,the SAT observed that higher must be the preponderance of probabilities to establish the wrong as the offence of insider trading is a serious charge by considering the gravity of offence in the stock market. Similarly in R.K.Global Shares and Securities Ltd. v. SEBI, the SAT observed that a serious charge cannot be established on mere suspicion and should have a firmer ground to stand upon. It requires proof by a high degree of probability to be established.
Moreover, it was emphasized by SAT that to establish insider trading, the evidence that fulfills the standard of proof which is reasonable will be required. In V.K.Kaul v. The Adjudicating Officer, SEBI,it was held by SAT that to prove the commission of insider trading, reliance can be placed on the sequence of events and circumstantial evidence and it will not clash with SEBI’s regulatory framework. While adjudicating a case of insider trading, it is necessary to see the circumstantial evidence.
Generally, for convicting a person for an offence under the criminal law, the existence of mens rea is required. The personal fault is a requirement for punishment.The provisions of the SEBI Act do not necessitate the knowledge of the person involved in the act of insider trading. It means that the element of mens rea is not important for the commission of an act of insider trading. So, it is regardless if a person knowingly, deliberately or intentionally commits an offence of insider trading, then he would be convicted. Moreover, there is no requirement under the SEBI regulations for convicting a person for insider trading with motive, intention or knowledge.
In Hindustan Unilever Limited v. SEBI,it was contended that there was a necessity to prove the misuse of fiduciary position for the offence of insider trading as the transactions were effected to make a profit, gain or to evade loss. But SAT negated these arguments and held that there was insider trading involved in the transaction. On the contrary, the SAT in Rakesh Agarwal v. SEBI, observed that the motive or intention of the person involved in insider trading must be taken into consideration although there is no specific requirement of the ingredient of mens rea under the SEBI regulations. However, the Bombay High Court in SEBI v. Cabot International Capital Corporation,declared that under the regulations the criteria of the penalty prescribed is only for breach of civil obligation or failure of a statutory obligation. The ingredient of mens rea is not essential for punishing under the SEBI Act and SEBI Regulations as the constituent for a criminal offence is not present as required by the criminal law.
The already available laws make it evident that the offence of insider trading is punishable without proving mens rea and motive as it is not essential. The aim of punishing for insider trading as a tool to acquire an unfair advantage based on the price-sensitive information is defeated. Merely possessing UPSI cannot be taken as a sufficient ground to establish insider trading since mostly key managerial persons and directors will have access to that information. This would be a barrier to those involved in the management, operation of the company and to investors investing in the company.
Hence the element of mens rea should be a deciding criterion to punish for the offence of insider trading. Moreover, the burden for establishing that the defendant knowingly acted in the commission of the act of insider trading must be on the prosecution. The ingredient of mens rea should require a high standard and that person must know that his act was prohibited by law. The opinion of regulatory authorities and the Indian Judiciary which is largely used should be changed.
DEFENCES AGAINST INSIDER TRADING
The procurement and communication of UPSI will be permissible when it is done in the continuance of discharge of duties, lawful object or performance of legal roles. The general defense to the commission of insider trading is, the confidential information which was indeed shared did not lead to any buying and selling of securities. Further, it can be contended that the confidential information which was shared was not material.
Agreements need to be executed to obtain confidentiality and non-disclosure by the parties as it is compulsory on the part of the Board of Directors to require the same.The board of directors with the exercise of due diligence can allow for some specific transactions where a person may provide, communicate, procure or allow access to UPSI. These include the circumstances when:
- Where the company’s board of directors is intimated that the proposed transaction is in the best interest of the company while making an open offer under the takeover regulations.
- Where the board of directors may determine the form in which the UPSI shall commonly be available at least two trading days before the proposed transaction. Hence to avoid selective disclosure of UPSI, it will be a public disclosure.
To prove their innocence while in possession of UPSI, there are specific defences for insiders and non-individual insiders. The defense by an insider is that the transaction was an off-market interest transfer among promoters who possessed a similar UPSI without breaching Regulation 3 and they had made an informed and conscious decision. The rationale for this defense is that it shall not be considered as an offence of insider trading if the transactions between two similarly positioned persons are aware of the same kind of information. The defense by a non-individual insider is that those persons who had possession of UPSI are different from those people who take decisions and when the latter took the trade decision did not have UPSI. The reason for this defence is the fact that in any company comprising of various entities discharging many roles, if it is possible to ring-fence of individuals who possess UPSI from those who are responsible for making trade decisions, then this rationale underlying the commission of insider trading will not be used.
A trading plan enables insiders such as senior management, who are perpetually in possession of UPSI to trade securities. It acts as a safe harbor for insiders to pre-arrange the sale of securities in accordance with a formulated trade plan. The exception to insider trading is the concept of a trading plan, where public disclosure ensures that people are given adequate notice about such plans and the integrity of the market is maintained.A trading plan can be adopted by the directors, employees, officers and other insiders who may possess UPSI about the company or its securities.
If it is sufficiently proved that there was any prior knowledge of settlement and offenders were on the wrong side of the law, it can very well be proved that all shareholders were being offered the same price with their shares like that of the others. Better read, the transaction remains “as per” the regulations of the takeover code under the Indian law.
The SAT inRajiv.B.Gandhi v. SEBI, viewed that if a person buys or sells shares of a company listed in the stock market, then it will be presumed that he had access to UPSI unless he can prove the same and provide reasonable clarification to justify the trade transaction. In the matter of Chandrakala v. SEBI,it was observed by SAT that the regulator shall prove that they were not just trading routinely but they were attempting to make a profit by using UPSI. This means that the purchase and sale of securities must be driven by the confidential information possessed by the insider. If the person proves that he did not buy or sells the securities based on UPSI and he traded on some other basis, then he shall have violated the provisions under Regulation 3.
Insider trading is a significant dangerto the securities market and the interests of bona fide investors and the current ambiguous provision must not provide the persons involved in the same to have an easy exit from their liability. Any defence in this regard must be clear and not vague.Although the SEBI Act empowers SEBI with vast powers to investigate irregularities in the stock market including the offence of insider trading, successfully detecting such irregularities and collecting evidence for such cases remains a challenge. Hence even if fraud is to be proved based on probability and not the strict principles of evidence, it is incumbent on the SEBI to bring out cogent, convincing evidence to prove the charge of fraud and it shall be based on a high degree of probability to prove the same.
- Chandrakala v. SEBI,(2012) SAT 21 (India).
- Dilip S Pendse v. SEBI, (2009) SAT 176 (India).
- Hindustan Level Limited v. SEBI, (1998) 18 SCL 311 (AA)(India).
- Indian Council of Investors v. Union of India, (2014) 186 Comp.Cas. 512(India).
- K.Venkateswarlu v. SEBI, 2008 (2) Comp.L.J 205(India).
- N.Narayanan v. Adjudicating Officer, SEBI, 2013(3) R.C.R (Civil) 68(India).
- R.K.Global Shares and Securities Ltd. v. SEBI, (2010) SAT 285(India).
- Rajiv.B.Gandhi v. SEBI, (2008) 84 SCL 192 SAT (India).
- Rakesh Agrawal v. SEBI, (2004) 49 SCL 351 (SAT)(India).
- Samir Arora v. SEBI, (2005) 59 SCL 96 SAT (India).
- SEBI v. Cabot International Capital Corporation, (2004) 51 SCL 307 (Bom)(India).
- V.K.Kaul v. The Adjudicating Officer, SEBI, (2012) 116 SCL 24 SAT(India).
- Avtar Singh, Company Law, 16th Ed, Eastern Book Company, 2015.
JOURNALS & ARTICLES:
- Armaan Patkar & Diya Uday, Standard of Proof: Civil securities fraud, market manipulation and insider trading in India, Vol. 8, SCC Journal, Issue 25, (2018).
- Akshata Namjoshi, Safe Harbour under insider trading in India, PL March 53, (2014).
- Charles C Cox & Kevin S Fogarty, Bases of Insider Trading Law, Vol. 49, Ohio State Law Journal, Issue 353, (1988).
- John Hasnas, Mens Rea Requirement: A critical casualty of over criminalization, Vol. 18, Washington Legal Foundation, Issue 27, December (2008).
- Nishith Desai Associates, Insider trading regulations- A primer, July 2013.
- Rajat Sethi, Sudip Mahapatra, and Jinaly Dani, Insider Trading Regulations: Implications for M&A Transactions, Sebi’s Investigative Powers and Penalties Imposed, NLS Business Law Review, Issue 73, (2016).
- Shubham Aparajita & Rishee Rhudra, Insider Trading Regulation 2015, Vol. 2, GNLU Law Review, Issue 69, April (2013).
- Vinita Solanki & Shruti Nandwana, Analysis of the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015- An overview, 58 PL September (2015).
 Shubham Aparajita & Rishee Rhudra, Insider Trading Regulation 2015, Vol. 2, GNLU Law Review, Issue 69, April (2013).
 Avtar Singh, Company Law, 16th Ed, Eastern Book Company, 2015.
 Charles.C.Cox & Kevin.S.Fogarty, Bases of Insider Trading Law, Vol. 49, Ohio State Law Journal,Issue 353, (1988).
N. Narayanan v. Adjudicating Officer, SEBI, 2013(3) R.C.R (Civil) 68 (India).
Rajat Sethi, Sudip Mahapatra & Jinaly Dani, Insider Trading Regulations: Implications for M&A Transactions, SEBI’s Investigative Powers and Penalties Imposed, NLS Business Law Review, Issue 73, (2016).
 Sections 11(2)(i), 11(2)(ia), 11(2A) and 11C, SEBI Act, 1992.
K. Venkateswarlu v. SEBI, 2008 (2) CompL.J 205 (India).
Indian Council of Investors v. Union of India, (2014) 186 Comp Cas 512 (India).
Rakesh Agrawal v. SEBI, (2004) 49 SCL 351 (SAT) (India).
Samir Arora v. SEBI, (2005) 59 SCL 96 SAT (India).
Dilip.S.Pendse v. SEBI, (2009) SAT 176 (India).
R.K. Global Shares and Securities Ltd. v. SEBI, (2010) SAT 285 (India).
 Armaan Patkar & Diya Uday, Standard of Proof: Civil securities fraud, market manipulation and insider trading in India, Vol. 8, SCC Journal, Issue 25, (2018).
V.K. Kaul v. The Adjudicating Officer, SEBI, (2012) 116 SCL 24 SAT (India).
 John Hasnas, Mens Rea Requirement: A critical casualty of over criminalization, Vol. 18, Washington Legal Foundation, Issue 27, December (2008).
Hindustan Unilever Limited v. SEBI, (1998) 18 SCL 311 AA (India).
Supra Note 9.
SEBI v. Cabot International Capital Corporation, (2004) 51 SCL 307 (Bom) (India).
Nishith Desai Associates, Insider trading regulations- A primer, July 2013.
 Regulation 3(3) of SEBI (Prohibition of Insider Trading) Regulations, 2019.
 Regulation 4 of SEBI (Prohibition of Insider Trading) Regulations, 2019.
Vinita Solanki & Shruti Nandwana, Analysis of the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015- An overview, 58 PL September (2015).
 Regulation 5 of SEBI (Prohibition of Insider Trading) Regulations, 2019.
Supra Note 14.
Rajiv.B.Gandhi v. SEBI, 2008 84 SCL 192 SAT (India).
Chandrakala v. SEBI, (2012) SAT 21 (India).
Akshata Namjoshi, Safe Harbour under insider trading in India, PL March 53, (2014).