Moneylife Foundation Study: Insider Trading Rules May Need Another Upgrade To Avoid Arbitrary and Contradictory Decisions
The US made insider trading illegal way back in 1934; and, yet, an academic study in 2020 showed that only about 25% of it is ever detected and prosecuted. Despite continuous efforts by policy-makers around the world to tighten rules and plug loopholes, people continue to profit from advance information on price sensitive corporate actions or earnings, because insider trading is extremely hard to detect and prove. 
India introduced inside trading regulation only in 1992 after the Securities and Exchange Board of India (SEBI) got its statutory teeth. Since then, it has worked at tightening the rules. In 2013, justice Sodhi committee was set up to make insider trading regulation ‘more predictable, precise and clear by suggesting a combination of principles-based regulations and rules’. It led to a major overhaul in regulations in 2015. Earlier this month, a news report said that SEBI is looking to introduce artificial intelligence (AI) methods used by casinos, to boost its ability to crack-down on insider trading. 
How is this effort translating into successful prosecution of insider trading by SEBI and through legal precedents established by the orders of courts and tribunals? A study by Moneylife Foundation delved deep into the issue to conclude that the insider trading law, through precedents set by SEBI orders and other judgements, is evolving in a haphazard manner, sometimes due to new situations and cases, but often due to contrary positions taken by SEBI, as well as the appellate tribunal. Consequently, insider trading verdicts, except in standard and brazen violations, are prone to arbitrary outcomes.
This "Review of Insider Trading Cases" was mentored and guided by securities law expert, advocate Ravichandra Hegde, partner of Parinam Law Associates assisted by his colleague Mitravinda Chunduru with the help of two law school interns. The study analysed SEBI’s interpretation of its own rules as well as various judgements by the securities appellate tribunal (SAT) and the courts in landmark insider trading cases, especially after the 2015 amendments. 
The problem, we discover, starts with SEBI but is not limited to the regulator; SAT has also issued contrary orders in similar cases adding to the confusion. For starters, instead of adopting a uniform approach to decide similar cases, SEBI’s whole-time members (WTM), often, analyse cases, previously decided by other WTMs, to make fine distinctions in the cases they are hearing. The result is divergent orders that need further adjudication by the appellate forum on whether or not such distinctions are justified and which interpretation is correct. 
This causes confusion among investors and leads to more litigation and embarrassment when many of SEBI’s orders are struck down by courts and tribunals. In the latest instance, on 19 April 2022, a Supreme Court (SC) order in the case of Balaram Grag vs SEBI  also known as the PC Jewellers case, has overturned ‘a plethora of cases decided by SEBI, while limiting the regulator’s ability to establish insider trading based on circumstantial evidence. More on this later.
The study examines how SEBI defines key concepts of insider trading, as crystallised by its own orders and various precedent-setting decisions at the appellate levels. For instance, what is generally available information (GAI) as opposed to possession of ‘unpublished price sensitive information’ (UPSI). And, whether mere possession of UPSI amounts to insider trading or does it have to be established that a person acted ‘on the basis’ of UPSI (Chandrakala case) to be held guilty of insider trading. It concludes that legal provisions are incongruent with the rulings and need further clarity.
The use of social media has posed a new set of challenges. SEBI’s orders have expanded the definition of ‘connected person’ by drilling into 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 as opposed to merely forwarding what is generally available or published in research reports or media columns.
Another set of landmark cases involves transactions connected with corporate actions (sale of shares by an investment company, early stage discussion on a rights issue or information that should be normally disclosed to stock exchanges) would lead to a charge of insider trading. 
The study has identified two key issues where SEBI may need to re-examine regulations for achieving a rational and uniform approach. One is the importance of motive or mens rea and the second is ‘preponderance of probability’ (or the role of circumstantial evidence and burden of proof) to convert its allegations and findings into a conviction that stands scrutiny in appeal. Let us examine each of these.
Motive or mens rea
SEBI’s regulations say that the motive or mind set of the insider is not relevant to establish an insider trading charge. However, Sodhi committee’s recommendations included certain well-reasoned caveats while imputing liability. SEBI chose to disregard these and adopt a principle of ‘absolute liability’ to determine guilt. This has led to several contradictory rulings. In Rakesh Agrawal versus SEBI, the appellate tribunal ruled that the motive must be taken into account. This view had been held 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 vs Shriram Mutual Fund) has ruled that mens rea cannot be an essential factor to determine insider trading. As things stand, due to the SC judgement, a person can be punished for insider trading even if it is inadvertent or done unknowingly and the motive of the person accused is not relevant. The Sodhi committee had intended motive and intent to have a role in establishing insider trading—especially 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, hence, unaware that it is UPSI, and ought not to be punished for acting on it. The study concludes that adopting an ‘absolute liability' approach is not sacrosanct and this makes it impossible to have a clearly laid down law. Hence, SEBI needs to revisit its regulation to make intent or motive a determining factor while establishing guilt.
Preponderance of Probabilities
Another key issue is the role of the body of circumstantial evidence or, what is described as, ‘preponderance of probabilities’ in establishing insider trading. SEBI’s market surveillance software throws up system-based alerts which trigger insider trading investigation, often resulting in ex-parte orders that lead to imposition of severe hardship, restriction on business and livelihood. The study says, in such cases, adjudication reveals that there is little evidence to uphold the charges or a string of contradictory decisions, even at the appellate level. 
Moneylife Foundation’s study argues that SEBI had invariably relied on a negative connotation of this phrase in deciding cases; but all these cases may be overturned by the SC’s landmark order in the case of PC Jewellers (Balram Garg) in April this year. In this case, despite a formal partition in 2001, SEBI had relied on a family connection based on a common residential address to establish insider trading and impose stringent penalty. The apex court decided that the allegation would need to be backed by a higher burden of proof about circumstantial evidence, or to use regulatory jargon, the degree of ‘preponderance of probabilities’ must be much higher.
The study of landmark insider trading orders suggests that SEBI’s insider trading regulations are due for another, much-needed overhaul to ensure uniformity and reduce unintended harassment and litigation. But even before it does that, the regulator, perhaps, needs to put in place an internal framework to ensure that its officials have a consistent and uniform approach to cases, instead of interpreting regulation to a desired outcome.
1 month ago
A well researched study that the policy makers should take cognizance of.
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