The SC is right, mere possession of unpublished, price-sensitive information does not suffice
By Sandeep Parekh
The Supreme Court (SC) in its recent judgment in Securities and Exchange Board of India v. Abhijit Rajan has delineated certain key principles for charging persons with insider trading. The judgment states that parameters such as motive for making an undeserved gain on part of the insider, the direction of the trade that the insider made and the purpose with which the transaction was carried out, are relevant factors that Sebi must consider in order to prove an insider trading charge.
Rajan was the chairman and MD of Gammon Infrastructure Projects Ltd. (GIPL). GIPL entered into two shareholder agreements (SHAs) with another infrastructure company, Simplex Infrastructure Ltd (SIL). Both companies had received contracts from National Highways Authority of India and set up Special Purpose Vehicles (SPVs) for their respective execution(s). As per the SHAs, both GIPL and SIL were to acquire a stake of 49% in the other entity’s SPV. However, the values of the contracts awarded to the parties were different. The contract that the GIPL was awarded was larger in terms of value and thus, GIPL’s shareholders were at a disadvantage because of the SHAs. Subsequently, in a board meeting of GIPL, a resolution was passed which terminated both SHAs. This resolution was the unpublished price-sensitive information (UPSI) in the case. Rajan sold his shares a week before this UPSI was disclosed to the stock exchanges. He was alleged to have violated regulation 3(i) read with regulation 4 of Sebi (Prohibition of Insider Trading) Regulations, 1992 (PIT Regulations, 1992).
The SC held that a motive to make an undeserved gain is a precondition for proving an insider trading charge. The actual gain of profit or sufferance of loss was held to be immaterial. The SC took the aspect of a payment to be made by Rajan as promoter’s contribution towards a corporate debt restructuring package into consideration and held that the sale of shares by Rajan was a distress sale and was not made for gaining an unfair advantage but rather to rescue the company. If the payment would not have been made towards the package, the parent company of GIPL would have gone for bankruptcy.
Moreover, the price of the share rose after the information was disclosed to the public as the value of the contract won by the GIPL SPV was larger. The SC concluded that any reasonable man would not sell shares prior to the disclosure of positive UPSI. Therefore, the sale was made out of necessity by Rajan and the direction of the trade was opposite to the likely impact that the UPSI would have had on the price of the share. Thus, the literal interpretation of trading while ‘in possession of’ UPSI was not followed and the purposive interpretation of trading to obtain an ‘unfair advantage’ was taken for adjudicating the case.
The Sebi order against Rajan did not take into account the direction of the trade that he had placed. It was overturned by the Securities Appellate Tribunal (SAT) which upheld the appeal by Rajan, which was later affirmed by the SC. Further, SAT also observed that the fact of termination of the SHA through a board resolution cannot be termed as price-sensitive information, on account of the minor proportion of the transaction in the overall turnover of GIPL. In this regard, the SC found that the percentage contribution of the transaction to the turnover of GIPL was an irrelevant consideration, and the de minimis rule had no application to insider trading. The approach taken by the SC is not just correct but also in line with the overarching legislative intent of prohibiting insiders from obtaining an ‘unfair advantage’ at the expense of other investors or general market participants, the origins of which lie in insiders’ fiduciary duties.
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Moreover, the judgment also indicates a shift in the factors that must be looked into to substantiate an insider trading violation. Prior to the judgment, a person could be charged with insider trading if he traded ‘in possession of UPSI’ without necessitating any inquiry into any intention or motive of the insider.
Ironically, the need to look into the motive or intention of an insider that was emphasised by the SC in the judgment, was further diluted through an amendment to the regulation of the PIT Regulations, 1992 in 2002 where the basis of charging a person with insider trading was changed from “on the basis of” UPSI to “in possession of” UPSI. The PIT Regulation, 2015 have incorporated the same principle of prohibiting trading by an insider while they are in possession of UPSI. As long as a person is proven to be an “insider” and possession of UPSI can be demonstrated, it is presumed that the trades would be motivated by the knowledge of the said UPSI.
The SC, through this judgment, has read down regulation 3 of the PIT Regulations, 1992. The approach laid down by the SC dilutes the ‘parity of information’ theory, which states that trading on informational advantages undermines the confidence of investors and the integrity of capital markets. The theory imposes a burden on those with mere possession of UPSI in the interest of ensuring parity of information. As it happened in the case, mere possession of the UPSI might hinder any person from making any trades, even when it may be necessary for them to do so. Therefore, the differentiation created by the SC is well founded. Possession of UPSI should not be the only determining factor for charging an insider, it should be qualified by trading with the motive to obtain an ‘unfair advantage’ over other investors.
Different tribunals and courts have given their interpretation to the regulation for prohibiting insider trading regulations. The case of Rakesh Agrawal v. SEBI, decided by SAT in 2004, bears some semblance to the facts of the aforementioned case. In that case, the Appellant had acquired shares in the company to facilitate entry of an acquirer, for the survival of the company. It was held by SAT that if it is established that the person who had indulged in insider trading had no intention of gaining any unfair advantage, the charge of insider trading warranting penalty cannot be sustained against him. SAT gave a purposive interpretation to the provision while Sebi had given a literal interpretation to Regulation 3 of the PIT Regulations, 1992, wherein trading while in possession of UPSI was restricted.
The SC, through the present judgment, has laid down the tests of assessing an insider trading charge on the basis of the motive of an insider to make an undeserved gain, the reason behind and the direction of the trade made by the insider. It has also provided the threshold for assessing the same. This is an important ruling which injects an element of fraud into insider trading and it also injects an element of breach of fiduciary duty as a key principle in deciding insider trading cases.
The author is Managing partner, Finsec Law Advisors
Coauthored by Anirudh Sood and Rashmi Birmole, associates,
Finsec Law Advisors