[By Himanshi Garg]
The author is a student at University Institute of Legal Studies, Panjab University, Chandigarh.
Abstract
The Supreme Court (Hereinafter as “SC”) in the case of the SEBI v Abhijit Rajan has held that the motive on the part of an insider is an essential element to hold an insider in violation of the provisions of the SEBI (PIT) Regulations 1992 .This present blog seeks to critically analyze the judgment of the SC referred to above in light of the insider trading jurisprudence developed in the U.S.A, by securities fraud scholars, courts, and commentaries. The author then tries to draw home her argument as to why the possession test should be used in determining the liability of the person charged for violating the Act and why the SC’s judgment sets a bad precedent.
Analyzing Supreme Courts judgment holding ‘motive’ as an essential element in violating SEBI Act 1992
The brief facts of this case were as follows Mr. Abhijit Rajan was the chairman and managing director of Gammon Infrastructure Projects Limited GIPL. and another company Simplex Infrastructure Limited SIL were awarded separate contracts by the National Highways Authority of India NHAI. However,in 2013, the Board of GIPL passed a resolution authorizing the termination of contracts. The information was communicated to the stock exchange 21 days later. During that period, Mr. Rajan had already sold his shares which became the subject matter of an investigation of insider trading shares by SEBI.
The Securities regulator held Mr. Rajan liable for the violation of SEBI(PIT)Regulations, 1992, On appeal, the Securities Appellate Tribunal (Hereinafter as “SAT”) overturned the order of SEBI holding Mr. Rajan not guilty.
The SAT order was now appealed before the SC by the SEBI. Two issues arose before the SC, one of which was Does the Sale of Equity Shares by Mr. Rajan, under the compelling circumstances amounts to insider trading? There is no requirement under the SEBI (PIT) Regulations,1992, for SEBI to prove the motive of the insider, only an essential requirement of possession of unpublished price-sensitive information (UPSI) on part of the insider is required to be established by SEBI to prove his liability.
Mr. Rajan advanced his arguments by contending that the sale of shares was occasioned by the compelling need to save the bankruptcy of the parent company of GIPL and utilize the proceeds of the share sale towards it rather than making unlawful gains. He further advanced that he had no motive to use the UPSI to defraud the securities market.
The SC in its turn went beyond the SEBI Regulations by applying a profit motive test.The Supreme Court observed that Mr. Rajan’s actions were contrary to the arithmetic movement of the Securities market, had the UPSI been disclosed. Based on this analysis, the SC concluded that Mr. Rajan’s actions did not originate from unlawful motives, but from a pressing need to prevent the parent company of GIPL from going into bankruptcy.
In view of the Court, the result that is profit/loss from the resulting transaction may not provide an escape route to the insider, but one cannot ignore human conduct. The determining factor is whether the insider has the necessary motive to make unlawful gains and manipulate the securities market. However, one may observe that in holding ‘Motive’ as an essential requirement,both the SC and SAT have deviated from their past rulings. In Chairman, SEBI v Shriram Mutual Fund the SC held that unless the language of the statute otherwise indicates, it is unnecessary to ascertain whether the violation is intentional or not. A similar viewpoint was shared by SAT with SEBI in Hindustan Lever Ltd v SEBI.
The Rationale of the Courts in adopting the Possession Test
The fundamental provision governing insider trading in the U.S. is SEC Rule 10b-5, etched in the light of Section 10(b) of the Securities Exchange Act, 1934. This Section prohibits fraud in connection with the purchase and sale of any security. However, different Circuits have adopted different tests in determining the liability of the insider based on different rationales which are analyzed below.
The first case that extensively dealt with this issue was United States v Teicher in which a lawyer leaked the inside information to the defendant. The defendants argued that he had other reasons to trade such as his fundamental research about the value of the stock. His contention that there could only be a violation when trading was casually connected with the information established by the SEC was rejected by the Second Circuit, which upheld his conviction. Teicher case, therefore, stands for a Pro-Government approach, where a trader is judged for the worst reasons to trade and the reasons for trade are rejected. The Second Circuit observed that it’s difficult to assume in light of human nature, that the UPSI would not have influenced the behavior of the insider and “Unlike a loaded weapon, ready to use but not used, material information cannot lay idle in the human brain and the Use Standard pose difficulties for the SEC in requiring factual inquires in the state of mind.”
Motive Test: A Safe Harbour for the Insiders?
The supporters of the Use test primarily argue that adopting the possession test to determine liability would encompass in its punishable net the innocent trader who did not use the UPSI. The innocent trader is no better than the uninformed trader because he did not use that information and no unfair disadvantage accures to the uninformed trader.
The Ninth Circuit in United States Vs Smith took this view, in that Smith argued that the jury must prove that there is a causal connection between the information and trade to convict him. The Ninth Circuit accepted his arguments and acquitted him. The burden of proof shifts from the defendant to the SEC. Thus, the Ninth Circuit comes to a very stronger conclusion that if the insider does not use the information, there cannot be any inference of his motive to defraud the market.
Why the Possession of Information test should be used in determining liability
The author here submits that unlike the U.S Law, the Insider Trading Law, in India is unambiguous and clear. The SEBI while formulating the Statues has never incorporated a requirement of intention on part of the insider for determining his liability. The SEBI (PIT) is not a fraud-based law and the motive of insider is irrelevant to the proceedings. The primary objectives of SEBI Law are to protect investors’ confidence in the Indian securities market. Moreover, under Indian insider trading law, the duty is not towards a person with whom the insider shares a fiduciary relationship, but towards the public market as a whole, thus protecting the fairness and integrity of the Securities Market.
Some corporate insiders are in direct contact with UPSI, and they have a superior information advantage owing to their power, position, and due diligence. And no matter what, the other shareholders cannot obtain this information, by utilizing their fullest resources. This advantage threatens the stability and strength of the capital markets, which depends on the investors’ confidence.
The author here advances four compelling arguments in support of the knowing possession test, discussed in brief:-
- Difficulty Establishing Actual Use: – Requiring the SEBI to prove the unlawful Motive would make it difficult for the SEBI to adjudicate the cases. Under the use test, the SEBI would have to establish not only the possession of UPSI but also get to the mind of the insider to determine his intention. Under the Use Standard, the traders would contrive false innocent explanations, thereby impeding the enforcement of the law. The Possession test is being lauded for its simplicity in objectively establishing the guilt of the insider.
- The perception that Markets are Honest And Fair: – The fundamental rationale for prohibiting insider trading is the underlying expectations by the investor of the honest and fair securities market, and insider trading discourages investors from participating in the securities market. Investors believe that the information possessed would in some way influence the trade and the securities market is unfair. The possession test thereby ensures that no one-sided information advantage exists and that the integrity of markets will be better protected.
- Confirming the Legislative Intent: – The Possession Test, comports with the language of the statute. The SEBI (PIT) Regulations 1992, and SEBI (PIT), Regulations, 2015 expressly embody the possession test language in the statute and observe that the reasons or motive of trade is irrelevant in determining liability.
- Better Clarification:- The Possession test offers certainty to the traders by setting forth what behavior would be considered actionable, and providing a course of action to potential trades on what to do with inside information There are also certain exceptions under Regulation 4(1), 2015 Act for the insider under which he can trade even while in possession of UPSI.
Conclusion (The Path Forward).
As analyzed above, the possession test for all its potential benefits should be adopted while adjudicating insider trading cases. Already, the SEBI is grappling with various difficulties in adjudicating cases, and the SC judgment will further make the enforcement of the law an arduous task. One should note that the present case was brought under SEBI (PIT), 1992 Regulation, however,it would remain to be seen whether the ruling has a significance on the interpretation of 2015 regulations. Further,how the SEBI and SAT will walk this fine balance in establishing Motive alsoremains to be seen.