Mens rea and Insider trading: A comparative study of the Indian and US regulatory frameworks

[By Rishika Sharma & Rishi Raj

The authors are students at the Maharastra National Law University, Aurangabad.

  1.     Introduction

To achieve the goal of safeguarding the interests of the investors, the Securities Regulators around the globe have consistently imposed stricter insider trading regulations to ensure and sustain capital market transparency and fairness. It was given broad powers, including the ability to enact regulations prohibiting insider trading as it deemed fit but not enough which can include mens rea as an essential of insider trading.

Before we proceed to examine the role of mens rea in insider trading it is essential to elucidate this topic. The watchdog of the Indian securities regulator i.e., Securities and Exchange Board of India (SEBI) prohibits the practice of insider trading under SEBI (Prohibition of Insider Trading) Regulations, 2015 (SEBI Regulations). The SEBI Regulations define insider trading as an offence against dealing with a company’s securities on the basis of unpublished price sensitive information (UPSI) to gain an undue advantage over the other people who do not have such information. Regulation 2(1)(n) of the SEBI Regulations provides that information that is related to a company or its securities, that is not generally available to the public, which upon disclosure is likely to affect the price of securities can be termed as UPSI.

  1. A comparative study of the need for inclusion of mens rea

This article seeks to examine the necessity of mens rea in the provisions of insider trading in the USA and India. These regimes were chosen because the United States, as one of the world’s largest financial markets, may serve as a model for India’s securities market. Further, the authors are of the opinion that India needs adequate penal laws to protect investors’ interest in the securities market which prohibits the practise of insider trading and those laws must meet the regulations of developed nations.

2.1 The Indian position 

It would be very prudent to start analysing the Indian regulatory framework where mens rea has not been recognised as an essential of insider trading. Regulation 3(1) of SEBI Regulations states that any person who is in the possession of UPSI shall be considered to be an “insider” irrespective of how the person gained such information. In addition to this, Section 15G of the Securities and Exchange Board of India Act, 1992 (SEBI Act) lays down the penalty for violation of the provisions of Insider trading.

In Hindustan Lever Limited v. SEBI wherein it was contended that for imposing any penalty under insider trading it is essential to prove that the purchase was made for making profit or to avoid loss. While rejecting the contentions Securities Appellate Tribunal observed that information or knowledge is irrespective of Insider trading. It is noteworthy here to observe that the SEBI Act does not recognise the need for the inclusion of mens rea in insider trading. It is not considered an essential element in insider trading and a person can be convicted regardless of his intentions.

The Securities Appeal Tribunal, however, did not always have the same view. A contrary view was taken by it in Rakesh Aggarwal v. SEBI wherein it held that intention or knowledge has to be taken into cognizance in case of insider trading even though the statute doesn’t particularly bring mens rea as an essential criterion but it was subsequently overruled. However, in SEBI v. Cabot International Capital Corporation, the Bombay High Court held that the punishment prescribed in the SEBI Act and SEBI Regulations are for the non-compliances of the provisions.

The proceedings relating to Section 15G are neither criminal nor quasi-criminal, as the Act and The Regulations provides that there is no question of proof of mens rea is required as a fundamental component for the imposition of penalty. The SEBI Act and SEBI Regulations were enacted to punish those individuals who are in default of statutory provisions and hence the intention of the parties committing such violation becomes wholly irrelevant. Therefore, it is noteworthy to observe that the statutory provisions contradict the principle of “no mens rea, no punishment” which is a settled principle in common law countries.

Further, the authors are of the opinion that the present provisions make somehow mens rea is not an essentials of insider trading. This negates the purpose of criminalising insider trading as a means of gaining an unfair advantage based on price-sensitive information. The mere possession of unpublished price-sensitive information should not be considered as sufficient grounds for insider trading. Further, it is noteworthy to observe that the views adopted by the Indian judiciary and regulatory authorities is wrong and hence, mens rea must be included as a fundamental of insider trading.

2.2 The US position 

The US frequently acts as the “gold standard” for many emerging economies, it is necessary to understand what constitutes mens rea in order to attract criminal responsibility for insider trading offences committed within the jurisdiction of the US. The U.S. Securities and Exchange Commission (SEC) defines Insider trading in a much broader sense when compared to the Indian provisions. Instead of only buying or selling securities on the basis of UPSI, SEC also includes “breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, non-public information about the security” under the ambit of insider trading.

In 1984, for the first time, the US Supreme Court in Dirks v. SEC observed that the mens rea must be considered while determining the Insider trading proceedings. Further, in deciding whether or not the insider has violated a fiduciary obligation, the Court reached its conclusion by using a test to determine if the tippee committed the insider trading offence. The Court laid down a test to determine the Insider’s knowledge by [i] insider’s personal benefit from his disclosures [ii] absence of personal gains and [iii] absence of breach by the insider.

Hence, after the Dirks judgement, in US v. Newman, the Court ruled out the term “mens rea” and made it far more difficult for individuals to be prosecuted. The personal benefit test by clarifying that a simple breach of an insider’s fiduciary duty to not disclose sensitive information, even if the information was communicated to a friend, is not enough to constitute insider trading unless the insider had some improper purpose in mind. However, the shortcomings of the “personal benefit test” were developed which made the matter more complicated in the United States v. Lee, where, defendant tippee’s guilty plea was rejected because there was no evidence that the defendant was aware of any personal benefit received by the tipper.

Section 10B of the Act provides that the actions must be done in willful violation of provisions preventing insider trading. It is noteworthy that Section 32A of the SEC Act implicitly recognises the need for the inclusion of mens rea. As a result, SEC adopted Rule 10b-5 which stated that engaging in fraud or misrepresentation in connection with the sale of securities is illegal, and a willful violation is punishable by law.

The SEC Act does not identify mens rea as to the requirements for the offence, but the criminal common law standard applies to the standard of willfulness. That is to say, one cannot recklessly commit insider trading. In view of this, the U.S. House of Representatives passed The Insider Trading Prohibition Act (“Act”). The act was introduced to amend the Securities Exchange Act, 1943 by inserting new sections that define the elements of Insider trading. The bill eliminates the “Personal Benefit Test” and sets forth the “knowledge requirement”. This language broadens the scope of criminal liability in eliminating the “Personal Benefit Test” which removes a key impediment to insiders receiving information several links down the chain from the initial tipper being prosecuted.

The US has played a key role in defining the function of mens rea as a critical part of attracting liability for insider trading. It is frequently considered a shining example for many emerging economies, such as India. To maintain investor trust, India must have robust punitive measures on par with the securities markets of developed countries and in the instant scenario its the US which particularly includes mens rea as an essential of insider trading. The US regulatory frameworks primarily centred on the predominance of criminal intent, to prevent innocent traders from being exploited.

  1. Conclusion  

Due to the exclusion of mens rea as an essential of insider trading, the purpose of section 3(1) of the SEBI Regulations has been rendered vague. The primary goal of SEBI Regulations is to prohibit individuals from gaining an unfair advantage by trading on sensitive information. A breach of the SEBI Regulations might result in excessive penalties for an individual. Because of the wide-ranging consequences of the offence, it is critical that market regulators take efforts to prosecute people after determining the proper cause. As a result, Securities Regulation Agencies in countries like the United States have begun to examine mens rea as a key factor in determining culpability in order to avoid applying harsh penalties in situations of unintentional tipping.

Further, Investors’ interests are not hurt if an insider is penalized for just communicating information or trading securities with no advantage over the broader population Penalizing such activities becomes irrelevant in this situation because the intent to commit an offence is necessary while convicting the offender. This is also outside the purview of the just legal system that considers mens rea as an essential while penalizing.

Insider trading rules in India are far too strict to cope with. Even if the defendants are innocent i.e., they did not have mens rea to commit the offence, facing the charges becomes too burdensome. Given the astronomical penalties for insider trading, it is critical to creating legislation that provides equal protection.

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