SAT on Scope of Insider Trading

In the past, the SEBI regulations against insider trading were attracted only if the insider traded “on the basis of” unpublished price sensitive information (UPSI). Since it became unduly onerous on SEBI to prove that the trading was “on the basis of UPSI”, regulation 3 was amended to provide that an insider trading offence would be committed if the trading was carried out merely “when in possession of” UPSI. Surprisingly though, while the SEBI regulations were amended to make it seeming beneficial for SEBI to initiate enforcement of insider trading violations, section 15G of the SEBI Act that provides for the penalty for insider trading continues to carry the words “on the basis of” thereby creating some level of incongruence between the two sets of legal provisions.
In the light of a recent judgment of the Securities Appellate Tribunal in Chandrakala v. SEBI, the requirement that the insider trade “on the basis of” UPSI is read into even regulation 3 of the SEBI regulations, at least partially in the sense of creating a presumption, which is rebuttable by alleged insider. Relevant parts of SAT’s ruling (at para. 7) are extracted below:
The prohibition contained in regulation 3 of the regulations apply only when an insider trades or deals in securities on the basis of any unpublished price sensitive information and not otherwise. It means that the trades executed should be motivated by the information in the possession of the insider. If an insider trades or deals in securities of a listed company, it may be presumed that he / she traded on the basis of unpublished price sensitive information in his / her possession unless contrary to the same is established. The burden of proving a situation contrary to the presumption mentioned above lies on the insider. If an insider shows that he / she did not trade on the basis of unpublished price sensitive information and that he / she traded on some other basis, he / she cannot be said to have violated the provisions of regulation 3 of the regulations.
By requiring an examination of the insider’s motives for trading, this interpretation effectively nullifies the expansion that SEBI sought to bring about by amending the regulations such that mere possession of UPSI is sufficient. While SEBI’s intention in the regulations appears to be driven by the need to introduce some sort of strict liability, the interpretation of the regulation has reintroduced the requirement of a mental element.
In its judgment, SAT also provides further guidance on the manner in which one can consider whether the insider traded “on the basis of” UPSI (at para 7):
… where an entity is privy to unpublished price sensitive information it will tend to purchase shares and not sell the shares prior to the unpublished price sensitive information becoming public if the information is positive. In this case declaration of financial results, dividend and bonus were positive information but the appellant not only bought but also sold the shares not only during the period when the price sensitive information was unpublished but also prior to and after the information becoming public. A person who is in possession of unpublished price sensitive information which, on becoming public is likely to cause a positive impact on the price of the scrip, would only buy shares and would not sell the shares before the unpublished price sensitive information becomes public and would immediately offload the shares post the information becoming public. This is not so in the case under consideration. The trading pattern of the appellant … does not lead to the conclusion that the appellant’s trades were induced by the unpublished price sensitive information.
In arriving at its conclusion, SAT sought to distinguish its earlier decision in Ranjana R. Kothari v. SEBI.
SAT’s observations in the Chandrakala case could potentially have some implications on two other orders of SEBI on insider trading passed last month in the cases involving Manoj Gaur (in respect of shares of Jaiprakash Associates) and V.K. Kaul (in respect of shares of Orchid Chemicals), if those were to be heard on appeal before SAT. A discussion of SEBI’s orders in those cases is available at Moneycontrol – The Firm.

On a related note, legislative efforts are being made in the United States to impose curbs on members of Congress from trading based on nonpublic information they may have received in their congressional capacity.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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