SAT Expands the Scope of Exonerating Circumstances for Insider Trading

[Shubh Arora is a fourth year student at National Law University, Delhi]

The Securities Appellate Tribunal (the “Tribunal”), in its ruling in Rajeev Sheth v. SEBI (19 April 2022), quashed the order of a Whole Time Member (“WTM”) of the Securities and Exchange Board of India (“SEBI”). The WTM found the Chairman of Tara Jewels Ltd., Mr. Rajeev Sheth, and his daughters, to have indulged in insider trading in the shares of the company. In this post, the author elaborates on two interconnected infirmities in the SAT order. First, the Tribunal erred in ruling that the list of exonerating circumstances enumerated in the proviso to regulation 4(1) of the SEBI (Prohibition of Insider Trading) Regulations, 2015 (“PIT Regulations”) is illustrative, and not exhaustive. Second, and on a related note, the Tribunal went against the express text of the PIT Regulations by allowing the defence of “emergency” in a case of trading while in possession of unpublished price sensitive information (“UPSI”).

Facts and the WTM Order

Tara Jewels had incurred a loss of Rs. 166.80 crores during the quarter ended September 2017, which was over 25 times the loss incurred in the previous quarter. The appellants were in possession of the financial results of the quarter, which was considered UPSI, for a period of almost two months after which they were publicly disclosed. Within this period, the appellants sold a large number of shares, allegedly for avoiding future losses resulting after the disclosure of financial results.

Mr. Sheth argued that the company was facing extreme financial hardships when they sold their shares. The global jewellery market was facing several difficulties that placed a substantial strain on the business and financials of the company. It was not only unable to meet its working capital requirements, but it was also facing severe pressure from creditors, some of whom required urgent repayment. In this backdrop, they sold their shares only to pay such creditors and infuse the proceeds into the company as working capital. Therefore, the sale was justified in light of the emergency faced by the company.

The WTM dismissed this argument in toto and opined that, in the first place, the Mr. Sheth had failed to prove any exceptional circumstances that necessitated the sale of their shares. Even if such was the case, it does not fall under any of the exceptions to regulation 4(1). The closest exempted circumstance was ‘statutory or regulatory obligation’, but no document was placed on record to show any such legal compulsion. Thus, the claimed utilization of sales proceeds could not be treated as a permissible exonerating circumstance in terms of regulation 4(1).

The WTM opined that, to avoid losses, the appellants disposed of almost the entirety of their shareholding in the company before the poor quarterly financial results were out in the public domain. The WTM found the appellants to have violated regulation 3(1) for communicating UPSI among them and regulation 4(1) for trading while having possession of the UPSI. Consequently, the appellants were barred from accessing the securities market for one year and six months respectively, with directions to deposit with interest the amount of loss avoided, along with a penalty of Rs. 52 lakh.

Order of the Securities Appellate Tribunal and Analysis

The Tribunal concurred with several findings of the WTM. However, it noted that the proviso to regulation 4(1) provides that the insider may prove their innocence by demonstrating certain exonerating circumstances. It opined that the word “including” in the proviso suggests that the exonerating circumstances provided are not exhaustive. There could be other circumstances beyond the six clauses that could exonerate the offender. The Tribunal held that the WTM had patently erred in ruling that this was not a permissible exonerating circumstance because, without the sale of shares and the consequent repayment and infusion of working capital, the company would have been downgraded to a non-performing asset.

Before critiquing the position of the Tribunal, it becomes imperative to explain the significance of the legislative notes in the PIT Regulations, which is a standout feature. The Supreme Court in Daiichi Sankyo Company Ltd. v. Jayaram Chigurupati had emphasized the need for authors of subordinate legislation to articulate their intent behind the provisions. In accordance with this observation, Justice N.K. Sodhi Committee, which was in charge of overhauling the PIT Regulations of 1992 and in preparing a draft for the new regulations, provided specific notes on each provision setting out the legislative intent for which that provision was formulated. These notes were retained in the final legislation and are considered an integral and operative part of the PIT Regulations.

The interpretation of the Tribunal stems not only from a fixated reading of the provision but also from indifference towards the legislative intent that the notes encapsulate. While the word “including” generally suggests inclusive nature, the same is negated by the legislative note to the relevant regulation, which expressly limits the scope of exceptions to “the circumstances mentioned in the proviso”. The Report of the Committee also suggests that it intended to make the prohibition more effective by clearly enumerating “specific defences”, each based on “a specific principle” that demonstrably counteracts against a charge of insider trading.

The Tribunal failed to unearth the intent behind providing a limited set of circumstances; its expansion in this regard may not bode well for future litigation in insider trading matters. It is expected encourage parties to insider trading proceedings to plead several defences not contemplated in the PIT Regulations and it will have no option but to engage with such defences, adding to the already heavy burden of bringing home an insider trading charge.

After asserting that the proviso is illustrative, the Tribunal considered the objective behind the appellants indulging in insider trading – urgent repayment of creditors and desperate need for working capital infusion – to ascertain the legality of the acts. In this regard, the Tribunal went starkly against the letter of the legislative note. The note is unequivocal that the reasons behind the trade or the purposes for which the proceeds of sale are used are irrelevant for deciding a violation. The Tribunal lent unfounded importance to the motive behind the trade, which goes diametrically opposite to the legislative intent articulated in the note.

The reliance of the Tribunal on previously decided cases is also entirely misplaced. The Tribunal opined that its decision in Abhijit Rajan v. SEBI was squarely applicable as the appellants therein were also let off because they traded for the similar purpose of infusing funds into the entity. However, without exploring the merits of that case, the reliance on the order can be dismissed since the decision therein pertained to a transaction in 2013, when the PIT Regulations in their current form had not come into existence. Thus, the legislative note, or a similar provision, was missing at that point in time.

The Tribunal also relied on its decision in Rajiv B Gandhi v. SEBI wherein it had opined that necessity or emergency, for instance, arising out of daughter’s marriage or surgery of a close relative, could be an exonerating factor. However, that was only an illustration given by the Tribunal which had no bearing whatsoever on the decision, therefore, rendering it as an obiter dictum at best. Notwithstanding, like other precedents cited by the Tribunal, this order also predates the overhaul of the PIT Regulations in 2015, thus losing its relevance to the matter in hand.

By reading an exception of emergency or necessity into the proviso, the Tribunal has treaded on dangerous ground. It encourages indulgence in insider trading whenever a person finds themselves in a position of danger, either by virtue of external factors or self-induced. The ruling of the Tribunal in the given matter hinges on the fact that, but for the utilisation of the sale proceeds, the Tara Jewels would have become a non-performing asset. This sets a wrong precedent as it not only justifies insider trading for preservation of the company, but it also intrudes on the course set by laws like the Insolvency and Bankruptcy Code, 2016 that seek to effectively deal with situations of inadequacy of funds for repayment of financial as well as operational debts.

Most importantly, the Tribunal failed to consider the notes in the corpus of the PIT Regulations that throw light on the object and purpose behind the provision. The Supreme Court, in District Mining Officer v. Tata Iron and Steel Co, noted that the most fair and rational method for interpreting a statute is by exploring the intention of the legislature. SEBI WTMs have, on several previous instances, including the fairly recent matters of ITC Ltd. and Yes Bank Ltd., referred to Justice Sodhi Committee Report for ascertaining the legislative intent behind the provisions in question. In this particular background, the apathy of the Tribunal appears anomalous.

Concluding Remarks

If at all the Tribunal notices exceptional circumstances in play that are beyond those enumerated in the PIT Regulations, instead of altering the interpretation of the charging provision, it may take them into account while deciding the penalty. Section 15J of the SEBI Act lays down factors that should be considered while determining the quantum of penalty. Further, the conditions listed in Section 15J are not exhaustive and other factors may also be considered for ascertaining the penalty. A SEBI WTM, in the matter of Biocon Limited, was swayed by a number of justifications offered by the noticee but, since none of them fell under in the proviso to regulation 4(1), the WTM accounted for them while issuing the final directions. The Tribunal should have taken a similar course if it had found the trading be a result of exceptional circumstances. The adjudicating authority must pay heed to this scheme of law, which strikes a balance between the relatively rigid charging provisions against the flexible penalty provisions.

Shubh Arora

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