Background
One continues to be surprised by how blatantly insiders carry out insider trading, though the law prohibiting it is in place for more than 20 years now. This is particularly so in case of some Independent Directors who think that inside information is a perk of the office! On the other hand, it is equally strange that even after the experience of 20 years, the law framed by SEBI is so clumsy that, often, only by a little stretched interpretation of law it can catch and punish such offenders. A recent decision of the Securities Appellate Tribunal (“SAT”) is interesting in this context. This is in the case V. K. Kaul vs. SEBI (Appeal No. 55 of 2012 dated 8th October, 2012).
Relevant Law
Insider trading is often wrongly perceived in India. The general impression of insider trading is that it is profiting unfairly from unpublished inside information by insiders of that company. To that extent, it is surely true. For example, the CFO of a listed company may know in advance that the Company is going to declare far larger profits that would result in the market price to soar. He may thus buy shares before this information is made public officially and then sell shares at a higher price after the information is made public. This is the commonly understood concept of insider trading.
However, the actual legal concept of insider trading is much wider, particularly as a result of amendments over the years. Firstly, the inside information may not be merely about the company in relation to which a person may be an insider. It can be even about another company with which the first company may be dealing in. For example, Company X may be in the process of giving a huge contract to Company Y whereby the share price of Company Y may get a boost. This is also an inside information that the insiders of Company X are prohibited by law to deal in.
Secondly, a person who even receives or has access to unpublished inside information, is deemed to be an insider and hence his deals may amount to inside trading, though he may not be connected with the Company the way directors, officers, auditors, etc. are connected. This is an unduly wide and badly drafted provision though.
In context of the present case, the facts were Company X, through one of its controlled companies, sought to acquire substantial shares, of Company Y. This information was admittedly price sensitive in the sense that if known to the market, would have resulted in increase in the price of the shares of Company Y. The issue was, can persons connected with Company X (such as a non-executive director) deal in the shares of Company Y on the basis of such information?
Facts of the Case
In the present case, the facts (as reported in the decision cited above) were as follows. Ranbaxy Laboratories Limited (“Ranbaxy”) was a company in which one Mr. V was a non-executive director. Ranbaxy had two wholly owned subsidiaries which, in turn, jointly and wholly owned another company, Solrex Pharmaceuticals Limited (“Solrex”). Ranbaxy decided to acquire the shares of Orchid Chemicals and Pharmaceuticals Ltd. (“Orchid”), a listed company. The quantity of shares proposed to be acquired were substantial enough for it to be taken as accepted that such proposed acquisition was a price-sensitive information, which if made known to the markets would result in an increase of the price of the shares of Orchid. Solrex did not have funds to make this acquisition and the funds would have come from Ranbaxy.
The Board of the two subsidiaries held a meeting on 20th March 2008, to open a demat account for the purposes of such acquisition of shares on behalf of Solrex. Ranbaxy held a Board Meeting on 28th March 2008 to approve use of funds for such acquisition of a sum upto Rs. 800 crore (though actual acquisition was of Rs. 151 crore).
V transferred funds to his wife’s bank account and 35000 shares of Orchid were acquired by her at an average price of Rs. 131.71 on 27th and 28th of March 2008. These shares were sold on 10th April 2008 at an average price of Rs. 219.94. Solrex had made its acquisition of shares of Orchid from 31st March 2008 onwards. The proceeds of sale of such shares were transferred to the account of V from his wife’s account. The broker through whom such transactions were carried out was the same broker through which Solrex bought the shares of Orchid.
It was found that V was in constant touch with decision makers in respect of such purchases by Solrex.
The question was whether V and his wife were guilty of insider trading. SEBI held on the facts that they were guilty and, accordingly, levied a penalty of, in the aggregate, Rs. 60 lakh.
V and his wife appealed against this decision before the SAT.
Decision by SAT
The main contention raised before SAT was that, insider trading can only be in respect of a company in relation to which a person is an insider. In essence, the contention was that V could have been an insider only in respect of inside information in relation to Ranbaxy. The information of proposed purchase of shares of Orchid was not price sensitive information as far as Ranbaxy was concerned. As far as Orchid was concerned, V was not an insider. Further, even if the information was price sensitive as far as share prices of Orchid was concerned, legally speaking, so the appellant argued, it was not covered by the definition of unpublished price sensitive information. The appellant contended that the framework of law was such that the unpublished price sensitive information could only be in relation to the acquirer company and not the company whose shares were being acquired. Such latter company, it was argued, may not even be aware of such proposed acquisition.
The SAT did not accept this contention. However, it is interesting to see how weak the provisions of law are on the basis of which the appellants, perhaps because of special facts, were confirmed to be guilty.
The provisions of law relating to insider trading are scattered and even undefined to some extent. On the other hand, they are so broadly framed that even unintended cases may be covered.
Section 12A of the SEBI Act prohibits insider trading. It also prohibits dealing in shares on the basis of “material or non-public information”, etc. In addition but without directly linking to these express provisions, there are the SEBI (Prohibition of Insider Trading) Regulations 1992, which provide a very detailed set of provisions in relation to prohibition of insider trading.
The appellants had submitted that they could be held to be guilty of insider trading, only if they dealt in the shares of the company with respect of which they were insiders. The SAT pointed out that this was not the law. They can be insiders with respect to the company with which they were connected. However, the inside information and also the ban on trading of shares was in respect of any company. In the present context, though the appellant was a director of Ranbaxy and thus a connected person/ insider with respect to it, the inside information may be in respect to any other company also. Thus, the SAT held that the prohibition on dealing in shares on the basis of inside information was in respect of the shares of another company too.
The SAT thus held that since the appellants, who were insiders with respect to Ranbaxy, dealt in the shares of Orchid on the basis of unpublished price sensitive information in respect to shares of Orchid, they were guilty of insider trading.
Thus, the SAT confirmed the penalty of Rs. 60 lakh.
Problems in law
While the decision of SAT cannot be faulted either in law or in facts, the loose and vague framework of law as well as its extreme wide nature comes to light.
The scheme of law generally was indeed what the appellants argued and that it is framed in respect of insider trading with respect of the shares of the company with whom a person is an insider. However, by partial amendment of the law later, it has been provided that an insider with one company can still be prevented from dealing in shares of another company.
Thus, a person who is not an insider with respect to a company may still be held to be guilty of insider trading of the company. However, the narrow wording of the provisions itself, has the seeds of its own failure. For example, a person would still need to be insider with respect to another company. On one hand, this is too narrow a definition and on the other hand, this connection obviously does not always make sense.
At the same time, the dual and unconnected provisions – one in the Act and one in the Regulations – make the provisions too broad. The Act does not define many things including what is insider trading.
Perhaps, in this case, the findings of facts as stated in the decision were so glaring that they may have made it difficult for the parties to pursue a purely technical stand. V was a non-executive director. The purchases by him of shares were quite near the dates when the important decisions in relation to purchase of shares were taken. The price rose substantially by more than 60% in barely a couple of weeks. V/his wife purchased and sold the same number of shares and through the same broker.
However, it may happen in other cases that the facts may not be so glaring. It is possible that owing to such provisions of law that are porous on one hand and over-broad on the other, may not always have the desired effect and consequences that were intended of it.
The obvious reason for this is that the amendments have been made piecemeal, sometimes in the Regulations and sometimes in the Act. An rehaul of the provisions is desirable. At the same time, a far higher consciousness and law abiding approach is also required. As an ending point, it is also worth pointing out that the SAT referred to and, to an extent, relied on the observations in the most recent US decision in Rajratnam’s case in relation to insider trading.
