Background A recent SEBI order on insider trading is worth considering for certain reasons. It is a case concerning Promoters of a listed company and persons connected with them who have allegedly engaged in insider trading. The case is a good case study on how SEBI investigates into and determines the connections between the parties. Interestingly, for one of the persons, the fact that he was connected with another through Facebook, even if indirectly, was considered a relevant factor to establish connection between them. Further, the manner in which the pattern of investments and their funding were scrutinized, even if fairly basic, is also illuminating. Finally, the recent trend of how SEBI takes quick interim action in this regard is also noteworthy. SEBI is increasingly into passing interim orders whereby the illegal profits made, along with interest till date of order, are impounded and required to be deposited till final orders are passed. Till they deposit such amounts, their bank and demat accounts are effectively frozen.
This case is under the regulations relating to insider trading of 1992, which have since been replaced by the Regulations of 2015. However, the case has full relevance since the findings and conclusion would not have been different under the new law.
Brief summary of the case
The case concerns a software company (Palred Technologies Limited or “Palred”) that had run into financial difficulties from which it recovered and achieved some stability. Thereafter, it decided to sell its business on a slump sale basis to another party. The price of the shares of the Company was low following the period of recovery. However, the proposed restructuring would enable the Company to raise substantial cash and value. The Company had, following such a deal, decided to declare a hefty special dividend and/or also carry out a buyback of shares. The dividend itself would have resulted in the shareholders receiving an amount far higher than the then ruling market price. The price of the shares thus rose substantially.
It later came to light that insiders consisting of the Promoters and certain persons allegedly connected with them had purchased the shares of the Palred at the earlier low ruling price. While they held on to most of the shares so purchased, obviously they benefitted from the very significant appreciation in the market price.
SEBI investigated the matter, examined the direct and indirect connections between such parties and Palred and the nature of their transactions in the shares of Palred. SEBI listed the transactions of such persons and the notional profits made by them considering the appreciation in the price of the shares of the Company. It then passed an interim order impounding such notional profits with interest. SEBI also issued orders effectively freezing the bank and demat account of such parties till they deposited such amount.
In the following paragraphs, some interesting features of this Order have been discussed in detail.
Date from which unpublished price sensitive information can be said to have arisen
A core component of any case of profiting from insider trading is that there should be unpublished price sensitive information (UPSI). UPSI, simply stated, is that information which is not yet made public by the Company but which, if published, would materially affect the ruling market price of the shares of the Company. In the present case, the UPSI obviously related to (i) the slump sale of the business of the Company and (ii) proposal to distribute, thereafter, substantial special dividend/return of money through buyback.
It was noted that the first board meeting of Palred held to formally approve the slump sale of business and consider declaration of special dividend was on 10th August 2013, which was reported to the stock exchanges two days later. However, the discussions relating to the slump sale of business with the proposed buyer was initiated almost a year earlier on 5th September 2012. The Nondisclosure Agreement with the buyers was signed on 18th September 2012. Thus, SEBI considered this date of 18th September 2012 as the date on which the UPSI had come into being. As will be seen later, transactions of the parties on and from this date till the date when the UPSI was made public were held to be insider trading in violation of the law.
SEBI observed:-
“The PSI regarding the ‘slump sale of software solutions business to Kewill group’ came into existence on September 18, 2012, i.e. when the non-disclosure agreement was executed between Kewill group and PTL. The non-disclosure agreement (having a confidentiality clause) was a binding contract on both the sides. Disclosure of the agreement would certainly have an impact on the deal. Therefore, the same can be considered to be an ‘unpublished price sensitive information’ (hereinafter referred to as ‘UPSI’) which had definitely originated on September 18, 2012 and the same had remained unpublished till August 10, 2013 at 13:01 hrs., in terms of the Regulation 2(ha)(vi) of the PIT Regulations. The period of such UPSI was from September 18, 2012 to August 10, 2013.”
It is noteworthy that the price of the shares of the Company on 5th November 2012, from which date an insider was found to have acquired shares, was Rs. 10.71. The price thereafter rose to Rs. 39.20 on the day when the UPSI was made public.
Similarly, the date when the UPSI relating to declaration of special dividend/buyback was also determined and transactions from that date were considered.
Determination of parties found connected for purposes of insider trading
The connections between the parties who had traded from the time when the UPSI came into being were considered.
Mr. Palem Srikanth Reddy, the Chairman and Managing Director of Palred, was a connected person under the Regulations and the Company accepted that he, along with two other persons, were privy to the UPSI relating to slump sale. Mr. Reddy was also accepted to be privy to the UPSI relating to special dividend.
Connections with the other parties were found on various grounds. One person – Ameen Khwaja – was found to be common director/promoter with the Chairman on another company which incidentally had also provided services to the Palred. This company was also proposed to be merged with Palred. It was found that while Ameen himself did not deal in the shares of Palred during the relevant period, several of his family members did and thus such dealing was held to have carried out insider trading.
Common friends on Facebook as basis of determination of “connection”
Perhaps for the first time in my recollection, SEBI considered connections on social media on internet between the parties and in this case, the social media was Facebook. SEBI observed that, “Mr. Pirani Amyn Abdul Aziz is also found to be connected to Mr. Ameen Khwaja through mutual friends on ‘Facebook’”. While this was not the only basis for alleging connection, it is still noteworthy.
It is strange though that having “mutual friends” on Facebook is treated as a relevant factor. Facebook is a relatively open social media network and “friends” are often made (and removed) without knowing in detail the background of parties. Such “friends” are often strangers with whom there are no other connection and sometimes not even offline contact. Having common mutual friends (which is what seems to be meant from the slightly unclear sentence in the Order) makes the connection even less strong. Nevertheless, it is safe to say that SEBI would resort in the future to examine social media connections of parties in its investigation for insider trading and even other purposes. Prominent social media networks include Facebook, Linkedin, Twitter, etc.
Consideration for determining whether the dealing was insider trading
An argument is often put forth by a person alleged to have committed insider trading that his dealing was in ordinary course of business. SEBI examined the background of trading by the parties in the shares of Palred and other scrips and generally other relevant factors to determine whether the dealings were in the ordinary course of business. It was found, for example, that some of the parties had dealings in the shares of Palred either as their only trading or the main one. In some cases, the parties had opened trading accounts just prior to dealing in shares of Palred. In another case, it was found that cash deposits were made in the bank account to make payments for purchase of the shares of Palred during the relevant period. These factors were held by SEBI to be sufficiently indicative of the trading in shares of Palred being in nature of insider trading and not regular trading by the parties.
Interim order of impounding
Such orders impounding profits are of course not wholly new. But they seem to have been used in a particular way in recent times by SEBI and hence some aspects of such orders need emphasis. Such orders are interim orders, in the sense that they are made in the interim pending further investigation. More importantly, they are made not only without giving any hearing to parties but even without giving them any notice. Thus, they often come as a bolt from the blue. The parties wake up one morning to find that their bank and demat accounts are frozen and they cannot operate them. They are of course given postorder opportunity to present their case, including, if they so desire, by way of a personal hearing. The objective is that certain preventive action is taken so that parties are not forewarned and thus they do not take any steps such as diversion of funds.
Manner of determination of profits made in the interim order
The Interim Order makes a finding, which is provisional pending final order, of the amount of profits from insider trading said to have made. In this case, SEBI has determined the purchase price of the shares during the relevant period. Since most of the shares were continued to be held till the date when the UPSI was made public, the price of the shares at the end of such relevant period is noted. The notional profits were then calculated which is the difference between such closing price and the purchase price. To that, simple interest @12% per annum has been added. The total amount is thus held to be the profits form insider trading.
Order of impounding of unlawful gains from insider trading
SEBI thus made this interim order impounding the unlawful profits made along with interest. For this purpose, it froze the bank and demat accounts of the parties whereby no debits to such accounts were permitted. The parties were also ordered not to alienate any of their assets till the amount impounded was duly deposited in an escrow account.
Conclusion
Such decisions over a period have displayed not just the development of the law and the improved detection and investigation of acts of insider trading by SEBI, but also the effective measures to ensure disgorgement of unlawful profits, and also the deterrent punishment being meted out.
