By JAYANT M. THAKUR
Chartered Accountant
SEBI recently passed an interim
order in an alleged case of insider trading and ordered impounding of profits
running into several crores of rupees, along with interest on it. This order
was apart from other adverse directions in the form of restrictions and also
such further other action that may be initiated later in the form of penalty,
etc. While the order by itself has several points which are analysed here,
there are certain other issues arising out of this order, as also a settlement
order in a related matter of the company, which also need a look.
Insider trading is something that
every securities regulator across the world seeks to prevent and strictly
punish and, as an offence, stands second perhaps only to blatant market
manipulation. Insider trading is a breach of trust by insiders with
shareholders and the public generally and by itself also leads to loss of faith
in stock markets. When persons are placed in positions of power and access to
sensitive information, they are duty-bound not to profit illegitimately from
it. If, for example, a Chief Financial Officer learns something from sensitive
information relating to accounts / finance made available to him due to his
position of power and trust, he is duty-bound not to exploit it for his
personal profit. For instance, if he comes to know that his company has made
substantial profits, he is expected not to buy shares based on this information
that is not yet public and also not to share such information.
The
offence of insider trading – whether dealing on the basis of such unpublished
sensitive information or sharing such information – is so difficult to prove,
that the law has been drafted very widely and presumptively. Many aspects are
presumed in law even if some of these presumptions can be rebutted by persons
accused of insider trading. The tools of punishment for insider trading
available with SEBI are varied and far-reaching. The profits made can be
disgorged, penalty up to three times the profits made, or Rs. 25 crores,
whichever is higher, can be levied, the guilty persons can be debarred from
capital markets and so on.
Let us examine and analyse a recent
order which is a good test study of how the legal concepts are applied in an
actual case (Order No. WTM/GM/IVD/55/2019-20 in the matter of PC Jeweller
Limited, dated 17th December, 2019).
BASIC FACTS
SEBI has made certain allegations of
findings relating to this listed company, PC Jeweller Limited (‘PC Jeweller /
Company’). These allegations of findings are given below as the basic facts and
then we will see how SEBI established the guilt of insider trading, how the
alleged illegitimate profits from insider trading have been calculated and what
initial directions have been issued.
To
broadly summarise, the company had proposed a substantial buyback of its shares
and obtained approval of its board of directors. The announcement resulted in a
sharp rise in its share price. Later, however, when the company approached the
lead banker / lender for approval, it was rejected. The rejection was
reconfirmed when the lender was approached a second time. Consequently, the
company had no choice but to withdraw the buyback decision. In the meanwhile,
during this period certain insiders not only sold shares in the company at the
then ruling high price but even squared off certain buy futures and also
entered into fresh sell futures. Each of these resulted in the insider
allegedly avoiding significant loss and even profited. The buy / long future
was for purchase of shares and if squared off at the ruling high price, it
saved the insider from suffering loss that would have arisen when the share
price fell after the announcement of withdrawal of the buyback decision.
Similarly, the put option was for sale of shares at the ruling high price and
when squared off when the price fell, profits were made.
Several issues arose. Whether the
company should have initiated the buyback proposal without duly disclosing that
it was subject to approval of lenders? Whether this was a case of insider
trading and, if yes, what action should be taken?
The following are some specific
facts as per findings in this interim order (note that the interim order is issued
without giving parties a hearing, which is given after the order and
which may result in modification of facts / directions):
(i) There
were two directors who were brothers and promoters. There was another brother
who was ex-Chairman. There were certain relatives of such persons who were the
sons and wives of such sons. There was also a private limited company (QDPL) in
which a family member held 50% shares. One of the brothers passed away by the
time this order was passed;
(ii) The company initiated the buyback proposal on 25th April,
2018 after internal discussions followed by discussions with auditors and
merchant bankers. Thereafter, it convened a Board meeting on 10th
May, 2018 when the Board approved the buyback;
(iii) The buyback proposed was at a significant price and of a
significant amount. It was for 1.21 crore shares at a price up to Rs. 350 (the
ruling market price of shares just before the Board meeting was about Rs. 216).
The total buyback consideration would have been approximately Rs. 424 crores;
(iv) The company also had in the meantime initiated approval of
shareholders for the buyback through postal ballot. However, it appears that
the outcome of the voting of the ballot was not announced, although it appears
that more than 99% of votes were in favour of the buyback;
(v) However,
on 7th July, 2018, the lead banker rejected the request to allow the
buyback of shares. A request to reconsider was also rejected. Consequently, the
company convened a Board meeting on 13th July, 2018 to withdraw the
buyback proposal and duly announced the decision;
(vi) Certain relatives of the promoter-directors and QDPL (the
private company in which a relative held 50% shares) entered into certain
transactions during the time after the announcement of the buyback
proposal but before the announcement regarding the withdrawal of the
buyback. Fifteen lakh shares were sold. A long position in futures of 2.25 lakh
shares was squared off by a similar put future. A fresh short position of three
lakh shares was also entered into.
FINDINGS BY SEBI
SEBI made the following findings in
its interim order: The relations and transactions between the
promoter-directors and the relatives / QDPL who traded in the shares / futures
were laid down in detail. These relatives / QDPL were thus held to be insiders
/ beneficiaries of inside information. The timing of the transactions was
specified as being during the time after the buyback was announced and
information about the rejection by the lead banker, but before the time
when the announcement of withdrawal of buyback was published.
SEBI worked out the notional gains /
losses avoided by such transactions by taking the price when such transactions
were undertaken and the price quoted in the markets after the announcement of
withdrawal of buyback was made. This was calculated at about Rs. 7.10 crores.
To this, interest @ 12% per annum was added till the date of order which
amounted to Rs. 1.21 crores. The total came to Rs. 8.31 crores.
ORDERS BY SEBI
SEBI held that the
promoter-directors were insiders and they communicated the price-sensitive
information to persons connected to them who traded in the shares / futures.
Thus, there were two sets of alleged violations. One was by the
promoter-directors who were alleged to have shared the price-sensitive
information to persons connected to them. The second was by such connected
persons who dealt in the shares / futures based on such information and avoided
a large amount of losses.
SEBI directed the persons who traded
in the shares / futures to deposit the notional gains along with interest in an
escrow account pending final orders. Till that time, no transactions were
allowed in their bank, demat and other accounts and they were not allowed to
dispose of any of their other assets, except for complying with such directions
and till such deposit was made.
Further, they were asked to show
cause why such notional gains should not be formally disgorged, along with
interest, and why they should not be restrained from accessing securities
markets / dealing in securities for an appropriate period. The
promoter-director was also asked to show cause why he should also not be
restrained similarly from accessing securities markets / dealing in securities.
SETTLEMENT ORDER
Interestingly, a settlement order
was passed a few weeks before the interim order. Vide this, the company agreed
to pay Rs. 19,12,500 as settlement charges for certain alleged defaults in
disclosures. These mainly related to not informing in time about the objections
of the lenders to the buyback offer which was stated to be material information. SEBI had initiated
proceedings to levy a penalty. However, the company came forward for a
settlement and paid the agreed amount.
OBSERVATIONS
There
are several interesting issues here. Some are lessons for companies and persons
associated with such companies generally. The other is about concerns over such
interim orders and findings and their implications.
It
is critical that companies and managements should consider carefully the
implications of major decisions and disclose to public meticulously all
relevant information in that regard. In this case, the issue was not so much
that the buyback had to be cancelled because of lack of approval from the lead
lender, but that such condition was not disclosed beforehand. It may be that
often such approvals ordinarily do come in due course. But in this particular
case, it mattered significantly, so much so that the buyback had to be called
off and the share price seems to have crashed because of this.
Promoters
/ insiders need to be generally very careful in dealing in shares. There are
many safeguards provided in law. For example, prior approval of the Compliance
Officer ensures a check on whether any price-sensitive information remains
undisclosed. However, even in such cases, the promoters / management may have
as much, if not more, knowledge of what critical issues may arise.
There
are also concerns about such an interim order and some very general
observations can be made for academic analysis. In this case, it appears that
the promoters held more than 60% shares and even after the sale, the holding
was 57.59%. It is not as if a very significant portion of the shares was sold.
One does not know whether there was a particular reason for such sale other
than what SEBI has alleged for the sale of the shares. Interim orders, it is
well settled, have to be made sparingly. The SEBI order states that if an
interim order is not passed, it would ‘result in irreparable injury to the
interests of the securities markets and the investors’. From the facts stated
in the order itself, the promoter holding is very significant even after such
sale. It is not clear how then such an order would have prevented such
‘irreparable injury’. An interim order of such a nature is stigmatic and
restrictions placed can affect day-to-day business. One wonders whether first
issuing a show-cause notice giving all alleged facts as presented and giving
due opportunity to the parties would have been a better course.
Be that as it may, such orders continue to
provide and reinforce lessons for companies, promoters and insiders generally
for exercising due care.
