Synopsis In this article, the learned author stresses on Insider Trading as a growing phenomenon globally, especially in India and the efforts taken by SEBI to safeguard the investors. The author brings to our attention a new concept ‘Temporary Professional Relationship’ and its coverage with regards to Insider Trading. Importance is also given to various important nuances of Insider Trading and several types of persons who could be termed as ‘Insiders’ with their knowledge of price sensitive information.
INTRODUCTION
The law to define and catch insider trading on unpublished price sensitive information is quite widely worded. Moreover, several terms contain legal fictions/deeming provisions. Appellate authorities too have adopted further legal fictions or rebuttable presumptions. The noose of the law has got one notch tighter with a recent decision (in the matter of KLG Capital Services Limited, order of SEBI dated 24th July, 2014). In this decision, SEBI, perhaps for the first time, applied the concept of “temporary professional relationship” of a person with a company that would make him an insider, and thus, held that his trades with unpublished price sensitive information (UPSI), is insider trading. Whether such trades were with such UPSI was also determined by applying deeming provisions. Moreover, two other deeming principles established by earlier cases have also been applied here. Finally, the case is especially noteworthy for the systematic manner in which information is collected, the relationships determined and the sequence of transactions analysed.
Background of law relating to insider trading
The law relating to insider trading is principally contained in detailed Regulations – the SEBI (Prohibition of Insider Trading) Regulations, 1992 (“the Regulations”). The punishable act of insider trading is determined in a fairly complex manner wherein several legal fictions/deeming provisions are applied. Importantly, not all of deeming provisions are rebuttable presumptions, and hence they are presumed to be true with no choice to prove otherwise. Certain persons are deemed to be insiders if have certain specified types of close relationships with the Company. However, several categories of persons are deemed to be connected with the Company and hence insiders.
Insider trading takes place if such insiders trade while in possession of UPSI or if they share such UPSI. However, several types of information are deemed to be UPSI. Then, certain trades by insiders are also deemed to be insider trades in the sense that such trades are simply prohibited. And so on. However, it is ironical that even with such a widely framed law, the cases caught and punished are relatively very few. And even in cases detected and punished, a very detailed investigation is required to establish the violation.
Facts in the present case
In the present case, it was found that a certain company (“Acquirer”) acquired shares of a listed company (“the Company”) that resulted in the Acquirer being required to make an open offer. Certain persons (“the Traders”) were alleged to have acquired shares of the Company while in possession of the UPSI that such open offer would be made. The shares were thereafter sold at a substantially higher price, resulting in a large sum of gains to the Traders.
SEBI alleged that this was in violation of the insider trading Regulations. Let us see how SEBI went about establishing the necessary ingredients of insider trading in the facts of that case using several legal fictions.
Having information of open offer whether UPSI?
Does having information of an impending open offer by itself a UPSI? The answer is yes, though it appears that this was not disputed in this case. Hence, this was not required to be established in detail. A takeover is deemed to be UPSI as per the definition of that term.
Whether the traders in the present case were “insiders”?
The crucial question was whether the Traders were insiders. There were two aspects to this. One was that the fact that the Traders were not connected with the Company but they were connected with the Acquirer. Secondly, even with regard to their connection with the Acquirer, the Traders were not connected in any of the forms specified in the Regulations. The question was whether they could still be deemed to be connected with the Acquirer.
For the first aspect, the issue was whether the Traders need to be connected with the Company whose shares were dealt in, or whether they can be connected to any company. The common understanding is that the inside information usually emanates from the Company whose shares are traded in. A person is closely connected with such company as officer, consultant, director, etc. and becomes aware by virtue of such connection about UPSI. He then trades, based on such UPSI. Thus, a connection with any other company ought not meet the requirement. However, SEBI relied on an earlier decision of the Securities Appellate Tribunal (“SAT ”) which had held that the connection may be with any company. Since the Traders were shown, as is seen later, connected with the Acquirer company, it was held that this was sufficient.
The following words of the SAT in V.K. Kaul vs. Securities and Exchange Board of India (Appeal No. 55 of 2012) were relied on:-
“Regulation 2(e) defines ‘insider’ to mean any person who, (i) is or was connected with the company or is deemed to have been connected with the company and who is reasonably expected to have access to unpublished price sensitive information in respect of securities of a company or; (ii) has received or has had access to such unpublished price sensitive information. It needs to be appreciated that the clause makes a distinction between ‘the company’ and ‘a company’. When it refers to ‘the company, the references is to the company whose Board of Directors is taking a decision and when it refers to ‘a company’, the reference is to a company to which the decision pertains. This has been explained even by the adjudicating officer by way of an illustration in para 30 of his order dated January 4, 2012, in the case of Mr. V. K. Kaul as under:-
“30. To illustrate, if noticee’s submission is accepted then a situation will arise wherein a Director of the company X cannot be held guilty of insider trading if he trades in the scrip of company Y based on the UPSI, that company X is going to make a strategic investment / placing a huge purchase order for plant and machineries in company Y. Such a scenario will defeat the purpose of PIT Regulations.”
We are, therefore, of the view that the term price sensitive information used in regulation 2(HA) is wide enough to include information relating directly or indirectly to ‘a company.’ The solrex had decided to purchase shares of the target company. Here, solrex is ‘the company’ and target company is ‘a company.’ The decision of solrex to purchase shares of the target company is likely to materially affect the price of securities of the target company. Only the insiders of solrex are aware about this decision of the company. If the insiders of solrex are allowed to trade in the shares of the target company ahead of purchase of shares by solrex, surely the trading will be on the basis of insider information. the decision of solrex to purchase shares of the target company is, therefore, UPSI for the insiders of solrex and they are prohibited from dealing in the shares of the target company till such information becomes public. It is not obligatory under the regulations that the upsi must be in the possession or knowledge of ‘a company’ in whose securities an insider of ‘the company’ deals. As long as, an insider of ‘the company’ deals in the securities of ‘a company’ listed on any stock exchange while in possession of UPSI relating to that company, the provisions of regulation 3(i) of the regulations will get attracted.”
The next aspect was whether the traders were connected with the acquirer. the traders were not directors, advisors, etc. of the acquirer. however, the records showed that they had some connection with either the acquirer or companies connected with it. they were involved directly or indirectly with the acquirer in terms of carrying out of certain acts relating to the takeover or otherwise having other connections. the persons who actually traded in the shares were also shown connected and the flow of the UPSI to them was also shown. Based on such findings, SEBI held that the traders had a “temporary professional connection” with the acquirer and hence, were deemed to be connected.
This is relevant for any person connected with a Company, particularly professionals like Chartered accountants. even if they are not statutory auditors and have a one- time connection of any sort, they could be held to have a “temporary professional connection”, and thus deemed to be insiders.
Reliance on Phone/sms records it is interesting to note, how the records of phone/sms between the traders during the critical time when the transactions were carried out were obtained and placed on record. This helped support the case of SEBI.
How to Establish that Insiders Traded while in Possession of UPSI
A regular problem faced in cases of insider trading is how to establish that dealings by insiders were so, while being in possession of UPSI. Not all trades of insiders are automatically insider trading. An additional condition required to be proved is that they were, while in actual possession of inside information. An earlier decision of the sat helped introduce yet another fiction. At that time, the law was worded more strictly and it was required to be proved that the person dealt on the basis of UPSI. However, sat held that once an insider deals in securities, it will be presumed that he has done so on the basis of inside information. SEBI relied on the observation of hon’ble sat in the matter of Rajiv B. Gandhi and Others vs. SEBI (appeal no. 50 of 2007) that:
“We are of the considered opinion that if an insider trades or deals in securities of a listed company, it would be presumed that he traded on the basis of the unpublished price sensitive information in his possession unless he establishes to the contrary. Facts necessary to establish the contrary being especially within the knowledge of the insider, the burden of proving those facts is upon him. The presumption that arises is rebuttable and the onus would be on the insider to show that he did not trade on the basis of the unpublished price sensitive information and that he traded on some other basis. He shall have to furnish some reasonable or plausible explanation of the basis on which he traded. If he can do that, the onus shall stand discharged or else the charge shall stand established.”
Relying on this decision, SEBI held that the insider who trades would be presumed to have traded while in possession of UPSI.
This principle is also important for persons close to the Company which would include Chartered accountants acting as auditors, internal auditors, advisors, independent directors, etc. if they deal in the shares of such a Company, it is possible that they would be presumed to have done so while in possession of UPSI. And then it would be upto them to show how they did not. Thus, such persons may consider adopting a policy to never deal in the shares of a Company in which they are regularly or even temporarily connected.
Whether a Person merely Possessing is UPSI Deemed To be an Insider?
The decision of the sat in Dr. Anjali Beke’s case (Dr. An- jali Beke vs. SEBI (appeal no. 148 of 2005)) was relied on to support the argument that even a non-insider who receives UPSI would be deemed to be an insider person who could violate the regulations if he deals, etc. in the securities. Reliance on this decision explicitly was perhaps necessary since at the time of the alleged acts of insider trading, the law was ambiguous. It was only a few months later that the regulations were amended explicitly and clearly state that a person who merely receives UPSI is an insider.
Reliance on Circumstantial Evidence for Establishing offence of Insider Trading
The next concern arises out of the peculiar nature of insider trading. Many of the ingredients required to prove insider trading are difficult to establish directly. The US Court in rajratnam’s case had held that circumstantial evidence can be relied on in insider trading cases. This decision was applied on by the sat in V. K. Kaul’s case. SAT had observed:-
“…The adjudicating officer has rightly relied on the observations of u. s. Court in rajaratnam case (supra) on the relevance of circumstantial evidence in para 38 of the impugned order which reads as under :-
38. Regarding the issue of relevance of circumstan- tial evidence, the hon’ble district Court southern district of new york in the matter of united states of america V raj rajaratnam 09 Cr. 1184 (rjh) decided on 11.08.2011 has observed as follows: “…moreover, several other Courts of appeals have sustained insider trading convictions based on circumstantial evidence in considering such factors as “(1) access to information; (2) relationship between the tipper and the tippee; (3) timing of contact between the tipper and the tippee; (4) timing of the trades; (5) pattern of the trades; and (6) attempts to conceal either the trades or the relationship between the tipper and the tippee.” United States vs. Larrabee, 240 f.3d 18, 21-22 (1st Cir. 2001)…”
The above principles are not in conflict with the regulatory framework prescribed by the Board and can be looked into while deciding case of insider trading under the indian regulatory framework.”
SEBI relied on this decision to rely on various circumstantial evidence in the present case.
Disgorgement of Gains with Interest the gains made by the traders were thus worked out. to that, simple interest @ 12% was added for six years. the traders were also debarred from dealing in the securities markets for specified period of time.
Conclusion
This decision reiterates and emphasises several aspects that need consideration by professionals and executives having any connection to the company. The wide definitions and numerous deeming provisions may result in their own trades, or of persons related/connected to them, being held to be insider trading. Apart from suffering disgorgement of the gains with interest, the person may also suffer penalties, prosecution, debarment and of course, loss of reputation.
