PROHIBITING INSIDER TRADING

The case “SEBI and its Role in Prohibiting Insider Trading” describes the role
played by the Securities and Exchange Board of India (SEBI) in regulating
the securities market to prohibit insider trading activities. The case starts
out with a brief history of insider trading and then explains the need for a
regulatory body in the Indian Capital market. It then describes the various
SEBI Acts starting with the SEBI Prohibition of Insider Trading Act 1992, and
the subsequent amendments in 2002, 2015, and 2018. The case also covers
the process of investigation under the SEBI Prohibition of Insider Trading,
1992. Besides, it highlights the challenges faced by SEBI in prohibiting
insider trading. It also shows that the cases of insider trading have been
increasing and concludes by stating that more support from the Government
of India (GoI) will help SEBI in controlling insider trading more effectively.
Issues
The case is structured to achieve the following teaching objectives:
 Understand the role of a regulator in a financial/capital market.

 Understand how the regulator protects the interests of

investors.

 Understand what a regulator needs to do to remain watchful

and efficient.

INTRODUCTION
 

In October 2019, Indian capital market regulator the Securities and

Exchange Board of India (SEBI) declared that the code of conduct under the
insider trading norms was applicable not only to persons designated by the
board of a company but also to the promoters. It said, “The Prohibition of
Insider Trading (PIT) regulations identify promoters as designated persons.
Hence a person identified as a promoter is required to comply with the code
of conduct requirements as required by other designated persons”

THE NEED FOR A REGULATOR

 

To control insider trading, the Companies Act of 1956 incorporated Sections

307 and 308 (Refer to Exhibit I for Details of Sections 307 and 308 of
Companies Act, 1956). During 1940-60, capital market operations were
controlled by the Controller of Capital Issues – the regulatory authority
under the Capital Issues (Control) Act, 1947. During the 1980s, the rapid
growth in the capital market led to a huge cash flow which was followed by
several malpractices and frauds being reported in the stock markets of
India. People wanted to get rich quickly by finding loopholes in the system.
The most prominent of these frauds was price rigging. And there was no
authority to listen to the grievances of the traders and investors. This
forced many traders and investors to stay away from the stock market. The
 Government of India (GoI) recognized the urgent need to establish a
regulatory body to monitor the operations of the capital market and find
solutions to the problems the market was going through
EXCERPTS
A REGULATOR IS BORN
 

 
In the year 1987, Rajiv Gandhi, the then
Prime Minister of India, declared in his
budget speech for the financial year 1987-
1988 that the GoI intended to set up a or
separate authority to regulate the Indian
Capital Market. Finally, in April 1988, SEBI
was constituted as an administrative body to
function under the control of the Ministry of
Finance. The aim of creating SEBI was “to or
protect the interests of investors in
securities and to promote the development PayPal (5 USD)
of and regulate the securities market, and
deal with matters connected therewith.” ...
 
 

CHALLEGES BEFORE SEBI

SEBI faced various challenges in establishing and proving a case to convict
the person/s accused of insider trading, due to the lack of evidence. In the
Rakesh Agarwal (Rakesh) vs. SEBI case, Rakesh, the Managing Director of
ABS Industries Ltd. (ABS) , was involved in negotiations with Bayer A.G (a
company registered in Germany) regarding their intentions to take over
ABS. Therefore, he had access to this unpublished price sensitive
information. ..
 

CASES OF ALLEGED INSIDER TRADING GROWS

Even after penalties were imposed and legal action was taken, SEBI
observed that, over the years, there was an increase in the number of
insider trading cases being filed. In FY 2019, SEBI received the highest
number of suspected cases of violation of insider trading regulations i.e.
70 (Refer to Figure I for Number of alleged cases from 2015-19). In the
period 2015-19, SEBI received around 141 alleged insider trading cases
but completed investigation into only half of them because in many of the
cases, SAT dismissed the insider trading charge and penalty that SEBI had
levied on the accused person or company
Five landmark cases on
insider trading
Introduction
The Securities and Exchange Board of India (“SEBI”) Act, 1992 and the
SEBI (Prohibition of Insider Trading) (“PIT”) Regulations, 1992, were
the first laws addressing insider trading. The idea of prohibiting insider
trading of securities was included into Section 195 of the Companies Act,
2013 (“The Act”) by virtue of its enactment. In order to reform the current
capital market regulatory framework, SEBI replaced the 1992 regulations
with the SEBI PIT Regulations, 2015. Regulation 3 and 4 under PIT
Regulations, 2015, deals with the communication of Unpublished Price
Sensitive Information (“UPSI”) and trading when in possession of UPSI,
respectively. Any information, relating to a company or its securities, such as
financial results, dividends, change in capital structure, merger, de-merger,
acquisitions, delisting etc., that is not generally available, which upon
becoming generally available, is likely to materially affect the price of the
securities is considered as UPSI. 

Penalty specified under SEBI Act, 1992 (Section 15G) and Companies Act,
2013, (Section 195) shall not be less than Rs 10 lakhs, may extend to Rs
25 crores or three times the amount of profits made out of insider trading,
whichever is higher.

This article will discuss few of the important cases in respect to Insider
Trading:

Rakesh Agrawal vs. SEBI

In 1996, Rakesh Agrawal, managing director of ABS Industries Ltd., signed a
deal with Bayer AG, a German business, which agreed to purchase 51% of
ABS Industries Ltd.’s shares. Following UPSI’s announcement of the
acquisition, the accused sold a significant portion of his ABS Industries
ownership, which he owned through his brother-in-law, Mr. I. P. Kedia.
Considering Mr. Kedia to be a well-connected individual, SEBI held that Mr.
Rakesh Agrawal was guilty of insider trading and directed him to deposit Rs.
34 lakhs with Investor Protection Funds of Stock Exchange, Mumbai and
NSE (in equal proportion i.e. Rs.17 lakhs in each exchange) to pay any
investor who may make a claim afterwards.

On appeal to the Securities Appellate Tribunal (SAT), it was concluded that

even if Mr. Agrawal had traded securities while in possession of UPSI, he was
not guilty of insider trading because his actions were in the best interests of
the company (as Bayer AG was not willing to acquire the company unless it
could obtain a minimum of 51% of the shares) and there was no intention to
make a profit.

Further, SAT decided that in order to penalise an insider for violating the
Regulations, it must be proven that the insider benefited unfairly from the
trade. The tribunal also rejected SEBI’s argument that insider trading
jurisprudence is founded on the concept of ‘disclose or abstain’, and that an
insider in possession of UPSI cannot trade in a company’s stocks until he
reveals the UPSI. After revisiting the entire jurisprudence of insider trading
on requirement of Mens Rea under Indian legal system, the tribunal held
that: “Taking into consideration the very objective of the SEBI Regulations
prohibiting the insider trading, the intention/motive of the insider has to be
taken cognizance of. It is true that the regulation does not specifically bring
in mens rea as an ingredient of insider trading. But that does not mean that
the motive need be ignored.”

Hindustan Lever Limited vs. SEBI

Hindustan Lever Ltd. (“HLL”) bought 8 lakh shares of Brook Bond Lipton
India Ltd. (“BBLIL”) from Public Investment Institution, Unit Trust of
India (“UTI”) two weeks prior to the public announcement of the merger of
two companies, i.e., HLL and BBLIL. SEBI, suspecting insider trading, issued
a Show Cause Notice (“SCN”) to the Chairman, all Executive Directors, the
Company Secretary and the then Chairman of HLL.

London-based Unilever was the parent company of HLL and BBLIL, and were
operating under the same management. SEBI determined that HLL and its
directors were insiders because they had prior knowledge of the merger.
SEBI further determined that HLL was in the possession of UPSI as
mentioned under Section 2(k) of the 1992 Regulations, which included any
information regarding amalgamation/mergers/takeovers that “is not widely
known or published by such company for general information, but which if
published or known, is likely to substantially impact the price of securities of
that company in the market”. 

Observations made by SAT

The issue before SAT was whether HLL was an insider and the information
held by the HLL constituted UPSI. The SAT concurred with the SEBI order
that the information accessible to HLL in regard to the merger went beyond
self-generated information, i.e., information derived from the company’s own
decision-making. In addition, SAT stated that the presence of directors who
were common to both HLL and BBLIL, as well as a common parent company
in Unilever, indicated that they (i.e., HLL and BBLIL) were effectively
managed together. As a result, HLL could be classified as an insider under
the 1992 Regulations, and it was reasonable to assume that HLL was privy to
the BBLIL board’s decision-making on the merger issue.

SAT observed that even in the merger of two healthy companies, there are
synergistic possibilities that might lead to price sensitivity for either
company, on the subject of whether the information shared with HLL
constituted UPSI. As a result, SAT concurred with SEBI’s judgment that
merger information was price sensitive (albeit not “unpublished”).

The outcome of the decision

This decision of the SAT led to an amendment in the definition
of “unpublished”  under Section 2(k) which stated, “unpublished” means
information which is not published by the company or its agents and is not
specific in nature.” Explanation — Speculative reports in print or electronic
media shall not be considered as published information”. 

By the same Amendment, SEBI also introduced a new provision, Section

2(ha) which defined “price sensitive information” to include any information
relating to an amalgamation, merger or takeover as deemed price sensitive
information, regardless of whether such information actually has any affect
the price of the securities in the market. However, the amendments did not
definitively and expressly define “generally available information” and then
2015 regulations finally came out defining what constitutes UPSI by
stating “generally available information” under Section 2(1)(e) which
stated, “generally available information” means information that is accessible
to the public on a non-discriminatory basis;”.

WhatsApp Leak Case

This case involved Shruti Vora in the Institutional Sales Department of
Antique Stock Broking Ltd., circulating the price sensitive information of
companies like Wipro, Ambuja Cement, Mindtree, Bajaj Auto etc., through
several WhatsApp groups. SEBI conducted a preliminary investigation and
directed search and seizure operations for 26 entities of the Market Chatter
WhatsApp Group, confiscating around 190 devices, documents, and other
items. Furthermore, SEBI fined Shruti Vora for sending WhatsApp messages
containing UPSI relating to the financial results of the aforementioned
companies. Besides, analysts from other brokerages, Parthiv Dalal and
Neeraj Kumar Agarwal, were also fined.

The contentions set forth by the accused was the concept of “Heard on
Street” (“HOS”) which is a common practice among traders, market
analysts, institutional investors etc. The accused further argued that
unsubstantiated information is widely shared and even big journals in the US
and news agencies like CNBC, Reuters, Bloomberg and Twitter handles share
HOS.

SEBI’s insider trading charges against employees of a few stockbroking firms

who had ‘forward(ed) as received’ WhatsApp messages regarding
unpublished quarterly reports of leading companies were set aside by SAT,
who reasoned that SEBI couldn’t find the origin of the messages and was
only pursuing those who forwarded them. SAT relied on the fact that
generally available information would not be seen as UPSI, and therefore the
person just forwarding it would not be considered an “insider”. However, the
information may only be labelled as a UPSI if the person receiving it was
aware that it was a UPSI, and SEBI has to establish “preponderance of
probability” under the circumstances.

The case of Kishore Biyani

Kishore Biyani is the Founder & CEO of Future Group, (brick-and-mortar
retailers) and is also the founder of retail businesses such as Pantaloon Retail
and Big Bazaar.

SEBI initiated an investigation in the scrip of Future Retail

Limited (“FRL”) to ascertain whether certain persons/entities had traded in
the scrips of FRL during the period March 10, 2017 to April 20, 2017 on the
basis of UPSI, in contravention of the provisions of the SEBI Act, 1992 and
SEBI PIT Regulations, 2015.

What was considered UPSI by SEBI in this case?

Composite Scheme of Arrangement between Future Retail Limited and
Bluerock eServices Private Limited and Praxis Home Retail Private Limited
and their shareholders in 2017 was the concerned UPSI in this matter. It
resulted in the demerger of certain business from Future Retail and was
expected to have a positive impact on Future Retail’s share price. Future
Corporate Resources and FCRL Employee Welfare Trust purchased FRL
shares before the scheme of arrangement was publicly announced, and these
trades were carried out by involved entities who were aware of the scheme
and thus found to have traded while in possession of UPSI, according to
SEBI. As per SEBI’s order these trades were authorized by Kishore Biyani
and Anil Biyani.

SEBI barred the notices from accessing FRL stocks for 2 years and ordered
Future Corporate Resources, Kishore Biyani, and Anil Biyani to jointly
disgorge a sum of over Rs 17.78 crore, with interest at a rate of 12% per
year from April 20, 2020 to the date of actual payment. However, the SAT
has stayed the SEBI’s order that had barred Future Group CEO Kishore Biyani
from accessing the securities market and directed to deposit Rs 11 crore as
an “interim measure”. The case is pending before the SAT.

Infosys and Insider Trading

During an investigation around July 2020 by SEBI, there were few entities
(Capital One, Tesora Capital etc.) that were found to be involved in trading in
the scrips of Infosys (“INFY”), while in the possession of the UPSI, prior to
the public corporate announcement. The scrip was in the Future and Option
segment (“F&O Segment”) and is a part of SENSEX and NIFTY. 

What was UPSI in this case? 

INFY’s audited financial statements for the quarter ended June 30, 2020
were released on July 15, 2020 to the BSE and NSE. Basic financial elements
of the P&L and Balance Sheet (“BS”), as well as significant financial and
operational factors that contributed to different aspects of the P&L and BS,
were included in the results which altogether constituted UPSI.

The Partners of Capital One and Tesora Capital traded in the F&O segment of
INFY scrips prior to the corporate announcement and soon after the
announcement, squared off their positions such that net positions were zero
and which allowed them to make an illegal gain of Rs 3.06 crores. Along
with these entities, Senior Corporate Counsel and Senior Principal, Corporate
Accounting Group of INFY were found to be involved in the said transaction.
SEBI order stated that these two employees of INFY were in constant touch
with each other during June 29, 2021 till July 15, 2021 which led to passing
of UPSI with one another and later with the other partners of Capital One and
Tesora Capital, implicated here. 

SEBI in its order has impounded the illegal gains as mentioned above and
further restricted the entities from accessing the securities market till further
orders. The matter is pending before SEBI.

Closing thoughts
On May 21, SEBI fined Rs 1 crore on Indiabulls Venture former non-
executive director, Pia Johnson, and her husband Mehul Johnson for violating
PIT Regulations by trading the firm’s scrip using USPI. A month back, ed-tech
firm Aptech was fined Rs 1 crore for violating insider trading norms. Insider
trading cases seem to be surging up as many large corporations such as
SpiceJet, Sun Pharma, Future Group etc., seem to be violating the insider
trading laws. SEBI still has to go a long way in strengthening the governance
of Insider Trading laws as it lacks behind in many ways such as lack of
technological expertise wherein it is very difficult for SEBI to catch the
offender. Even if SEBI is successful in identifying the offender, establishing
insider trading cases is challenging due to the fact that these accusations are
usually dependent on circumstantial evidence, making them tough to prove.
SEBI does not have the authority or power to tap phones. 

The challenge with existing Indian laws is that they do not have
extraterritorial application. Under the current regulations, no inquiry or
punishment may be imposed on any foreign national who has committed the
offence of insider trading. There are also instances when, despite the fact
that an inquiry has been initiated in India, certain evidence is situated
outside the country. Additionally, there is no mechanism for obtaining
transnational support or assistance in this regard. 

Another challenge is the possibility of getting a consent order. Insider trading

cases that are resolved with modest fines convey the impression that insider
trading is not a serious crime. However, this is not the case, hence, it must
be avoided to ensure that insider trading is not normalised