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Insider Trading Violations: The implications of SEBI’s recent rulings

Sandeep Parekh

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Co-authored with Anil Choudhary, Partner and Manal Shah, Associate, Finsec Law Advisors

SEBI recently issued two orders wherein penalties were imposed against two individuals for insider-trading in the scrip of Biocon Ltd (Biocon). Both held that the individuals traded in the scrip while in possession of unpublished,price-sensitive information (UPSI) relating to collaboration of Biocon with Sandoz in 2017. Although these orders have been issued in the same factual matrix, the issues surrounding both these orders are separate and they raise their own sets of issues.

The first order was issued against a senior vice-president and designated person(DP) of Biocon who was found guilty of insider-trading because he had sold certain shares of Biocon prior to the announcement of the company’s collaboration with Sandoz. Admittedly, the news relating to the deal with Sandoz was a positive news, as the price of Biocon’s scrip rose 5-6% after its publication.

Any person selling shares prior to a positive news should never be charged for insider-trading, as she has not gained any undue benefit of the information.SEBI, nevertheless, found the employee liable for insider-trading in spite of the finding that such shares were sold for making payments for the purchase of a self-occupancy property and that the employee had also taken pre-clearance from his employer. The findings in this order are diametrically opposite to the common law jurisprudence on insider-trading laws that treat insider-trading both as a civil and criminal offence. The rationale is to punish a wrong arising out of an insider ‘taking advantage’ or ‘undue benefit’ of UPSI in her possession, to the exclusion of others. The origin and sustained jurisprudence on insider-trading globally is in the fiduciary duty of insiders not to take advantage of their official standing and access to superior information to short-change the ordinary shareholders.

A high-level committee, chaired by Justice NK Sodhi, had emphasised this,observing that if an insider’s trades were in fact contrary to the nature of the UPSI, such trading ought not be treated as a wrongful act. Further, this issue was also deliberated by the Securities Appellate Tribunal (SAT) in the matter of Chandrakala v SEBI, wherein SAT observed that an entity privy to positive UPSI is likely to purchase, and not sell shares, prior to the publication of UPSI.

SEBI’s finding that a trade is wrong under the PIT Regulations merely because it was executed during the UPSI period and not considering the direction of trade,reduces a serious wrong such as insider-trading to a mere technical violation.This order goes against the very edifice on which insider-trading laws are promulgated and unjustly penalise perfectly legal and ethical behaviour of insiders of listed companies. SEBI needs to realign its findings with the regulatory objectives of the insider-trading law, viz. outlawing the ‘abuse of UPSI’ and not bar all trades while a person in possession of UPSI.

Coming to the second order, that was issued against a director of Mazumdar Shaw Foundation who had bought certain shares of Biocon prior to the announcement of Biocon’s collaboration with Sandoz. He was not an employee or designated person of Biocon and therefore in an ordinary course of business would not be reasonably expected to have information relating to Biocon and, specifically,the Sandoz deal.

The order doesn’t provide evidence that an officer/employee of the company had leaked the information about the deal to him. However, the order assumes that he was in possession of the information as he was a ‘connected person’ because of (a) his directorship in the Foundation run by the promoters of Biocon and(b) he was connected to Biocon as he had acted in an advisory capacity in the negotiations for an agreement between Biocon and CIMAB, which ran concurrently with the Biocon-Sandoz deal.

Thisorder casts a far-flung net that the concerned individual had the knowledge of inside information on the Sandoz deal solely due to the above connections,particularly in absence of any other evidence that this information was leaked to him. The order presupposes that UPSI of listed companies are nonchalantly communicated by their officers/insiders to all persons interacting with them,even sensitive deals such as collaboration with Sandoz. The logical extension of the order would mean that any person who is in touch with an officer of listed company would be presumed to have knowledge of inside information of the company and no evidence is required to prove that such information was leaked to him.

Aninference that implies knowledge of UPSI merely by virtue of knowing a KMP of listed entity or working with a company during the existence of UPSI, sets a precarious threshold for standard of proof in insider-trading cases. Some credible evidence must be shown by SEBI to establish link and access to UPSI,since insider-trading charges cannot be based on mere presumptions.

The two orders are unique in nature and begin a trend where professionals working as employees or otherwise related to listed companies are charged with serious violations such as insider-trading merely because they traded in the scrip of a company at the same time when the company was negotiating a major deal. These orders will have a chilling effect on trades by insiders and criminalise what is not just innocuous but, in the first case, the very opposite of insider-trading. SEBI should pay heed to the observation of the HLC:

“The easiest but most simplistic approach would be to prohibit any trading by aninsider. However, such an approach would not only be as ineffective as any blanket prohibition policy but would also be unrealistic and out of sync with economic and regulatory realities”.