Co-authored with Sudarshana Basu, associate at Finsec Law Advisors
The recent Supreme Court (SC) decision in the PC Jeweller case is expected to force the market regulator to adopt higher standards of proof while investigating potential offenders, particularly in insider trading matters. The ruling, which rejects the prevalent practice of relying on a combination of rebuttable proof and circumstantial evidence, is especially pertinent as it indicates the importance of the evidentiary burden that the Securities and Exchange Board of India (SEBI) must overcome in order to successfully establish a charge of insider trading.
In the above case, the apex court overturned both the SAT and SEBI orders that found the MD and promoter of PC Jeweller Limited and some of his relatives,including a group entity, guilty of insider trading in the company’s shares. Asper SEBI, the noticees had executed trades in the shares of PC Jeweller while in possession of unpublished price-sensitive information (UPSI) related to the company’s buyback proposal and subsequent withdrawal of the buyback upon failure to receive consent of its lenders.
It is relevant to note that SEBI’s insider trading framework, i.e. the SEBI (Prohibition of Insider Trading) Regulations, 2015, not only prohibits trading in the shares of a listed company by insiders while in possession of UPSI, but also any communication or procurement of UPSI by insiders, except for legitimate purposes or discharge of legal obligations. As per the law, aninsider is any person who has access to UPSI or is a connected person—the latter being a deeming fiction to include persons who are expected or presumed to have access to non-public information of a listed entity by virtue of their association with the listed entity.
Immediate relatives of connected persons, who are financially dependent on such connected persons, are also considered as deemed connected persons. Such presumptions are however rebuttable, thus enabling those charged to logically disprove the deeming fiction with supporting evidence. The standard of proof, therefore, as laid down by the SC in its earlier decision in SEBI v. Kishore Ajmera, is that of preponderance of probabilities based on an evaluation of all attending facts and circumstances. This approach of placing reliance on circumstantial evidence has been consistently adopted by Sebi in most cases ever since.
In the present instance, Sebi had primarily relied upon the connection between the MD of the company and his relatives, to hold that the latter were also deemed connected persons and, consequently, were insiders presumed to have access to UPSI. While holding so, Sebi had dismissed the claims of estrangement made by the noticees that ruled out any possibility of communication of UPSI between the alleged tipper and the tippees, as also pointed out by the SC. The court also held that the appellate tribunal’s observations that the existing family arrangements did not result in complete estrangement were incorrect as the said fact, by itself, could not discharge Sebi from the onus of proof placed on itto show that the noticees had access to UPSI.
Further, SEBI had also relied upon the trading pattern of the noticees to show that they were in possession of information pertaining to the buyback, presumably communicated by the MD. However, the SC clarified that trading patterns solely cannot be determinative of the appellants being insiders or that there was communication of UPSI. Besides, the court noted that significant sale transactions before the beginning of the UPSI period show that the appellants were not in the know of the good news ahead. Stressing on the significance of establishing ‘foundational facts’ before any presumption, the court observed that trading patterns and close proximity cannot be used to prove communication of UPSI without producing cogent evidence such as letters, emails, witnesses,etc.
The above observations are a departure from the SC’s observations in Kishore Ajmera wherein it had emphasised on the importance of using circumstantial evidence“by a logical process of reasoning from the totality of the attending facts and circumstances”, based on which an “irresistible inference” can be drawn that the tipper had passed on price-sensitive information to the tippee. This position was also re-affirmed by it in SEBI v. Kanaiyalal Baldevbhai Patel wherein it had successfully applied circumstantial evidence to prove front running.
Considering the Kishore Ajmera decision has been extensively applied by both SEBI and SAT,the present ruling potentially limits the scope of application of circumstantial evidence without corroboration, especially in insider trading cases. For example, in the present case, SAT had acknowledged that there was no direct evidence to show communication of information such as calls or emails,etc, but nonetheless proceeded to hold that the fact that the noticees were connected and had exchanged financial transactions were enough to conclude that there was dissemination of information. However, the fallacy of this was pointed out by the SC, which emphasised that mere close relationship would not be adequate to draw an inference of communication. While doing so, it also distinguished its decision in Kishore Ajmera by holding that it pertained to a case of fraudulent and manipulative trade practices and not insider trading. The SC seems to apply different standards to insider trading cases compared to securities fraud cases, which is now an important distinction.
In the above ruling, the SC reiterated the princples laid down in Chintalapati Srinivasa Raju, which require that “a reasonable expectation to be in the know of things can only be based on reasonable inference drawn from foundational facts”. While not necessarily prescribing an illustrative list of acceptable foundational facts to prove a charge of insider trading, the court seemingly left the regulator to gauge the same depending on the facts and circumstance of each case, as long as it passes the test of reasonableness.
Over the years, the number of insider trading investigations taken up by Sebi has considerably increased, and rightly so, especially with an increased capacity to monitor insider trading with its data-based alert systems and a robust insider trading framework. However, prosecution remains a challenge in most insider trading cases considering that direct evidence is particularly difficult to obtain. In light of this, the regulator is enabled to draw presumptions and inferences and build a prima facie case before finding credible proof so as to prevent any potential harm to the investors or the securities market. However, in cases of serious charges such as insider trading, rebuttable presumptions could also have dangerous implications,especially in cases where there is no causal link between the price sensitive information and the alleged trades. In such cases, breaking a causal link which does not exist in the first place can prove to be an uphill task for the defendants.
(This article was first published in Financial Express)