MERE POSSESSION OF SENSITIVE INFORMATION NOT ENOUGH FOR INSIDER TRADING – ACTUAL PROFIT MOTIVE ESSENTIAL

[Mr. M. GOVINDARAJAN]

Introduction

Securities and Exchange Board of India (‘SEBI’ for short) is the regulatory authority to control and supervisor the stock market.  In this regard SEBI framed a regulation called as ‘Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 (‘Regulations’ for short).  These regulations did not intend to generally prohibit insiders from trading in securities of a company.  It only aims to enforce disciplined trading with the underlying objective that all investors should have a fair opportunity to trade.

Prohibition

Regulation 3 imposes a prohibition on dealing, communicating or counseling on matters relating to insider trading.  The said Regulation provides that no insider shall-

• either on his own behalf or on behalf of any other person, deal in securities of a company listed on any stock exchange when in possession of any unpublished price sensitive information; or
• communicate or counsel or procure directly or indirectly any unpublished price sensitive information to any person who while in possession of such unpublished price sensitive information shall not deal in securities.

This regulation shall not be applicable to any communication required in ordinary course of business or profession or employment or under any law.

Insider trading

The expression ‘insider trading’ has not been defined in these regulations but the term ‘insider’ has been defined under Regulation 2(e) as any person who-

• is or was connected with the company or is deemed to have been connected with the company and is reasonably expected to have access to unpublished price sensitive information in respect of securities of a company; or
• has received or has had access to such unpublished price sensitive information.

Unpublished price sensitive information

Regulation 2(k) defined the expression ‘unpublished price sensitive information’ (‘UPSI’ for short).  After the amendment in these regulations with effect from 20.02.2002, the term ‘unpublished’ was alone defined in Regulation 2(k) and Regulation 2(ha) defines the rest of the words ‘price sensitive information’.

Guilty under Regulation 3

A person can be held guilty of violating Regulation 3 if the following conditions are satisfied-

• He must be an insider within the meaning of the word “insider”, under Regulation 2(e), by virtue of his past or present connection or deemed connection with the company and he is also reasonably expected either to have had access to UPSI or has received such information.
• The information that such a person received or has had access or reasonably expected to have had access should be unpublished, in the sense that it was not published by the company or its agent or though published, it was not specific in nature.
• Such unpublished information should fall within the definition of the expression ‘price sensitive information’ within the meaning of Section 2(ha) of the Regulations; and
• He must have indulged in trading, either by dealing in securities of the company or in communicating or counseling or procuring directly or indirectly any such information to any person.

Issue

The issue to be discussed is whether possession of sensitive information is enough to make a person liable under Regulation 3 or not with reference to decided case law.  As already discussed these regulations did not intend to generally prohibit insiders from trading in securities of a company.  It only aims to enforce disciplined trading with the underlying objective that all investors should have a fair opportunity to trade.  Therefore mere possessing of sensitive information will not attract Regulation 3 and the motive behind the person concerned in looked into.   This has been discussed elaborately by the Supreme Court in SECURITIES AND EXCHANGE BOARD OF INDIA VERSUS ABHIJIT RAJAN - 2022 (9) TMI 1072 - SUPREME COURT, 

In the above said case Shri Abhijit Rajan, the respondent in the present appeal is the Chairman-cum-Managing Director of Gammon Infrastructure Projects Limited (‘GIPL’ for short) till September 2013.  Thereafter he was only the Director of the said company.  National Highways Authority of India (‘NHAI’ for short) awarded a contract to GIPL in the year 2012, the cost of which is Rs.1648 crores.  GIPL set up a Special Purpose Vehicle called ‘Vijayawada Gundugolanu Road Project Private Limited’ (‘VGRPPL’ for short). 

NHAI also awarded a contract to Simplex Infrastructure Limited (‘SIL’ for short) in Jharkhand and West Bengal the cost of which is Rs.940 crores.  SIL also set up a special purpose vehicle called ‘Maa Durga Expressways Private Limited’ (‘MDEPL’ for short).  Both GIPL and SIL entered into share agreements.  According to the agreement GIPL was to invest in MDEPL and SIL was to invest in VGRPPL.  The companies shall have 49% of equity interest in each other project.

GIPL, on 09.08.2013 passed a Board resolution terminating both shareholding agreements.  The respondent sold about 144 lakhs shares held by him in GIPL for Rs.10.28 crores on 22.08.2013. GIPL informed the stock exchanges about the termination of shareholding agreements.

Based on the information received by it and the possibility of the trading having taken place on the basis of unpublished price sensitive information (‘UPSI’ for short), National Stock Exchange conducted a preliminary enquiry.  On completion of the said enquiry Securities SEBI passed an ex-parte order holding the respondent violated the provisions of Section 12A(d) and (e) of the Securities and Exchange Board of India Act, 1992 (‘Act’ for short) on 17.07.2014.  SEBI vide that order restrained the respondent from buying, selling or dealing in securities and accessing the security markets directly or indirectly.  SEBI confirmed the ex-parte order after giving reasonable opportunity to the respondent on 23.03.2015.    The respondent filed appeal against the said order but later withdrew the same. 

In the meanwhile SEBI completed the investigation on this issue and issued certain directions on 21.03.2016.  SEBI also issued show cause notice on 29.03.2016 on the respondent.  The respondent replied to the show cause notice.  The Whole Time Member, after giving reasonable opportunity to the respondent passed an order on 13.07.2016.  In the said order it was held that the respondent was guilty of insider trading and liable to disgorge the amount of unlawful gains made by him to the tune of Rs.1.09 crores. 

The respondent filed an appeal before the Securities Appellate Tribunal (‘SAT’ for short) against the order of Whole Time Member.  SAT allowed the appeal.  SAT allowed the appeal on the following grounds-

• The termination of two shareholding agreements was not actually price sensitive information since the investment of the companies in the projects is only 0.05% of GIPL order book value and 0.7% of its turnover for the financial year.
• In any case the respondent was in dire need to sell the shares at that time for the purpose of corporate debt restructuring and therefore he cannot be said to have indulged in trading on the basis of information within his knowledge.
• SEBI did not take into account the last trade price on 03.09.2013 but chose the price on 04.09.2013.

SEBI filed an appeal before the Supreme Court challenging the appellate order of SAT.  SEBI submitted the following before the Supreme Court-

• The proportionality is a dangerous and subjective ground in matters involving insider trading, especially since one third of the total number of directors of a listed company are independent directors and even transactions involving thousands of crores might be a minor proportion to the turnover, if the company is very large in size.
• A statutory prohibition cannot be diluted by arguing that the total value of the contracts terminated by the company was just a minor percentage of the order book value and the total turnover of the company.
• The total value of the contracts terminated on both sides was nearly Rs.2600 crores and hence the information relating to the termination of the contracts was definitely likely to materially affect the price of the securities of the company under Regulation 2(ha).
• The price of the share dropped in just one day and the respondent avoided a loss of Rs.85 lakhs.
• The minimum has no application to insider trading, as it introduces an element of subjectivity.
• The termination of the contracts was given to the Bombay Stock Exchange at 1.05 p.m. and to NSE at 2.40 p.m. on 03.09.2013 and the trading concluded at 3:30 p.m. and hence the adoption of the closing price on 03.09.2013 would not correctly determine either the gains made or the losses averted.
• Therefore the question of SEBI taking the closing price as on 03.09.2013 did not arise.

The respondent submitted the following before the Supreme Court-

• The question whether an information is price sensitive or not, would depend upon its potency to materially impact, upon publication, the price of the securities.
• It is barely a question of fact or at the most, a mixed question of fact and law which will not fall within the scope of Section 15Z of the Act, 1warranting interference by Supreme Court.
• One of the key factors which the Courts take into account while interpreting the circumstances revolving around transactions such as the one in question, is the purpose for which the transaction was effected.
• The termination of the Agreements actually resulted in GIPL gaining total control of a larger project worth Rs.1648 crores and hence the information relating to the termination of the Agreements was actually favorable and not adverse information.
• The value of the contract terminated was just 3.1% to 4.1% and hence it cannot be reasonably expected to have a material impact on the market price of the shares of GIPL.
• A project with a small percentage of the order book and a miniscule percentage of the turnover cannot ipso facto become material for information about it to become UPSI.
• The shares sold by the respondent on 22.08.2013 constituted 0.99% of the share capital of GIPL.
• The failure of the respondent to meet the obligation towards corporate debt restructuring package would have led to GIL filing for bankruptcy.
• SEBI itself has accepted the fact that the sale proceeds were used for funding the corporate debt restructuring package.
• The present appeal does not raise a substantial question of law and that in any case the order of the SAT does not call for any interference.

The Supreme Court considered the submissions of both the appellant and the respondent.  The Supreme Court framed the following questions for its determination-

1. Whether the information regarding the decision of the Board of Directors of GIPL to terminate the two contracts can be characterized as ‘Price Sensitive Information?’
2. Whether the sale of shares by the respondent in GPIL would fall within the mischief ‘insider trading’?
3. Whether SEBI should have taken into account the last trade price of the day on which the information was disclosed instead of the trade of the next day?

The Supreme Court observed that the price sensitivity of information has a correlation directly to the materiality of the impact that it can have on the price of the securities of the company. Information may materially affect the price of the security of a company either positively or negatively. The impact may be beneficial or adverse. The information should have the potential either to catapult the price of the securities of the company to a higher level or to make it plunge. The effect can be bullish or bearish. But the effect should be material and not completely insignificant.

In view of the above the Supreme Court was clear that the respondent was an insider as he was the Chairman-cum-Managing Director of GIPL till 20.09.2013.  He possessed information which was both unpublished and price sensitive, was guilty of the charge of insider trading as he undoubtedly dealt in securities.  The Supreme Court analyzed the provision of Regulation 2(ha).  Regulation 2(ha) provides the likelihood of the price of the securities getting materially affected in the following-

1. periodical financial results of the company;
2. intended declaration of dividends (both interim and final);
3. issue of securities or buy back of securities;
4. any major expansion plans or execution of new projects;
5. amalgamation, mergers or takeovers;
6. dispose of the whole or substantial part of the undertaking; and
7. significant changes in policies, plans or operations of the company.

The Supreme Court observed that the likelihood of the securities getting materially affected is inherent in items (i) to (vi) above.  But such is not the case with the information in item No. (vii).

While dealing with a case falling under Explanation (vii) of Regulation 2(ha), one may have to see whether there was any likelihood of the said information materially affecting the price of the securities of the company. Additionally, the activity in which the insider was involved also determines his culpability for violation of Regulation 3.

The Supreme Court observed that in the present case GIPL was awarded a contract for the execution of a project, whose total cost was admittedly Rs. 1648 crores. SIL was awarded a contract for a project whose cost was Rs. 940 crores. Both GIPL and SIL created Special Purpose Vehicles and then they entered into two shareholders Agreements. Under these Agreements, GIPL and SIL will have to make investments in the Special Purpose Vehicles created by each other, in such a manner that each of them will hold 49% equity interest in the other's project.

The acquisition by GIPL, of an equity interest in SIL’s project was worth Rs. 460 crores approximately. Similarly, the acquisition by SIL, of the equity interest in GIPL's project was worth Rs. 807.52 crores. Therefore, the cancellation of the shareholders Agreements resulted in GIPL gaining very hugely in terms of order book value. In such circumstances an ordinary man of prudence would expect an increase in the value of the shares of GIPL and would wait for the market trend to show itself up, if he actually desired to indulge in insider trading. But the respondent did not wait for the information about the market trend, after the information became public. The reason given by him, which is also accepted by the WTM and the SAT is that he had to dispose of his shares as well as certain other properties for the purpose of honoring a CDR package. It is on record that if the CDR package had not gone through successfully, the parent company of GIPL namely, Gammon India Ltd., could have gone for bankruptcy.  Therefore the findings of the SAT that the respondent had no motive or intention to make undeserved gains by encashing on the unpublished price sensitive information that he possessed was correct.

Therefore the Supreme Court was of the view that on Question No.1 that the information regarding the termination of the two contracts can be characterized as price sensitive information, in that it was likely to place the existing shareholders in an advantageous position, once the information came into the public domain. In such circumstances the  answer to Question No.2 would be that the sale by the respondent, of the shares held by him in GIPL would not fall within the mischief of insider trading, as it was somewhat similar to a distress sale, made before the information could have a positive impact on the price of the shares.  Question Nos. 1 and 2 are sufficient to hold that the impugned order of the SAT does not call for any interference.  The Supreme Court dismissed the appeal.