Across jurisdictions, the mischief of insider trading is sought to be curbed and punished by the market regulators since any securities market of repute would measure its success, among other variables, based on the integrity and fairness of transactions conducted on its platform. As such, the prohibition of insider trading stems from the moral imperative, which demands that there is no information asymmetry between insiders and other shareholders while dealing in listed securities. This effectively translates into restraint being exercised by insiders i.e. the persons who have access to the unpublished price sensitive information in relation to the listed securities in which they deal.
Interestingly, the SEBI (Prohibition of Insider Trading) Regulations, 2015 (“PIT Regulations”) does not define the term ‘insider trading’ but a person is presumed to be guilty of insider trading if the following twin conditions are conjunctively met: (i) such person is an insider of a company in whose listed securities he deals; and (ii) such person dealt, directly or indirectly, in the listed securities in relation to which he possesses unpublished price sensitive information (“UPSI”). Once these twin conditions are satisfied, the onus then shifts on to the insider to prove his innocence by relying on any of the prescribed defenses.
While the legal regime surrounding insider trading may seem straight-forward, the charges of insider trading are often hard to prove owing to difficulty in providing direct evidence of the chain of information flow. On the other hand, the strong presumption of guilt under the PIT Regulations can sometimes lead to illogical conclusions.
In this blog post, we will discuss the recent ruling of the Supreme Court in the case of SEBI vs. Abhijit Rajan and the decision of the SEBI to amend the PIT Regulations to bring trading in mutual fund units by insiders under the insider trading regime.
Recently, the judgment by the Supreme Court (“SC”) in the case of Securities and Exchange Board of India vs. Abhijit Rajan (“Abhijit Rajan case”) made headlines. The Abhijit Rajan case held that while the actual gain or loss is immaterial in cases of insider trading, the underlying motive to make underserved gains by encashing on the UPSI is essential to successfully prove the charge of insider trading.
The Abhijit Rajan case was based against the backdrop of the erstwhile 1992 insider trading regulations, wherein Abhijit Rajan, the then chairman and managing director of Gammon Infrastructure Project Limited (“GIPL”), sold shares of GIPL worth approximately INR 10 crore in 2013. This sale took place in the period between termination of GIPL’s shareholder agreements (“SHAs”) with Simplex Infrastructure Limited (“SIL”) for execution of roadway projects worth approximately INR 1648 crore by GIPL and INR 940 crore by SIL, and the point when GIPL disclosed the said termination to the public through stock exchanges. Pursuant to the regulatory inquiries, Mr. Rajan was held to have indulged in insider trading and was directed to disgorge all profits made from the sale. However subsequently, Securities Appellate Tribunal (“SAT”) set aside SEBI’s order on the grounds that: (a) information in respect of the termination of SHAs were not price sensitive since GIPL’s investment in SIL constituted only 0.05% of GIPL’s order book value; and (b) there was a dire need to sell the shares to prevent GIPL’s parent company from going into bankruptcy. The SEBI’s challenge to the aforesaid SAT order became the subject matter of the SC’s order in the Abhijit Rajan case.
Issues before the Supreme Court
The two key issues before the SC were: (a) firstly, whether the termination of the SHAs constituted price sensitive information; and (b) secondly, whether the sale transaction fell within the mischief of insider trading.
On the first issue, the SC noted the need to determine if there was any likelihood that the said information could materially affect the price of the securities. The SC agreed with the contention of SEBI that the de-minimis rule has no application to insider trading as it brings an element of subjectivity. Therefore, notwithstanding the fact that GIPL’s investment in SIL constituted only 0.05% of GIPL’s order book value and 0.7% of its turnover, termination of both the contracts put GIPL in a more advantageous position, in which one would have expected the price of the securities to soar. Accordingly, it was held that the termination of the SHAs could be characterised as price sensitive information.
Similarly, the SC noted that the magnitude of what an insider did, in relation to the size of the company, may not have a bearing on the question whether someone indulged in insider trading or not.
However, to finally determine the second issue of whether or not the mischief of insider trading has been committed, the SC went beyond the technical reading of the PIT Regulations and applied the test of profit motive i.e. establishing if an attempt was made to take advantage or encash the benefit of UPSI. The SC explored arithmetic of market movement based on the nature of the UPSI and its correlation to the actions of the insider who is alleged to have committed insider trading.
In SC’s view, the termination of the SHAs put GIPL in a more advantageous position, the fact of which when made public could have had a positive impact on the price of the shares in the assessment of a man of ordinary prudence. As such, if the insider would have intended to, in fact, encash the benefit of the UPSI, he would have either purchased more shares in anticipation of the notional gains which would have accrued on such shares upon the disclosure of the termination or undertaken the sale transaction only after the UPSI (positive news) become public. Based on this analysis, the SC concluded that the sale transaction by the insider did not originate out of an unlawful information arbitrage but only on account of a pressing necessity to prevent GIPL’s parent company from going into bankruptcy, and as such, did not fall within the ambit of insider trading.
SEBI, in its board meeting of September 30, 2022, approved the proposal for amendment to the PIT Regulations for inclusion of trading in units of mutual funds (“MFs”) through a separate chapter (“PIT Amendment”). The official notification of the PIT Amendment is awaited. In the meantime, it may be worthwhile to re-visit the SEBI’s discussion paper in this regard issued in July 2022 (“Consultation Paper”) and the related background.
The SEBI floated a Consultation Paper and, highlighted that the reason for bringing trading in MF units within the ambit of PIT Regulations is the recent instances of misuse of sensitive, non-public information pertaining to MF schemes by persons who have access to such information by virtue of their fiduciary capacity.
In the Franklin Templeton case, it was argued that the SEBI may be guilty of regulatory overreach if it sought to apply in the present case the principles used in prosecuting insider trading cases since PIT Regulations expressly excluded MF units from its applicability. Following this, SEBI seems to have sharpened its knives by introducing a circular on October 28, 2021 (“SEBI MF Circular”) to update its existing framework for regulating investment/ trading in securities (including MF units) by employees or board members of asset management companies and trustees of MFs. In view of the SEBI MF Circular, some industry experts are of the opinion that there already exists a robust mechanism for SEBI to regulate trading in MF units by employees of MF units, and bringing trading in units of MFs under the ambit of insider trading even by market intermediaries and professional firms may lead to unintended red-tape and litigious enforcement.
Although there were several mitigating factors to be considered in the Abhijit Rajan case (such as, the alleged transaction being akin to a distressed sale on account of the impending bankruptcy of GIPL’s parent company), the SC’s order in this case is likely to result in a paradigm shift in insider trading prosecution. In addition to the codified defenses made available under the PIT Regulations in case of insider trading allegations, the lack of profit motive could be argued as a valid defense going forward. By reading in the requirement of ‘attempt by the insider to encash the benefit’ as an essential part of the offence of insider trading, the SC has clearly moved away from the strict liability approach adopted by the SEBI until now. However, it stopped short of putting in a requirement to prove mens rea for establishing the offence of insider trading and seemed inclined towards a preponderance of probability threshold which avoids illogical convictions as was the case in the Abhijit Rajan case. Only time will tell how well SEBI and SAT have walked this fine balance.
As regards to trading in units of MF being included within the ambit of PIT Regulations, there may be merit in bringing unfair trade practices in relation to MF units within the ambit of insider trading to enable swift and harmonised enforcement action in cases of abuse of information asymmetry. Indeed, it is also refreshing to see that the SEBI itself had noted in its Consultation Paper that the regulatory approach for such cases should not be onerous, recognising the very apparent distinction between MF units and other securities. Given that the market regulator also mandates alignment of interest of key employees of asset management companies by requiring part of their compensation to be paid in MF units, a very rigid regime can be counterintuitive.
 “insider” means any person who is: (i) a connected person; or (ii) in possession of or having access to unpublished price sensitive information. “connected person” means inter alia any person who is or has during the six months prior to the concerned act been associated with a company, directly or indirectly, in any capacity including by reason of frequent communication with its officers or by being in any contractual, fiduciary or employment relationship or by being a director, officer or an employee of the company or holds any position including a professional or business relationship between himself and the company whether temporary or permanent, that allows such person, directly or indirectly, access to unpublished price sensitive information or is reasonably expected to allow such access.
 “unpublished price sensitive information” means any information, relating to a company or its securities, directly or indirectly, that is not generally available which upon becoming generally available, is likely to materially affect the price of the securities […].
 Civil Appeal No. 563 of 2020, Supreme Court order dated September 19, 2022
 SEBI Press Release PR No.29/ 2022
 Consultation Paper on applicability of SEBI (Prohibition of Insider Trading) Regulations 2015 to Mutual Fund units issued by SEBI on July 08, 2022
 SEBI Order WTM/ GM/ IMD/ 06/ 2021-22 dated June 07, 2021
 SEBI Circular SEBI/HO/IMD/IMD-I DOF5/P/CIR/2021/654 dated October 28, 2021