[Sharun and Kiara are students at NALSAR University of Law.]
A recent ruling of the Supreme Court (Court) has fundamentally altered the acceptable criteria for adducing evidence in insider trading cases. In the landmark case of Balram Garg v. SEBI (Balram Garg), the Court delved into the intricacies surrounding the burden of proof imposed upon the Securities and Exchange Board of India (SEBI).
To understand the significance of this decision, it is imperative to familiarize oneself with the concept of insider trading and the associated burden of proof. Insider trading is proscribed under the provisions of Section 12-A(e) of the SEBI Act and the SEBI (Prohibition of Insider Trading) Regulations 2015 (PIT Regulations). These laws effectively restrict individuals who possess unpublished price-sensitive information (UPSI) from engaging in securities transactions. An individual is deemed to be an insider if they are affiliated with a company and have access to UPSI. For the purposes of this discussion, it is crucial to appreciate that SEBI is required to demonstrate that an individual was in possession of such sensitive information.
This article aims to provide an in-depth analysis of the Court's ruling in Balram Garg. It delves into the decision's implications and the shortcomings of the current legal framework that the ruling endeavours to rectify. Finally, the article evaluates the Court's judgment in light of similar rulings issued by foreign jurisdictions.
Understanding Balram Garg
The Balram Garg case concerned insider trading allegations within the company, P.C. Jewellers. Two brothers, P.C. Gupta and Balram Garg served as the Chairman and the Managing Director for the company, respectively. SEBI accused three family members, Sachin Gupta, Shivani Gupta, and Amit Garg, of trading in the company's shares through a holding company while being in possession of UPSI. The UPSI pertained to the company's announcement of a buyback of particular securities, which was later cancelled due to a lack of consent from the other party.
SEBI argued that the three individuals gained access to the UPSI through their proximity to Mr Gupta and Mr Garg, and claimed that both qualified as a "connected person" and "insider" under the PIT Regulations. The Securities Appellate Tribunal and the SEBI found the three individuals guilty of insider trading, but the Court overturned this ruling. The Court posed two central questions:
1) Whether the individuals were disconnected from the source of the UPSI?
2) Whether circumstantial evidence amounts to a sufficient criterion to classify a party as an insider?
The Court evaluated the relationship between the alleged insiders and communicators of the information while addressing the first issue. It determined that the parties were estranged in their personal and professional lives, making it highly unlikely for any UPSI communication to have taken place. The Court's assessment of the second question is pivotal in this matter. This ruling fundamentally impacted the evidentiary burden in insider trading cases by clarifying that patterns of trade and timing of trade cannot serve as the sole basis for determining an individual's status as an "insider". The Court found a lack of correlation between the UPSI and the trading patterns and stated that the decisions to sell shares and the timing thereof were purely personal and commercial in nature.
Consequently, the Court ruled that circumstantial evidence cannot be used to establish the existence of communication between the tipper and the tippee. Direct evidence such as letters, emails, and witnesses testifying to the parties' proximity must be presented to reach such a conclusion.
Filling the Gaps in the Law: Understanding the Jurisprudence
To appraise the significance of the Court's decision in Balram Garg, it is important to consider the evolving standard for evidence in insider trading cases. Historically, direct evidence in such cases has been rare, leading the courts to adopt a lower standard. The “prudent man's evaluation” of the case circumstances has been deemed crucial. The Sodhi Committee also emphasized that if direct evidence is lacking, the examination of the facts and circumstances of the case should determine access to UPSI. The judgment in SEBI v. Kishore R. Ajmera (Kishore Ajmera) established that circumstantial evidence can suffice in establishing insider trading if it creates an “irresistible inference” of information being conveyed between parties. Reliance was placed on trade patterns, the timing of the trade, and the volume and frequency of orders to make this determination. This viewpoint was strengthened in SEBI v. Rakhi Trading, where circumstantial evidence was held to be acceptable when direct evidence is absent.
Courts have since employed circumstantial evidence to build a presumption of guilt based on the entirety of the surrounding facts and circumstances, rather than simply one isolated occurrence. Kishore Ajmera outlined the broad strokes of handling circumstantial evidence with caution and restraint. However, despite this, courts have relied on incomplete and objectionable facts to hold parties guilty. Cases such as Deep Industries and Scrip of CRISIL have exemplified courts' discretionary interpretation of standards when evaluating circumstantial evidence. In Deep Industries, reliance was placed on Facebook likes to establish USPI sharing and proximity, whereas in the Scrip of CRISIL, only trading patterns and volume of trade were considered without any direct evidence of communication between the parties. This highlights that, despite the established standard for evaluating circumstantial evidence, courts may still exercise discretion in their interpretation.
The Court's ruling in Balram Garg has a significant impact on the application of circumstantial evidence in cases of insider trading. The decision aims to set a higher bar for evidence, to prevent instances where regulators win cases based on insufficient coincidental evidence without any direct proof of communication. The Court has now mandated the requirement for direct evidence, rather than leaving it to the Courts' discretion to interpret the strength of the circumstantial evidence chain. These instances of having a lower bar and condemning parties for the tiniest of coincidences would have a “chilling effect” on the market. Parties would prefer not to participate in the market for fear of getting into trouble. The Court has accurately interpreted Regulation 3 of the PIT Regulations, putting an end to the previous abuse of circumstantial evidence as a basis for guilt.
Pedestalizing Direct Evidence: A Step Too Far?
While the Court merits applause for enhancing the burden of proof on the regulator, it has to be criticized for going too far. By laying down the demand of “producing cogent materials” of communication of the USPI, it has failed to understand the ground reality that it is challenging for authorities to gather direct evidence. The current technological advancements make it difficult to obtain direct evidence, and from a practical standpoint, the regulators rely on circumstantial evidence such as patterns in the market to identify misconduct. Imposing the bar too high by only accepting direct evidence would also hinder the efforts made by regulators to maintain market integrity. The Court's decision needs to account for the difficulties faced by regulators in obtaining direct evidence.
Foreign jurisdictions have also grappled with the standard of “appropriate evidence” in insider trading cases. For instance, the US Securities Exchange Commission has faced criticism for its low threshold for admissible evidence. A recent ruling emphasized the need for more direct evidence to support a connection, highlighting a growing recognition of this legal principle. Meanwhile, in Canada, the case of Donna v. Hutchinson emphasized the importance of direct evidence, but also acknowledged that circumstantial evidence can play a role in filling “evidentiary gaps”. The court stated that final conclusions must be based on clear and convincing evidence, and regulators must consider all relevant circumstances in a balanced manner between direct evidence and the preponderance of probability.
Proving the tipper-tippee relationship has been a thorn in the shoes of enforcement agencies all over. Establishing a cogent link to the passing of information is the key to convicting a party of insider trading. Consequently, the author maintains that the actions must be considered in their entirety, in light of the surrounding circumstances. The Court should have adopted a balanced approach, raising the standard of evidence, whilst allowing the use of circumstantial evidence to fill any evidentiary gaps. Using actions in isolation would harm traders; however, enabling circumstantial evidence to be stitched together like a mosaic would preserve a firm threshold while also allowing the regulator to detect illicit activity in the securities market.
Conclusion
The author argues that the Court must take a balanced approach while evaluating evidence when dealing with complex issues such as insider trading. The author believes that the Court's decision, in this case, was appropriate in terms of the burden of proof, but the undervaluation of circumstantial evidence was a misstep. This argumentative sanctuary is critical for regulators because other options are rarely available. The author suggests that courts should consider the entire chain of circumstances and the overall context of the situation instead of relying on isolated pieces of evidence such as emails or phone calls. Adopting this approach will enhance the quality of investigations and protect traders and investors without having a “chilling effect” on the market. This decision will prompt SEBI and other regulatory bodies to reassess their investigation, prosecution, and penalty strategies that contribute significantly to the current quandary.