Insider Trading and Mens Rea: Indian Jurisprudence, Comparative Developments and the Way Forward
[Shruti is a student at NALSAR University of Law.]
The recent pronouncement of the Supreme Court (SC) -- that the mere possession of unpublished price-sensitive information (UPSI), in the absence of profit motive, is insufficient to prove insider trading -- may significantly bolster the Indian position on mens rea in insider trading jurisprudence.
Central Issues and Status Quo
Insider trading is unlawful in India as per the Securities and Exchange Board of India Act 2002. The Securities and Exchange Board of India (SEBI) issued the SEBI (Prohibition of Insider Trading) Regulations 2015 with the intention of outlawing and regulating insider trading in India. The central issue in the present case is the agreements between Gammon Infrastructure Projects Limited (Gammon India) and Simplex Infrastructures Limited (Simplex Infrastructures). Under these agreements, Gammon India and Simplex Infrastructures agreed to invest 49% equity capital into the projects of the other company. These arrangements were subsequently terminated in 2013.
On 22 September 2013, Gammon India's Chairman and Managing Director, Mr. Abhijit Rajan, transacted the sale of 14.4 million shares of the company. Concurrently, there was no public announcement of the termination of the projects until 30 September 2013. The eventual revelation caused a significant increase in the price of Gammon India's shares since it was now the sole owner of the road project. SEBI then issued an order against him in response to allegations that Rajan had engaged in unlawful insider trading. The Securities Appellate Tribunal (SAT) issued a verdict in 2019 that went in Rajan's favor, which was subsequently challenged by SEBI before the SC.
The SEBI passed the SEBI (Prohibition of Insider Trading) (Amendments) Regulations 2018 (PIT Regulations), in order to prohibit 'dealing in securities', which is defined as buying, selling, or agreeing to buy, sell, or deal in any securities by any person either as principal or agent, by insiders on the basis of any ‘unpublished price sensitive information’. On a broad reading of these provisions, insiders are prohibited from disclosing or discussing any confidential information with other parties. It is necessary for the transmission or revelation of the content at issue for the act to be against the law. Hence, the previous standard of there being an innocent tippee liability is not entirely accepted as being equitable.
Insider Trading in the USA
On the other hand, potential defendants in economic crime cases who might face prosecution in the United States have very strong cause to fear that they will be found guilty. It is a widely held belief that the US law enforcement for economic offenses will go much further under the administration of President Joe Biden.
At present, Rule 10b-5 of the Securities and Exchange Commission (SEC) prohibits officers, directors, and other employees who have access to non-public information from trading on the company's shares with the intention of generating a profit (or avoiding a loss) as a result of the information confidentially. The disclosure of confidential information to third parties, also known as 'tipping', is strictly forbidden under this provision.
Rule 10b-5 indeed encompasses a scope that is far larger than that of officers, directors, and major investors. This regulation applies to any employee of the company who trades (i.e., buys or sells) the company's stock or other securities after obtaining non-public information about the company or receiving a "tip" from an insider of the company regarding material, non-public information about the company, with the standard of the fiduciary relationship or duty having been established in the case of United States v. Newman. Due to this, the rules have been broader, and the burden of proof has more definitely been moved from the prosecution to the defendants.
However, the US Supreme Court has remained invested in expounding the importance of intention ("wilfulness") in insider trading- while laying the groundwork for a reliable standard to determine this criterion. In the case of United States v. Dixon, Friendly J. found that "innocent mistake, ignorance, or inadvertence" are not included in the definition of "wilful". The court went on to decide in the above-mentioned case that the "wilfulness" threshold is satisfied when an actor deliberately disregards or disobeys securities laws while being aware that doing so involves a considerable risk of breaking the law.
In an attempt to shed light on the meaning of "wilfulness", Judge William B. Herlands wrote an article titled "Criminal Law Aspects of the Securities Exchange Act of 1934." In this, he argued that the prosecution need only prove that the defendant "realized on his part that he was doing a wrongful act," rather than proving that the defendant had prior knowledge of the relevant statute or rule. The Ninth Circuit Court of Appeals has generally adopted this ruling in securities fraud cases.
Insider Trading as a Public Welfare Offense (PWO)
One of the arguments against engaging in insider trading is the concern that the market would suffer adverse effects if just a select few players were able to profit from significantly material non-public information. That might be detrimental to people's confidence in the economy, causing the public to grow apprehensive of investing their money into the financial markets.
Those who have access to information that is not readily available to the public may be able to defend themselves against losses and benefit from any upswings. This brings the risk that would otherwise be borne by investors to a level that is more manageable, given that they now have access to the information. As a result of the public's lack of trust in the markets, businesses may have a more difficult time securing access to finance through the primary financial markets. Therefore, characterizing these aspects and repercussions of insider trading as a PWO would mean that mens rea is not necessary - thus supporting the previous Indian position on this aspect.
Regulation 4(1) of the PIT Regulations prohibits trading in securities that are listed or proposed to be listed on a stock exchange when in possession of UPSI. Further, there exists a rebuttable presumption of motivation in the possessor of such UPSI.
Arguably, the ambiguity in the meaning of ‘intent’ or ‘motivation’ may undermine the intended deterrent effect of insider trading laws. In law per se, the mere fact of possession of UPSI should not be considered sufficient grounds to constitute insider trading because the majority of directors and senior executive people of a firm would have access to the aforementioned information. Additionally, this can deter prospective investors from investing money into the company or being engaged in its management.
In the present case, the shares were sold by Rajan. The SC ruled that there was, nonetheless, no clear profit motive involved as the transactions were likely to result in loss.
A reference to previous cases may be relevant here. It was the previous position in the contentious case of Reliance Petroinvestments Limited and Rajiv B Gandhi v. SEBI that if a person trades while in knowledge of UPSI, it is presumed that they engaged in insider trading. In addition, the Bombay High Court ruled in the case SEBI v. Cabot International Capital Corporation that the SEBI Act and related regulations are meant to control the securities market and associated elements. Further, the imposition of penalties under the insider trading regime cannot be disputed on the premise of "no mens rea, no punishment."
In view of the above, it is necessary that the Indian law develops a cohesive standard based on mens rea, either through legislative provisions or judicial precedents, to prevent any wrongdoer from escaping accountability on the pretext of ambiguity and to provide the market with a clear notion of what behavior draws culpability. Such clarity may bolster confidence in various categories of market participants.