Pedestalizing Intention - A Vivid Interpretation of the Insider Trading Regulations
[Mayank and Rohan are students at Jindal Global Law School.]
The Securities Exchange Board of India (SEBI) came up with the SEBI Prohibition on Insider Trading Regulations 2015 (SEBI Regulations 2015) to protect free and fair market competition. Resultantly, penalties were imposed upon individuals for not just trading based on unpublished price sensitive information (UPSI) but also for communicating such information. UPSI is regarded as any information which can materially affect the price of the securities of a company. Regulation 4 of the SEBI Regulations 2015 clearly highlights that no person shall trade in securities when they are in possession of UPSI. To understand the legislative intent behind the relevant regulation, it becomes imperative to read the same with the explanation added to the Regulation in 2018. It stipulates that when an individual who has UPSI, trades based on such confidential information, there is a presumption that such action was based on the fact that such individual had knowledge and awareness of being in possession of UPSI. This simply means that while importing the explanation to Regulation 4, the legislative intent was to eliminate ‘intention’ as a criterion for holding someone liable for insider trading. All that was required to prove to trigger Regulation 4 was (i) trade, and (ii) trade while in possession of UPSI.
Regulation 4 was drafted with the vision to protect the information asymmetry that is caused when someone happens to have UPSI. Consequently, it can be argued that Regulation 4 is itself based on the principle of parity of information. This essentially means that because the person in possession of UPSI is on a pedestal, the level of compliance for such an individual is also higher. Resultantly, the acquirer’s intention becomes irrelevant, and it does not matter if the transaction benefits the company or its shareholders. However, the judicial pronouncements have concluded to the contrary. While discussing the scope of Regulation 4, courts have gone ahead and devised 'intention’ as a prerequisite for prosecuting someone under the provision. Through this article, the authors argue that the Indian judiciary has gone ahead and unreasonably diluted the legislative intent in the name of judicial interpretation.
Yardstick for Interpretation
To realise whether the judiciary has correctly interpreted Regulation 4 in its various dicta, it is imperative to purport the rules of statutory interpretation to Regulation 4. In Grundy v. Pinneger [(1852) 21 LJ Ch 405] Lord Caranworth, it was noted that the literal rule of statutory interpretation is the cardinal rule, and any deviation from it would be unfathomable, i.e., impossible to rectify. The apex court in Municipal Board, Pushkar v. State Transport Authority, Rajasthan held that the court must interpret a regulation as it is, in its grammatical form even if the conclusion is a harsh one. Thus, any argument stemming from the fact that Regulation 4 would disproportionately punish individuals who lacked motive would hold no ground in front of this ruling of the Supreme Court. Surprisingly, what the Indian courts have done is that they have imputed the mischief rule of interpretation while assessing the scope of Regulation 4 and subsequently widened it more than what the legislature envisioned.
To understand the real positionality and intent behind Regulation 4 and especially the explanation that was added vis-à-vis the SEBI Prohibition of Insider Trading (Amendment) Regulations 2018 (2018 Amendment), a reference must be drawn to the SEBI Prohibition of Insider Trading Regulations 1992 (SEBI Regulations 1992). Regulation 3(i) and 3A are pari materia to Regulation 4 of the SEBI Regulations 2015. The provisions of the SEBI Regulations 1992 did not explicitly provide for any presumption against an insider for trading with/without knowledge of UPSI. Therefore, this ambiguity and vagueness in terms of the provision allowed the court to use its understanding and interpretation by applying the mischief rule. This means that the court identified that there is a certain gap and uncertainty in the language of the law and to remedy it, they imputed their interpretation and endeavored to make the law more conclusive.
The Conflicting Judicial Dicta
In Rakesh Agarwal v. SEBI, it was noted by SEBI via a literal textual interpretation of Regulation 3 of the SEBI Regulations 1992 that mens rea does not have to be taken into consideration to prove insider trading. This essentially meant that SEBI construed the silence of the provision on the requirement of mens rea as the legislative intent behind not making ‘intention’ a prerequisite for triggering Regulation 3 of the SEBI Regulations 1992. However, on an appeal made to the Securities Appellate Tribunal (SAT), the Tribunal surprisingly took a different approach and observed that “it is true that the regulation does not specifically bring in mens rea as an ingredient of insider trading. But that does not mean that the motive need be ignored”. SAT while adjudicating the appeal observed that the legislative intent of Regulation 3 was to prohibit persons with UPSI to deal in securities to make secret profits. Therefore, an interpretation that ignores mens rea as an important ingredient to constitute insider trading will be a wrong interpretation of impugned Regulation. Further, SAT observed that under Section 15G of the SEBI Act 1992, a monetary penalty be imposed in a case of commission of insider trading.
However, the Supreme Court in The Chairman, SEBI v. Shriram Mutual Fund, reaffirmed the conclusion of SEBI noted in Rakesh Agarwal v. SEBI that mens rea was irrelevant to constitute insider trading but developed a separate rationale to arrive at this conclusion. The Court observed that Sections 15A to 15HB of the SEBI Act 1992 provide for only monetary penalties, which means the wrongs the above-mentioned provisions dealt with are civil wrongs. Contrarily, mens rea is a precondition in cases involving a criminal wrong and not a civil wrong. This means that the requirement of proving mens rea as a necessary element to seek remedy under Section 15G does not arise as the same deals with the regulation of penalty for insider trading which is of a civil nature. The court further held that “unless the language of the statute indicates the need to establish the presence of mens rea, it is wholly unnecessary to ascertain whether such a violation was intentional or not”.
Resultantly, it is submitted that the judicial position and understanding of Regulation 3 of the SEBI Regulations 1992 is amply clear. However, such scope of interpretation that was provided in the SEBI Regulations 1992 by it being silent on the aspect of ‘intention’ completely ceased to exist with its replacement by the SEBI Regulations 2015. Regulation 4 of the SEBI Regulations 2015 is devoid of all ambiguities related to the requirement of ‘intention’ via the 2018 Amendment that added the explanation to the relevant regulation. Thus, if courts hold the criterion of ‘knowledge’ or ‘intention’ mandatory, then that would unnecessarily lead to the creation of a third prong that would be antithetical to the objective of Regulation 4 of the SEBI Regulations 2015.
Surprisingly, even after the addition of the explanation to Regulation 4, courts are still imputing their interpretation to understand the ambit of the provision. In Balram Garg v. SEBI, the Supreme Court discussed the importance of proving intent to constitute insider trading. In this case, SEBI held that three persons were guilty of insider trading by relying only on circumstantial evidence. The Supreme Court set aside the decision of SEBI stating that circumstantial evidence cannot be the sole factor to charge people. The court reiterated the importance of proving intent to determine insider trading or else any person with the possibility of being a connected person would be held liable for insider trading based on circumstantial evidence.
More recently, in SEBI v. Abhijit Rajan, it was noted by the Supreme Court that the accused were not guilty of insider trading because they did not have any intention of making profits with the help of the UPSI in their possession. The court further went ahead to observe that “the actual gain or loss is immaterial, but the motive for making a gain is essential”. However, it is submitted that a very large assumption is taken by the court without taking into consideration the relevant material facts. The reason a higher threshold of care is expected out of a connected person is due to their access to such UPSI and their ability to manipulate trading accordingly. The access to UPSI puts insiders in an advantageous position in comparison to an ordinary individual by allowing them to control market forces and disrupt fair market practices. For the same reason, Regulation 5 of the SEBI Regulations 2015 requires such insiders to submit an elaborate trading plan that allows the regulatory bodies to constantly monitor the actions of such connected persons.
It is contended that the judicial decisions have led to the shifting of the onus of proof. It is now on the prosecuting agency to prove that the accused has the requisite intention to indulge in insider trading. Earlier, owing to the seriousness of the offence, the legislature has categorically put the burden on the accused themselves to prove their innocence and resultantly, created a de facto presumption against such an accused. The dichotomy perpetuated by the courts has created a hard barrier for the SEBI Regulations 2015 to achieve their objective. It is submitted that the requirement of intention can be regarded as an exception that must be fulfilled in certain cases, but making it a blanket rule would directly strike at legislative intent and allow courts to assume a significant amount of authority.