SEBI's Insider Trading And Unfair Trade Regulations May Soon Have A Baby
The regulator wants to change the rules of the game for enforcement against insider trading and fraudulent activity. Here's how.
Mule accounts. Layering of funds. Encrypted, vanishing communication. Concealed identifies. Untraceable funding arrangements.
These are some of the hurdles that markets regulator SEBI runs into while establishing insider trading or unfair trade practice violations. The legal standard under both these frameworks is circumstantial evidence and preponderance of probability—that is evidence which indicates a high probability of a violation.
But encrypted means of communication and proving suspected entities are connected is increasingly becoming challenging for the regulator.
This challenge may soon lead to an offspring.
The Securities and Exchange Board of India has proposed a new framework for unexplained suspicious trading activities.
If implemented in the proposed form, it will make repetitive abnormal gainful trades, around the presence of material non-public information, unlawful. And, in a significant deviation from existing rules against insider trading and unfair trade practices, the burden of proof will be on the accused.
Acknowledging the need for a new framework, Trilegal's Shruti Rajan said that there is a universe of trading activity, that does not fit into the insider trading, or unfair trade practices regulations.
According to Regstreet Law Advisors' Sumit Agrawal, this proposal is trying to address two of the Supreme Court's decisions.
One, the PC Jeweller case, where the apex court had held that only circumstantial evidence such as trading pattern, without establishing possession and communication of unpublished price-sensitive information, cannot be enough to bring insider trading charges.
And two, the Abhijit Rajan case, where it was held that profit motive of the insider is an essential precondition for a successful insider trading charge.
These judicial pronouncements, coupled with the government's reluctance to grant SEBI the powers to decrypt electronic communications, have resulted in the markets regulator proposing this new framework, Agrawal said.
But the issue is that SEBI is saying that the presumption of guilt approach it is proposing is similar to what income tax law provides vis-à-vis unexplained cash credits. However, the provision under income tax, and similar ones under other laws, are provided in the parent legislation. No such provision exists in the SEBI Act itself, Agrawal highlighted.
Now, imagine if SEBI could, merely on the basis of suspicion, use its powers to pass ex-parte, interim orders, it'll really be draconian. So, the constitutionality of such a provision is questionable, which means SEBI will have to provide safeguards if it implements this proposal.Sumit Agrawal, Founding Partner, Regstreet Law Advisors
To be clear, the regulator has listed some defences that an accused could take, namely:
Trades were not made basis material non-public information.
Trading pattern was not repetitive, does not show substantial change in risk taken.
Trading activity did not deliver abnormal profit, or avert abnormal loss.
For any defence an accused takes, detailed documentary evidence will need to be provided, according to the proposal.
The defences need to be relooked at, Rajan said, pointing out that several others will need to be added.
Let's say quant traders whose goal is to achieve abnormal profits. They may be unable to show that the trading pattern was not repetitive, since they are guided by algos, AI. So, SEBI may have to give an exemption to certain kinds of businesses.Shruti Rajan, Partner, Trilegal
And, unless the regulator is able to discharge a higher burden of proof in terms of access to information, the entity shouldn't be held liable, she said.
Insider Trading: SEBI Wants To Change Rules Of The Game
Besides this new framework, SEBI has also proposed a significant amendment to its insider trading framework.
The rules make trades based on unpublished price-sensitive information unlawful. Now, SEBI has proposed to change the definition of UPSI, to say that trades based on material information will fall foul of the regulations.
The materiality threshold under Listing Regulation will now apply to insider trading too, SEBI has proposed.
To back its suggestions, the regulator has cited ,1100 disclosures by the top 100 listed companies between January 2021 and September 2022. In 227 cases, the information impacted the stock price by over 2%; but only 18 were categorised as price sensitive by the companies.
SEBI has cited this data to show that while trades are being made basis UPSI, it's unable to bring enforcement action against individuals, since companies themselves are not categorising the information as UPSI.
Those of us who have seen the law evolve will find this proposal quite surprising, Rajan said. This was something that the stakeholders thought was settled after the 2018 TK Viswanathan Committee report, which had noted that not all material information is price sensitive, post which the law was amended, she said.
This proposal, if implemented, will make the life of compliance officers very difficult. If they've to now treat all material information as UPSI, they have to take steps like trading window closure, pre-clearances, etc. So, SEBI will need to give clarity on these aspects as well.Shruti Rajan, Partner, Trilegal
Also, if the regulator goes ahead with this, it needs to specify that only material information emanating from the company will be considered as UPSI. Else, even a notice of an investigation or regulatory scrutiny will trigger this threshold, Rajan said.
Agrawal said that across regulations and proposals, SEBI is using various terms like unpublished price-sensitive information, material non-public information, material information or a material event. "This has completely blurred the regulatory landscape, and companies are not able to make a distinction despite the best of intentions."