The SEBI (Prohibition of Insider Trading) Regulations, 2015 prohibit an 'insider' from trading in securities while in possession of unpublished price sensitive information. However, when charging a person with violating the Regulations, SEBI's finding must be based on proper and cogent material and cannot be founded upon circumstantial evidence.
The Supreme Court of India in Balram Garg v. Securities and Exchange Board of India (SEBI) was faced with an interesting question on whether SEBI can charge an individual for being an 'insider' under the SEBI (Prohibition of Insider Trading) Regulations, 2015 (PIT Regulations) solely based on circumstantial evidence.
Facts leading to the dispute
The dispute arose in relation to SEBI's investigation into alleged insider trading in respect of securities of P.C Jewellers Ltd. (Company). SEBI alleged that Balram Garg, the managing director of the Company, (Managing Director) had disclosed unpublished price sensitive information (UPSI) regarding a potential buyback of the Company's shares to his nephews Amit Garg and Sachin Gupta, and Sachin Gupta's wife, Shivani Gupta (together the relatives) in relation to a potential buyback of shares of the Company. The disclosure of UPSI was supposed to have occurred between 1 April 2018 to 31 July 2018 (Investigation Period).
In addition to the fact that they were related, in order to establish proximity, SEBI alleged that the relatives and the Managing Director shared the same residence.
Shivani Gupta had authorised her husband's cousin, Amit Garg, to trade on her behalf and undertook trades in the shares of the Company while allegedly in possession of UPSI in 3 phases:
- From 2 April 2018 to 24 April 2018 (Phase I)
– Shivani Gupta sold 74,35,071 shares of the Company –
the Company only announced the proposed buyback on 10 May
- From 22 June 2018 to 6 July 2018 (Phase II)
– Shivani Gupta sold 1,00,000 shares of the Company –
State Bank of India (SBI), the lead banker of the
Company refused to grant a a no-objection certificate for the
proposed buyback on 7 July 2018; and
- From 7 July 2018 to 13 July 2018 (Phase III) – Shivani Gupta sold 15,00,000 shares of the Company – the Company disclosed the withdrawal of the proposed buyback on 13 July 2018.
Shivani Gupta continued to hold 12,84,111 shares of the Company upon completion of the above sales.
SEBI had based its charge on the fact that a preponderance of probabilities indicated that the Managing Director had disclosed UPSI to the relatives and that this was evidenced by Shivani Gupta's trading pattern. SEBI held that due to their alleged proximity with the Managing Director, the relatives were "...in possession of or having access to UPSI..."1 and, therefore, 'insiders' in terms of the PIT Regulations. Interestingly, SEBI held that that the relatives were not "connected persons"2 or "immediate relatives"3 qua the Managing Director. SEBI's findings were subsequently confirmed by the Securities Appellate Tribunal (SAT).
Issues at hand
The Supreme Court had to determine:
- Whether SEBI and SAT were correct in presuming that the
relatives were in possession of UPSI based on their alleged close
relationship with the Managing Director, and
- Whether the relatives could be held to be 'insiders' in terms of the PIT Regulations solely on the basis of circumstantial evidence.
Presumption must follow proper appreciation of facts and evidence
Regulation 2(1)(g) of the PIT Regulations defines an 'insider' as any person who is:
- a connected person; or
- in possession of or having access to UPSI
SEBI had, in its show cause notice, concluded that the relatives were not 'connected persons' in terms of Regulation 2(1)(d)(i) of the PIT Regulations or 'immediate relatives' in terms of Regulation 2(1)(f) of the PIT Regulations. Therefore, they could only be 'insiders' if they were in possession of, or had access to, UPSI.
In the proceedings before SEBI, the relatives contended that they were estranged from their family and did not have the required connection with the Managing Director to obtain UPSI. The estrangement was evidenced by 2 family arrangements which were entered into in 2015. Pursuant to the family arrangements, the relatives ceased to be associated with or hold any positions in the Company. Given that their personal and professional relationship with the Managing Director had ceased in 2015, the relatives contended that they could not have been insiders in 2018 when the trades in question took place.
The Supreme Court held that both SEBI and SAT had erred in failing to appreciate the facts of the case. There was clear evidence of a breakdown of ties both at a professional and personal level, particularly since the estrangement occurred prior to UPSI coming into existence. As far as the alleged common residence was concerned, the Supreme Court observed that although the plot of land was common, it was large, and the Managing Director and the relatives and their respective families lived in separate buildings.
The Supreme Court also opined that SEBI and SAT's reasoning that the relatives were in possession of, or had access to, UPSI based on a preponderance of probabilities was unsustainable in law. Given that SEBI – and, subsequently, SAT – had concluded that the relatives were not 'connected persons' or 'immediate relatives' under the PIT Regulations, SEBI could not have then relied on the nature of the relationship between the Managing Director and the relatives to reach its conclusions.
On the contrary, the Supreme Court also observed that the PIT Regulations provided that the onus of proving that persons who were not connected persons were in possession of, or had access to, UPSI was on SEBI. However, there was no direct evidence to establish if anyone had disclosed the UPSI to the relatives. SEBI had simply proceeded on the assumption that the relatives had access to UPSI by virtue of their relationship to the Managing Director, and that the relatives had failed to demonstrate estrangement. SEBI had, therefore, failed to establish this requirement of proof, and SAT was incorrect in discharging SEBI of this burden.
The PIT Regulations and circumstantial evidence
The second question before the Supreme Court was whether the relatives could be held to be 'insiders' solely on the basis of circumstantial evidence. The circumstantial evidence in this present case was the trading pattern of the relatives during the Investigation Period.
The Court analysed each phase during which Shivani Gupta undertook trading in the securities of the Company and reached the following conclusions:
- Phase I – the Court held that the show cause notice does
not contain any allegations for the trades undertaken during this
- Phase II – the Court held that while the shares of the
Company were sold on 6 July 2018, it was only on 7 July 2018 that
SBI conveyed its refusal to issue a no objection certificated for
the proposed buyback was refused. Therefore, the relevant UPSI had
not come into existence when the shares were sold on 6 July 2018.
Therefore, there was no question of the relatives having traded on
the basis of UPSI;
- Phase III – while Shivani Gupta had sold 15,00,000 shares of the Company during Phase III, she had not disposed of all her shares in the Company and continued to hold 12,84,111 shares out of the total shares that were transferred to her by way of one of the family arrangements of 2015.
Moreover, the Court also observed that the share price of the Company continued to fall across the Investigation Period (including after the announcement of the buyback offer and after the announcement of the withdrawal of the buyback offer).
Based upon its analysis and appreciation of the facts on record, the Court held that the decisions to sell the shares of the Company were purely personal and commercial in nature, and nothing more could be imputed from these decisions.
The Court further opined that an offence of 'communication or procurement' of UPSI can only be established through the production of cogent materials. In fact, the onus is on SEBI to properly investigate and establish the communication of UPSI though letters, emails, witnesses, etc. SEBI cannot simply presume that communication occurred based on the alleged proximity between the parties. Analysing a plethora of judgements on presumption, the Court held that even where a presumption is drawn, it must be on the basis of established foundational facts and circumstances. In the present case, SEBI failed to produce any material on record to establish the communication or procurement of UPSI by the relatives, or that they were 'connected persons' or 'immediate relatives'. Consequently, in absence of these essential foundational facts and circumstances, a presumption of communication of UPSI by the Managing Director to his relatives could not be established.
Finally, the Court sounded a note of caution to SAT, and observed that SAT ought to have exercised its jurisdiction as a First Appellate Court and independently assessed the evidence and material on record.
Another blow to SEBI
SEBI's investigation procedures have come under fire from the Supreme Court recently, and the observations in Balram Garg are yet another blow. The Supreme Court has cautioned SEBI that while it has been granted wide powers under the SEBI Act, 1992, such powers should always be exercised judicially and not arbitrarily. In fact, by dealing and analysing the facts in great detail, the Supreme Court has reminded SEBI that, while conducting investigations, it must independently apply its mind rather than following a mechanical procedure. SEBI must, in its capacity as an independent quasi-judicial authority, abide by the doctrine of fair play and following established principles of law.
1. Final Order dated 11 May 2021 in the matter of Insider Trading in the scrip of P.C. Jeweller Ltd., available at https://www.sebi.gov.in/enforcement/orders/may-2021/final-order-in-the-matter-of-insider-trading-in-the-scrip-of-pc-jeweller-ltd-_50111.html and last accessed at 1700 hours on 14 June 2022.
2. Regulation 2(1)(d)(i) of the PIT Regulations defines a 'connected person' as a person who in the 6 months prior to the alleged act of insider trading was associated with the company, directly or indirectly, in any capacity. The linkage between the association of the person with the UPSI needs to be founded based on, frequent communication of the person with the officers of the company, or, the person enjoying a contractual, fiduciary or employment relationship with the company, or, the person being a director, officer or an employee of the company, or, the person enjoying a professional or business relationship with the company. Pertinently, the PIT Regulations also provide for an 'immediate relative' to be presumed as a 'connected person', however such presumption being a legal fiction can be rebutted based on the facts of each case.
3. Regulation 2(1)(f) of the PIT Regulations defines an 'immediate relative' as a "spouse of a person, and includes parent, sibling, and child of such person or of the spouse, any of whom is either dependent financially on such person, or consults such person in taking decisions relating to trading in securities".
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