[By Deepanshu Agarwal and Khushal Juneja . The authors are students of UPES Dehradun]
Insider trading is the wrong of trading in securities with the favor of having asymmetrical access to unpublished information which when published would affect the price of securities in the market. The SEBI (Prohibition of Insider Trading) Regulations, 2015 (“regulations”) prohibits trading by person in possession of unpublished priced sensitive information (“UPSI”).
As per the ‘Tipper/Tippee’ theory of Insider Trading, the prohibition of insider trading must extend beyond the insider involved. This would ensure an overall protection from insider trading in the market. If not ensured, the insider could then spread the UPSI to his friends/relatives or even sell it to traders willing to purchase it. Here, the insider passing UPSI is called as ‘tipper’ & the party who receives it is called as ‘tippee’.
In India, any person can be deemed to be an insider so long as the connection with “access to” UPSI can be met, notwithstanding the degrees of separation from the company. This implies that even an innocent tippee/receiver i.e., one who receives the information in good faith & without having reasons to believe that such information is UPSI, can be deemed to be an ‘insider’. Even the accidental leak of UPSI, which entails no profits either to tipper or tippee, has not been exempted. This defeats the objective of the regulations which is to prevent undue advantage to parties over general investors.
This article analyzes the current application of the ‘tipper-tippee’ theory in India& also presents a way forward.
Position in India
As per the Black’s Law Dictionary, the term ‘innocent’ means ‘free from guilt’ or ‘acting in good faith’. Therefore, when it comes to determining the innocence in cases of insider trading, it is the intention which becomes relevant. In India, both the market regulator SEBI as well as the courts, have neglected intention as an important element when it comes to insider trading.
It is to be noted that the regulations itself specifies that mens rea is not considered essential while determining the liability for insider trading (notes to regulation 4). The fact that a person traded while in possession of UPSI is enough to presume a charge of insider trading. Apart from this, it has been held by the Bombay Court in the case of SEBI v. Cabot International Capital Corporation that “the SEBI Act & the Regulations are intended to regulate the Security Market & related aspects & the imposition of penalty under it cannot be tested on the ground of “no mens rea no penalty”. For breaches of provisions of SEBI Act & Regulations, which are civil in nature, mens rea is not essential.” This view was also upheld by the Hon’ble Supreme Court in the case of SEBI v. Shri Ram Mutual Fund, in which, while dealing with Chapter VI-A (including section 15G which deals with penalty for insider trading) of the SEBI Act, it was observed that the provisions under the said chapter imposes statutory liability & thus, intention of the person committing breaching of such provision becomes irrelevant. It was further held that the penalty must be imposed as soon as the statutory obligation is reached & the Adjudicating Officer should not be given any discretion in this regard.
Therefore, in the light of the above, it seems difficult as to how an innocent tippee finds a valid defense to the charge of insider trading in India.
Interestingly, SEBI has recently addressed this issue in the adjudication orders in the matters of Aditya Birla Sunlife AMC Limited, SBI FundsManagement Private Limited&Kotak Mahindra Life Insurance Company relating to investigation of alleged selective disclosure of UPSI by Mannapuram Finance Limited (“MFL”). The AMCs had traded in the securities of MFL pursuant to receiving a research report that disclosed UPSI about MFL. SEBI allowed for the defense of innocent tippees on the grounds that the report (a) was authored by a reputed broking entity, & (b) contained a disclaimer expressing that it was based on information which was publicly available.
Though the MFL orders have tried to establish a new jurisprudence for the innocent tippee’s defense in India, yet the foundation remains very weak. It is not reasonable that to provide for the defense of innocence, it is not essential to check the requirement of mens rea. The biggest lacunae in the SEBI orders is that it has turned a blind eye to the strict interpretation of the prevalent regulations as well as the rulings in Shri Ram &Cabot International. The conclusion arrived upon by the SEBI, omitting to delve into the basics, requires a thorough revisiting.
Position in US & UK
It was in the year 1984 that the US Supreme Court in the case of Dirks v. SEC established that while considering the liability for insider trading by tipper/tippee, the intention has to be scrutinized. The court laid down that the ‘personal benefit’ test which states that the “test is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach.” In other words, to establish the offence of insider trading post-Dirks, it was important to establish that the insider shared the information with the mala-fide intention to earn undue personal benefit. If this was established, it would amount to breach of fiduciary duty by the tipper. Moreover, the tippee would also be liable if he knows of the breach of fiduciary duty committed by the tipper.
The test has been made profound in the case of United States v Newman. The court held that to sustain an insider trading conviction against a tippee, the government must prove each of the following elements beyond a reasonable doubt: (1) the tipper was entrusted with a fiduciary duty; (2) the tipper breached his fiduciary duty by disclosing confidential information to a tippee, in exchange for a personal benefit; (3) the tippee knew of the tipper’s breach; & (4) the tippee used the information to trade in a security or to tip another individual for personal benefit.
The crucial point to be noted here is the intention of tippee being relevant. It is the tippee’s knowledge of tipper’s breach & his intention to gain personal benefit that attracts the liability for him. Similar to US, ‘intention’ is also considered an important element in UK when it comes to insider trading. This is the reason section 53 of the Criminal Justice Act, 1993 provide for some defenses to insider trading on bona-fide grounds. In order to raise defense, the accused must show that: (1)it was not expected at the time of dealing that the transaction would result in a profit; (2) he genuinely believed that the information was publically available; & (3) he would have done what he did even if he had not had the information.
The Way Forward
As it has been recognized worldwide, mens rea is an indispensible part of insider trading. It is the need of the hour that India’s capital markets regulator needs to realize this & subsequently, amend the regulations to pave the way for inclusion of mens rea. In fact, the defense of ‘innocent recipient’ was even suggested as a statutory defense for insider trading in the NK Sodhi High Level Committee Report in 2013. However, owing to the stern insider trading regime in India & the amount of subjectivity the change would bring with it, the defense was not incorporated back then. It is suggested that change proposed seven years back be implemented now. This would not only remove the prevailing complexities but would also bring the Indian laws at par with other jurisdictions.
India’s insider trading laws are too rigid to deal with. In the absence of any defense of lack of mens rea, it becomes too onerous for the defendants to tackle the allegations, even if they are innocent. Given the whopping amount of penalty prescribed for the insider trading, it becomes imperative to draft a law which grants equal positions to both the parties. This would not only strengthen insider trading regime in India but would also ensure a free & fair securities market.