A white-collar crime involving ethics rather than law, insider trading does not occur at the instance of petty clerks and accountants.
Following the imprisonment of Raj Rajaratnam and the subsequent indictment of Rajat Gupta, India Inc’s iconic leader, insider trading cases are making breaking news in Indian markets as well. A white collar crime involving ethics rather than law, insider trading does not occur at the instance of petty clerks and accountants, but is the making of those in the top layer, making it extremely difficult to detect and establish.
Introduced in 1992, the inadequacies of the Insider Trading Regulations (Regulations) were demonstrated fairly early. The Hindustan Lever Limited (HLL) insider trading case (1998) was perhaps the first under the Regulations, wherein SEBI’s findings on insider trading were set aside by the Securities’ Appellate Tribunal (SAT), which held that there was no trade involved, based on inside information, not being price sensitive, as it was available in the public domain. The definition of ‘Insider’ was subsequently amended and the Regulations re-vamped to include any person who “has received or has had access to such unpublished price sensitive information”, and not just a person who is or was connected with the company. A criterion of “deemed connected person” was introduced to include relatives of the connected person(s).
A recent adjudication of SEBI involves the trading of shares in a company by the name of Orchid Chemicals (OCPL), whose scrip value had fallen substantially due to off loading by Bear Stearns. However, the prices recovered and rose substantially fairly soon after the low period. The Exchange reports made certain adverse observations on a single trading activity during the low period by one Mrs Kaul, the wife of Mr V K Kaul (‘Kaul’), an independent director of Ranbaxy Laboratories (‘Ranbaxy’) the parent company of Solrex Pharmaceutical (‘Solrex’), which subsequently purchased OCPL shares. SEBI’s Investigation Report (IR) observes that the OCPL shares were bought in a window of 3 days prior to Solrex’s buying at Rs 131.71 and sold on April 10 @Rs 294/- per scrip. The IR alleged Mr Kaul to be a connected person of RLL trading on behalf of his wife, based on his access to the unpublished price sensitive information (UNPSI). Based on the above, a Show Cause Notice (SCN) was served on Kaul, which recorded that certain key officers were clearly aware of the deal on the dates the shares were acquired, and several telephonic connects between at least two senior officers and Kaul took place, but there was no conclusive proof. The concerned officers are believed to have independently confirmed to SEBI that they were not in possession of any UNPSI.
Kaul’s defence was no different from any other case of insider trading, that there was no supporting evidence, whether direct or circumstantial to establish the knowledge whether the shares would be purchased by Solrex or another Ranbaxy group company, and the SEBI’s conclusion was mere speculation. The law on the subject is clear – reiterated recently in the Rajarathnam case by the US Court that there cannot be an absolute proof of insider trading knowledge and activity. In a different case, the US Courts had observed “you cannot expect a tipper or tippee to voluntarily confess to passing or receiving insider information”.
Back home, the SAT in the Rajiv G Gandhi v. SEBI (2008) appeal had held that if an insider trades in the securities of a listed company, the presumption is on the basis that he had access to UNPSI, unless he is able to rebut the same and provide a plausible explanation to discharge the onus or justify the transaction e.g. a family emergency for which the sale was imperative.
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Kaul’s argument that as a Non-executive Independent Director not involved in day to day matters of the company or its subsidiaries during the relevant period he could not be charged for insider trading is moonshine. The definition of insider includes past connections, Kaul had been a whole time director and Head of Finance of Ranbaxy. Perhaps a more arguable defence emerges from the confusion occurring in the context of the definition of insider as ‘is or was connected with the company... reasonably expected to have price sensitive information in respect of securities of a company”. The defence sought to interpret this as the references to ‘a company and ‘the company’ being interchangeable, an insider had to be in connection with the target i.e. OCPL, which is clearly erroneous, but the language can do with refining.
Kaul has been slapped with a fine of Rs 50 lakhs, the punishment envisaged under Section 15g of the SEBI Act provides for the maximum fine to be Rs 25 crore or three times the amounts of profits derived, whichever is higher, and/ or imprisonment up to 10 years. Kaul’s penalization was rapidly followed by that of Manoj Gaur of Jaiprakash Associates and his family members, wherein the trading involved 500 shares and a net profit of Rs 2,216.93, and separate penalties of Rs 10 lakh on each family member was imposed. In the Gaur case SEBI relied on a Supreme Court judgment in the matter of SEBI vs. Shri Ram Mutual Fund, interpreting Section 15g to hold that penalty is attracted when the contravention takes place, the intention of the parties being irrelevant. The SAT ruling cited above does not take this into account in justifying insider trading. Clearly Supreme Court intervention is necessitated to resolve the inconsistency. But that’s a story for another day.
Kumkum Sen is a partner at Bharucha & Partners Delhi Office and can be reached at kumkum.sen@bharucha.in