Deceit-free fraud and stigma-free indictment

One would truly know one has lost one’s way with regulating fraud when told that there can be fraud without deceit and injury without a victim. Unfortunately, securities market regulation and enforcement are getting there rapidly.

Essentially, two bodies of law are at play — regulations prohibiting violative insider trading and those prohibiting fraudulent and unfair trade practices relating to the securities market. A series of regulatory enforcements, based primarily on regulations designed as a body of principles but enforced like a hidebound set of rules, is taking the Indian securities market to a domain of fraud without deceit.  

At the heart of the problem is a general perception that in India fraudsters get away lightly and that they are so innovative that the standards laid down by law to hold one guilty should be kept low. In that narrative lies the design problem. The regulations prohibiting fraudulent and unfair trade practices, define “fraud” consistent with how fraud is understood across legislation across the globe — essentially, actions involving lying, deception, misrepresentation, suppression of material information and the like. However, one particular charging provision, that puts the definition to use, equates fraudulent transactions with “unfair trade practices”, by bringing the term within its sweep and listing out a set of practices that would be “deemed” by legal fiction to be manipulative,  fraudulent or unfair.

Used thus, one could interpret the term “unfair trade practice” to be a trade practice that is unfair (as understood commonly) and is in the nature of being fraudulent or manipulative. Words used in sequence are meant to be read that way. However, another way to read the phrase is that anything that is unfair is necessarily prohibited and, therefore, to be visited with the same consequences as faced by a fraud. This is where the problematic nature of the beast rears its head.  

Indeed, it is routinely argued that intention and state of mind do not have to be established in securities regulatory enforcement. When applied in the context of treating reckless conduct as being violative, this is a sustainable argument. However, when applied in the context of stating that anything that is unfair to anyone is the same as fraud can lead to complications — one would then be faced with situations like a share trade between a husband and  wife sitting at home without touching the securities market, being heightened to a securities market fraud on the grounds that they priced their trade way off the market price. This has indeed been alleged however incredible it may sound.

Likewise, regulations prohibiting insider trading, outlaw trading by an insider when in possession of unpublished price sensitive information. The principle is that what the mind is possessed of would influence the decision taken by the same mind. Therefore, if an insider’s mind knows about an adverse development about a company’s future that is not yet publicly announced, a decision to sell shares of that company would presumably be motivated by a desire to profit from such information. Yet, routinely, one sees proceedings being initiated without regard to the state of mind of the persons who decided to trade in securities. One even sees advisers losing sight of first principles and opining that buying despite being in possession of unpublished adverse news is violative insider trading. Or for that matter, selling shares despite being in possession of unpublished positive news, is violative insider trading.

It gets worse. The regulations governing insider trading have taken an innovative turn. They not only codify principles into regulations but also set out the legislative intent underlying the principles in the form of notes. The notes making it clear that insider trading is about the state of mind of the person deciding on the trade in the securities, and not the state of mind of the person in whose name the securities are traded. Yet, for trades effected by the exercise of discretion by a manager, routinely the person on whose behalf trades are executed, is hauled up. It is said that a large corporate excelled in the race to mindless enforcement, when it hauled up an independent director for trades effected by a discretionary portfolio manager of his wife and announced its action.

Meanwhile, the crisp and short set of principles in insider trading regulations have now grown into a long laundry list of secretarial record-keeping mandates codified into the regulations. What was begun as principles-based regulations in 2015 with bold and clear legislative notes to help courts see the intent behind each provision, is now a bundle of multiple secretarial compliance requirements. Keeping a register of connected persons, and keeping track of information recipients, are all well-intentioned. However, if one loses track of first principles of insider trading, the pile of false positives will keep rising.  

With deceit-free fraud will emerge stigma-free indictment. If society feels that regulations can hold even the innocent to be guilty, the stigma attached to findings of guilt would also erode alongside. That is a grave danger.

The writer is an advocate and independent counsel