The SEBI (Prohibition of Insider Trading) Regulations, 2015 (the PIT Regulations)1 are based on the parity of information theory. Under this theory, insider trading results due to information disparity caused by insiders possessing unpublished price-sensitive information (UPSI) which is not available to the general public. This is expressed in Regulation 4(1) of the PIT Regulations, which prohibits trading “while in possession” of UPSI instead of prohibiting trading “on the basis” of UPSI.
However, all trades where UPSI disparity exists should not be labelled insider trading. Bona fide trades without the intent to commit insider trading should be excluded and the charge should not be strictly enforced solely on possession of UPSI. Therefore, Regulation 4(1) provides that an insider that trades while in possession of UPSI may prove innocence by demonstrating certain defences, which are listed in the proviso. While bona fide trading is not listed as a defence, the proviso is inclusive and such defences can and are being raised in insider trading proceedings.
In his book “Insider Trading: Law and Practice”2, the author highlighted the “compelling reasons” defence and the “legitimate corporate purpose” defence.3 Both defences developed under the SEBI (Prohibition of Insider Trading) Regulations, 1992 (the 1992 Regulations)4 and recent Securities Appellate Tribunal (SAT) decisions have applied these principles in the context of the PIT Regulations as well.
Compelling reason defence: This defence is based on the insider having a compelling reason to trade, which is distinct from the UPSI possessed by the insider. The classic example of this defence is raising funds for a medical emergency. SAT (2007) recognised this defence in Rajiv B. Gandhi v. SEBI5, when it found that insiders should be permitted to demonstrate a reasonable or plausible explanation for trades, such as raising funds for a medical emergency or for family matters.6 In such cases, the reason to trade is distinct from the UPSI, such that the person would have made the same trade whether or not he possessed UPSI.
This principle was applied by SAT under the PIT Regulations in 2022, in Shreehas P. Tambe v. SEBI7. The appellant was a key managerial person of Biocon Ltd. and possessed UPSI relating to a proposed global collaboration between Biocon and Sandoz. The appellant obtained pre-clearance, sold shares of Biocon, and used the sale proceeds to fund an apartment purchase pursuant to a memorandum of understanding (MoU) with a developer. SAT found that the proviso to Regulation 4(1) of the PIT Regulations is inclusive and that the appellants should receive the benefit of the proviso, as the trades were bona fide and were not motivated or induced by UPSI (even presuming that the appellant possessed UPSI).
Legitimate corporate purpose defence: This defence seeks to demonstrate that while the trade was motivated by the UPSI itself, the insider did not intend to commit insider trading and that there was a legitimate purpose for trading.
Under the 1992 Regulations, in Rakesh Agrawal v. SEBI8, SAT (2003) found that an appellant who traded whilst in possession of UPSI was not guilty of insider trading, as the trade was for a legitimate corporate purpose.9 SAT found that that prohibiting insider trading would be meaningless, if the insider does not gain any unfair advantage for his acts and it cannot be said to be against the interest of the investing public either. SAT stated that 1992 Regulations were not intended as an all-purpose ban on trading and legitimate transactions undertaking to achieve a corporate purpose or to discharge a fiduciary duty or in the interest of a body of public shareholders would not be prohibited.
While the UPSI drove the decision to trade in this case, the intention was not to make unlawful gains from insider trading. Similarly, a lender may invoke a pledge to protect its financial interests if a listed debtor defaults on a loan, despite such default giving rise to UPSI. While driven by UPSI, the decision to invoke the pledge is supported by a legitimate purpose, without the intention to commit insider trading. Similarly, lenders may make margin calls if pledged shares drop in value and a top-up is required.10 In such cases, there is no reason to trade other than the UPSI and the trade would not have been required if not for the UPSI.
A recent decision of SAT (2022) in Rajeev Vasant Sheth v. SEBI11 applies this principle under the PIT Regulations. SAT held that a sale of shares by the promoter group of Tara Jewels Ltd. was not insider trading, as the sale proceeds were used to fund the company to enable it to repay loans and avoid a non-performing asset (NPA) downgrade.12 They sold shares of Tara Jewels Ltd. when there was UPSI relating to the financial results of the company. The objective of the sale was to raise funds to assist the company in the repayment of loans and to avoid an NPA downgrade. The appellants were forced to take this step as lenders had refused to provide additional working capital, which was needed to prevent the cancellation of certain orders. SAT found that the proviso to Regulation 4(1) of the PIT Regulations is inclusive and that the appellants should receive the benefit of the proviso as the appellants had not traded for personal gain.
Some questions remain: If an insider claims to sell shares to urgently raise funds for a medical emergency, it would fall within the compelling reasons defence. Though the defence may fail if the insider had sufficient funds parked in other investments, such as mutual funds or fixed deposits, which could have been used instead of selling shares. In such cases, Secuities and Exchange Board of India (SEBI) and SAT may need to examine whether the defence is being misused and the insider may need to demonstrate financial reasons to sell shares instead of other investments.
These defences may also require insiders demonstrating additional circumstances to prove that the trade was bona fide. One such circumstance, which has been consistently upheld, is to show that the nature of UPSI was opposite to the trade.13 If the insider is selling shares but the UPSI is positive, it belies logic and normal human conduct that the sale was motivated for insider trading. Similarly, if the trade is consistent with the trading pattern of the insider14 or if the amounts involved were nominal,15 the inherent probability would be that insider trading has not occurred.
Regardless, these SAT decisions have moved the law forward in terms of softening the strict nature of insider trading regulation based on possession of UPSI. Given the complex nature of insider trading regulation and difficulty in finding direct evidence, these principles are likely to be applied and tested frequently in the coming years.
*Partner in Argus Partners General Corporate, M&A, Private Equity and Venture Capital practice in Mumbai and is the author of the book, Insider Trading: Law and Practice (Eastern Book Company, 2019). Author can be reached at armaanpatkar@gmail.com.
1. SEBI (Prohibition of Insider Trading) Regulations, 2015.
2. See, Insider Trading: Law and Practice (1st Edn., 2019).
3. See, Insider Trading: Law and Practice (1st Edn., 2019), pp. 312-313 and 319-320.
4. SEBI (Prohibition of Insider Trading) Regulations, 1992. [pending uploading]
5. 2008 SCC OnLine SAT 78. An appeal was preferred to the Supreme Court in Rajiv B. Gandhi v. SEBI, 2008 SCC OnLine SC 27 .
6. Rajiv B. Gandhi v. SEBI, 2008 SCC OnLine SAT 78. At the time, the 1992 Regulations prohibited trading “on the basis of” UPSI. This was interpreted to mean that the trade must be motivated by UPSI, such that UPSI must be the factor or circumstance that induces the insider to trade. This motive is contained in the words “on the basis of” itself but can be rebutted by the insider by proving that there was no motive, by demonstrating circumstances such as a medical emergency.
8. 2003 SCC OnLine SAT 38 . However, this was under the earlier form of the 1992 Regulations which prohibited trading “on the basis” of UPSI, not merely possession of it. See, Insider Trading: Law and Practice (1st Edn., 2019), pp. 308-315. Similarly, in SEBI v. Abhijit Rajan, 2022 SCC OnLine SC 1241, the Supreme Court had held in the context of the 1992 Regulations that a sale of shares to assist a company with a corporate debt restructuring (CDR) package would show that there is no motive to commit insider trading. However, the Supreme Court clarified that this was only a factor that it considered and that it had focused on the issue of whether the facts showed that the insider intended to encash the advantage of knowing the UPSI.
9. In Rakesh Agrawal v. SEBI, 2003 SCC OnLine SAT 38, the appellant's trade was motivated by UPSI. Rakesh Agrawal communicated UPSI relating to a foreign joint venture being negotiated by his company to his brother-in-law and asked him to acquire shares of the company. This was required to ensure the success of the deal, by ensuring that the foreign joint venture partner would receive at least 51 per cent of the shares of the company post an open offer under SEBI's erstwhile SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997. This was considered a legitimate corporate purpose, though it was based on the UPSI relating to the joint venture. Rakesh Agrawal's brother-in-law had no reason to trade, other than to ensure the success of the joint venture.
10. See, Insider Trading: Law and Practice (1st Edn., 2019), pp. 319-320; SEBI, Guidance Note on SEBI (Prohibition of Insider Trading) Regulations, 2015 dated 24-8-2015; No-action letter issued to Geetanjali Trading and Investments Pvt. Ltd. dated 9-11-2015.
12. The appellants were the Chairman and Managing Director of Tara Jewels and his two daughters (who were Vice-President, Business Development and Vice-President, Product Development).
13. See, SEBI v. Abhijit Ranjan, 2022 SCC OnLine SC 1241, Chandrakala v. SEBI, 2012 SCC OnLine SAT 21, Bharti Airtel Ltd. v. Gopal Vittal, 2020 SCC OnLine SEBI 452.
14. Manoj Gaur v. SEBI, 2012 SCC OnLine SAT 176.
15. Manoj Gaur v. SEBI, 2012 SCC OnLine SAT 176. See also, ITC Ltd., In re, 2016 SCC OnLine SEBI 414. However, cf. Harish K. Vaid v. SEBI, 2012 SCC OnLine SAT 174 (nominal trades and profits were still found guilty, ostensibly as the trades were by the compliance officer himself who was supposed to act carefully as was fully aware of the rules and the code of conduct).
