The Supreme Court (“SC”) has, in its judgment dated September 19, 2022, in the case of Securities and Exchange Board of India v. Abhijit Rajan [Civil Appeal No. 563 of 2020], held that in deciding cases pertaining to insider trading, the actual gain or loss is immaterial, but the motive for making a gain is essential.

Facts

Abhijit Rajan (“Respondent”) was the chairman and managing director of Gammon Infrastructure Projects Limited (“GIPL”) till September 20, 2013. Thereafter, he ceased to be the chairman and managing director, but continued to be a director of GIPL.

In the year 2012, GIPL was awarded a contract by National Highways Authority of India (“NHAI”). For the execution of the project, GIPL set up a special purpose vehicle called Vijayawada Gundugolanu Road Project Private Limited (“VGRPPL”). Similarly, Simplex Infrastructure Limited (“SIL”) was awarded a contract by NHAI in Jharkhand and West Bengal. For the execution of the project, SIL set up a special purpose vehicle called Maa Durga Expressways Private Limited (“MDEPL”).

GIPL entered into two shareholders agreements with SIL. Under these agreements, GIPL was to invest in MDEPL and SIL was to invest in VGRPPL for their respective projects. The mutual investments were to be tuned in such a manner that GIPL and SIL would hold 49% equity interest in each other’s projects.

However, on August 9, 2013 the board of directors of GIPL passed a resolution authorizing the termination of both shareholders agreements. On August 22, 2013, the Respondent sold about 144 lakhs shares (approx.) held by him in GIPL. On August 30, 2013, GIPL made a disclosure to the National Stock Exchange of India (“NSE”) and Bombay Stock Exchange (“BSE”) regarding the termination of two shareholders agreements.

Pursuant to an input received from NSE, about the aforesaid transaction and the possibility of the trading having taken place on the basis of unpublished price sensitive information (“UPSI”), Securities and Exchange Board of India (“SEBI”) conducted a preliminary enquiry. After completion of the preliminary enquiry, SEBI passed an ex parte interim order holding prima facie that the Respondent violated the provisions of The Securities and Exchange Board of India Act, 1992 (“SEBI Act”) and consequently restraining the Respondent from buying, selling or dealing in securities and accessing the security markets directly or indirectly. This ex parte interim order was also confirmed by a confirmatory order, passed after providing an opportunity of hearing to the Respondent.

In the interregnum, SEBI completed the investigation and issued certain directions on March 21, 2016, followed by a show cause notice dated March 29, 2016. The show cause notice was addressed not only to the Respondent, but also to another company ‘Consolidated Infrastructure Company Private Limited’ (“CICPL”) and two of its directors. The noticees filed their replies and after giving an opportunity of hearing to the noticees, the Whole-Time Member (“WTM”) passed an order, by which the WTM held the Respondent guilty of insider trading and hence liable to disgorge the amount of unlawful gains made by him. The show cause notices issued to the others, namely, CICPL and its directors were closed without any directions, on the ground that no case was made out against them.

Challenging the said order of the WTM, the Respondent filed a statutory appeal before the Securities Appellate Tribunal (“Tribunal”). The appeal was allowed by the Tribunal by an order and it is against the said order that SEBI has come up with the above appeal in the SC.

Issues

• Whether the information regarding the decision of the board of directors of GIPL to terminate the two shareholders’ agreements can be characterized as ‘price sensitive information’ within the meaning of Section 2(ha) of the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 (“PIT Regulations”).
• Whether the sale by the Respondent of the equity shares held by him in GIPL, under peculiar and compelling circumstances in which he was placed, would fall within the mischief of ‘insider trading’ in terms of Regulation 3(i) read with Regulation 4 of the PIT Regulations.
• Whether SEBI should have taken into account the last trade price of the day on which information was disclosed instead of the trade price of the next day.

Arguments

Contentions by SEBI:

SEBI contended that proportionality is a dangerous and subjective ground in matters involving insider trading, especially since one-third of the total number of directors of a listed company are independent directors and even transactions involving thousands of crores might be a minor proportion to the turnover, if the company is very large in size. SEBI also contended that Regulations 3 and 4 of the PIT Regulations contain an absolute prohibition against insider trading and such a statutory prohibition cannot be diluted by arguing that the total value of the contracts terminated by the company was just a minor percentage of the order book value and the total turnover of the company. The de minimis syndicate has no application to insider trading, as it introduces an element of subjectivity.

Further, in any case the total value of the contracts terminated on both sides was nearly INR 2,600 crores and hence the information relating to the termination of the contracts was definitely likely to materially affect the price of the securities of the company under Regulation 2(ha).

It was also stated by SEBI that explanation (vi) under Section 2(ha) which speaks about “significant changes in policies, plans or operations of the company” cannot limit the scope of the main part of the definition and in this case as a matter of fact the price of the share dropped in just one day and the Respondent avoided a loss of INR 85 lakhs. SEBI argued that bona fide intentions or grounds of necessity, such as those pleaded in this case, cannot frustrate the object of strict ban on insider trading, especially when the expression “lawful excuse” as used in about 88 central statutes to justify non-compliance, is conspicuously absent in the PIT Regulations. Also, that in any case, SEBI took note of the situation in which the Respondent was placed, warranting the necessity to sell the shares and hence confined the final order only to disgorgement, which is merely in the nature of restitutionary relief.

Further, the intimation regarding the termination of the contracts was given to the BSE at 1.05 p.m. and to NSE at 2.40 p.m. on September 3, 2013 and the trading concluded at 3:30 p.m. and hence the adoption of the closing price on September 3, 2013 would not correctly determine either the gains made or the losses averted. Therefore, the question of SEBI taking the closing price as on September 3, 2013 did not arise.

Contentions by the Respondent:

The Respondent contended that the primary object of insider trading regulations anywhere in the world is to prohibit an insider from taking advantage of asymmetrical access to UPSI over others who do not have such access and that the question whether an information is price sensitive or not, would depend upon its potency to materially impact, upon publication, the price of the securities.

The Respondent also contended that by its very nature, the issue is barely a question of fact or at the most, a mixed question of fact and law which will not fall within the scope of Section 15Z (Appeal to Supreme Court) of SEBI Act warranting interference by this Court.

Further, one of the key factors which the courts take into account while interpreting the circumstances revolving around transactions such as the one in question, is the purpose for which the transaction was effected. Apart from looking into the purpose of the transaction, courts have also taken into account other circumstances such as the scale of the transaction, pattern of trading and honesty in responses during the proceedings.

In the case on hand, the information in question, namely, the termination of the shareholders’ agreements actually resulted in GIPL gaining total control of a larger project and that in other words what was lost by the termination was far lesser than what was gained and hence the information relating to the termination of the agreements was actually a favourable and not adverse information.

The Respondent noted that GIPL’s investments in the project of SIL represented 0.05% of GIPL’s order book and 0.7% of its turnover and that a project with a small percentage of the order book and a miniscule percentage of the turnover cannot ipso facto become material for information about it to become UPSI.

The Respondent contended that the failure of the Respondent to meet the obligation towards Corporate Debt Restructuring (“CDR”) package would have led to GIL filing for bankruptcy. Further, every penny of the sale proceeds of the shares, was transferred by the Respondent towards the implementation of CDR package, a fact that SEBI itself has accepted. Hence, it is a misconception to think that he made unlawful gains that ought to be disgorged.

Furthermore, SEBI itself exonerated the co-noticee, namely, CICPL, on the ground that its sale of shares was on account of a pressing need to meet a margin shortfall to its stock broker. Thus, SEBI applied two different yardsticks, one in respect of the Respondent and another in respect of the co-noticee in the very same proceeding, which necessitated interference by the Tribunal.

Observations of the Supreme Court

The SC noted that an appeal under Section 15Z (Appeal to Supreme Court) of SEBI Act concerns appeals with ‘any question of law arising out of the order of the Tribunal’. The focus of Section 15Z is on ‘any question of law’ and not ‘any substantial question of law’.

The SC observed that in order to find out if a person is guilty of violation of Regulation 3 of the PIT Regulations, the courts should address the following questions namely: (i) is he an insider?; (ii) did he possess or have access to any information relating to the company?; (iii) whether such information was price sensitive?; (iv) whether the information was unpublished?; and (v) whether he dealt in securities by subscribing, buying, selling or agreeing to do any of these things in any securities.

The SC noted that one important fact namely, that the price sensitivity of an information has a correlation directly to the materiality of the impact that it can have on the price of the securities of the company. An information may materially affect the price of the security of a company either positively or negatively. The effect should be material and not completely insignificant.

Keeping the above parameters in mind and coming to the facts of the case on hand, it was clear, (i) that the Respondent was certainly an insider, as he was a chairman and managing director of GIPL till September 20, 2013 and was a party to the resolution of the board of directors authorising the termination of the shareholders’ agreements; (ii) that the information relating to the termination of both the shareholders’ agreements that the Respondent had, would certainly fall under the category of “significant changes in policies, plans or operations of the Company” under Regulation 2(ha)(vii) of the PIT Regulations; (iii) that the Respondent dealt in securities by selling 144 lakhs shares, a month before his resignation as chairman and managing director; and (iv) that the termination of the shareholders’ agreements was disclosed to the NSE and BSE after the sale of the shares, which made the information relating to the termination of the agreements unpublished as on the date of the sale.

Therefore, it may appear at first blush, that the Respondent, who was an insider and who possessed information which was both unpublished and price sensitive, was guilty of the charge of insider trading as he undoubtedly dealt in securities.

While it is true that the actual gaining of profit or sufferance of loss in the transaction, may not provide an escape route for an insider against the charge of violation of Regulation 3 of the PIT Regulations, one cannot ignore normal human conduct. If a person enters into a transaction which is surely likely to result in loss, he cannot be accused of insider trading. In other words, the actual gain or loss is immaterial, but the motive for making a gain is essential.

The cancellation of the shareholders’ agreements resulted in GIPL gaining very hugely in terms of order book value. In such circumstances an ordinary man of prudence would expect an increase in the value of the shares of GIPL and would wait for the market trend to show itself up, if he actually desired to indulge in insider trading. However, the Respondent did not wait for the information about the market trend, after the information became public because he had to dispose of his shares as well as certain other properties for the purpose of honouring a CDR package.

Therefore, the Tribunal was right in thinking that the Respondent had no motive or intention to make undeserved gains by encashing on the UPSI that he possessed. As a matter of fact, the Tribunal found that the closing price of shares rose, after the disclosure of the information. This shows that the UPSI was such that it was likely to be more beneficial to the shareholders, after the disclosure was made. Any person desirous of indulging in insider trading, would have waited till the information went public, to sell his holdings. The Respondent did not do this, obviously on account of a pressing necessity.

The SC observed that the allegation of insider trading cannot be measured in terms of the value of the contracts terminated and the percentage of shares sold and that the theory of proportionality cannot be applied in such cases. The magnitude of what an insider did, in relation to the size of the company, may not have a bearing upon the question whether someone indulged in insider trading or not, but what is sought to be encashed by the insider should be an information which if published is likely to materially affect the price of the securities of the company. It is true that the de minimis rule has no application to insider trading, as it introduces an element of subjectivity. Hence, the SC did not go on the basis that GIPL’s investments in the project of SIL represented 0.05% of GIPL’s order book value and 0.7% of its turnover.

The SC had gone on the basis that the termination of both the agreements put GIPL in a more advantageous position, in which one would have expected the price of the securities to rise. The normal human conduct would be to wait for this event to happen. This event could have happened only after the publication of the information in question. The fact that the Respondent did not wait to take advantage of the situation, convinced the SC that the Respondent’s intention was not to indulge in insider trading.

The contention that SEBI took note of the situation in which the Respondent was placed, and the dire need that he had to sell the shares, and that therefore SEBI confined the final order only to disgorgement, is neither here nor there. The argument is actually an argument of convenience. It so happened that according to SEBI the closing price of the stock on September 3, 2013 showed favourable position for the Respondent and SEBI was able to calculate as though the Respondent made a profit.

Decision of the Supreme Court

The SC, on issue no. 1, held that the information regarding the termination of the two shareholders’ agreements can be characterized as price sensitive information, in that it was likely to place the existing shareholders in an advantageous position, once the information came into the public domain. In such circumstances, on issue no. 2, the SC held that the sale by the Respondent would not fall within the mischief of insider trading, as it was somewhat similar to a distress sale, made before the information could have a positive impact on the price of the shares.

Accordingly, there was no necessity to go into issue no. 3 and that the impugned order of the Tribunal did not call for any interference. Hence, the appeal was dismissed.

VA View:

The present appeal clearly demonstrates the complexity in adjudicating insider trading cases. Distinguishing between mens rea and profit motive, the SC held that, in respect of matters under the PIT Regulations, the test that is to be applied is of profit motive, that is, whether the insider’s actions were an attempt to gain from the UPSI in his possession. In other words, mere possession of UPSI and acting on it are not sufficient to prove insider trading.

While the actual profit or loss incurred is immaterial, the SC has clearly identified the intent behind penalizing insider trading, that is to prevent insiders from making illicit gains. However, the requirement of profit motive may involve a great deal of subjectivity. The decision in the present matter may have far-reaching effects in the manner in which insider trading cases are decided by regulators.

For any query, please write to Mr. Bomi Daruwala at [email protected]

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