By Sezal Mishra, fourth-year student at NLIU, Bhopal
Securities Regulations in India prohibit the offence of Insider Trading under the SEBI (Prohibition of Insider Trading Regulations), 2015. (‘PIT Regulations’) Insider Trading is the offence of dealing in the securities of a company on the basis of unpublished price sensitive information (‘UPSI’) in order to gain an unfair advantage over the general public. UPSI refers to any information relating to a company or its securities, directly or indirectly, that is not generally available and which upon becoming generally available is likely to materially affect the price of the securities. In simple words, information which relates to internal matters of a company and is not disclosed by it in the regular course of business can be considered as UPSI. Communication of UPSI by an insider without any legitimate reason is prohibited under Regulation 3 of the PIT Regulations.
Recently, through a series of orders, SEBI penalized several individuals in the ‘WhatsApp Leak Case’ for the unlawful communication of UPSI relating to several companies like Asian Paints, Wipro, and Mindtree through the popular messaging app. An exorbitant penalty of Rs 45 Lakh was levied upon these individuals who were found to be in violation of Regulation 3. These orders interpret some of the most important aspects of Regulation 3 of the PIT Regulations and have severe implications in deciding the liability of insiders in communication of UPSI. Through this article the author advocates the need of taking cognizance of mens rea while adjudicating liability in insider trading cases to ensure just penalization of offences.
Communication of UPSI and the Need for Mens Rea
The PIT Regulations have been enacted in accordance with Section 12A of the Securities and Exchange Board of India Act, 1992 with a purpose of ensuring a level playing field and to prevent undue benefit to any individual at the expense of public investors. Regulation 3(1) of the PIT Regulations prohibits an insider from communicating any UPSI, relating to a company, to any person except for legitimate purposes or in discharge of legal obligations. The aim of the legislature in enacting such regulations is to oblige all insiders to handle sensitive information with care since a leak of such information can lead to an undue advantage to both – the tipper and the tippee. The legislature, however, fails to take into consideration a scenario entailing an accidental leak of information which yields no benefit to the tipper or the tippee. Since it has already been established that the purpose of insider trading regulations is to prevent undue advantage to the tipper or the tippee over public investors, a paradox is created when regulation agencies seek to punish even the accidental communication of UPSI which entails no profit to the parties.
In India, at present, communication of UPSI without personal benefit or even unknowingly, is a ground for liability under the insider trading regulations. Mens rea or intention of the tipper is considered irrelevant under the PIT Regulations. The only available means of solving this paradox lies in the insertion of the element of mens rea in insider trading regulations. The consideration of mens rea at the time of imposition of liability under insider trading regulations can be justified on the two grounds –
(i.) Mens Rea is in Consonance with the Objectives of PIT Regulations
Firstly, the purpose with which the PIT Regulations have been enacted is rendered meaningless by the non-inclusion of mens rea. The basic purpose of insider trading regulations is to prevent undue advantage to individuals engaging in trade on the basis of sensitive information. At present, however, the control of SEBI in such cases has been strengthened to a point where the mere possession or communication of UPSI can be considered as a ground for insider trading.
The legislature has lost sight of its true purpose and engaged itself in policing information and its spread rather than regulating trading done with the intention of acquiring profits. If an insider is penalized for mere communication of information or for trade in securities with no advantage to him over the general investors, the interest of investors remains unharmed. In such a scenario, penalization of such acts becomes meaningless and is clearly beyond the scope of the purpose of the PIT Regulations.
(ii.) Punishment without Mens Rea is Unjustified
Secondly, the penalty levied upon an individual for a violation of the PIT Regulations is often exorbitant. Due to the diverse repercussions entailed by the offence, it is of utmost significance that the market regulations take steps towards prosecuting individuals after ascertaining proper cause. This has lead Securities Regulation Agencies in countries like the USA to consider mens rea as a vital element in imposition of liability in order to avoid imposing large penalties in cases of accidental tipping.
In India, the opinion of the Supreme Court in SEBI v. Shriram Mutual Fund and the legislative notes to Regulation 4 have made it clear that mens rea cannot be considered as an essential element for penalization under the PIT Regulations since it is neither a criminal nor a quasi-criminal offence. Insider trading proceedings pertain to Section 15G of the SEBI Act which are essentially civil proceedings and so the question of proof of mens rea does not arise. However, the Securities Appellate Tribunal has not always subscribed to the same opinion. Previously in Rakesh Agarwal v. SEBI, SAT decided that if an insider deals in securities based on the UPSI for no advantage to him, over others, it is not against the interest of investors and hence should not constitute an offence. It can be similarly inferred that mere communication of information without any advantage to the insider must not be considered an offence. The position adopted by SAT widens the scope of PIT Regulations by correctly interpreting the purpose for which the Regulations were enacted.
Mens Rea as a Requirement for Insider Trading in the UK and US
For the first time in 1984, the US Supreme Court in Dirks v. SEC established that while adjudicating liability in insider trading cases, the mens rea of the tipper must be considered. The Court arrived at its decision by devising a test to decide whether or not breach of a fiduciary duty had been committed by the insider and consequently, whether or not the tippee had committed the offence of insider trading. This was explained by the Court as,
“The test is whether the insider personally will benefit, directly or indirectly, from his disclosures. 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 by the tippee.”
Hence, post the judgment in Dirks case, the simple test for insider trading violations was whether the insider has communicated sensitive information with the unlawful intention of earning undue personal benefit. If communication of information was done with a guilty intention, the insider had breached his fiduciary duty and would be liable under the regulations. Additionally, the tippee would be considered liable on the basis of his knowledge of the said breach by the tipper.
The prosecution of individuals was made much more difficult by the Court in the subsequent case of US v. Newman. Here, the Court reinstated its faith in the personal benefit test by clarifying that a mere breach of an insider’s fiduciary duty to not disclose sensitive information is not sufficient to constitute an offence of insider trading, even if the information was communicated to a friend, unless some improper purpose on the part of the insider is demonstrated.
Similarly, insider trading is illegal under Section 52 of the Criminal Justice Act, 1993 in the UK. Since the offence entails criminal liability under the Act, the requirement for mens rea is indispensible. Section 53 of the Act lays down three defences that can be used by individuals accused of insider trading. To qualify for a defence, the accused must exhibit that, (i) it was not expected at the time of dealing that the transaction would result in a profit; or, (ii) the accused was under the impression that the information is within the public domain; or, (iii) that transaction would have been undertaken even without access to the sensitive information.
In a situation entailing an accidental communication of sensitive information where no personal benefit is derived by the tipper, an application of the personal benefit test or the defences enlisted under Section 53 would lead us to the conclusion that there exists no ground for imposing penalty under insider trading regulations.
Over the years, the scope of SEBI’s insider trading norms has been widened in order to protect the interests of the investors and to create a healthy environment for trade in the securities. While recent orders in the WhatsApp leak case provide an impression of SEBI’s tireless efforts in curbing insider trading, upon close scrutiny it becomes evident that these orders establish a new threshold of evidence for liability under the existing PIT Regulations. The orders omit discussion on the issue of mens rea and turn a blind eye to a situation where the sharing of the information is accidental and has not resulted in any insider trading or undue benefit. Evidently, at present, the Insider Trading Regulations operating in India are much more rigid and strict than those operating in other countries of the world. It is, thus, proposed that the tipper-tippee test and other principles relating to mens rea prevalent in other jurisdictions should be incorporated in the Indian jurisprudence at the earliest.