For "Insider Trading", Mere Possession Of Sensitive Information Not Enough; Actual Profit Motive Essential : Supreme Court

The Bench comprised of Justices Indira Banerjee and V. Ramasubramanian.

Background Facts

The respondent was the Chairman and Managing Director of Gammon Infrastructure Projects Limited (GIPL). GIPL was awarded a contract by the National Highways Authority of India (NHAI) for the execution of a project worth Rs 1648 crores. In the meantime, another company, Simplex Infrastructure Limited (SIL) was also awarded a contract by NHAI for a project, the total cost of which was Rs 940 crores. Both GIPL and SIL created special purpose vehicles (SPV) to execute these projects. Subsequently, two shareholders agreements were brokered between the companies requiring each to invest in the SPV administered by the other, in such a manner that both of them would hold 49% equity interest in the other's project. However, these agreements were terminated in 2013 by a resolution passed by the Board of Directors under Rajan's leadership.

Subsequent to the termination of the agreements, Rajan sold about 70% of his shareholding in GIPL along with other assets to raise money for the corporate debt restructuring (CDR) package of the company and save it from bankruptcy. However, he came under the scanner of SEBI because the sale of the shares was concluded before the information about the termination of the two agreements was made public. The market regulator held him guilty of insider trading and directed him to disgorge the amount of "unlawful gains" made by him to the tune of Rs 1.09 crores.

This order was set aside by the appellate tribunal on the following grounds:

• The information regarding the termination of the two shareholders agreements was not price-sensitive information, since the investment of GIPL constituted only 0.05% of GIPL's order book value and only 0.7% of its turnover for the financial year.
• Rajan was in dire need to sell the shares at that time for the purpose of the CDR package and hence, it could not be said that he indulged in trading on the basis of the information within his knowledge.
• There was no reason why SEBI did not take into account the last trade price of 03.09.2013 but chose the price as on 04.09.2013.

Aggrieved by this order, SEBI preferred an appeal before the Supreme Court under Section 15Z of the Securities and Exchange Board of India (SEBI) Act, 1992.

Summary of arguments

Senior Advocate Arvind P. Datar, appearing for SEBI, argued Regulations 3 and 4 of the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 contained an absolute prohibition against insider trading which could not be measured in terms of the value of the contracts terminated and the percentage of shares sold. Next, he submitted that since the total value of the contracts terminated on both sides was nearly Rs 2600 crores, the information relating to the termination of the contracts would be likely to materially affect the price of the securities. He also urged the Court to not consider intentions or grounds of necessity since they could not be said to have frustrated the object of a strict ban on insider trading. He also told the Bench that the question of SEBI taking the closing price as on 03.09.2013 did not arise.

Per contra, Advocate Somasekhar Sundaresan, appearing on behalf of the respondent, contended that the Court needed to take into account factors such as the purpose of a certain transaction while deciding on this issue. Other attendant circumstances such as the scale of the transaction, the pattern of trading and honesty in responses during the proceedings must also be considered, Sunderesan argued. Next, he submitted that the gains emanating from the transaction outweighed the losses, and as such, the information relating to the termination of the agreements was favourable and not adverse. Furthermore, the sale was not an isolated one but coupled with the sale of multiple other assets to raise money to fund promoters' contributions to the CDR package. Finally, he argued that the termination of the contracts could not be expected to have a material impact on the market price of the shares of GIPL since the company's investment in the project represented a small fraction of their order book value and annual turnover.

Supreme Court's analysis

The Court refused to set aside the order passed by the appellate tribunal and dismissed SEBI's appeal. In this judgement, the Court addressed three questions that arose for their determination, namely –

Issue 1: Whether the information regarding the decision of the Board of Directors of GIPL to terminate the aforesaid two contracts 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?

Answer: The Court held that the information regarding the termination of the two contracts could be characterised 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.

Issue 2: 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 Regulations?

Answer: The Court held that the sale by the respondent, of the shares held by him in GIPL, 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.

Issue 3: 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?

Answer: The Court found no necessity to examine the third question since the answers to the first two were sufficient to hold that the impugned order did not call for any interference.

Rationale

Right at the outset, the Court enumerated the conditions that must be satisfied for holding a person guilty of having violated Regulation 3. It explained –

"To find out if a person is guilty, the Court should address itself to 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 Court also noted that the price sensitivity of information had a direct correlation with the "materiality of the impact" that it can have on the price of the securities of the company. It remarked –

"An information may materially affect the price of the security of a company either positively or negatively. The impact may be beneficial or adverse. The information should have the potential either to catapult the price of the securities of the company to a higher level or to make it plunge. The effect can be bullish or bearish. But the effect should be material and not completely insignificant."

After applying the five-pronged test of determining culpability, the Court conceded that "at first blush", it would appear 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."

However, the Court categorically rejected this conclusion. It clarified that on an analysis of the Explanation given under Regulation 2(ha), it became evident that Item (vii) (significant changes in policies, plans or operations of the company) stood on a different footing when compared with the other items of information listed as price-sensitive information. Unlike Item (vii), the likelihood of the price of the securities getting materially affected is inherent in the first six items. The Court observed –

"Out of the 7 items of information listed under the Explanation, all the others except Item No.(vii) are likely to have an impact directly upon the financial strength of the company. Item No.(vii) stands apart, in that it is very broad and general in nature. While nothing more is required to show that the information listed in Items (i) to (vi) of the Explanation under Regulation 2(ha) is likely to materially affect the price of securities of a company, the same is not the case insofar as the information in Item No.(vii) is concerned. Therefore, while dealing with a case falling under Explanation (vii) of Regulation 2(ha), one may have to see whether there was any likelihood of the said information materially affecting the price of the securities of the company. Additionally, the activity in which the insider was involved also determines his culpability for violation of Regulation 3."

Therefore, the Court held that it was necessary to consider whether the insider had the requisite motive for making a gain when examining a case falling under Item (vii) of the Explanation appended to Regulation 2(ha). The actual gain or loss, however, would be immaterial. The Court explained –

"For instance, the sale by a person at a time when the price of the securities is likely to shoot up on account of price sensitive information coming into the public domain or the purchase by a person at a time when the price of the shares is likely to go downward due to price sensitive information getting published, cannot come under the category of insider trading."

The Court also explained that the entry would have to be read with the words "likely to materially affect the price" appearing in the main part of the regulation –

The words, "likely to materially affect the price" appearing in the main part of Regulation 2(ha) gain significance for the simple reason that profit motive, if not actual profit, should be the motivating factor for a person to indulge in insider trading. This is why the information in Item No. (vii) may have to be examined with reference to the words "likely to materially affect the price"."

The Court, disagreeing with the assertion made by Senior Advocate Arvind Datar regarding the total value of the contracts, observed that it would have been prudent to wait for the disclosure of the information since the share prices of GIPL were likely to increase. This was because GIPL had secured a positive advantage of about Rs 800 crores. The Court said –

"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. But the respondent did not wait for the information about the market trend, after the information became public."

The Court, noting that the shares had been sold to honour a CDR package and restore liquidity, concluded –

"Therefore, the Tribunal was right in thinking that the respondent had no motive or intention to make undeserved gains by encashing on the unpublished price sensitive information that he possessed. 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."

The Court clarified that this ruling was not made solely on the argument of necessity. But the fact that the respondent had sold his stocks at a time when "he had every reason to wait for the information regarding the termination of the contracts to go public" in order to "save the parent company" weighed heavily with the Bench. On whether "immediate and proximate facts and circumstances surrounding the events", such as the volume, the nature of the trading and the timing of the transactions, should be taken into consideration the Court, relied on SEBI v. Kishore R. Ajmera [(2016) 6 SCC 368] and SEBI v. Kanaiyalal Baldevbhai Patel [(2017) 15 SCC 1], in which, the Supreme Court had answered the question in the affirmative. The Court also referred to the decision of the apex court in Chintalapati Srinivasa Raju v. SEBI [(2018) 7 SCC 443] where it had considered compelling circumstances under which an individual had sold his shares as a mitigating factor.

The Court also noted that in Kanaiyalal Baldevbhai Patel [(2017) 15 SCC 1], mens rea was not considered to be an indispensable requirement to attract the rigour of the Prohibition of Fraudulent and Unfair Trade Practices Regulations, 2003. The Court set the record straight –

"An attempt by the insider to encash the benefit of the information is not exactly the same as mens rea. Therefore, the Court can always test whether the act of the insider in dealing with the securities, was an attempt to take advantage of or encash the benefit of the information in his possession. This is the test we have applied to the case on hand."

Cause Title: Securities and Exchange Board of India v. Abhijit Rajan

Citation : 2022 LiveLaw (SC) 787