The ‘why’ of a trade will matter in insider trading cases

A recent Supreme Court (SC) decision in the matter of Abhijit Rajan, the erstwhile chairman and managing director of Gammon Infrastructure, is the latest missive from India’s apex court on insider trading. Based on a straightforward fact pattern, the order surgically cuts through two eternal dilemmas of insider trading enforcement: what constitutes price-sensitive information, and how one gleans the underlying motive behind such trades.

The 19 September decision is based on events that date back to 2013 and is set against the backdrop of India’s 1992 insider trading regulations, when Abhijit Rajan sold shares of Gammon India, then worth approximately 10 crore. The sale took place in the period between termination of the company’s agreements with Simplex Infrastructure for execution of roadway projects and the point when Gammon informed the public of this termination through exchange disclosures. Regulatory inquiries and Securities and Exchange Board of India (Sebi) orders followed, which directed Rajan to disgorge all profits made from the sale (amounting to around 1 crore). On appeal in 2019, the Securities Appellate Tribunal set aside Sebi’s findings entirely, holding that cessation of these agreements could not qualify as price sensitive for the listed company, since these proposed projects were an insignificant portion of Gammon’s overall order book as well as a de-minimis percentage of its annual turnover. The Tribunal also drew comfort from the fact that Rajan’s trades lacked a profit motive, since the sale proceeds were used to fund the debt restructuring then underway for Gammon’s parent company. Sebi’s appeal against this order is what finally carried these questions to the SC’s threshold.

Insider trading enforcement often makes for piquant headlines, but when pared to its core, fundamentally involves tracing just three key elements carefully: the ‘who’, the ‘what’ and the ‘when’ of a trade. This Supreme Court order now affirmatively and correctly introduces the ‘why’ as well.

In dismissing Sebi’s appeal and upholding Rajan’s exoneration, the court emphasized the importance of quantifying the impact of unpublished price sensitive information (UPSI), to then assess its material impact on a listed company’s stock. While the law defines UPSI to mean information that is “likely to materially affect the price of the securities», it does not clarify how such impact must be gauged. In this case, the arithmetic of how market-moving the information was withstood scrutiny. Cancellation of the agreements had allowed the company to retain control over its own projects, making the termination a positive financial development rather than adverse information that would motivate a sale of shares to pre-empt losses. The company’s gains from this termination far outweighed any probable disadvantages, and so the top court concluded that such information could not directionally influence a sale and hence would not be “price sensitive».

Having cast this as its primary thesis, the SC then unspools another strand by examining “human conduct» or the profit motive driving these transactions. The law today does not expressly enable the defence to demonstrate an underlying intent of trades. But in this case, to decide if there had indeed been information arbitrage, the court evaluated if there was an attempt to take advantage or benefit from the UPSI, while distinguishing such a profit motive from criminal intent (or mens rea), since the latter is not needed to establish market conduct violations. Applied to the case facts, it was clear that the nature of Rajan’s trade (a sale) was anomalous to the nature of information he possessed (positive news). To be culpable of leveraging inside information, the court rightly concludes that the nature of trades must be aligned with the nature of information, where, say, purchases (and not sales) are made in anticipation of good news.

An actual gain or loss is not relevant, but it’s the underlying objective of the trade that must ascribe guilt.

In this case, there were a few other factors that played a fortuitous role in exonerating Rajan, such as the debt restructuring package and resultant financial exigencies. But by taking us back to the first principles of securities enforcement, the central legal premise of this order takes a big step forward. It will impact several ongoing proceedings against listed companies, compliance officers and key managers. Earlier, we had just a handful of cases that called for a need to look at the profit motive. But now, edified by the top court, this approach will have to find its place in Sebi’s investigations and orders; and in case of a departure from these principles, it will have to record reasons for divergence.

Another perspective bears mention. Can such an interpretation create ground to make UPSI a subjective assessment, where the price sensitivity of listed-company information could lie in the eyes of the beholder? To a degree, perhaps, yes. This may not hold true for classical forms of UPSI like financial results and changes in capital structure, but may come into play while assessing the impact of large contracts, big hires, etc. For regulators too, this may appear to be a somewhat quixotic standard to sustain, especially in cases where the effect of UPSI on markets is not easily discernable or objectively renderable into data. But with this order now a binding law, Sebi’s key task ahead will be to allow the benefit and discipline of this precedent to cases that can claim it.

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