The essence of mens rea in insider trading

Supreme Court contradicts its previous ruling while considering the ‘intent’ in insider trading

– CS Aisha Begum Ansari | aisha@vinodkothari.com

Insider trading means dealing in the securities of the listed company on the basis of unpublished price sensitive information (‘UPSI’), thereby gaining an unfair advantage over the market. A person guilty of insider trading is punishable with a monetary penalty^[1] under section 15G of the SEBI Act, 1992 (the ‘Act’). Further, under section 24 of the Act, SEBI can punish a person with imprisonment of upto Rs. 10 years or with a fine of upto Rs. 35 crores or both for violation of the Act and its regulations.

Now, to understand what constitutes ‘insider trading’ and what are its essential elements, one needs to see the SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’). A bare reading of PIT Regulations, reveals that the following are the essential prerequisites to consider trading as ‘insider trading’ –

The information in question should be ‘price sensitive’ and ‘undisclosed’ i.e., it can have a material impact on the price of the securities of the company upon disclosure;
The person who traded was an ‘insider’. The term ‘insider’ further has two limbs:
- Connected person;
- In possession of or having access to UPSI.

A pertinent and often debated question in the context above is whether the ‘intent’ of the insider is actually a relevant factor in determining the existence of insider trading and thus, treating the same as a wrongful act in terms of prohibitive rules/ regulations. This may be mainly because SEBI has not defined insider trading, unlike in SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003, wherein SEBI has linked fraud with the intent. Further, section 15G of the Act mentions dealing in securities ‘on the basis of’ UPSI while section 12A mentions dealing in securities ‘while in possession of’ UPSI. There have been an array of rulings and authoritative commentaries and committee deliberations around the subject matter, however, there does not seem to be any concluded view on the same. The recent ruling of the Hon’ble Supreme Court in the matter of SEBI v. Abhijit Rajan^{^[2]} has reignited the debate around it.

The author, in this article, attempts to delve into this question in the light of existing jurisprudence, deliberations by various expert committees, and international perspective as well, and tries to find an answer.

Relevant provisions under the Act and PIT Regulations

SEBI Act, 1992

As mentioned above, section 12A(e) of the Act prohibits a person from dealing in securities ‘while in possession of’ material or non-public information, while, under section 15G, SEBI has prescribed penalty for dealing in the securities ‘on the basis of’ UPSI. It is unclear from the Act itself whether the intent is to be seen while establishing insider trading.

SEBI (PIT) Regulations, 1992

Originally, the PIT Regulations prohibited dealing in the securities of the company on the basis of UPSI. However, pursuant to an amendment in 2002, the language was changed to dealing in the securities of the company while in possession of UPSI. Here, it seems like SEBI was clear that the motive is irrelevant to charge a person with insider trading.

SEBI (PIT) Regulations, 2015

Reg. 4(1) of the PIT Regulations prohibits the insider from trading in securities of a listed company ‘when in possession of UPSI’. The legislative note under reg. 4(1) does not consider the reasons for trade. A person traded when in possession of UPSI is what really matters. Once that is established, it is on the insider to prove his innocence by demonstrating the circumstances given under the proviso to reg. 4(1).

From the plain reading of the provisions of existing and erstwhile PIT Regulations, it can be inferred that if a person trades while in possession of UPSI, with or without the intention of misusing the UPSI, it will be considered insider trading

Judgements considering the intent of trading while proving insider trading

In the recent case of SEBI v. Abhijit Rajan^{^[3]}, SEBI alleged that the respondent, being a Chairman and MD of the Company traded on the basis of UPSI and passed an order to disgorge the unlawful gains of Rs. 1.09 crore. Aggrieved by the SEBI order, the respondent approached SAT which allowed the appeal. The Supreme Court also upheld the SAT order relying on the motive and outcome of the transaction. The Supreme Court held that:

“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”.

Similarly in the matter of Rakesh Agrawal v. SEBI^{^[4]}, SAT stated that:

“It is true that the regulation does not specifically bring in mens rea as an ingredient of insider trading. But that does not mean that the motive need to be ignored”.

The courts in the above judgements emphasized on the presence of ‘motive’ and concluded that mere possession of UPSI while trading will not amount to insider trading, there should be a motive to take advantage of such UPSI and make undue profits or avoid losses.

Judgements disregarding the relevance of intent

In the matter of The Chairman, SEBI v. Shriram Mutual Fund^{^[5]}, the Supreme Court disregarded the relevance of mens rea or guilty intent. It observed that:

“A breach of civil obligation which attracts penalty in the nature of fine under the provisions of the Act and the Regulations would immediately attract the levy of penalty irrespective of the fact whether contravention must made by the defaulter with guilty intention or not. We also further held that unless the language of the statute indicates the need to establish the presence of mens rea, it is wholly unnecessary to ascertain whether such a violation was intentional or not.”

As per this judgement, the violation of SEBI Act and its Regulations is a civil wrong as section 15A to 15HB provides for monetary penalty and it is an established principle that mens rea is not required to prove a civil wrong. Therefore, the violation of any provision of the SEBI Act and its Regulations will attract monetary penalty, irrespective of whether the intent was involved to violate the provision.

Similar stand was taken by the Bombay High Court in the matter of SEBI v. Skdc Consultants Ltd.^{^[6]}and SEBI v. Cabot International Capital Corporation^{^[7]}.

In the landmark case of Hindustan Lever Ltd v. SEBI^[8] dealt by SAT, the appellant argued that mere possession of information does not preclude the dealing and it is for SEBI to prove that the dealing was motivated by the information. The appellants also contended that it is also necessary to establish the motive for profit or gain or advantage for an offence of insider trading to be made out. SAT agreed with the view of SEBI that under reg. 3(1), there is no requirement of profit or avoiding loss for establishing the charge of insider trading, and held the case to be of insider trading.

In 2003, SEBI passed an order against DSQ Holdings Ltd.^[9] for indulging into insider trading. The Company contended that it had not traded on the basis of inside information but had done so for a corporate benefit and had not breached the PIT Regulations. Rejecting the claim of the Company, SEBI held that:

“Dealing in securities as defined under Reg. 2(d) i.e. the mere act of buying/ selling or agreeing to buy/ sell or deal in any security by any person as principal/ agent on the basis of UPSI is covered and is made an offence under Regulation 3. Profit motive is therefore not an ingredient of the offence.”

Upon reading of cases given above and the provisions of insider trading laws, one can establish that the ‘intent’ is not important to demonstrate the case of insider trading. Here it is pertinent to note that the Supreme Court as well as the SAT have conflicted their own past rulings in deciding the matter of insider trading.

Committee Reports preceding the Regulations

The Report of the High Powered Committee on Stock Exchange Reforms^[10] preceded by SEBI (PIT) Regulations, 1992 (‘1992 Regulations’) explained insider trading (in para 7.25) as follows:

“Insider trading generally means trading in the shares of a company by the persons who are in the management of the company or are to close to them, on the basis of undisclosed price sensitive information regarding the working of the company which they possess but are not available to others. Such trading as it involves misuse of confidential information, is unethical tantamounting to betrayal of fiduciary position of trust and confidence.”

Further, Para 53 of the Report of the High Level Committee to review the 1992 Regulations^[11] emphasized on the trading pattern, stating:

“If the insider’s trades were in fact contrary to the nature of the UPSI in his possession, such trading ought not to be treated as a wrongful act. Therefore, where an insider has traded in a manner contrary to how a reasonable man who is seeking to benefit from the UPSI would act, it should follow that he has not committed a tort or a crime.”.

From the reading of the above extracts, it can be said that the intent of insider trading regulations was to curb such transactions carried out on the basis of UPSI at the disadvantage of market participants. If there is no intent to misuse the UPSI, it cannot be said to be insider trading.

However, the Report of Committee on Fair Market Conduct^[12] says otherwise. Para 2.1 of Chapter 2 of the Report states that:

“Section 15G (i) mentions dealing in securities on the basis of unpublished price sensitive information whereas Section 12 A mentions dealing in securities while in possession of unpublished price sensitive information.

There was a need to align the two sections so that they refer to the same action i.e. dealing in securities while in possession of unpublished price sensitive information.”

The Committee pointed out the difference in the language used in section 12A and section 15G of the SEBI Act and recommended aligning the two sections so that they refer to the same action i.e. dealing in securities ‘while in possession’ of UPSI. The Committee dismissed the presence of ‘intent’ while dealing with insider trading cases.

Relevance of ‘motive’ for insider trading in foreign jurisdictions

United States of America (‘USA’)

SEC Rule 10b-5 prohibits fraudulent activities in the securities market. It states that:

“It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.”

While the above provisions do not explicitly talk about insider trading, rather the unlawfulness of insider trading is predicated on the notion that insider trading is a type of securities fraud. The US Supreme Court in the matter of USA vs. Newman^[13] observed that

“Liability for securities fraud also requires proof that the defendant acted with scienter, which is defined as “a mental state embracing intent to deceive, manipulate or defraud. In order to establish a criminal violation the securities laws, the Government must show that the defendant acted “willfully.”

United Kingdom (‘UK’)

Section 53 of the Criminal Justice Act, 1993^[14] provides the defences through which the individual can prove that he did not indulge in insider trading. Sec. 53(1) states that:

“An individual is not guilty of insider dealing by virtue of dealing in securities if he shows—

that he did not at the time expect the dealing to result in a profit attributable to the fact that the information in question was price-sensitive information in relation to the securities, or
that at the time he believed on reasonable grounds that the information had been disclosed widely enough to ensure that none of those taking part in the dealing would be prejudiced by not having the information, or
that he would have done what he did even if he had not had the information.”

Singapore

Section 220 of the Securities and Futures Act 2001^[15] states that:

To avoid doubt, in any proceedings against a person for a contravention of section 218 or 219, it is not necessary for the prosecution or claimant to prove that the accused person or defendant intended to use the information referred to in section 218(1)(a) or (1A)(a) or 219(1)(a) in contravention of section 218 or 219, as the case may be.
In any proceedings against a person for a contravention of section 218 or 219, it is not necessary for the prosecution or claimant to prove the absence of facts or circumstances which if they existed would, by virtue of sections 222 to 230 or any regulations made under section 341, preclude the act from constituting a contravention of section 218 or 219, as the case may be.”

It evidently mentions that the intent is not necessary to prove insider trading. It states that it is not necessary for the prosecution or claimant to prove that the accused person or defendant intended to use the UPSI. Further, it is not necessary to prove the absence of facts or circumstances which, if they existed would preclude the act from constituting insider trading.

Conclusion

In order to establish the act as insider trading, the courts rely on various factors such as trading pattern, circumstantial evidence, relationship between the connected person and the person who traded. The ‘intent’ or ‘motive’ of trading was always a subject of debate. As we have seen above, the USA and UK laws seemingly consider the mens rea in insider trading, but the Singapore law outright rejects the element of intent. The Indian legislation, committee reports and judgements are not very clear on the subject, in fact, the Supreme Court as well as SAT have contradicted their own rulings while dealing with the ‘intent’ of insider trading. It is therefore, to be seen if SEBI goes for a review of the decision in SEBI v. Abhijit Rajan, or the judgment becomes the final word on the matter.

Our Resource Centre on “Prohibition of Insider Trading” can be accessed here

^[1] Section 15G of the SEBI Act provides penalty of not less than Rs. 10 lakh which may extend to Rs, 25 crore or 3 times the amount of profits made out of insider trading, whichever is higher.

^[2] https://main.sci.gov.in/supremecourt/2020/1791/1791_2020_4_1501_38300_Judgement_19-Sep-2022.pdf

^[3] https://main.sci.gov.in/supremecourt/2020/1791/1791_2020_4_1501_38300_Judgement_19-Sep-2022.pdf

^[4]https://www.sebi.gov.in/enforcement/orders/nov-2003/rakesh-agrawal-vs-sebi_16029.html

^[5] https://indiankanoon.org/doc/1741822/

^[6] https://indiankanoon.org/doc/687975/

^[7] https://indiankanoon.org/doc/1080676/

^[8] (1998) 18 SCL 311 (AA)

^[9] https://www.sebi.gov.in/enforcement/orders/feb-2003/order-against-dsq-holdings-ltd_16543.html

^[10] https://indianculture.gov.in/flipbook/2826

^[11] https://www.sebi.gov.in/sebi_data/attachdocs/1386758945803.pdf

^[12]https://www.sebi.gov.in/reports/reports/aug-2018/report-of-committee-on-fair-market-conduct-for-public-comments_39884.html

^[13]https://cases.justia.com/static/pdf-js/web/?file=/federal/appellate-courts/ca2/13-1837/13-1837-2014-12-10.pdf?ts=1418225408#page=1&zoom=auto,-14,799