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-Rishav Sen and Faizan Ahmad†
1. INTRODUCTION
Insider trading can be defined as trading in a company's securities based on material information that is not available to the public at large, to profit from in the short or long run. The rapid evolution of India’s insider trading regime, through legislative amendments and judicial pronouncements, has resulted in one of the strictest insider trading regulations in the world (see here). Following the SEBI (Prohibition of Insider Trading) Regulations, 2015, persons trading while in possession of unpublished price sensitive information (“UPSI”) are presumed to have engaged in insider trading. Under Regulation 2 (n), UPSI is defined as any information that is not generally available, which, if revealed, could materially affect the price of a company’s securities. Furthermore, according to Regulation 3 (1), communicating UPSI to any other person is prohibited except in furtherance of a legitimate purpose.
At this stage, a question arises as to what happens when an insider of a company communicates confidential information to an outsider (“tippee”), who then trades based on such information. In the above scenario, the tippee shall be liable for insider trading under Regulation 4 (1). However, would the liability of a tippee change under the same circumstances if they did not have the required mental element while trading based on UPSI (“innocent tippee”)? An innocent tippee refers to a tippee who wasn’t aware that the confidential information received was of the nature of UPSI (“mental element”), while trading based on it. To resolve this question, we trace the doctrinal basis for prohibiting insider trading in India and its recent encounter with adjudicating the liability of an innocent tippee. Finally, we attempt to show how India can adopt an ‘innocent tippee’ defence within its doctrinal and legislative framework.
2. INDIAN POSITION ON TIPPEE LIABILITY
2.1. Dissecting the different doctrinal strands
Broadly speaking, there are two distinct doctrinal stands favouring insider trading prohibitions. First, the ‘special relationship’ doctrine dictates that insiders, by virtue of their ‘special relationship’ with the company, gain access to UPSI. This imposes on them a corresponding duty to not trade based on such information. Second¸ the ‘equal access to information’ doctrine emphasizes the general investing public’s expectation of having equal access to material information in the securities market. In the absence of such information equity (in the case of UPSI), trading should be prohibited.
Under the ‘special relationship’ doctrine, a tippee, notwithstanding their intent to trade using UPSI, may not have any liability. This is because they do not enjoy a ‘special relationship’ with the company, leading to no correlative duty to abstain from trading based on UPSI. A ‘special relationship’ in this context arises from being privy to the internal affairs of a company. In contrast, following the ‘equal access to information’ doctrine, a tippee, notwithstanding any ‘innocent’ intent, would be liable for trading in securities based on UPSI. This is because, their liability is based on their superior access to UPSI instead of a specific duty owed towards the company.
2.2. Introduction of the ‘Special Relationship’ Doctrine
The insider trading prohibition regime in India was first codified by the SEBI (Prohibition of Insider Trading) Regulations, 1992 (the “1992 Regulations”). The substantive prohibition against insider trading was laid down in Regulation 3 which prohibited an insider from dealing in securities of a company based on UPSI. Furthermore, Regulation 2 (e) defined an insider to include any person who is connected or deemed to be connected with the company and is reasonably expected to have access to UPSI affecting the company. Therefore, the 1992 Regulations clearly adopted the ‘special relationship’ doctrine since it restricted the scope of insider trading to a group of people (i.e. insiders) who have a ‘special relationship’ with the company, which would lead them to gain access to UPSI. Hence, in the absence of a ‘special relationship’ with the company, a tippee would not incur any liability for trading in its securities based on UPSI.
2.3. Transition towards ‘Equal Access to Information’ Doctrine
A significant doctrinal shift towards the equal access to information doctrine occurred after the 2008 amendment to the 1992 Regulations. Following this amendment, the definition of ‘insider’ was expanded to cover any person who has received or has had access to UPSI. Therefore, post-2008, notwithstanding the absence of a ‘special relationship’ with the company, a tippee would be deemed liable for insider trading given the mere fact of their possession of UPSI while trading. As a result, the limitations of the previous conception of a connected and deemed to be connected person were forgone.
Moving forward, the Sodhi Report made a departure from the equal access to information doctrine by creating a defence for an innocent tippee. As per the report, a ‘bona fide recipient’ of UPSI, who had exercised ‘reasonable’ due diligence to ascertain the nature of information received, should be excluded from the scope of an insider. Therefore, the report started a conversation about introducing an ‘innocent tippee’ defence in India for the first time. However, it wasn’t able to reconcile the introduction of such defence with the equal access to information doctrine underlying India’s insider trading regime. Nevertheless, the defence of an innocent tippee was not recognized later by the SEBI (Prohibition of Insider Trading) Regulations, 2015 (the “2015 Regulations”).
2.4. Introduction of the ‘Innocent Tippee’ defence in India
Post the 2015 Regulations, a shift in the liability of an innocent tippee occurred in In re Manappuram Finance Ltd. (“Manappuram”) and Shruti Vora v. SEBI (“Shruti Vora”).
In Manappuram, SEBI was faced with the question of whether trading based on a widely circulated research report containing UPSI would constitute insider trading. Relying on the Sodhi Report, SEBI came to the following conclusions favouring the accused: a) The research report could no longer be deemed UPSI and was instead public in nature due to its widespread dissemination; and b) The accused were ‘innocent tippees’ since the research report, published by a reputed broking entity, stated that it was based on publicly available information. Hence, there was no reason to believe that it was UPSI. In this way, Manappuram introduced the defence of ‘innocent tippee’ in India.
The ‘innocent tippee’ defence was again invoked in Shruti Vora where, following its investigation, SEBI issued a set of orders imposing penalties on certain individuals for forwarding WhatsApp messages containing UPSI prior to its public announcement. However, the orders issued by SEBI were overturned by the Securities Appellate Tribunal (the “SAT”) in favour of the accused. In its decision, the SAT observed that an information can only be deemed UPSI if the accused had knowledge that the information being received was UPSI. Thus, Shruti Vohra crystalized a knowledge requirement while determining the liability of a tippee.
3. CRITIQUING THE EXISTING APPLICATION OF THE INNOCENT TIPPEE DEFENCE
The explanatory note to Regulation 4 (1) of India’s 2015 Regulations clarifies that: a) trading in securities while in possession of UPSI imputes knowledge and awareness regarding the nature of such information on the accused; and b) any intent behind trading in securities under the above circumstances is irrelevant in determining the liability of the accused. Therefore, this places an onerous burden on the accused to prove their innocence against an insider trading charge brought forward by SEBI. This necessitates introducing the defence of an innocent tippee in some form in India.
Now, as discussed previously, the ‘innocent tippee’ defence is incompatible with: a) the equal access to information approach to insider trading prohibition in India from a doctrinal standpoint; and b) the explanatory note to Regulation 4 (1) of the 2015 Regulations. However, the ‘innocent tippee’ defence has implicitly been introduced in India by the decisions in Manappuram and Shruti Vora. This is given the application of the principle that a tippee should have knowledge that the information received by them is of the nature of UPSI, in the absence of which it cannot be deemed UPSI.
However, we contend that the above conclusion is erroneous since the determination of whether any given information is UPSI is an objective one, as defined under Regulation 2 (n) of the 2015 Regulations, as opposed to the subjective standard introduced above. Regulation 2 (n) clarifies that an UPSI must satisfy the following conditions: a) the information must not be generally available; and b) the information is likely to materially affect the price of a company’s securities. Therefore, determining whether any given information satisfies both these conditions does not take into consideration the accused’s mental state, as opposed to the rationale in Manappuram and Shruti Vora. As a result, the need remains for an ‘innocent tippee’ defence to be introduced in an alternate manner in the Indian context.
4. INTRODUCING AN ALTERNATE FRAMEWORK FOR THE INNOCENT TIPPEE DEFENCE
Accordingly, we argue that a tippee’s liability in the Indian context should be absolute, in consonance with the 2015 Regulations, irrespective of their lack of intent or knowledge regarding the nature of information received. Section 15G of the SEBI Act, 1992 imposes a penalty of twenty-five crore rupees or three times the amount of profits made, whichever is higher, for insider trading. Further, Section 195 (2) of the Companies Act, 2013 penalizes insider trading with imprisonment for a term which may extend to five years. Herein, an exception should be carved out for an innocent tippee wherein they should be penalized only to the extent of their profits made, while still finding them liable for insider trading despite their absence of mens rea. Moreover, an innocent tippee should be excluded from the scope of Section 195 (2) since the presence of mens rea is a fundamental requirement for criminal prosecution in India.
In determining whether the accused is an innocent tippee, one needs to establish that there was no reason for the accused to believe, after exercising ‘reasonable’ due diligence, that the information received by them was UPSI (see here). This would be consistent with the Sodhi Report’s recommendation of creating an exception for an innocent tippee, while still heeding the equal access to information approach to prohibiting insider trading. While concluding, it’s important to caution that we have tried to introduce an innocent tippee defence while staying within the existing framework of insider trading laws in India instead of trying to critique it. Thus, we did not consider the more fundamental question of whether we need to altogether transition from the existing ‘equal access to information’ approach towards the ‘special relationship’ approach to prohibiting insider trading. This structural question is left open for future engagement.
5. CONCLUSION
Through this piece, we have traced the shift from the ‘special relationship’ to the ‘equal access to information’ doctrine, underlying India’s insider trading prohibition regime. Subsequently, we have analysed judicial attempts at introducing the ‘innocent tippee’ defence in Manappuram and Shruti Vora. At this stage, we have pointed out the inconsistencies between the findings in these cases vis-à-vis the ‘innocent tippee’ defence and the text of the 2015 Regulations. Therefore, we have recommended that the liability of a tippee should be absolute under the 2015 Regulations. However, an exception should be carved out by limiting their damages, provided the accused had no reason to believe that the information received was of the nature of UPSI, after exercising ‘reasonable’ due diligence.
†Rishav Sen and Faizan Ahmad are 4th Year B.A. LL.B (Hons.) students at Jindal Global Law School