[Harshita and Priyanshu are students at Hidayatullah National Law University.]
In its latest amendment proposal on 29 July 2024, India’s capital markets regulator, the Securities and Exchange Board of India (SEBI) has proposed to amend the definition of ‘connected person’, which is defined under Section 2(1)(d) of the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations 2015 (PIT Regulations). As defined under various statutes, the concept of ‘connected person’ includes different aspects which constitute connected persons as a whole. One of the key aspects is ‘relative’ or ‘immediate relative’ depending on the statute. PIT Regulations volunteers for the inclusion of ‘immediate relative’ which narrows the scope of ‘connected person’ in the Regulation. On the other hand, the Income Tax Act 1961 broadens the scope with the inclusion of ‘relative’. SEBI, through this proposed amendment, aims to do away with this variation of scope of the same phrase.
This amendment aims to bring clarity and improve the regulatory framework by broadening the scope of the ‘connected person’ and bringing it in line with the Companies Act 2013. It also ensures to reduce the practice of insider trading by expanding the scope of who could be a receiver of unpublished price sensitive information (UPSI). However, it does not seem to be waterproof and several loopholes have surfaced, including the incorporation of Section 2(1)(d)(ii)(n), which further extends the scope of ‘connected person’ to “persons sharing household or residence with a connected person”.
Changes Proposed in the Consultation Paper
There are multiple changes proposed by SEBI in order to enhance the scope of ‘connected person’ and ‘insider’ defined Sections 2(1)(d) and 2(1)(g), respectively under the PIT Regulations. For the purposes of this blog, a few of those changes are taken into regard. SEBI has proposed to dilute the dividing line between ‘connected person’ and ‘deemed to be connected persons’, which is categorized under Section 2(1)(d)(ii) of the PIT Regulations. The reasoning provided by the Board on this change pertains to the level of proximity between the parties. Thus, it is aimed to rationalize with the definition of ‘related party’ under Section 2(76) of the Companies Act 2013.
One of the categories to consider under the ambit of deemed to be connected persons is ‘an immediate relative’. The board has also proposed to amend it to ‘a relative’ through the addition of a new clause in the Regulations i.e., 2(1)(hc). The clause provides a list of persons who could be construed as relatives. They are spouse, sibling(s); or sibling(s) of spouse; or siblings of parents; or any lineal ascendant or descendant of the individual or spouse; or spouse of the person referred to in any of the earlier categories. Due to the addition of ‘lineal ascendants or descendants’, the scope of relatives would encompass the larger family tree of both the individual and his/her spouse.
Furthermore, the consultation paper also proposes a major procedural change in investigation of insider trading. As per the current Section 4(2) of the PIT Regulations, the onus of proving that the concerned individual has not done insider trading is upon the individual if he/she is a connected person. At the same time, the onus is on SEBI if the concerned individual is not a connected person. However, the paper proposes to change this stand and place the onus on the individual even if that person is deemed to be a connected person, which essentially does not constitute the definition of ‘connected person’.
Undefined Scope of the Proposed Amendments
The new sub-clause ‘(n)’ added to Section 2(1)(d) about 'sharing household or residence' fails to establish a definite scope and leaves it open for misinterpretations which might lead to practical obstacles for SEBI and traders and investors. The clause seems to be very general in nature as it fails to specify any particular period for which the designated household or residence needs to be shared for a person to qualify under the criteria for connected person.
It is worth noting that there exists a similar clause in foreign regulations governing stock market activities, including insider trading. The comparison of this unsettled provision with respect to its foreign parallels serves an insight to rationalize the scope of this clause. Article 3(26) of the European Union’s Market Abuse Act puts forward the concept of a ‘person closely associated' (PAC). The clause (c) of the given Article specifically defines PAC to include 'a relative who has shared the same household for at least one year on the date of the transaction concerned'. It can be deduced from this definition, unlike one proposed in the consultation paper, that it has specified the ambit of the time period by providing a bracket of one year so as to avoid the risk of improper interpretation.
Furthermore, as per the PIT Regulations, there is no specific test encompassing the precise definition to determine what constitutes a ‘household’ under clause (n). The parent legislation of PIT Regulations, i.e., SEBI Act 1992, also fails to underline or provide for an interpretation of the term ‘household’. At present, the only reference that can be drawn in the context of Indian Laws is to the Income Tax Act 1961. The concerned statute does not provide for a definition itself but the interpretation of the same can be understood taking help of judicial pronouncements. To evaluate, the courts merely define ‘residential house property (RAP)’ for the purposes of income tax and not a straight-jacket interpretation of the term ‘household’ or ‘residence’. The case of ITO v. Smt. Rohini Reddy explains RAP as “a plot of land with a temporary structure not put up with intent to use it as residential house either for self –occupation or letting out could not be treated as residential house.” (emphasis supplied)
Assessing the Impact through the Balram Case
It seems that SEBI has taken into consideration the loopholes highlighted in the case of Balram Garg v. SEBI (Balram Case) and released the proposed amendments. The consultation paper proposes to shift the onus of proof upon the charged individual instead of SEBI to prove that they were not in possession of UPSI while trading. The Supreme Court (SC) allowed the appeals filed by Balram Garg and other appellants in a case of insider trading wherein SEBI failed to place on record any material evidence to prove that the appellants benefited from UPSI while trading.
This case established a new standard for evidence to be presented before the court in the cases of insider trading. It laid down that mere circumstantial evidence is insufficient to prove a tipper-tipper relationship, and there must be some substantial merit to prove the charges. As paragraph 2.5 of the consultation paper aims to shift the onus to prove onto the person being charged of insider trading, a question arises as to whether the concerned individual would be required to meet the same standard of establishing evidence to satisfy the burden. This modification may ensure an improved degree of conformity to the PIT Regulations, but the task of contesting the charges would involve a long process whereby investors will have to disclose their trading patterns, relationships, and proof of other compliance undertaken by them.
According to Section 2(1)(f) of the PIT Regulations which defines the term 'immediate relative', two criteria are set to qualify as the same. The first criterion is that the concerned person must share a relationship as provided in the section. Further, the second criterion underlines the existence of financial dependency and involvement in the decision-making process relating to trade in securities. In this case, the primary contention of the respondents was that there existed a close relationship between the parties (the appellants being son and daughter-in-law of Balram Garg’s brother), which ultimately led to sharing of the UPSI. This contention was rejected by the SC as SEBI failed to provide material evidence to establish the given criteria. In line with the changes proposed, the first criterion solely constitutes the definition of ‘relative’, thereby negating the requirement for the second criterion. This development regards the relative as a connected person by mere virtue of being a relative listed under the definition, which gives an excessive advantage for the authorities to level charges.
Conclusion
SEBI brings massive changes in the insider trading world with this consultation paper. The rationalization of the term ‘relative’ in PIT Regulations with the Income Tax Act 1961 aids in clarity and consonance of the same throughout the Indian legislations. Moreover, these proposed amendments would assist the authorities in regulating the practice of insider trading in the stock market. However, the broadening of terms such as ‘connected person’ and ‘relative’ provides an excessive advantage to SEBI. The procedural change of shifting the onus on the charged person to prove against the charges would result in inconvenience to traders and investors. Further, the open-ended additions under the definition of ‘connected person’ such as sharing household or residence might give arbitrary powers to the authorities exercising it. Evaluating the benefits and drawbacks of the proposed amendments, it could be concluded that these changes can be introduced in the PIT Regulations after certain modifications to the clauses.
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