[Sanskruti and Aneesha are students at Gujarat National Law University.]
The Securities and Exchange Board of India (SEBI) is duty-bound to take measures “as it thinks fit” to protect, promote and regulate the securities market. However, sometimes, what the SEBI “thinks fit” might not actually be “the fit”, and ends up going off the deep end. The recently notified SEBI (Prohibition of Insider Trading) (Third Amendment) Regulations 2024 (concerned amendment), is one such example.
The concerned amendment redefined the terms “connected persons” and “relatives,” thus expanding the scope of individuals who could be deemed to have access to unpublished price sensitive information (UPSI). This broader definition is concerning, as it unreasonably subjects people, merely related to the connected person, to a reversed burden of proof under the SEBI (Prohibition of Insider Trading) Regulations 2015 (PIT Regulations).
Therefore, this article addresses the concerned amendment and its shockwaves in 4 parts. Part I provides an overview of the re-defined definitions of “connected persons” and “relatives.” Part II examines the concerned amendment in light of the Supreme Court’s (SC) decision in Balram Garg v. SEBI. Part III analyses the constitutional implications of the concerned amendment. Lastly, Part IV advocates for a balanced approach.
Part I
Insider trading involves buying or selling securities of a listed company based on UPSI, giving certain individuals an unfair advantage, thus it is prohibited under the SEBI Act 1992 and the PIT Regulations. An individual is deemed an insider if they are affiliated with a company and have access to UPSI; previously, the SEBI had to prove such possession to establish liability. However, this burden of proof has been reversed, and now there is an existing (rebuttable) presumption that the accused is guilty.
The concerned amendment presumes that “connected persons” are likely to have access to UPSI; and now, due to the redefining, such “connected persons” encompass a broader category of relatives linked to a company within six months of a specific event - due to their job, role, or relationship. Similarly, the term “immediate relative” is replaced with “relative.” Cumulatively, these two modifications, have, in effect, also expanded the scope of “deemed connected persons.”
Previously, only immediate relatives such as parents, siblings, or children qualified as “deemed connected persons,” the rationale being financial dependency. However, due to the removal of the term “immediate,” now “deemed connected persons” would encompass all relatives whatsoever. So, for instance, if Ms A, an executive at XYZ Limited, possesses UPSI about an upcoming transaction, relatives such as her spouse, parents-in-law, her spouse’s siblings, her siblings and their spouses, her children and their spouses, etc. could qualify as “deemed connected persons.” Similarly, if a “connected person” is a partner in a firm and also on the board of a listed company, then the entire firm could be “deemed connected persons.” This way, the amendment weaponizes mere relational nexus, to impose insider trading liability, thus, forcing individuals – connected even remotely to a “connected person” – to endure the burden of rebutting it.
Further, the amendment goes even more south by including individuals “residing with or sharing a household with a connected person” under the category of “deemed connected persons.” Thus, if a person is sharing an apartment with Ms A, an executive at XYZ Limited, but is neither a relative nor professionally associated, still they would fall under the ambit of “deemed connected person.” This inclusion is particularly troubling as a precise definition of the term “household” doesn’t exist, and the concerned amendment does not find it important to lay one down. Thus, nobody knows what constitutes a household, or what is the timeframe for which, “a household or residence must be shared” to qualify an individual as a deemed connected person.
Part II
Indian courts have long wrestled with the “standard of proof” required in insider trading cases. Over the years, the SEBI has consistently maintained—and the courts have largely accepted—that insider trading allegations should not require proof beyond a reasonable doubt.
In the case of Samir C. Arora v. SEBI, the SC clarified that the SEBI need not prove its case beyond a reasonable doubt, but it must rely on “legally sustainable evidence.” This was reiterated in VK Kaul v. Adjudicating Officer, SEBI, holding that reliance on circumstantial evidence to establish insider trading aligns with SEBI’s regulatory framework.
Further, in Kishore Ajmera, SC firmly crystallized the law and held that circumstantial evidence can suffice to prove insider trading, provided it leads to an “irresistible inference of wrongdoing.” The SC emphasized that the appropriate test is, “what a reasonable and prudent person would infer from the facts,” thereby entrenching the “preponderance of probabilities” as the standard for proving securities market violations.
But then came Balram Garg v. SEBI, which flipped the script entirely, hence altering the course of “standard of proof” jurisprudence in insider trading cases. The SC held:
first, in the absence of material, on record, of frequent communication, the connected person cannot be presumed to have shared UPSI;
second, SEBI must prove that the “immediate relatives” were “financially dependent” or “consulted” the connected person, as these are the foundational facts and must be established before any presumption can be made. “Merely because a person is related to the connected person cannot by itself be a foundational fact to draw an inference.”;
third, it is imperative to appreciate the evidence of “breakdown of ties” between parties;
fourth, relying solely on trading patterns or timings to infer the communication of UPSI is impermissible;
fifth, even if the “connected person” and the “relatives” reside on a common plot of land, the size of the plot or separate accommodation should be considered by SEBI; and
sixth, and quite revolutionarily, the SC clarified that, under the PIT Regulations, the burden of proving that persons related to the “connected persons” were in possession of, or had access to, UPSI, lies on the SEBI; and SEBI must produce direct evidence, such as letters, emails, or witness testimony, to establish the same. It further went on to hold that the standard of proof of “preponderance of probabilities” was legally unsustainable, thus overturning Kishore Ajmera.
Part III
The concerned amendment, when read alongside Balram Garg, appears to be a calculated attempt to overturn the case, as it effectively enhances the burden of proof on SEBI. However, the authors argue that, while legislative and executive maneuvers to overturn judgments are not unprecedented, the concerned amendment goes too far, raising questions about its constitutional validity.
In the case of Sahara v. SEBI, the SC expressly held that the presumption of innocence is embedded in Part III of the Indian Constitution, not only as part of the rule of law under Article 14 but also as an Article 21 right.
Admittedly, a legal provision doesn’t become unconstitutional merely because it provides for a reverse burden. However, as highlighted in Noor Aga v. State of Punjab, a “heightened scrutiny test” is necessary to be invoked before invoking the reverse burden clause. The SC held that “the standard of proof required to prove the guilt of the accused on the prosecution is “beyond all reasonable doubt” but it is “preponderance of probability” on the accused to prove his innocence, thus the latter must not be as high as that of the prosecution.” Thus, by employing a “heightened scrutiny test” the SC acknowledged that the consequences of a reversed burden, even if rebuttable, hit the very core of the Indian Constitution. But by introducing the concerned amendment, SEBI has absolved itself from any such test.
It must be noted that Balram Garg was not subjecting SEBI to any extraordinary standard of proof, but to the well-settled position of law i.e., “the foundational facts test.” However, if SEBI does not want to adhere to this standard, and in response resorts to measures like the concerned amendment, such actions portend a bleak future where protecting fundamental human rights is also an inconvenience to the regulators.
Part IV
Indeed, Balram Garg was no gold standard, it had its fair share of cracks, one of the most glaring being the undervaluation of circumstantial evidence. By creating a stringent “cogent materials” standard, the SC overlooked the realities of modern technology, where direct evidence is often elusive. Similarly, the “direct evidence requirement” also raises concerns about SEBI’s ability to shoulder such an impractical evidentiary burden.
Therefore, it is recommended that the courts consider the entire chain of circumstances rather than relying on isolated pieces of evidence. It would prevent any “chilling effect” on market participation. Similarly, SEBI should establish a uniform standard of proof and formulate guidelines for the use of circumstantial evidence.
Balram Garg, indeed, was a heavy blow to SEBI. However, the answer does not lie in overreaching amendments that unjustly subject more and more (mostly unrelated) people to a reversed burden of proof. True reform must strike a balance, ensuring accountability without trampling on fundamental rights.
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