Supreme Court clarifies insider trading norms: Family relations alone not proof of guilt in securities fraud cases (19 April 2022)

Introduction

Date of the Judgment: 19 April 2022

Citation: (2022) INSC 352

Judges: Vineet Saran, J., Aniruddha Bose, J.

Can a person be held guilty of insider trading simply because they are related to someone with access to sensitive company information? The Supreme Court of India recently addressed this crucial question in a case involving allegations of insider trading against family members of company directors. The court clarified that mere family ties and circumstantial evidence are not enough to prove guilt; concrete evidence of information sharing is necessary.

Case Background

The case revolves around P. Chand Jeweller Pvt. Ltd., which later became PC Jeweller Ltd. (PCJ). The Securities and Exchange Board of India (SEBI) initiated action against the appellants based on an impounding order dated 17 December 2019 and a show-cause notice dated 24 April 2020. SEBI alleged that Padam Chand Gupta (P.C. Gupta), the Chairman of PCJ, and Balram Garg, the Managing Director (MD) of PCJ, were “insiders” under the SEBI (Prevention of Insider Trading Regulations), 2015 (PIT Regulations). It was further alleged that Sachin Gupta, Shivani Gupta, and Amit Garg, relatives of P.C. Gupta and Balram Garg, traded on the basis of Unpublished Price Sensitive Information (UPSI) received through their proximity to P.C. Gupta and Balram Garg between 1 April 2018 and 31 July 2018.

The proximity was based on the fact that Sachin and Shivani Gupta are the son and daughter-in-law of P.C. Gupta, and Amit Garg is the son of Amar Garg, another brother of Balram Garg. It was also alleged that all the appellants shared the same residence. Balram Garg denied the allegations, stating that the other appellants were not “connected persons” and that no information was transferred to them. He also argued that family relations alone could not be grounds for insider trading, especially since the family had been partitioned in 2011.

Timeline

Course of Proceedings

The Whole Time Member (WTM) of SEBI imposed a penalty of Rs. 20 lakhs on the appellants, along with restraining them from accessing the securities market for one year and from dealing with the scrip of PCJ for two years. The appellants then filed appeals before the Securities Appellate Tribunal (SAT). The SAT dismissed the appeals, upholding the WTM’s order. The SAT concluded that despite family arrangements, there was no estrangement, and the trading patterns of the appellants indicated they were aware of UPSI. It noted that although there was no direct evidence of who disseminated the information, it could be concluded on a “preponderance of probability” that P.C. Gupta and Balram Garg had shared the UPSI.

Legal Framework

The case involves several key legal provisions:

• Section 11(2)(g) of the Securities and Exchange Board of India Act, 1992: This section empowers SEBI to prohibit insider trading in securities.
  
  “11. (1) Subject to the provisions of this Act, it shall be the duty of the Board to protect the interests of investors in securities and to promote the development of, and to regulate the securities market, by such measures as it thinks fit. (2) Without prejudice to the generality of the foregoing provisions, the measures referred to therein may provide for— (g) prohibiting insider trading in securities;”
• Section 11(4) of the Securities and Exchange Board of India Act, 1992: This section empowers SEBI to take measures in the interest of investors or securities market, including restraining persons from accessing the securities market.
  
  “[(4) Without prejudice to the provisions contained in sub-sections (1), (2), (2A) and (3) and section 11B, the Board may, by an order, for reasons to be recorded in writing, in the interests of investors or securities market, take any of the following measures, either pending investigation or inquiry or on completion of such investigation or inquiry, namely:—(b) restrain persons from accessing the securities market and prohibit any person associated with securities market to buy, sell or deal in securities;”
• Section 12A of the Securities and Exchange Board of India Act, 1992: This section prohibits manipulative and deceptive devices, insider trading, and substantial acquisition of securities.
  
  “12A. No person shall directly or indirectly—(d) engage in insider trading; (e)deal in securities while in possession of material or non-public information or communicate such material or non-public information to any other person, in a manner which is in contravention of the provisions of this Act or the rules or the regulations made thereunder;”
• Section 15G of the Securities and Exchange Board of India Act, 1992: This section specifies the penalty for insider trading.
  
  “15G. If any insider who,—(i) either on his own behalf or on behalf of any other person, deals in securities of a body corporate listed on any stock exchange on the basis of any unpublished price-sensitive information; or (ii) communicates any unpublished price-sensitive information to any person, with or without his request for such information except as required in the ordinary course of business or under any law; or (iii) counsels, or procures for any other person to deal in any securities of any body corporate on the basis of unpublished price-sensitive information, shall be liable to a penalty [which shall not be less than ten lakh rupees but which may extend to twenty-five crore rupees or three times the amount of profits made out of insider trading, whichever is higher].”
• Regulation 2(1)(d) of the SEBI (Prohibition of Insider Trading) Regulations, 2015: Defines “connected person.”
  
  “2.(1)In these regulations, unless the context otherwise requires, the following words, expressions and derivations therefrom shall have the meanings assigned to them as under:–(d) “connected person” means,—(i) any person who is or has during the six months prior to the concerned act been associated with a company, directly or indirectly, in any capacity including by reason of frequent communication with its officers or by being in any contractual, fiduciary or employment relationship or by being a director, officer or an employee of the company or holds any position including a professional or business relationship between himself and the company whether temporary or permanent, that allows such person, directly or indirectly, access to unpublished price sensitive information or is reasonably expected to allow such access.”
• Regulation 2(1)(f) of the SEBI (Prohibition of Insider Trading) Regulations, 2015: Defines “immediate relative.”
  
  “2.(1)In these regulations, unless the context otherwise requires, the following words, expressions and derivations therefrom shall have the meanings assigned to them as under:–(f) “immediate relative” means a spouse of a person, and includes parent, sibling, and child of such person or of the spouse, any of whom is either dependent financially on such person, or consults such person in taking decisions relating to trading in securities;”
• Regulation 2(1)(g) of the SEBI (Prohibition of Insider Trading) Regulations, 2015: Defines “insider.”
  
  “2.(1)In these regulations, unless the context otherwise requires, the following words, expressions and derivations therefrom shall have the meanings assigned to them as under:–(g)”insider” means any person who is:(i) a connected person; or (ii) in possession of or having access to unpublished price sensitive information;”
• Regulation 3(1) of the SEBI (Prohibition of Insider Trading) Regulations, 2015: Restricts communication of unpublished price-sensitive information.
  
  “3.(1) No insider shall communicate, provide, or allow access to any unpublished price sensitive information, relating to a company or securities listed or proposed to be listed, to any person including other insiders except where such communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.”
• Regulation 4(1) of the SEBI (Prohibition of Insider Trading) Regulations, 2015: Prohibits trading when in possession of unpublished price-sensitive information.
  
  “4.(1) No insider shall trade in securities that are listed or proposed to be listed on a stock exchange when in possession of unpublished price sensitive information:”
• Regulation 4(2) of the SEBI (Prohibition of Insider Trading) Regulations, 2015: Specifies onus of proof in case of connected persons.
  
  “(2) In the case of connected persons the onus of establishing, that they were not in possession of unpublished price sensitive information, shall be on such connected persons and in other cases, the onus would be on the Board.”

Arguments

Arguments by the Appellants:

• Balram Garg argued that the other appellants were not “connected persons” or “immediate relatives” and that SEBI failed to prove any communication of UPSI. He contended that the burden of proof was on SEBI to establish the communication of UPSI, which they failed to do by not providing any call details, emails, or witnesses. He further argued that family relationships alone cannot be grounds for insider trading, especially since the family was partitioned in 2011.
• The other appellants (Shivani Gupta, Sachin Gupta, and Amit Garg) argued that their case was based solely on their close relationship with P.C. Gupta and Balram Garg. They presented evidence of a breakdown in personal and professional ties, arguing that this estrangement occurred before the UPSI came into existence. They also argued that the burden of proof was on SEBI to prove they had access to UPSI, which SEBI failed to do.
• They further contended that the charges were sustained solely on the basis of circumstantial evidence, such as trading patterns and timing of trades, without any concrete evidence of insider trading.

Arguments by SEBI:

• SEBI argued that PCJ initiated discussions for a buy-back of shares on April 25, 2018, which was approved by the board on May 10, 2018. This was considered UPSI-1. On July 7, 2018, the lead banker, SBI, refused to give a No Objection Certificate (NOC) for the buy-back, leading to the withdrawal of the offer on July 13, 2018, which was considered UPSI-2.
• SEBI contended that Balram Garg, as an “insider” and “connected person,” violated Regulation 3(1) of the PIT Regulations and Section 12A(c) of the SEBI Act by communicating the UPSI to the other appellants.
• SEBI further argued that the appellants in C.A. No. 7590 of 2021 traded while in possession of UPSI, making unlawful gains and avoiding losses. They highlighted the trading patterns of Shivani Gupta, who sold shares before and during the UPSI periods. SEBI also contended that Quick Developers Pvt. Ltd. took short positions in anticipation of a price fall.
• SEBI argued that the family settlement was merely an internal division and did not sever ties between the family members. They presented evidence of continued business transactions between Sachin Gupta and PCJ, and the shared residential address of the appellants.

Submissions by Parties

Issues Framed by the Supreme Court

The Supreme Court framed the following key issues for consideration:

1. Whether the WTM and SAT rightly rejected the claim of estrangement of the appellants in C.A. No. 7590 of 2021, namely, Mrs. Shivani Gupta, Sachin Gupta, and Amit Garg?
2. Whether the aforementioned appellants could be rightly held to be “insiders” in terms of Regulation 2(1)(g)(ii) of the PIT Regulations, only and entirely on the basis of circumstantial evidence?

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• H.K.N. Swami v. Irshad Basith [(2005) 10 SCC 243]* and *UPSRTC vs Mamta [(2016) 4 SCC 172]*: The Supreme Court followed these cases, reiterating that the first appellate court must address all issues and evidence.
• Utsav Pathak vs. SEBI (order dated 12.07.2020 in Appeal No. 430 of 2019)*, *SEBI vs. Kishore R. Ajmera [(2016) 6 SCC 368]*, *United States of America vs. Raj Rajaratnam and Danielle Chiesi [09 Cr 1184 (RJH)]* and *Navin Kumar Tayal & Anr. Vs SEBI (order dated 02.08.2021 in Appeal No. 08 of 2018)*: The Supreme Court distinguished these cases, emphasizing that foundational facts must be established before a presumption is made.
• Hanumant vs. State of Madhya Pradesh [AIR 1952 SupremeCourt 343]*: The Supreme Court followed this case, emphasizing that in cases of circumstantial evidence, the facts must be fully established and consistent only with the guilt of the accused.
• Chintalapati Srinivasa Raju vs Securities and Exchange Board of India [(2018) 7 SCC 443]*: The Supreme Court followed this case, holding that a reasonable expectation to be in the know of things can only be based on reasonable inferences drawn from foundational facts.
• Seema Silk & Sarees vs. Directorate of Enforcement [(2008) 5 SCC 580]*: The Supreme Court followed this case, reiterating that a presumption is raised only when certain foundational facts are established by the prosecution.
• Tarlochan Dev Sharma vs State of Punjab [(2001) 6 SCC 260]* and *Hindustan Lever Ltd. vs. Director General (Investigation and Registration) [(2001) 2 SCC 474]*: The Supreme Court followed these cases, reiterating that an order cannot be founded on grounds different from those in the show cause notice.
• Dushyant N. Dalal vs. SEBI [(2017) 9 SCC 660]*: The Supreme Court distinguished this case, stating that it related to interests and penalty rather than the subject matter at hand.
• Statutory Provisions: The Court considered all the relevant statutory provisions of the SEBI Act and the PIT Regulations.

Key Reasons for the Decision:

1. Lack of Concrete Evidence: The Supreme Court emphasized that SEBI failed to provide concrete evidence of communication of UPSI between Balram Garg and the other appellants. The court noted that circumstantial evidence alone is not sufficient to prove insider trading; direct evidence of information sharing is necessary.
2. Estrangement of Family Ties: The Court found that the appellants had demonstrated a breakdown in personal and professional ties with the alleged insiders before the UPSI came into existence. This estrangement weakened the argument that they had access to sensitive information through family connections.
3. Burden of Proof: The Court reiterated that the burden of proof lies with SEBI to establish that the appellants were in possession of UPSI and traded based on that information. The court held that SEBI failed to discharge this burden adequately.
4. Violation of Natural Justice: The Court noted that SEBI’s reliance on transactions between Sachin Gupta and PCJ, which were not part of the show cause notice, violated the principles of natural justice.
5. No Correlation of UPSI and Trading Pattern: The Court observed that the trading patterns of the appellants did not show a clear correlation with the UPSI, further weakening SEBI’s case.

Final Order

The Supreme Court allowed the appeals and set aside the impugned orders of the Securities Appellate Tribunal (SAT) and the Whole Time Member (WTM) of the Securities and Exchange Board of India (SEBI). The Court held that the appellants were not guilty of insider trading. The Court granted relief to the appellants, stating that they were not guilty of any violation of the SEBI Act or the PIT Regulations.

Key Takeaways

The Supreme Court’s judgment in this case provides several key takeaways regarding insider trading:

• Family Ties Are Insufficient: Family relationships alone are not sufficient to prove insider trading. There must be concrete evidence of information sharing.
• Burden of Proof: The burden of proof lies with SEBI to establish that an individual was in possession of UPSI and traded on that basis.
• Circumstantial Evidence is Not Enough: Circumstantial evidence, such as trading patterns and family relationships, is not enough to prove insider trading. Direct evidence of communication or access to UPSI is required.
• Estrangement Matters: If there is evidence of estrangement or a breakdown in personal and professional ties, it can weaken the presumption of insider trading based on family relationships.
• Natural Justice: Orders must be based on the grounds stated in the show cause notice, and any deviation violates the principles of natural justice.
• Foundational Facts Required: A reasonable expectation to be in the know of things can only be based on reasonable inferences drawn from foundational facts.

Flowchart of the Decision-Making Process