Supreme Court clarifies SEBI’s power to pass ex-parte orders in insider trading cases: SEBI vs. Udayant Malhoutra (2020)

Date of the Judgment: 18 November 2020

Citation: 2020 INSC 880

Judges: Dr Dhananjaya Y Chandrachud, J., Indu Malhotra, J., and Indira Banerjee, J.

Can the Securities and Exchange Board of India (SEBI) order an individual to deposit a sum of money based on a notional loss calculation before the conclusion of an investigation for insider trading? The Supreme Court addressed this question in a recent judgment. The core issue was whether SEBI could pass an ex-parte interim order directing the deposit of funds during an ongoing investigation. The Supreme Court bench comprised of Dr. Dhananjaya Y Chandrachud, J., Indu Malhotra, J., and Indira Banerjee, J.

Case Background

The case revolves around Udayant Malhoutra, the Chief Executive Officer and Managing Director of Dynamatic Technologies Ltd. SEBI initiated an investigation based on allegations that Mr. Malhoutra had sold 51,000 shares of the company on 24 October 2016, while possessing unpublished price-sensitive information (UPSI) about the company’s unaudited financial results for the quarter ending 30 September 2016. These results were later approved by the Board of Directors on 11 November 2016, which led to a significant drop in the company’s stock price. SEBI alleged that Mr. Malhoutra, being a connected person with access to UPSI, had avoided a notional loss by selling his shares before the price drop.

Timeline

Course of Proceedings

Initially, SEBI’s Whole Time Member passed an ex-parte interim order on 15 June 2020, directing Mr. Malhoutra to deposit Rs 3,83,16,230.73, the amount of notional loss avoided, into an Escrow Account. This order was based on the preliminary finding that Mr. Malhoutra had engaged in insider trading. Mr. Malhoutra appealed this order before the Securities Appellate Tribunal (SAT), arguing that there was no urgency to pass such an order, especially given that the investigation had been ongoing since 2017 and information had already been provided in 2019. The SAT set aside the SEBI order, stating that ex-parte orders should only be passed in extremely urgent situations. SEBI then appealed to the Supreme Court against the SAT’s decision.

Legal Framework

The Securities and Exchange Board of India Act, 1992 (SEBI Act) empowers SEBI to protect investors and regulate the securities market. Section 11(4) of the SEBI Act outlines the measures SEBI can take during or after an investigation. Specifically, Section 11(4)(d) of the SEBI Act states that SEBI can:

“(d) impound and retain the proceeds or securities in respect of any transaction which is under investigation;”

This provision allows SEBI to impound and retain proceeds or securities under investigation. However, the interpretation and application of this provision, particularly in the context of ex-parte orders, was the crux of the dispute in this case.

Arguments

Respondent’s (Udayant Malhoutra) Arguments:

• The respondent argued that there was no urgency to pass an ex-parte order against him, especially since the alleged trade took place about three years prior and the investigation was ongoing since 2017.
• He contended that the ex-parte action by SEBI, requiring a deposit during the pandemic, was arbitrary and unjustified.
• The respondent relied on the Tribunal’s decision in North End Foods Marketing Pvt Ltd v Securities and Exchange Board of India* (Appeal 80 of 2019) to argue that ex-parte orders should only be passed in extreme urgent situations.

Appellant’s (SEBI) Arguments:

• SEBI argued that the ex-parte order was necessary because there was a possibility of the respondent diverting the notional gain he had made.
• SEBI contended that it has the power to pass an interim order and that in extreme urgent cases, it can pass an ex-parte interim order.
• SEBI relied on Section 11(4) of the SEBI Act, which empowers it to impound and retain proceeds or securities under investigation.

The Tribunal, in its decision, had observed that no amount towards disgorgement can be directed to be deposited in advance unless it is adjudicated and quantified, and that such orders can only be passed during the pendency of the proceedings and not at the time of initiation of the proceedings. This observation was also a point of contention.

Issues Framed by the Supreme Court

The Supreme Court did not explicitly frame issues in a numbered list. However, the primary issue before the court was:

• Whether the Securities Appellate Tribunal (SAT) was correct in setting aside the ex-parte interim order passed by the Whole Time Member of SEBI.

A sub-issue that the Court dealt with was the interpretation of Section 11(4)(d) of the SEBI Act, particularly regarding the power of SEBI to pass ex-parte orders requiring the deposit of funds before the conclusion of an investigation.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues:

Authorities

Cases:

• North End Foods Marketing Pvt Ltd v Securities and Exchange Board of India* (Appeal 80 of 2019, Securities Appellate Tribunal): The Tribunal held that there is no real urgency in the matter to pass an ex-parte interim order, especially during the pandemic period. It stated that SEBI’s power to pass ex-parte orders should be exercised sparingly and only in extreme urgent matters. This case was relied upon by the Tribunal in the present case to set aside the ex-parte order passed by SEBI.

Legal Provisions:

• Section 11(4) of the Securities and Exchange Board of India Act, 1992: This section empowers SEBI to take measures, including impounding and retaining proceeds or securities under investigation. The Court clarified that SEBI’s orders must adhere to this section.

Judgment

How each authority was viewed by the Court?

• The Court noted that the Tribunal relied on North End Foods Marketing Pvt Ltd v Securities and Exchange Board of India* to set aside the ex-parte order. The Court clarified that the Tribunal’s interpretation of SEBI’s powers in the present case should not be treated as a precedent.
• The Court emphasized that SEBI’s orders must be in accordance with Section 11(4) of the SEBI Act.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the lack of urgency demonstrated by SEBI in passing the ex-parte order. The Court noted that the investigation had been ongoing since 2017, and the respondent had already provided information in 2019. The Court was also concerned about the Tribunal’s interpretation of SEBI’s powers in paragraph 9 of its order, which stated that no amount towards disgorgement can be directed to be deposited in advance unless it is adjudicated and quantified. The court clarified that this interpretation should not be cited as a precedent. The court emphasized that SEBI’s actions must be in accordance with Section 11(4) of the SEBI Act.

Logical Reasoning:

The Court considered the facts that the investigation was pending since 2017 and the information was already provided in 2019. The Court also considered the Tribunal’s interpretation of SEBI’s powers and clarified that it should not be treated as a precedent. The court emphasized that SEBI’s actions must be in accordance with Section 11(4) of the SEBI Act. The court did not find any alternative interpretation of the facts and law that would justify the ex-parte order. The Court concluded that on the facts of the case, the Tribunal was correct in setting aside the ex-parte order.

The court’s reasoning was based on the following points:

• The investigation was pending since 2017.
• The respondent had provided information in 2019.
• There was no extreme urgency to justify an ex-parte order.
• SEBI’s actions must be in accordance with Section 11(4) of the SEBI Act.
• The Tribunal’s interpretation of SEBI’s powers should not be treated as a precedent.

The court quoted from the judgment:

• “On the facts before it, the Tribunal, in our view, was correct in coming to the conclusion that since the investigation was pending since 2017 and information had been supplied on 28 November 2019, there was no urgency for passing an ex-parte interim order of the nature that was issued by the Whole Time Member.”
• “By way of abundant caution, we clarify that we are affirming the view on the facts which have emerged from the record before the Tribunal.”
• “The order passed by the SEBI must necessarily be in accord with Section 11(4) of the SEBI Act.”

There were no minority or dissenting opinions in this case. All three judges concurred with the judgment.

The decision clarifies that while SEBI has the power to pass interim orders, such powers must be exercised judiciously and only in situations of extreme urgency. The court’s analysis focused on the facts of the case, the timeline of the investigation, and the interpretation of Section 11(4) of the SEBI Act. The decision implies that SEBI cannot arbitrarily pass ex-parte orders without demonstrating a genuine need for such action.

Key Takeaways

• SEBI’s power to pass ex-parte interim orders is not absolute and must be exercised judiciously.
• Ex-parte orders should only be passed in cases of extreme urgency, where there is a genuine risk of diversion of funds or securities.
• The timeline of an investigation and the provision of information by the concerned party are crucial factors in determining the need for an ex-parte order.
• SEBI’s actions must be in accordance with Section 11(4) of the SEBI Act.
• The interpretation of SEBI’s powers by the Securities Appellate Tribunal in this case should not be treated as a precedent.

Directions

The Supreme Court did not give any specific directions but clarified that the interpretation of SEBI’s powers by the Tribunal in paragraph 9 of its order should not be treated as a precedent.

Development of Law

The ratio decidendi of this case is that SEBI’s power to pass ex-parte interim orders is subject to the requirement of extreme urgency and must be exercised in accordance with Section 11(4) of the SEBI Act. The judgment clarifies that an ongoing investigation and prior provision of information by the concerned party are relevant factors in determining the need for an ex-parte order. The Supreme Court did not change any previous positions of law, but clarified the interpretation of SEBI’s powers in the context of ex-parte orders.

Conclusion

The Supreme Court upheld the Securities Appellate Tribunal’s decision to set aside SEBI’s ex-parte order against Udayant Malhoutra. The Court emphasized that while SEBI has the power to pass interim orders, such powers must be exercised judiciously and only in situations of extreme urgency. The Court clarified that the Tribunal’s interpretation of SEBI’s powers in paragraph 9 of its order should not be treated as a precedent. This judgment serves as a reminder that regulatory bodies must act within the bounds of the law and demonstrate a genuine need for ex-parte actions.