Supreme Court clarifies the definition of “Insider” under SEBI Regulations in Satyam Scam Case (14 May 2018)

Introduction

Date of the Judgment: 14 May 2018

Citation: 2018 INSC 425

Judges: R.F. Nariman, J., Navin Sinha, J.

Can a director of a company be considered an “insider” simply by virtue of their position, even if they were not directly involved in any fraudulent activities? The Supreme Court of India addressed this crucial question in a series of appeals stemming from the infamous Satyam Computer Services Limited (SCSL) scam. The core issue revolved around interpreting the definition of “insider” under the Securities and Exchange Board of India (SEBI) (Prohibition of Insider Trading) Regulations, 1992, specifically whether a person is reasonably expected to have access to unpublished price-sensitive information (UPSI).

The Supreme Court, in this judgment, clarified that being a “connected person” (like a director) is not enough to be deemed an “insider.” The person must also be reasonably expected to have access to UPSI. The Court emphasized that the word “and” in the definition should be given its ordinary conjunctive meaning.

The judgment was delivered by a bench comprising Justice R.F. Nariman and Justice Navin Sinha, with Justice R.F. Nariman authoring the opinion.

Case Background

The case originates from the Satyam scam, where B. Ramalinga Raju, the former Chairman of SCSL, admitted to overstating the company’s financial statements in a letter dated 7 January 2009. This revelation triggered investigations by SEBI and other agencies.

The appellant, Chintalapati Srinivasa Raju, was an executive director of SCSL from 1993 to 31 August 2000, and a non-executive director from 1 September 2000 to 23 January 2003. He was also the “co-brother” of B. Ramalinga Raju. Initially, SCSL was incorporated as a private limited company on 24 June 1987, with B. Ramalinga Raju and D.V. Satyanarayana Raju as the original promoters.

Chintalapati Srinivasa Raju primarily managed Satyam Enterprise Solutions Private Limited (SES), a joint venture of SCSL. In 1999, SES merged into SCSL, and he received 800,000 equity shares of SCSL, which doubled to 1,600,000 after a bonus declaration. A stock split in 2000 increased his shareholding to 7,650,000 equity shares. The first instance of UPSI for SCSL was identified as 31 March 2001, by which time the appellant was a non-executive director.

The appellant sold his shares in SCSL between 22 February 2001 and December 2008. SEBI issued a show cause notice on 19 June 2009, alleging that as a promoter and director, he was an “insider” with knowledge of UPSI and had gained by selling shares at inflated prices. The appellant denied these allegations, stating he was not an “insider” under the 1992 Regulations.

Timeline:

Course of Proceedings

The Whole Time Member of SEBI, on 10 September 2015, held that Chintalapati Srinivasa Raju was an “insider” under the 1992 Regulations, due to being a director, a promoter and the co-brother of B. Ramalinga Raju. The Whole Time Member stated that even though the appellant had no role in the fraud committed by B. Ramalinga Raju, he was still liable as he was part of the board of directors and was declared as a promoter in disclosures filed by SCSL with stock exchanges. He was barred from accessing the securities market for 7 years and ordered to disgorge ₹136.64 crores.

The Appellate Tribunal largely dismissed the appeal. The majority held that it was enough that the appellant was a director after the date of occurrence of UPSI (31 March 2001). It stated that there was no difference between an executive and a non-executive director and that he could reasonably be expected to know about the fraud due to his close connection with B. Ramalinga Raju. However, the Appellate Tribunal granted relief, holding him liable only for six months after his resignation as a director (upto July 2003) and remanded the matter to assess the quantum of unlawful gains made during this period.

Legal Framework

The case primarily revolves around the interpretation of the following legal provisions:

• Section 12A of the SEBI Act, 1992: This section prohibits manipulative and deceptive devices, insider trading, and substantial acquisition of securities or control. It states that no person shall engage in insider trading or deal in securities while in possession of material or non-public information.
• Section 15G of the SEBI Act, 1992: This section specifies the penalty for insider trading, stating that any insider who deals in securities on the basis of unpublished price-sensitive information shall be liable to a penalty.
• Regulation 2(c) of the SEBI (Prohibition of Insider Trading) Regulations, 1992: This regulation defines “connected person” as any director of a company or any person who occupies a position that may reasonably be expected to have access to unpublished price-sensitive information.

  (c) “connected person” means any person who— (i) is a director, as defined in clause (13) of section 2 of the Companies Act, 1956 (1 of 1956), of a company, or is deemed to be a director of that company by virtue of sub-clause (10) of section 307 of that Act or (ii) occupies the position as an officer or an employee of the company or holds a position involving a professional or business relationship between himself and the company whether temporary or permanent and who may reasonably be expected to have an access to unpublished price sensitive information in relation to that company: Explanation :—For the purpose of clause (c), the words “connected person” shall mean any person who is a connected person six months prior to an act of insider trading;

• Regulation 2(e) of the SEBI (Prohibition of Insider Trading) Regulations, 1992: This regulation defines “insider” as any person who is connected with the company and is reasonably expected to have access to unpublished price-sensitive information, or has received or had access to such information.

  (e) “insider” means any person who, (i) is or was connected with the company or is deemed to have been connected with the company and is reasonably expected to have access to unpublished price sensitive information in respect of securities of a company, or (ii) has received or has had access to such unpublished price sensitive information;

• Regulation 3(i) of the SEBI (Prohibition of Insider Trading) Regulations, 1992: This regulation prohibits an insider from dealing in securities on the basis of any unpublished price-sensitive information. This was later amended in 2002 to prohibit dealing in securities when in possession of any unpublished price-sensitive information.

  3. No insider shall— (i) either on his own behalf or on behalf of any other person, deal in securities of a company listed on any stock exchange on the basis of any unpublished price sensitive information;

  3. No insider shall— (i) either on his own behalf or on behalf of any other person, deal in securities of a company listed on any stock exchange when in possession of any unpublished price sensitive information;”

• Regulation 2(1)(h)(i) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997: This regulation defines “promoter” as a person who is in control of the company, directly or indirectly, whether as a shareholder, director, or otherwise.

  (h) “promoter” means- (i) the person or persons who are in control of the company, directly or indirectly, whether as a shareholder, director or otherwise;

Arguments

Appellant’s Arguments:

• The appellant argued that the show cause notice was based on the premise that he was a promoter of SCSL. Since he was not a promoter, the findings of the Whole Time Member and the Appellate Tribunal should be set aside as they go beyond the scope of the show cause notice.
• The appellant contended that the Whole Time Member and the Appellate Tribunal erred in construing Regulation 2(e)(i) of the 1992 Regulations. They failed to consider that an “insider” is not only a “connected person” but also one who is “reasonably expected to have access to unpublished price sensitive information by virtue of such connection.” The second part of the definition was ignored by both authorities.
• Even if the appellant was considered an “insider,” Regulation 3(i) would not apply because he was neither in possession of nor acted on the basis of any unpublished price sensitive information.
• The Whole Time Member’s order suffered from pre-determinational bias as he had already found against the appellant in an earlier order related to B. Ramalinga Raju and his cohorts, without the appellant being a party to that decision.
• The judgments ignored the findings of the Special Court, the CBI charge sheet, and the SFIO’s report, which stated that only B. Ramalinga Raju and his cohorts were involved in the manipulation of accounts and had hidden this from the board of directors.
• The appellant relied heavily on the minority judgment of the Appellate Tribunal, which exonerated him after a detailed factual analysis.

SEBI’s Arguments:

• SEBI argued that the appellant was a promoter by virtue of being an executive director from 1993, making him a person in control of the company.
• SEBI relied upon Section 21 of the Securities Contracts (Regulation) Act, 1956 and Clause 35 of the Listing Agreement to show that the company has to file the shareholding pattern on a quarterly basis, which contains the promoters’ holding.
• SEBI contended that the appellant was clearly a promoter within the meaning of the definition in Regulation 2(1)(h)(i) of the 1997 Regulations, which is incorporated in the Listing Agreement. This definition includes a person who is in control of the company, directly or indirectly, whether as a shareholder, director, or otherwise.
• SEBI argued that the annual returns filed by the company did not need to disclose who were the promoters of the company and for this reason, SCSL did not disclose the appellant as a promoter.
• SEBI argued that the majority judgment of the Appellate Tribunal was correct in considering five factors to hold that the appellant was an insider: (i) he was a promoter; (ii) he promoted two joint venture companies closely linked with SCSL; (iii) one of these companies merged with SCSL; (iv) he would continue as a director until replaced; and (v) he was the co-brother of B. Ramalinga Raju.
• SEBI argued that Regulation 2(e)(i) must be contrasted with Regulation 2(e)(ii), where sub-clause (i) requires a connected person to be reasonably expected to have insider information, while sub-clause (ii) requires actual knowledge of insider information for non-connected persons.
• SEBI argued that penalty proceedings and criminal proceedings are different and independent of each other, and that, therefore, what is held by a Special Court would not have any real bearing on SEBI’s penalty proceeding.

Submissions of Parties

Issues Framed by the Supreme Court

The Supreme Court framed the following key issues:

1. Whether the appellant, Chintalapati Srinivasa Raju, was an “insider” as defined under Regulation 2(e)(i) of the SEBI (Prohibition of Insider Trading) Regulations, 1992.
2. Whether the appellant was a promoter of SCSL.
3. Whether the appellant was in possession of or acted on the basis of unpublished price-sensitive information.
4. Whether the findings of the Whole Time Member and the majority view of the Appellate Tribunal went beyond the scope of the show cause notice.
5. Whether the SFIO report and the judgment of the Special Court could be considered as evidence.

Treatment of the Issue by the Court

The following table demonstrates how the Court decided the issues:

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?

• The Supreme Court relied on Maharaja Sir Pateshwari Prasad Singh v. State of U.P., (1963) 50 ITR 731, M. Satyanarayana v. State of Karnataka, (1986) 2 SCC 512, Union of India v. Justice S.S. Sandhawalia, (1994) 2 SCC 240 and Spentex Industries Ltd. v. CCE, (2016) 1 SCC 780 to emphasize that the word “and” in Regulation 2(e)(i) should be given its ordinary conjunctive meaning.
• The Court cited Pooja Ravinder Devidasani v. State of Maharashtra, (2014) 16 SCC 1 to distinguish between executive and non-executive directors, stating that non-executive directors are not involved in the day-to-day affairs of the company.
• The Court referred to Dovey and the Metropolitan Bank v. John Cory, [1901] AC 477 to explain that directors are not expected to be involved in the minute details of the company’s operations and can rely on the judgment of other officers.
• The Court relied on Godrej Industries Ltd. v. CCE, (2008) 17 SCC 471 and SACI Allied Products Ltd. v. CCE, (2005) 7 SCC 159 to statethat the Tribunal cannot go beyond the scope of the show cause notice.
• The Court cited SEBI v. Kishore R. Ajmera, (2016) 6 SCC 368 to state that inferences can be drawn from foundational facts to reach a reasonable conclusion.
• The Court relied on Radheshyam Kejriwal v. State of W.B., (2011) 3 SCC 581 and Videocon Industries Ltd. v. State of Maharashtra, (2016) 12 SCC 315 to state that adjudication proceedings and criminal proceedings are separate and distinct.
• The Court referred to K.G. Premshanker v. Inspector of Police, (2002) 8 SCC 87 to state that judgments of civil courts are relevant if they relate to a matter of public nature but are not conclusive proof of that which they state.
• The Court relied on Section 12A and Section 15G of the SEBI Act, 1992, Regulation 2(c), 2(e) and 3(i) of the SEBI (Prohibition of Insider Trading) Regulations, 1992, Regulation 2(1)(h)(i) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, Section 246 of the Companies Act, 1956 and Section 42 of the Indian Evidence Act, 1872 to interpret the relevant provisions of law.

Holding

The Supreme Court held that the appellant, Chintalapati Srinivasa Raju, was not an “insider” under Regulation 2(e)(i) of the SEBI (Prohibition of Insider Trading) Regulations, 1992. The Court emphasized that for a person to be considered an “insider,” they must not only be a “connected person” but also be “reasonably expected to have access to unpublished price-sensitive information.” The Court clarified that the word “and” in the definition should be given its ordinary conjunctive meaning.

The Court further held that the appellant was not a promoter of SCSL and that there was no evidence to prove that he was in possession of or acted on the basis of any unpublished price-sensitive information. The Court also held that the findings of the Whole Time Member and the majority view of the Appellate Tribunal went beyond the scope of the show cause notice.

The Court set aside the order of the Appellate Tribunal and the Whole Time Member of SEBI. The Court also held that the SFIO report could be considered as evidence under Section 246 of the Companies Act, 1956 and the judgment of the Special Court was considered relevant under Section 42 of the Indian Evidence Act, 1872, but not conclusive.

Ratio Decidendi

The ratio decidendi of this judgment is that under Regulation 2(e)(i) of the SEBI (Prohibition of Insider Trading) Regulations, 1992, a person can be considered an “insider” only if they satisfy both the criteria of being a “connected person” and being “reasonably expected to have access to unpublished price-sensitive information.” The word “and” in the definition must be given its ordinary conjunctive meaning, and both conditions must be satisfied. This clarifies that simply being a director or a connected person is not sufficient to be deemed an insider; there must also be a reasonable expectation of access to UPSI.

Implications

This judgment has significant implications for insider trading regulations and corporate governance:

• Clarification of “Insider” Definition: The judgment clarifies that being a “connected person” is not enough to be deemed an “insider.” There must also be a reasonable expectation of access to UPSI. This provides a more nuanced understanding of who can be held liable for insider trading.
• Burden of Proof: The judgment highlights the importance of establishing a clear link between a person’s position and their access to UPSI. SEBI and other regulatory bodies must demonstrate that a person not only had a connection to the company but was also reasonably expected to have access to UPSI.
• Protection of Non-Executive Directors: The judgment protects non-executive directors from being automatically implicated in insider trading cases. It acknowledges that they are not involved in the day-to-day operations of the company and may not have access to UPSI.
• Importance of Evidence: The judgment underscores the importance of evidence in insider trading cases. Inferences must be drawn from foundational facts, and regulatory bodies must not rely on mere presumptions or assumptions.
• Scope of Show Cause Notices: The judgment emphasizes that regulatory bodies cannot go beyond the scope of the show cause notice. Findings must be based on the allegations made in the show cause notice.
• Impact on Corporate Governance: The judgment reinforces the importance of good corporate governance practices. Companies must ensure that access to UPSI is restricted to a limited number of people and that appropriate controls are in place to prevent insider trading.

Flowchart: Determining if a Person is an Insider