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[Mr. Satyam Agarwal is a 4th year B.A., LL.B. (Hons.) student at Gujarat National Law University in Gandhinagar, Gujarat.]
SEBI had released a draft consultation paper on Unexplained Suspicious Trading Activities with the intention of tackling unexplained suspicious trading activities [“USTA”]. USTA means a trading activity, for which no reasonable rebuttal or explanation is given, which exhibits an unusual trading pattern in a security or a group of security showcasing substantial change of risk over a short duration of time, resulting in abnormal gains or averted abnormal losses.
Background
The advent of novel technologies is bringing new challenges to the doorsteps of securities market regulator SEBI. The use of sophisticated, encrypted and untraceable methods of private communication has made it near impossible for SEBI to establish the preponderance of probability despite availability of circumstantial evidence of insider trading and front running. This has enabled market participants to engage in insider trading and other fraudulent activities while concealing their identity and communications. Moreover, the reluctance of the government to grant the market regulator the authority to decrypt electronic communications have made matters worse. It must be noted that this power is vested with the US securities market regulator.
The regulation is endeavoring to address two judgements of the Supreme Court which has increased the threshold for evidence needed to be provided by SEBI.
Supreme Court in the case of SEBI v. Abhijit Rajan[1], had held that to meet the threshold for an effective insider trading charge the essential precondition is the establishment of the profit motive of the insider.
The Apex Court has held in the case of Balram Garg v. SEBI[2] that proof of possession and communication of unpublished price-sensitive information is essential to establish the necessary threshold for insider trading charges.
SEBI had established a new alert generation model and around 5000 alerts were generated against 3588 unique entities in 2022, out of which there were five or more repetitions for 97 entities. Still, SEBI could not proceed with action, inspite of it being suspicious, because connection or communication could not be established. Different judgements require SEBI to show varied levels of preponderance of probability. Thus, the courts have in effect moved the threshold for evidence beyond providence of probability.
Preponderance of Probability
SEBI follows the principle of ‘preponderance of probability’ to hold the violators accountable for their actions. J Denning defined the term as ‘the degree of cogency required to discharge a burden in a civil case’. [3]
As per section 3 of the Indian Evidence Act, 1872, “A fact is said to be proved when, after considering the matters before it, the Court either believes it to exist, or considers its existence so probable that a prudent man ought, under the circumstances of the particular case, to act upon the supposition that it exists.”
The Supreme court has held in the case of SEBI vs Kanaiyalal Baldevbhai Patel & ors that “an inferential conclusion from proved and admitted facts would be permissible and legally justified so long as the same is reasonable”. It is basically a prudent and reasonable man’s test to come to a logical conclusion in the absence of a clinching evidence. Evidence is the form of a smoking gun that will not always be available. If the balance of probability is in the favour of innocence, it will lead to exoneration and if the balance tilts towards guilt, it shall lead to an enforcement action by SEBI.
This is the concept on which “Unexplained Suspicious Trading Activity” is based. It can be accurately stated this concept is the pedigree of the entire regulation.
Criticisms and Recommendations
The pertinent question that arises after an analysis of the consultation paper is first if a separate regulation to achieve the objectives as enumerated in the consultative paper is at all required. One can ask a sincere question if the objectives could have been achieved by a mere amendment in one of the existing regulations, rather than curating a novel distinct regulation all together. The provisions as envisaged under the present regulation is similar to those that are present in SEBI (Prohibition of Insider Trading) Regulation, 2015 SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003. Another pertinent question that needs to be answered by SEBI is whether the new regulation will override or overlap the existing earlier regulations. The focal predicament with so many separate regulations is that it tarnishes the respect of the law in the market. It leads to vexation among the investors, and creates ample opportunity for failures in the market due to stresses created as a result of policy incertitude.
Another astonishing feature of the regulation is that it reverses the basic common law principle of evidence. It puts the burden of proof on the accused rather than the prosecutor. There exists a deeming provision in the regulation which enables this perfidy. As generally is the case where under evidence law a person is deemed to be innocent until proven guilty, here the person will be deemed guilty until proven innocent. The most arduous task for any lawyer, under the principles of evidence law, is to provide positive evidence to prove the negative. The deeming provision in the regulation basically makes a mockery of basic common law principles of evidence law. Still, there are certain caveats to this criticism of the deeming provision. There are certain safeguards that have been instilled in the regulation to hinder unrestricted arbitrariness of SEBI. Although the burden of proof has been reserved, it is essential to see at what stage has it been reserved. It has not been reversed from the very beginning of the charges. The burden of proof is shifted upon the accused from the prosecutor only when SEBI proves the existence of Unusual Trading Pattern and Material Non-Public Information. The investigation is to be commenced only when these facts are sufficiently established.
As per the definition of “Unusual Trading Pattern” under section 2(j) of the regulation, it includes trading activity which delivered abnormal gains or averted abnormal losses. This definition seems to be a matter of concern and should draw our attention. The entire security market works as per the information, perception and risk appetite. This is what affects demand and supply, which is in turn is manifested in the behaviour of the market. Some investors may claim that the whole reason of their existence in the securities market is to someday make abnormal gains. The accused will have to show that the trading activity was not based on material non-public information, nor was it repetitive or delivered abnormal outcomes. Thus, what is normal or abnormal is a matter of concern and one needs to look as to how jurisprudence and principles are developed in this field, and how it is applied.
Lastly, the reliance placed by SEBI on Section 68 of the Income Tax Act, 1961 and Section 11 of the Securities Act 1933 of the United States of America is illogical and unnecessary. In the first instance, the Income Tax Act is only concerned with taxing the income and not in regulating the income, whereas in the securities market, entire architecture is regulated. They both have different consideration and compelling interest. Moreover, they are not pari materia. The presumption of guilt as provided in other laws are present in the parent act, but none such presumption finds a mention in the SEBI Act 1993. In the second instance, misleading disclosures are already a punishable offence in the SEBI Act 1993, thus rendering the reliance superfluous.
Conclusion
In conclusion, though the purpose behind the regulations seems to be benign, to protect the investors from manipulative, maligned elements, it will bring along with it a huge abyss of incertitude. It has all the possibility to work against the interests of the very investors it seeks to protect. This is because once a person comes under the suspicious lens of SEBI, no one perceives that person as an innocent person or investor. The investors will have to feel the heat of enforcement action by SEBI. Thus, it is consequential that additional safeguards are built into the regulations. SEBI must not notify the regulations in haste, and should let time take its course. A deeper level of consultation and discussion with all market players is consequential to curate an effective regulation that has the ability to protect the investors, without having unintended results.
[1] [2022 SCC OnLine SC 1241]
[2] [(2022) 9 SCC 425]
[3] Miller vs Minister of Pensions, 1947, House of Lords
