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By Kaishena Chauhan, 4th year law student from O.P. Jindal Global Law School
Background
SEBI has issued a draft of its newly formulated SEBI (Prohibition of Unexplained Suspicious Trading Activities in the Securities Market) Regulations 2023 (PUSTA) in a Consultation Paper inviting comments dated 18th May 2023. This draft aims to tackle the indirect violations of the existing regulations against unfair and fraudulent trading practices via growing encrypted technological advancements including BOTIM, video calls, WhatsApp, etc. since it gets almost impossible to trace evidences and prove violations where prima facie a breach or suspicion of such breach appears affirmative. SEBI has relied on SEBI v. Kanaiyalal Baldevbhai Patel and SEBI v. Rakhi Trading Pvt. Ltd. to demonstrate the need for PUSTA as a sword against unfair trading and consequently prioritizing the principles and ethical standards of fairness, good faith, and transparency in the securities market. SEBI, being a quasi-judicial body, follows the legal standard of proof as the preponderance of probability, which entails evidence to suggest a “high probability of a violation strongly”. However, the non-availability of evidence poses a difficulty for SEBI to levy and prove allegations.
The Change and the Challenge
SEBIPUSTA deviates from the jurisprudence on legal standard of proof that is established in cases under SEBI (Prohibition on Insider Trading) Regulations 2015 (PIT) and SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations 2003 (PFUTP). The Paper validates these amendments and recognizes PUSTA as their “subordinate legislation”. PUSTA brings two fundamental changes. First, it reverses the burden of proof. Second, it creates a rebuttable presumption against the accused. PUSTA permits SEBI to bring charges against individuals at an initial stage without collecting substantial evidence solely based on a certain level of assumption, which those individuals can contest by providing a detailed explanation. However, these major shifts strike inconsistencies with its sister regulations like PIT and PFUTP. Thus, this blog discusses and analyses the change in the threshold of the burden of proof under PUSTA and its probable clashing consequences.
Threshold of Preponderance of Probability: General framework for SEBI v. Framework to be followed by an Accused under PUSTA
The case of SEBI v. Kishore R. Ajmera relied on the test of preponderance of probability and noted that where direct proof indicating a fraudulent trade is rare, it is unnecessary to prove it. The test emphasizes that the “proof has to be inferred by a logical process of reasoning from the totality of attending facts and circumstances surrounding the allegations/ charges made and leveled” where the totality depicts that the “non-genuineness of these transactions is evident from the fact that there was no commercial basis…” but to psyche out the trading. The jurisprudence on this test of the burden of proof does not give a standard checklist for its discharge, since the degrees of probabilities within that standard vary and these degrees depend on the subject matter/ facts. Thus, this determination of non-genuineness via a preponderance of probability depends on certain evaluating parameters/ tests. General framework suggests SEBI to be bound by this standard; on the contrary, under PUSTA, the accused must prove the genuineness of the alleged transaction.
The threshold for establishing a case for SEBI involves certain metrics; thereby clearly determining its onus. For instance, where direct evidence is not available, the test of reasonable/prudent man should be applied to scrutinize the proximate and immediate circumstances and allegations. In MJ Shares & Securities Pvt. Ltd. v. SEBI, when the probabilities were linked to the factual evidence, it was held that there was no other probable way for executing such trade unless done fraudulently and the appellant was found to have traded unfairly even when there was no direct evidence. Hence, the general threshold for establishing a liability is the reasonability of an inferential conclusion that can be safely drawn from the circumstantial evidence or admitted facts. Additionally, SAT and the SC have time-to-time cautioned the use of this test and have affirmed its use where it can “only lead to one conclusion” and not merely lean towards a probability. However, these metrics are not determined for the accused to discharge its onus. Even if the same metrics are applied, they raise the bar for the accused to establish its case since no individual conclusion is sufficient in the securities market to suffice the higher threshold. Ultimately, there is the possibility that it will potentially open the hornet’s nest of accusations and will increase the conviction rates.
Another element that aids the test of preponderance of probability is that of mens rea or intention or knowledge. Although as per SEBI v. Kanaiyalal Baldevbhai Patel, this element is not essential for establishing the liability, however, is used by the deciding authorities to confirm the guilt. For instance, in SEBI v. Kishore R. Ajmera, a “deliberate intention to play the market” was found over and above the negligence and lack of duty of an intermediary. For an accused the element of intention becomes irrelevant as a material physical proof is required to rebut the presumption.
Thus, the general framework for SEBI has accused-friendly metrics, while the framework for an accused can be corrosive to its interest as the threshold to prove otherwise is higher, vague, and not standardized.
MNPI v. UPSI: Conflict with PIT
The draft PUSTA Regulations impose liability for an unexplained suspicious trading activity based on any Material Non-Public Information (MNPI), defined under Reg. 2(1)(f) PUSTA. It includes a wide variety of information on a company or its securities, including information not available to the public, impending orders, or recommendations, which, if they are at public disposal, can influence the securities’ prices. Whereas, Unpublished Price Sensitive Information (UPSI) as under Reg. 2(1)(n) PIT Regulations 2015 includes information on a company or its securities that are not available at public disposal. Here, MNPI is comparatively broader in ambit as it encompasses additional information along with UPSI. The issue that comes up is that it again changes the burden of proof requirement. Under PIT Regulations, the burden of proof is on the person or SEBI to establish the allegations. As per Reg. 2(1)(g) PIT Regulations, “The onus of showing that a certain person had received or had access to unpublished price sensitive information at the time of trading would, therefore, be on the person leveling the charge”. The charges of insider trading require the establishment of higher preponderance of probabilities by the accusing party. On the contrary, as per Reg. 5 PUSTA, when a suspicion is made by SEBI, the accused “may rebut” the charges and “shall present detailed documentary evidence to substantiate any claim made by them”. For instance, when any suspicious trading via UPSI/ MNPI is detected by the SEBI, then the accused must show the charges otherwise. This takes away the initial burden of proof from the alleging party/ SEBI and reverses it by putting the burden on the accused and making it tough to discharge. Therefore, it can be noted that both the Regulations conflict since PUSTA overreaches PIT. This gives SEBI an overarching authority to classify any UPSI as MNPI and drag any activity with an even slightly arbitrary suspicion of liability.
Additionally, if the PUSTA is enacted, then it will transform the established stance of the SC of using the test preponderance of probability on insider trading cases. In Balram Garg v. SEBI, it was held thatany specific identified trading pattern “cannot be the circumstantial evidence” and no inference can be drawn from it. Alternatively, the SC noted that the evidence must have “cogent material” for reliability. This again conflicts with the idea of Suspicious Trading Activity, defined under draft Reg. 2(1)(i) PUSTA, which includes unusual trading patterns. If this Suspicious Trading Activity is unexplained or not rebutted by the accused, then the test of preponderance of probability will work against the accused to discharge its liability. Thus, it shows that PUSTA not only reverses the burden but also makes it challenging for the accused to rebut the allegations by increasing the threshold.
Challenges to the reverse burden of proof
The draft of PUSTA poses a constitutional challenge for reversing the burden of proof. The case of Seema Silk & Sarees v. Directorate of Enforcement held that the law should allow for a reversal burden for any statutory presumption solely when some primary facts are established by the alleging party. This stems from the principle of procedural fairness of innocent until proven guilty. The presumption of guilt under PUSTA puts an unfair burden as it lacks proportionality and a rational connection between the objective and the provisions. Firstly, PUSTA lays down no clear standards for discharging this burden. Due to its ambiguous terms like “abnormal profits”, “effectively rebut”, “detailed documentary evidence”, and “substantial change in risk”, standards are made subjective. Secondly, it does not explain the particulars or the details of the “detailed documentary evidence” that the accused must submit. This is an arduous obligation since they will also face the new advent of dealings or technology and will be confronted with the task of discharging their burden. Moreover, for rebuttals, it does not clarify the threshold for sufficiently demonstrating the claims. Thirdly, it further dilutes the definition of “unusual trading pattern” by creating an ill-defined sub-category of “deemed unusual trading patterns”. Lastly, it does not specify how these “unusual trading patterns” can be linked to MNPI. Thus, these mentioned loopholes in the draft PUSTA, will create a chilling effect on the trading of securities wherein even legitimate trading will be affected negatively.
Conclusion and Solution
The primary aim of reversing the burden was to ease the procedure for SEBI to establish its claims and prevent the circumventing of regulatory compliances. PUSTA intends to mitigate the conclusions as that of the WhatsApp leak Case/ Shruti Vora v. Securities and Exchange Board of India, wherein the evidence showing the circulation of WhatsApp information was not found enough to prove the violations by the accused. However, due to the lack of procedural safeguards, it fails to bridge the legal and evidentiary gap. It is thus necessary to incorporate general safeguards so that PUSTA does not invalidate other regulations and the binding established precedents. Moreover, the standard of proof for the accused should be prescribed either by precisely mentioning it in the statute or by tying it to the standard as required by SEBI for its own evidentiary burden. Lastly, it should lay down precautions and compliances for SEBI to prevent doubtful penalization and substantiate procedural fairness.
