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THEIR FAILINGS, OUR LEARNINGS

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THE BURDEN OF KNOWLEDGE

Context:

In this large group, with presence in various sectors, the rigour of the SEBI (Prohibition of Insider Trading) Regulations exposed a chink in the armour. The need-to-know principle is a good defense when faced with an allegation regarding the sharing of Unpublished Price Sensitive Information. Was regulatory action disproportionate?

  • In 2016, SEBI issued a joint Show Cause Notice to a Company, its Chairman, 2 Executive Directors (EDs) and the Compliance Officer (the noticees), in relation to possible violation of provisions of SEBI (Prohibition of Insider Trading) Regulations (PIT Regulations).
  • In May, 2010, the Company had sold one of its businesses, and made a public announcement to the Stock Exchanges on May 21, 2010, the same day the Audit Committee (AC) and the Board had approved the transaction.
  • It was alleged that the noticees failed to handle Unpublished Price Sensitive Information (UPSI) relating to this transaction on a ‘need-to-know’ basis as the son of the Chairman and one of the EDs, who was neither an employee nor a Director, was privy to the decision to sell at every stage.
  • The noticees stated in their reply that at no point of time was the son involved in the decision-making process, and that he did not trade in the scrip of the Company at any time during the period.
  • It was also alleged that the Compliance Officer failed to close the trading window. Notice for Board meeting was given on May 20, 2010, and the Board met on May 21, 2010 to approve the transaction. Stock Exchanges were informed about the deal on the same day. However, the trading window was not closed at all.
  • Also, in a letter from the Company in January, 2011, it had listed the names and designations of all the persons who were privy to the decision regarding the sale at every stage, and the son’s name was one amongst them. SEBI took note of the letter.
  • SEBI in its order stated that it was necessary to ensure that UPSI was shared strictly on a need-to-know basis and not communicated to others who were not involved in the transaction, irrespective of their position in the Company or relationship with promoters and senior management.
  • Also, it was the responsibility of the Company to decide about the commencement of closure of trading window, which was to be opened only 24 hours after the price sensitive information was made public.
  • The Chairman, and 2 EDs (the appellants) filed an appeal with Securities Appellant Tribunal (SAT) against the decision of SEBI.
  • On May 15, 2019, SAT set aside the order of SEBI.
    1. SAT found that due diligence was carried out by the Company up to May, 2010 in strictest confidence. Except for certain individuals, who were identified as being privy to the transaction and informed to SEBI in January, 2011 itself, no one in the Company was aware of the information at any time prior to the Board meeting and subsequent public announcement on May 21, 2010.
    2. Also, the Chairman informed the Board members on May 10, 2010, of the possibility of the pending deal that may take place, and none of the persons identified as being privy to the deal, had sought any pre-clearance for trading in the scrip.
    3. It stated in its order that the information was given to the son, and others only on a ‘need-to-know’ basis.
    4. Also, the son was “deemed to be connected person” as per PIT Regulations. Being a promoter, holding about 2% of equity capital of the Company, he had to give an undertaking relating to multiple clauses in the Business Transfer Agreement like non-compete provision for 8 years. Hence, he had to know in advance regarding the decision.
    5. Further, he had not traded in the scrip of the Company during this period.
    6. SAT also noted that the purpose of closing the trading window was for a salutary purpose. It was to ensure that trading is restricted during the period in question and pre-clearance requests can only be sanctioned as per the Model Code of the Company. Even though the trading window was not closed, there was no trading of the scrips by any of the designated employees of the Company, nor any pre-clearance requests were received by the Company. Thus, even though, no announcement was made for closure of the trading window, the Model Code was followed.
  • SAT in its order stated that the object of the SEBI Act is not only to protect the investors, but also the securities market. SEBI is a watchdog and not a bulldog. If there is an infraction of a rule, remedial measures should be taken in the first instance, and not punitive measures. In the absence of any direct or clinching evidence of insider trading or misuse of UPSI, a reasonable benefit of doubt should be extended to the Company, instead of mechanically imposing a penalty.
  • Consequently, the imposition of penalty was converted into one of warning, with a further direction that if any such incident occurs in future, it would be open to SEBI to proceed in accordance with law.