I have a piece with Manas Dhagat and Pranjal Kinjawdekar in today’s Economic Times on the proposed changes on insider trading regulations. These proposals with have the disadvantage of 100% false negatives AND 100% false positives. In other words it will only catch the innocent in a quasi-criminal proceeding. In fact, the deeming provisions in insider trading regulations should be completly abandoned. Here is the full piece:
“SEBI has recently proposed amendments to the SEBI (Prohibition of Insider Trading) Regulations, 2015 ("PIT Regulations") through a consultation paper. The proposed changes pose risks, not to wrongdoers, but rather to innocent people. Under the PIT Regulations, an "insider" is someone who has access to unpublished price-sensitive information ("UPSI") or is a "connected person." The proposal expands the current law, which already criminalizes certain conduct by creating a presumption, effectively overturning the principle of "innocent until proven guilty." The PIT Regulations currently identify specific categories of individuals presumed or deemed to be connected persons to the insider, including immediate dependent relatives (such as parents, siblings, and children) and certain corporate entities, based on their connection and presumed access to such information. SEBI's proposal aims to broaden this definition by adding new categories of deemed connected persons and replacing "immediate relatives" with the broader term "relative," aligning it with the Income Tax Act. Additionally, SEBI has proposed including six new categories of individuals as connected persons, referencing the definition of "related party" under the Companies Act, 2013. The expansion includes ‘material financial relationship …for reasons of …frequent financial transactions’. This could literally be thousands of vendors of a single public company.
The lack of clear justification for SEBI's proposed changes, particularly the shift from "immediate relatives" to the broader term "relatives," raises significant concerns. While SEBI suggests aligning definitions with those in the Income Tax Act and the Companies Act, the consultation paper fails to adequately explain the need for such changes. In fact, the definition of relatives in the Income Tax Act is used for providing benefits to taxpayers, not for criminalizing them. The current inclusion of "immediate relatives" in the PIT Regulations was a deliberate choice, made to address the specific nuances of insider trading, which even in its limited scope often inverts justice. Broadening this scope to include all relatives, risks implicating individuals who may have no direct or material connection to sensitive information, leading to a potential increase in the number of people subject to insider trading punishment without sufficient justification.
Under the current framework, connected persons are presumed to possess UPSI unless they can prove otherwise. This creates a rebuttable presumption, placing the burden of proof on the accused to demonstrate their innocence. While this may be somewhat logical for individuals reasonably assumed to have access to UPSI, expanding the definition of connected persons significantly increases the number of people unjustly burdened by this presumption. The proposed changes would require individuals, who might only be related to someone with UPSI, to prove a negative—that they did not have access to or act upon insider information. This shift in the burden of proof is not only unfair but also creates a potential for significant injustice, as it effectively presumes guilt rather than innocence. While one might argue that the presumption is rebuttable, in reality, proving innocence under these circumstances is nearly impossible without a camara on everyone’s head recording every breath. How does one prove that a distant relative did not pass on information? Under the current framework, a financially independent relative who lives separately and does not seek advice on trading decisions would not be classified as a deemed connected person. However, with the proposed change to "relative," such second-degree relatives would be included solely due to their familial connection, regardless of financial independence or involvement in trading decisions.
If one assumes this is a theoretical problem, one needs to look only at caselaw. In the Balram Garg case which went all the way to the Supreme Court of India, SEBI accused a person of insider trading merely because the two were residing in the same residential complex. In fact, the two did not get along and were quarreling. In addition, even the pattern of insider trading was the opposite of what was logical (sale before good news). Yet, SEBI charged the person with insider trading. It took the Supreme Court to say: “it is only through producing cogent materials (letters, emails, witnesses, etc.) that the said communication of UPSI could be proved and not by deeming the communication to have happened owing to the alleged proximity between the parties.”. After losing, SEBI choose to file a review petition instead of reviewing its actions. With the proposed law, the parties could be deemed criminals and it would be more difficult for even the Supreme Court to defend the innocent.
Instead of expanding the definition and increasing the burden on individuals, it would be more prudent for SEBI to focus on enhancing its investigative capabilities. This would enable SEBI to build stronger cases based on actual evidence rather than relying on presumptions that may not hold true. The proposed regulatory changes represent a significant shift in SEBI’s approach towards addressing insider trading, with far-reaching implications. The approach indicates a tendency to shift the burden of proof onto the accused rather than carrying it themselves. While improving SEBI's investigative capacity is crucial, granting the regulator unchecked power to label individuals as "connected persons" without concrete evidence risks regulatory overreach. It would not be an exaggeration to say that the new law would be the first which has a possible 100% false positives and 100% false negatives. How many criminally minded would trade through their uncles? The proposed law is designed to indict the innocent and perhaps the not very smart criminal (presumably a small class). In 1769 William Blackstone said that “the law holds that it is better that 10 guilty persons escape, than that 1 innocent suffer”. The proposed law would free the 1 guilty to use their artifice and imprison the 10 innocent. The proposal should be abandoned and even the current law on presumption needs to be rationalised.”
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