A tale of two jurisdictions

Distinctions between the laws on insider trading in India and the US are nuanced rather than evident

The standard for treating as illegal, trading by those tipped off with price-sensitive information by insiders, underwent yet another yo-yo in the United States last week. The constant change in standard on what constitutes illegal insider trading is a hallmark of insider trading law in that country.

An appellate court has ruled that it would not be necessary to show that the person, who receives a tip-off from an insider, has to have a “meaningfully close personal relationship” with the latter. The same court had ruled in December 2014 that such a relationship would be vital to hold that insider trading took place. In that case, two men, who had traded in securities, were held to have had only vague and casual acquaintance with the source of the inside information. In the absence of any meaningfully close personal relationship, it was held that they could not be said to have been gifted or sold the tip by the insider for the trading to be violative. In short, no benefits could be inferred for those giving them the information.

Two years later, in December 2016, the US Supreme Court ruled in a case that involved trading by a person, based on information received from a sibling who was the insider, that there would be no need to look for a benefit or gain to provide the tip. Applying that rationale, the appeals court has now ruled that there is no real need for any “meaningful close personal relationship” to exist to render the trading illegal. The court has gone on to say that if an insider were to give a trading tip to a doorman instead of a tip in the form of money, he would still be achieving his objective of providing gratification and, therefore, the trading by the person receiving the tip would be illegal.

Cut to India. Virtually every man on the street here would believe that the US has a far greater regime for punishing insider trading and that India is lax on the matter. The truth is far more nuanced. First, under Indian law, by definition, any person receiving unpublished price-sensitive information becomes an “insider”. Therefore, trading by the recipient of any price-sensitive inside information would become violative “insider trading”. Second, the very act of communicating unpublished price-sensitive information has been rendered illegal by law in India — unless, of course, a legitimate purpose for such communication can be shown, for example, providing an auditor with draft accounts.

In practice, how this is enforced makes trading in securities quite dangerous in India. It is now becoming routine for any trade by any person to be rendered vulnerable to attack as being illegal if a link between the person who traded and an insider, however tenuous, is found. It is this extreme that the US legal system is zealously wary of — an exposure of innocent traders to the charge of insider trading leads that system to err on the side of caution in favour of presuming bona fides by those trading. The Indian regulator has chosen to err on the side of caution in favour of presuming mala fides by those trading: So long as some form of link is found, it would be presumed to be illegal trading motivated by inside information, regardless of whether information was actually communicated.

Surprisingly, despite the law having been amended to empower the regulator to demand and get call data records from telecom companies to demonstrate circumstantially the communication links between the insider and the person who has traded, the regulator never uses this power. Usage of such power would bring with it the necessity of having to prove the intensity of the link. Worse, informal guidance has been issued to say that without even going into evidence of communication between a discretionary portfolio manager and his client who may be an insider, trades on behalf of an insider by the portfolio manager, even if made without reference to his insider client, would be illegal (not “could be illegal if the client indeed exercised his own discretion in the trading decisions”).

The legal status of a person, who has actually received unpublished price-sensitive information from an insider, as an “insider” is easy to understand if evidence (circumstantial evidence) reasonably shows that the person who traded indeed received such information. However, for those who are actually insiders themselves, the treatment becomes even more dangerous. A “connected person” is one who is reasonably likely to have access to inside information. Whether such a person indeed had access and who would need to show that she had such access are questions that are routinely given the go-by, hoping that courts would give enforcement a long rope.

This is the kind of outcome that a dissenting judge in the appeal judgment has warned against. According to her, prosecutors would “seize on this vagueness and subjectivity”, which, to her mind, “radically alters insider trading law for the worse”.

There is one material distinction that makes the problem exponentially worse in India. US enforcement agencies have to satisfy a neutral judge of the strength of their charges, with cogent evidence. This leads to the finely nuanced and, at times, abstruse judicial analysis of the standards necessary to bring home a charge. In India, the regulator has to convince no one for declaring a person to be guilty of insider trading. How well it has to explain itself depends on the quality of the challenge mounted in an appeal that can only be filed after the event of being held guilty.

The author is an advocate and independent counsel; Twitter: @SomasekharS