Facebook friends may be treated as connected persons for the purposes of Insider Trading: SEBI

1. Introduction

Securities Exchange Board of India (SEBI) had originally framed SEBI (Prohibition of Insider Trading) Regulations, 1992 in order to deter the practice of insider trading in the securities of listed companies. Afterwards several amendments to the said Regulations and also judicial

paradigm through various case laws had also evolved to prohibit insider trading. But major overhaul of the Regulations have not been done. But SEBI on 15^th January, 2015 had notified SEBI (Prohibition of Insider Trading) Regulations, 2015 [Regulations 2015] and has been done in order to strengthen the legal and enforcement framework, toughen the insider trading rules, align Indian regime with International practices and to provide clarity to certain definitions and concepts.

2. Background

This article gives an analysis of the latest SEBI's order on insider trading especially it is a case concerning Promoters of a listed company and persons connected with them who have allegedly engaged in insider trading. This case delves into how SEBI investigates into and determines the connections between the parties. The interesting point of contention or the analysis include that one of the person in fact was connected with another through Facebook, i.e. even if established indirectly, was considered a relevant factor to establish connection between the parties. Further, the investigation also includes the manner in which the pattern of investments and their funding were scrutinized etc.

3. Facts of the case- Paired Technologies Ltd

3.1 SEBI's order no: WTM/PS/152/IVD/Feb/2016 dated 4^th February, 2016 in the matter of trading in the shares of Paired Technologies Ltd under Section 11(1), 11(4) and 11B of the SEBI Act, 1992

In the aforesaid order SEBI has held guilty Chairman and Managing Director (CMD) and Chief Executive Officer (CEO) of Paired Technologies Ltd (PTL), a micro-cap which runs LatestOne.com, an online mobile accessories store. The PTL had run into financial difficulties from which it recovered and achieved some stability and thereafter it decided to sell its business on a slump sale basis to another entity. It is to be noted that the price of the shares of the company was low following the period of recovery. But the proposed restructuring would enable the company to raise substantial cash and value. The company which has adopted and following such deal, decided to declare special dividend and also carry out a buyback of shares. Because of this, the shareholders received an amount far higher than the then ruling market price of the shares. Subsequently, the price of the shares also started rising substantially. It was later revealed through investigation that the CMD, CEO were part of a cartel of 15 people termed as 'insiders' and were in possession of unpublished price sensitive information (UPSI) on the basis of which they traded in the scrip of PTL. These persons allegedly connected with them had purchased the shares of PTL at the earlier low ruling price. While they held on to most of the shares so purchased, the fact is that they benefitted from the significant appreciation in the market price.

3.2 Unpublished Price Sensitive Information-Date from which it can be said to have arisen

UPSI is that information which is not yet made public by the company but which, if published, would materially affect the ruling market price of the shares of the company. It is to be noted that in any insider trading, the main component for making profiting is that the UPSI should be known well in advance. Obviously, in this case, the slump sale of the business of the company, the proposal to distribute substantial special dividend and of course the buy back through which return of money can be done were known well in advance and that has persuaded the parties to do Insider Trading.

On analysis, it was found that the first board meeting of PTL held to formally approve the slump sale of business and consider declaration of special dividend was on 10.12.2013. The said announcement was made to public through Stock Exchange two days later. But the discussions relating to the slump sale of business with the proposed buyer was initiated almost a year earlier on 5^th September, 2012. The Non-disclosure Agreement with the buyers was signed on 18^th September, 2012. Thus, SEBI concluded that the date 18^th September, 2012 as the date on which the UPSI had come into being. The transactions of the parties on and from this date till the date when the UPSI was made public were held to be Insider trading of shares which was in violation of the law.

Extracts from SEBI's order

"The PSI regarding the slump sale of software solutions business to Kewill group came into existence on September 18, 2012, i.e. when the non-disclosure agreement was executed between Kewill group and PTL. The non-disclosure agreement (having a confidentiality clause) was a binding contract on both the sides. Disclosure of the agreement would certainly have an impact on the deal. Therefore, the same can be considered to be an 'unpublished price sensitive information' (hereinafter referred to as 'UPSI') which had definitely originated on September 18, 2012 and the same had remained unpublished till August 10, 2013 at 13.01 hrs. in terms of the Regulation 2(ha) (vi) of the PTI Regulations. The period of such UPSI was from September 18, 2012 to August 10, 2013."

Analysis also revealed that the price of the shares of PTL on 5^th November, 2012 from which date an insider was found to have acquired the shares was Rs. 10.71. The price thereafter rose to Rs. 39.20 on the day when the UPSI was made public.

3.3 Determination of the parties found connected for purposes of Insider Trading

In the aforesaid case, connections with the other parties were found on various grounds. In fact Mr. Palem Srikanth Reddy, the Chairman and MD of PTL was a connected person under the Regulations and the company accepted that he, along with two other persons, were privy to the UPSI relating to slump sale. He was also accepted to be privy to the UPSI relating to special dividend. On scrutiny, it was also known that Mr. Ameen Khwaja was found to be common director/promoter with the Chairman on another company which incidentally had also provided services to PTL. Further investigations revealed that this company was also proposed to be merged with PTL. It was also revealed that several family members of Mr. Ameen Khwaja had dealt in the shares of PTL while Mr. Ameen Khwaja did not deal in the shares directly. SEBI concluded that such dealing of shares by the family members of Mr. Ameen Khwaja was held to have carried out insider trading. These dealings in shares clearly indicated that the shares were dealt with under Insider Trading.

3.4 Definition of "Insider"

Insider means any person who is (i) A connected person; or (ii) in possession of or having access to unpublished price sensitive information.

The definition of insider in Regulation 2015 is also widened i.e. any one in possession of or having access to unpublished price sensitive information should be considered an 'insider' regardless of how one came in possession of or had access to such information as the 'generally available information' has already been defined. It is also to be noted that the concept of generally available information has been adopted by various Regulators in different forms. Any information reasonably designed to provide broad as well as non-discriminatory dissemination of the information to the public at large would not be considered to be the inside information. It can be argued that any information which is restricted to a particular region or place say for e.g. information contained or published in a regional newspaper may not be considered to be generally available as it is not available to public at large. Thus, any information which is not accessible to the public on a non-discriminatory basis would be deemed to have contain price sensitive information and any one in possession of it would be termed as an 'insider'.

Further, the onus of showing that a certain person was in possession of or had access to unpublished price sensitive information at the time of trading would therefore be on the person levelling the charge. In order to escape from the charges, the person who has traded has to demonstrate the following:-

(a)		That he was not in such possession of unpublished price sensitive information or
(b)		That he has not traded or
(c)		He could not access or
(d)		That his trading when in possession of such unpublished price sensitive information was squarely covered by the exonerating circumstances.

In short, it can be said that any person who is in receipt of or has access to unpublished price sensitive information be considered as an "Insider".

If we apply the aforesaid definition of an 'Insider' the present case squarely covers under Insider Trading.

4. Facebook - Basis of determination of connection

Probably, it is for the first time that SEBI has treated Facebook as a relevant factor to determine connections between persons or to establish connection. In this case, SEBI observed that having "mutual friends" on Facebook will form the basis of determination of connection. Further, SEBI observed and noted that Mr. Pirani Amyn Abdul Aziz is also found to be connected to Mr. Ameen Khwaja through mutual friends on Facebook. Mr. Aziz was employed with Deloitte Tax Services, a group company of Deloitte Touche Tohmatsu India Pvt. Ltd which had conducted the due diligence of PTL during the slump sale. Facebook is a relatively open social media network and friends are often made and removed / deleted without knowing in detail the background of the parties. In fact, such friends are often strangers with whom there are no other connections and sometimes there may not be even offline contact for quite some time. Since SEBI made an observation and did comment on the connection in the Order, it is quite clear that SEBI would resort to all the social media to determine connection or to establish 'connection' for investigation purposes of insider trading violations. Apart from this other social media are twitter and linkedin etc. On investigation, SEBI considered connections on social media on internet between the parties i.e. through Facebook as relevant factor to determine connections between parties.

The definition of connected person under SEBI (Prohibition of Insider Trading) Regulations, 2015 has been widened and thus encompassed to include any person who has a connection with the company that has given him or in possession of unpublished price sensitive information. Thus, a banker or immediate relative of a banker or an official of a stock exchange or of clearing house or corporation who may not seemingly in occupation of any position in the company but are in regular touch with the company and its officers are all included under the definition of connected person because, these persons are presumed to know of the company's operations. Thus, through whatever connection is possible, if a person is in a position to access unpublished price sensitive information about any company or class of companies, then he is a connected person.

5. How to determine whether the transaction or dealing was Insider Trading

It is always open to the person alleged to have committed insider trading to put forth that his dealing was in ordinary course of business. In other words, he may show it as proof that his dealing in purchase of shares was covered under the ordinary course of business and has not triggered any Insider trading. But in this case, thorough investigations by SEBI with the background of trading by the parties, the shares purchased, its pattern in the scripts of PTL, revealed that some of the parties had dealings in the shares of PTL either as their only trading or the main one. This was done to find out whether the dealing in shares were in the ordinary course of business of the parties. In fact, it was also evident that in some of the cases, the parties had opened trading accounts just prior to dealing in shares of PTL, which shows to prove that there was no other trading and the trading was not in ordinary course of business. Also, investigations revealed that cash deposits were made in the bank accounts to make the payment for purchase of the shares of PTL during the relevant period. Thus, going by the record and evidences gathered SEBI declared that sufficient indicative evidences show that the trading was not regular by the parties and it was squarely covered under the Insider Trading.

6. Interim Order of SEBI

It is not uncommon to see that nowadays, SEBI pending investigation, passes interim order in the Insider Trading cases. Further orders of impounding is also not new and being passed to deter Insider Trading. These orders are made not only without giving any hearing to parties but even without giving them any notice. These orders are pronounced in a particular way and more often the bank account and demat accounts of the insiders are frozen and cannot be operated. But the parties are given opportunities to present their case. This is done by SEBI in order to discourage the insiders who have violated the Insider Trading norms, who may divert the funds in the accounts. In this case, SEBI listed the transactions of such persons and the notional profits made by them considering the appreciation in the price of the shares of the company and then passed an interim order impounding such notional profits with interest. Also, SEBI issued orders effectively freezing the bank and demat account of such parties till they deposit such amount. It is worthwhile to note that the trend is changed and SEBI takes quick interim action by way of interim order these steps. Thus, in order to curb insider trading, SEBI quickly passes interim orders whereby the illegal profits made, along with interest till date of order, are impounded and required to be deposited till final orders are passed. It is to be noted that once the bank account and demat accounts are frozen, no debits to such accounts are permitted. Further, in this particular case, the parties were also ordered not to alienate any of their assets till the amount impounded was duly deposited in an escrow account.

7. How to determine the profits made from Insider Trading

In this case, SEBI has determined the purchase price of the shares during the relevant period. It is also evident and on record that most of the shares which were purchased were continued to be held till the date when the UPSI was made public. Therefore, the price of the shares at the end of such relevant period is noted and taken into consideration in calculating the notional profits. The notional profits were then calculated which is the difference between such closing price and the share purchase price. On the total notional profits, simple interest @ 12% per annum has to be added. This total amount is thus held by SEBI to be the profits made from the Insider Trading transactions.

8. Conclusion

In a market that prides itself on being well-governed and strongly regulated, SEBI should get to the bottom of things to find out if there was a leakage of material price-sensitive information to trigger Insider Trading. After analysis of the aforesaid case, it has been proved that the market Regulator has developed robust systems and procedures to allow for audit of all the trails of a particular company's trading and transactions and identifies trades that may require further investigation. The passing of interim order impounding the profits and direction to frozen the demat and bank account are well thought move as the final order passing sometimes get dragged for years as investigation gather evidence from multiple sources, including trading and phone records, to build up a strong case that can withhold challenges in Tribunal/Court. This kind of quick interim orders would provide a big morale booster to investors that the Regulator are passing a level playing field for the stakeholders and Investors.