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Who Is An Insider?

Published on Sat, Aug 02,2014 | 13:48, Updated at Mon, Aug 04 at 17:21Source : CNBC-TV18 |   Watch Video :

Who is an insider? Can a person connected to the events surrounding companies be considered a connected person and hence insider? Or must he be connected to the company whose shares have been traded in the alleged insider trading? That’s one of the key questions answered by SEBI in its insider trading order in the matter of KLG Capital. Do these answers stand up to scrutiny? Payaswini Upadhyay finds out.  

In 2008, Awaita Properties made an open offer for a 20% stake in KLG Capital. A week before the open offer - 3 people traded shares of KLG Capital. It turned out that these 3 were allegedly connected to SKIL, a group company of Awaita – the company that made the open offer for KLG’s shares. SEBI alleged that these 3 were connected persons to KLG and had access to unpublished price sensitive information - hence the trades amounted to insider trading.  
 
WHO IS AN INSIDER?
 
3rd Mar, 2008

  • Awaita announced open offer for 20% stake in KLG Capital

22nd Feb, 2008

  • 3 entities traded in KLG Capital’s shares
  • Entities connected to SKIL; group company of Awaita

SEBI

  • 3 SKIL entities connected persons to KLG
  • Had access to & traded on the basis of UPSI

SEBI alleged that the unpublished price sensitive information or UPSI of the open offer was known to SKIL President Hemant Patel who traded in the shares of KLG and communicated the UPSI to the Executive Director Praveen Mohnot. Mohnot then passed this information to his daughter Priyanka Singhvi who traded in the shares of KLG based on this UPSI. Similarly, Deputy Chairman N Ravichandran communicated the UPSI to his wife Anita Ravichandran who then traded in KLG Capital’s shares.   

WHO IS AN INSIDER?
SEBI Order
 
Hemant Patel, President, SKIL (Awaita’s group company)

  • Was aware of UPSI of the open offer
  • Traded in KLG Capital’s shares on the basis of UPSI
  • Communicated UPSI to Praveen Mohnot, ED, SKIL

WHO IS AN INSIDER?
SEBI Order
 
Praveen Mohnot, ED, SKIL (Awaita’s group company)

  • Communicated UPSI to daughter Priyanka Singhvi
  • Priyanka traded on the basis of UPSI

N Ravichandran, Deputy Chairman, SKIL

  • Communicated UPSI to wife Anita Ravichandran
  • Anita traded on the basis of UPSI

The accused argued saying that they were not connected to KLG as they do not occupy any position nor have a business relationship with KLG Capital. And so, they cannot be reasonably expected to have access to UPSI. The crux of their arguments is that UPSI has to emanate from the company in whose shares transactions have taken place.  

WHO IS AN INSIDER?
Responses Of Accused
 
Not connected to KLG Capital
Do not occupy any position or have business relationship with KLG Capital
Cannot be reasonably expected to have access to UPSI
UPSI has to emanate from company whose shares are traded

But SEBI did not buy that logic. It concluded that SKIL’s President Hemant Patel was a connected person to KLG capital as he played a key role in the acquisition by Awaita, was in touch with KLG’s promoters and the lead manager to the open offer. This qualified as a temporary professional or business relationship with KLG and since he had the UPSI of the impending open offer, he was an insider. SEBI found Hemant Patel guilty of trading in KLG’s shares on the basis of the UPSI. It similarly alleged that Praveen Mohnot and N Ravichandran of SKIL were also involved in the open offer discussions and passed this information on to their relatives who went on to trade in the stock.

WHO IS AN INSIDER?
SEBI Order
 
Hemant Patel, President, SKIL (Awaita’s group company)

  • Connected to KLG Capital
  • Played a key role in open offer discussions with KLG’s promoter and open offer lead manager
  • Amounts to temporary professional or business relationship with KLG
  • Insider as he had access to UPSI   
  • Traded on the basis of UPSI

Praveen Mohnot and N Ravichandran

  • Connected to KLG Capital as involved in open offer discussions
  • Communicated UPSI to relatives who traded on its basis

The case comes down to the definition of connected person – and whether that person must be directly connected to the company whose shares have been traded. Sandeep Parekh, Founder, Finsec Law & Kartik Ganapathy, Partner, Indus Law join us for more.

Parekh: The question is simple but the answer is beastly complex. So I will go to the heart of this issue which is with reference to this specific case which we are talking about and that is that information has to be inside information. That sounds like a pretty innocuous and simple thing but the fact is it is slightly more complicated and is made more complicated by two rulings; one is the current one which we are discussing and one is the SAT ruling called the VK Kaul which have expanded the definition of insider trading to outsider information as well which kind of not only defeats the purpose of the law but also creates unintended consequence.

WHO IS AN INSIDER?
SAT, VK Kaul Case
 
“It is not obligatory under the regulations that the UPSI must be in the possession or knowledge of ‘a company’ in whose securities an insider of ‘the company’ deals. As long as, an insider of ‘the company’ deals in the securities of ‘a company’ listed on any stock exchange while in possession of UPSI relating to that company, the provisions of Regulation 3(i) of the regulations will get attracted."

Parekh: I will give an example in a short while but essentially it broadens the prohibition so vastly that all kinds of innocent conduct also would get captured if you start taking outside information into consideration. In the facts of this case for example the outside information is the information that the acquirer is going to buy the shares and therefore the share price of the target company would go up, in which case the information which is price sensitive is not inside information which comes from the target but outside information which is the intention of an acquirer to purchase shares.  Let me just give you one short example of the dangers of going beyond the classic case of inside information being misused by insiders. Let me take you back 30 years into the mind of US Supreme Court judges who decided a very famous case called ‘Dirks’ in which he unraveled a massive fraud, did some analysis, investigation and exposed the fraud of a company whose shares tanked and he was in fact prosecuted by the SEC for insider trading because he had access to inside information. So the dangers of kind of over expanding definitions are real and there have been examples where such powers have been kind of used very randomly.

Payaswini: Kartik would you agree that the information must emanate from the target company?

Ganapathy: I disagree with that. Inside information is basically any unpublished price sensitive information. From the point of view of who uses that information, the test of an insider is a person either who is deemed to be connected with the company or anybody who has access to unpublished price sensitive information. I fully understand the concern with respect to making this broader than it should be but under the principle of fairness if there is a person who is deemed to be an insider who communicates that to someone who is not an insider then that person using that information should not be allowed to profit from that information. I am going to suggest that the other example that I can give you is, you have two people sitting in a cab discussing a transaction of a company that doesn’t involve the cab driver, the cab driver hears this and tips somebody off who goes and buys the stock. Now theoretically that is still trading on unpublished price sensitive information because it is information that was confidential, that had a material impact on the price and should not have been used by someone. The place that I stand in is if a person has access to information which is not in the public domain which can be used by him to speculate in stock in a way that is not something a person in the public can do then I would believe that that person should be prosecuted.

Parekh: Let me give you an analogy as to why I disagree with Kartik on this, the best analogy I can think of is imagine there is a prohibition on theft which is there in almost all countries all over the world. Now I pick somebody's pocket, somebody catches me & I go to jail, I pay a penalty, etc. that is completely fair, in which what is illegal is also unfair and I go to jail for that. Compare that situation with me finding Rs 100 on the road and I pick it up. Should I be treated like a thief? Nowhere in the world would the two situations be considered as equal. I probably would not go to jail for picking up Rs 100 note though there is a duty of fairness that I should look for the owner of that note. So, to compare unfairness with illegality – all illegal stuff is unfair no doubt but it doesn’t work the other way round. In the insider trading case I am pretty clear that what ought to be illegal should be specified very strictly in black and white saying that if there is breach of fiduciary duty, if there is kind of  misuse of the powers of an insider who has access to special information, by all means go and prosecute them. Funnily enough in this case that seems to be kind of the case which was not at all developed by SEBI. One of the persons in this case in fact had access to insiders and SEBI could have developed the case in that manner and it could have been a reasonably strong case. However Sebi has chosen to rely on outside information.

Ganapathy: I disagree with the analogy because of the part of theft. In this case you are talking about information that is available to people. If this unpublished price sensitive information was available to everybody then everybody could have traded on it. The point that we are trying to make here is that the regulations themselves are fairly clear with respect to the fact that if you have inside information you should not use it. I agree with Sandeep, SAT didn’t need to go, the whole time member didn’t need to go into whether you are connected or not. It should have been as simple as if you had unpublished price sensitive information you should not have used that to make a gain. They should have stopped there. However by convoluting it by going in and try to show a connection and all of that they sort of muddied the waters a bit.

Besides the three that traded in shares, SEBI has also found guilty of Insider Trading, the officials of SKIL on grounds of communicating UPSI. SKIL’s Executive Director Praveen Mohnot and Deputy Chairman N Ravichandran are alleged to have communicated information on Awaita’s offer for KLG’s shares to their relatives who in turn traded in the shares of KLG. Further, SEBI found proof that the two SKIL officials communicated with brokers to help their relatives to make the trades.

COMMUNICATION OF UPSI: INSIDER TRADING VIOLATION?
SEBI Order

Praveen Mohnot & N Ravichandran

  • Communicated UPSI to relatives
  • Relatives traded on the basis of UPSI
  • Facilitated trades made by relatives with brokers  

Payaswini: Let me come to the second important and interesting issue that this case has thrown up. To your mind does mere communication of unpublished price sensitive information amount to an insider trading violation?

Parekh: Communication as is defined, again I am ignoring the mother question which I answered previously, but communication in India does amount to a violation even if there is no trade; at least technically or theoretically. However I doubt if Securities and Exchange Board of India (SEBI) would in fact prosecute people. There have been examples where SEBI has gone up to people for sharing of information unequally and one of the cases was with regard to a person coming on CNBC, the famous ISPAT case. There have been examples which are kind of similar but I am not sure of the examples where people have tipped information and no trade has occurred and SEBI has gone after them.

Ganapathy: I agree with Sandeep. The offence is really the fact that you have dealt in the securities. The offence is not really that you might have committed a breach of confidence certainly. You might have breached some obligations that you had with respect to your fiduciary duties but if you have just communicated that information and the consequence is not a dealing in securities then it is very hard to say that anything wrong has been done except perhaps breach of confidence or breach of your obligations. So I would say that the offence is really dealing in the securities pursuant to having that unpublished price sensitive information. I do not think that if you were to just communicate that information and there was no consequence to it like a deal or a trade or anything that isn’t offence.

Payaswini: What do you see as the grounds for appeal if this were to go to SAT and considering that SAT has ruled in a particular previous case famously known as the VK Kaul case in SEBI’s favour?

Parekh: My guess would be SAT would likely uphold it because in common law we have the system of precedent. So unless they kind of very violently disagree with the principles they have laid before for good reason there is a good chance that this will be upheld in SAT.

Ganapathy: I agree. Look at how the case has come out and the fact that SEBI has used information including the telephone calls, the contact between tipper and tippee, the fact that the insider actually was involved in the process, they have used information with respect to historical trades to show break from trading pattern and all of this. I believe that this will be upheld.   

Mohnot, Ravichandran and the three who traded the shares have been banned from the securities market for the next 2-5 years. Hemant Patel, Priyanka Singhvi & Anita Ravichandran have also been ordered to disgorge unlawful gains of Rs 3 crores in the next 45 days; this would probably amount to one of the largest disgorgement amounts in an insider trading case

SEBI ORDER: PENALTY

Accused banned from securities market for 2-5 years
Hemant Patel, Priyanka Singhvi & Anita Ravichandran: Disgorge unlawful gains of Rs 3 crore in 45 days

 
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