Testing Insider Trading Contours in India

The public securities market is prone to the ills of insider trading. To protect the market and its various stakeholders, regulations are typically broad based and intended to be dynamic in addressing different forms of insider trading. Recently, the United States District Court, Northern District of California (US District Court) delved into the question of ‘shadow trading’ in the case of SEC v Matthew Panuwat [4:21-cv-06322 (N. D. Cal. filed Aug 17, 2021)]. 

While insider trading typically envisages a scenario of an individual misappropriating unpublished price sensitive information (UPSI), by an order dated 14 January 2022 passed in the aforementioned case (USDC Order), the US District Court secured the power of the SEC to proceed against an individual for using UPSI in relation to one listed company for trading in the securities of another listed company. In the present case, the SEC proceeded on a complaint against Mr. Matthew Panuwat, an executive employee of the biopharmaceutical company, Medivation. On 20 August 2016, Mr. Panuwat bought the shares of a peer biopharmaceutical company, Incyte, minutes after Medivation’s CEO informed the company executives of the impending merger agreement between Medivation and Pfizer (the acquirer). By the USDC Order, the US District Court opined that the SEC could proceed against Panuwat for illegally generating profits of USD 107,066 from the 8% increase in the share price of Incyte, following the acquisition. Thus, it held that insider trading laws envisage scenarios of ‘shadow trading’.

In India, the SEBI (Prohibition of Insider Trading) Regulations 2015 (Insider Trading Regulations) define UPSI widely and restrict trading in securities by individuals in possession of UPSI. In the limited instances of dealing with questions of whether the use of UPSI of one company for the trading in the securities of another company violated the Insider Trading Regulations, the SEBI has utilized the ‘test of likelihood of material effect’. It has consistently taken the view that the UPSI of one company has a material direct impact on the holding company and a material indirect impact on the associate company. In light of the recent USDC Order, it would be interesting to assess the implications of the test employed by the SEBI and its potential extended application in varying scenarios of shadow trading.

Ambiguity in the scope of UPSI

The Insider Trading Regulations define UPSI as ‘…information, relating to a company or its securities, directly or indirectly, that is not generally available which upon becoming generally available, is likely to affect the price of the securities….’. The underlying legislative purpose of the Insider Trading Regulations is to create a level playing field in the securities market by preventing individuals utilizing sensitive information to manipulate or profit from trading in publicly listed securities. 

Therefore, the definition of UPSI poses two important questions. First, what is the scope of ‘affect the price of the securities’ in the context of insider trading. A narrow reading of the phrase and the test laid down by SEBI would only conceive the impact of UPSI on securities of the listed company itself and its holding / associate companies; whereas a broader reading would include instances of the UPSI impacting the performance and value of competitors, customers, suppliers, etc. (as has been done in the Panuwat case). Second, whether the mode of procuring the information is relevant in categorizing it as UPSI - for instance, the designation of self-generated information (knowledge of personal actions like investing in or litigating against a listed entity – which may be categorized as information relating to the listed company or its securities), remains ambiguous under the given definition. 

Assessing the ‘materiality’ of information

SEBI appears to have formalized the ‘test of likelihood of material effect’ to address the above queries by way of precedents. In such light, the emphasis on the ‘materiality’ of impact merits a further consideration of two aspects – first, whether, by consolidating direct and indirect impact on holding and associate companies of a listed company, SEBI has, in effect, inadvertently precluded itself from acting against trading in listed securities of third parties like the US District Court. Second, whether it’s possible to assess, ex-ante, the degree of impact that UPSI of a listed company is likely to have on securities of another listed company – and if so, the likely (and presumably unintended) consequence of restricting persons with UPSI of a listed company from dealing in securities of other listed companies within the same sector.

Conclusion

The insider trading regime in India is currently evolving. Consequently, the scope of definitions as envisaged by the Insider Trading Regulations remains indeterminate and offers itself to various interpretations. Recent developments and issues dealt with by foreign courts make it relevant for us to consider how such scenarios would play out in the Indian context and the implications of a broad or narrow interpretation of the law.