How are securities laws enforced in India: some facts from a new data-set of SEBI orders

by Devendra Damle and Bhargavi Zaveri Shah.

Introduction

The Securities and Exchange of Board of India (SEBI) is one of the most powerful regulators in India. As the regulator of one of the world's largest stock markets by market capitalization, SEBI has a variety of enforcement tools at its disposal. These include the imposition of monetary penalties, license cancellation and pursuing criminal proceedings against violators. The law empowers SEBI to issue directions to intermediaries, and more broadly, to persons associated with the securities market. Such directions may be of a prohibitory nature, such as restricting companies from raising capital in the public markets, disqualifying persons from acting on the board of publicly traded issuers and restricting access to the capital market altogether. They may also be of a remedial nature such as disgorging illegal gains made by violators or directing restitution to wronged investors. The grounds for issuing such directions are wide.

How has SEBI used these enforcement powers over time? Has it prioritized enforcement against some kinds of misconduct over others? If yes, have the priorities stayed static or changed over time? Do certain types of violations consistently entail certain types of sanctions? How efficient are the enforcement proceedings in terms of the time taken, and what is the success rate for enforcing such sanctions? Unlike some Indian financial sector regulators, SEBI follows a due process before issuing such orders, involving the issuance of a show cause notice and a hearing and publishes each enforcement order passed by its officials systematically on its website. This transparency in enforcement allows us to establish some basic facts on securities laws enforcement in India over a long observation period. In a new paper, we analyse over 8,000 enforcement orders passed by SEBI over a span of ten years to answer some of the questions we mentioned above. In this article, we summarize the key findings of our work.

Data description

In our study period beginning 1st January, 2011 and ending on 31st December, 2020, SEBI passed 9048 enforcement orders, of which we were able to sucessfully download and parse 8032 orders. We then analysed these orders, using text-mining software we designed ourselves, to arrive at some summary statistics on the frequency and type of enforcement undertaken by SEBI during the study period. To answer more detailed questions on the nature of enforcement, we manually analysed a stratified random sample of about 10% of these orders. The sample was drawn from the set of orders involving four regulations, which are most frequently enforced by SEBI (as per our data), namely, orders pertaining to fraudulent and unfair trade practices in the Indian securities market (FUTP), violations of the Insider Trading regulations, the Takeover Code and Broker regulations.

As mentioned above, the SEBI Act empowers SEBI to pass two types of orders, namely, orders imposing monetary penalties and orders issuing directions. Such orders can be issued against intermediaries, market participants, issuers of capital or persons generally associated with the securities market. Until 2019, monetary penalty orders could be passed only by adjudication officers and directions would be issued by whole time members of the SEBI board. With effect from 2019, the members of the SEBI board have also been empowered to pass orders imposing monetary penalties. In addition to these, the law also empowers SEBI to settle violations upon the payment of a settlement fee, without passing a guilty verdict against the violator. Basis this scheme of the SEBI Act, we categorize the enforcement orders in our data set into three categories shown in the Table. On an average, SEBI issues 250 enforcement orders with directions and double the number of orders imposing monetary penalties each year. The SEBI Act also empowers SEBI to initiate criminal prosecution against persons accused of having violated the SEBI Act or the regulations made by it, but we do not take account of this typology of enforcement proceedings in our study.

Table: Enforcement orders (2011-20)

Type of order	Type of sanction	Total^
Orders by Adjudicating officers	Monetary penalties	4911 (61)
Orders by Chairperson/member	Non-monetary sanctions	2484 (31)*
Settlement orders	Settlement fee	637 (8)
Total		8032 (100)
^Numbers in brackets are a percentage of the total. *We estimate that not more than 30 orders may involve a monetary penalty.

As is evident from the Table, securities law enforcement is largely undertaken in India through monetary penalties, but the proportion of enforcement undertaken through non-monetary sanctions is not trivial. Settlements account for less than 10% of the total enforcement orders in our data. The annual distribution of these types of orders is shown in the Figure. The Figure shows that from 2018 onwards, there has been a sharp increase in the intensity of enforcement, with the number of monetary penalty orders nearly doubling from the previous years. The proportion of settlements has also increased over time, particularly after 2016. While the growth in the size of the market, an increase in the intensity of regulation and enforcement capacity are intuitive explanations for this jump, more precise, causal explanations require further research.

Figure: Year-wise types of enforcement orders (2011-2020)

Findings

SEBI draws its substantive powers from a set of three laws, over and above the SEBI Act, namely, the Companies Act, 2013 (and its preceding legislation), the Securities Contracts (Regulation) Act,1956 (SCRA) and the Depositories Act, 1996. While the Companies Act largely deals with the incorporation of Indian companies and the governance of their affairs, it also governs primary issuances, the requirements to be met by public offer documents and some aspects of the governance of listed companies. These matters under the Companies Act are administered by SEBI. The SCRA governs the conceptual definition of securities and securities contracts, regulates some types of securities contracts and governs the licensing and affairs of stock exchanges. The Depositories Act, 1996 deals with the regulation of depositories and depository participants. Under each of these laws, and in particular under the SEBI Act, SEBI has issued regulations defining the registration and reporting requirements for intermediaries, the kinds of misconduct that will elicit penalties, and so on.

We find that orders against fraudulent and unfair trade practices (FUTP) are the single largest group (15%), followed by orders dealing with violations of the provisions of the Companies Act (11%), insider trading regulations (10%) and the takeover code (9%). The enforcement actions (i.e. the number of orders) under the remaining regulations are few, with some of them having witnessed enforcement not more than once during the study period. Some of these seemingly rarely-enforced regulations, such as the regulations governing alternative investment advisors, are relatively new, which may explain why they do not appear more often in our data. However, others, such as the regulations governing venture capital funds, stock exchanges and clearing corporations, are older, but we see fewer orders issued under these regulations as compared to other regulations. Whether this is because the regulations themselves are not violated as frequently by market participants, or because SEBI chooses not to enforce them, requires further study.

To answer more specific questions of these enforcement orders, we manually analysed a random sample of 818 orders (approximately 10% of the total sample) from amongst the orders against the following types of violations: (1) FUTP, (2) insider trading, (3) violations of the takeover code and (4) violations of brokers' regulations. Some findings from this micro-study are summarised below:

1. Duration of the enforcement proceedings: The formal enforcement process at SEBI begins with the appointment of an investigating authority who investigates the facts and reports her findings to the SEBI board. If the findings are adverse, a show cause notice is issued to the accused by the adjudication officer (where the proposed sanction is a monetary penalty) or a whole time member of the SEBI board (where the proposed intervention is a direction). We find that the median time for the issuance of a show cause notice is a little more than three years from the date on which the violation was committed. Further, the median time from the date of issuance of a show cause notice to the date of an order imposing monetary penalties is a year and a half. It is a little more than two years for orders issuing directions. A regulation-wise analysis of the duration suggests no relationship between the complexity of the violation involved and the duration of the enforcement proceeding.
2. Subject and outcome of enforcement: A bulk of the enforcement actions are in respect of unregulated entities, that is, entities that are not SEBI-licensed intermediaries. This phenomenon could be attributed to the type of violations that are most often enforced against, namely FUTP and insider trading. Both these practices would likely involve traders and market participants that are not SEBI-licensed intermediaries. Further, in nearly 80% of the cases, SEBI found the person(s) guilty of all the violations that they were charged with, with a marginally higher conviction rate for unregulated entities compared to regulated entities. The conviction rate for violations of the Takeover Code is also marginally higher, compared to violations under the three sets of regulations. It is hard to comment on the optimality of this high conviction rate as these enforcement proceedings are undertaken and decided by SEBI officers themselves. All orders of SEBI, except those rejecting an application for settlement, are appealable to the Securities Appellate Tribunal (SAT). The rate of appeals and the outcome of appeals before the SAT could be a rough proxy to evaluate the optimality of this conviction rate and would be a good direction for further research.
3. Proportionality of sanction: We find a lot of variation in the amount of penalty levied across cases. While the median (i.e. typical) size of the penalty is in the range of Rs 5,00,000, the average is in the range of Rs. 57,00,000. This difference indicates that while there are few cases where large penalties are issued, the size of these penalties is very large compared to the typically-imposed penalties. One explanation that could account for this variation is the amount involved in the violation. The SEBI Act requires an Adjudicating Officer to take into account, among other factors, the amount of disproportionate gain or unfair advantage made as a result of the default or the amount of loss caused to investors as a result of such default. However, we find that in a vast majority of the cases in our sample (90%), the size of the violation was not calculated.

   We similarly find a lot of variation in the orders that impose sanctions other than monetary penalties. Out of 118 such orders, 82 orders restricted the market access of the accused. The duration of such restrictions varied from 15 days to 4 years, and we could not discern any relationship between the duration of the restriction on the one hand and the violation or the purpose of the restriction on the other. Further, courts have repeatedly held that SEBI's direction making powers are remedial and preventive in nature, and not punitive. However, it is unclear at what point an order that operates to restrict market access starts to become punitive in nature, since none of the orders in our data clearly draw the line between remedial and punitive measures.

Conclusion

In India, the field of securities laws is often studied from the perspective of a specific case, individual legislative amendments or specific judgements of courts. While such analysis is useful, a slightly different, more quantitative approach is necessary to gain a systematic understanding of the manner in which the regulator uses the wide variety of enforcement tools available to it, the manner in which it seeks to enforce against different kinds of misconduct and the efficiency of its enforcement functions. The consistent publication of easily accessible enforcement orders by SEBI on its website makes it possible to undertake such systematic research on securities laws enforcement in India. This paper is one such effort to begin developing more systematic knowledge on enforcement of private law in India.

The data used for this analysis can be found here. The data-set can be cited as Zaveri Shah, Bhargavi; Damle, Devendra (2022), "Securities law enforcement in India", Mendeley Data, V1, doi: 10.17632/ppdk9pzfdp.1.

Devendra Damle is an independent researcher. Bhargavi Zaveri Shah is a doctoral candidate at the National University of Singapore.

Reconsidering SEBI disgorgement

by Renuka Sane and S. Vivek.

SEBI disgorgement is a regulatory remedy to recover wrongful gains from entities that have violated securities laws. It is justified based on the equitable principle that no one should benefit from their own wrong. This seems like a non-controversial, even obvious, ground for regulatory action that has 'compelling intuitive appeal'. However, there are basic conceptual issues that are not clearly settled, not just India but in other jurisdictions as well. For example, the U.S. Supreme Court has considered three cases on disgorgement over the last few years - in one case, it held that disgorgement was beyond the powers of the Federal Trade Commission, overruling decades worth of practice, and in another, upheld Securities and Exchange Commission's power to seek disgorgement but with important conceptual restrictions.

These are trends that the Securities and Exchanges Board in India (SEBI) should be watching carefully. Lack of conceptual clarity about the remedy can put years of regulatory action at risk, if the basis of the remedy is questioned in a case before superior Courts. Further, a study of how SEBI orders are interpreting disgorgement powers and if they are consistent with the conceptual justifications is critical. SEBI disgorgement does not have any statutory limit - the order can direct recovery of all the wrongful gain, whatever they may be. This exercise of of vast discretion by SEBI Whole-Time Members (who are executive members of the regulator and typically do not have substantial judicial training), without transparent statutory or conceptual guidance, raises regulatory governance concerns.

In a new working paper, Reconsidering SEBI disgorgement, we study disgorgement from three perspectives:

1. The theory of disgorgement: Disgorgement is a distinct remedy that must be distinguished from other remedies such as compensation, restitution, and penalties. Disgorgement is different from compensation because compensation is focussed on the loss suffered by claimants whereas disgorgement is focussed on the gains made by the wrongdoer. While disgorgement and restitution are both gain-based remedies, there is a subtle yet important difference. Restitution is focused on reversing a wrongful gain of the defendant based, for example, on a wrong or incorrect transfer from the plaintiff. Here, the (wrongful) gain made by the defendant is equal to the loss suffered by the plaintiff - the property in question (money, for example), is returned to status quo. Disgorgement, on the other hand, strips the defendant of its gains, even if such gains are not made from the plaintiff, and even if the plaintiff does not suffer any loss. Accordingly, the loss suffered by the plaintiff need not correlate to the defendant's gain that is clawed back through disgorgement. The objective for disgorgement is to have a deterrence effect, and not to merely reverse an illegal transfer. Penalties are also generally imposed for the purpose of deterrence, among others. However, while disgorgement amounts must be equal to the gains made by the wrongdoer, penalties can be imposed merely on the basis of the violation and need not correlate exactly to the gains, if any, made by the wrongdoer.

2. The evolution of disgorgement at SEBI: SEBI had even in the early years tried exercising powers to claw back illegal gains (disgorgement), or compensate victims in insider trading cases, with mixed success at appellate fora. Subsequently, parliamentary and expert committees over the years have recommended providing SEBI with clear powers to trace the illegal gains made by wrongdoers and return such gains to their victims. Before such powers could be formalised through statute, disgorgement was used by SEBI Whole-Time Members (WTMs) as a quasi-judicial innovation in their orders,and received approval from the Securities Appellate Tribunal. Since, at that time, SEBI WTMs did not have the power to impose monetary penalties, SEBI disgorgement was justified as a 'remedial' power which only returns the wrongdoer to status quo, and hence can be distinguished from a punishment. Further, as there was no express statutory provision at the time for SEBI disgorgement, it was traced back to 'equitable' powers of SEBI WTMs.

   In 2014, the Securities and Exchange Board of India Act, 1992 (SEBI Act), was amended to clarify that SEBI disgorgement was part of SEBI's remedial powers. The amendment also stated that the amounts so clawed back are not to be deposited with the Consolidated Fund of India as in the case of penalties; instead, they are retained by SEBI's Investor Protection and Education Fund, to be used in terms of SEBI's own regulations. Interestingly, despite tracing its origins to Parliamentary and expert committees which discussed disgorgement powers in the context of using the proceeds to compensate victims, the amendment did not require SEBI to even attempt to distribute the amounts to victims. Since then, SEBI's power to direct disgorgement without clear statutory limits has been entrenched. Gradually, SEBI also received judicial recognition for its power to impose interest on the disgorgement amount. These rates are calculated from the date of the violation, sometimes going back 10 years or more (as opposed interest on penalties which is typically calculated from the date of non-payment after the SEBI order). Further, the initiation of proceedings for disgorgement or penalties, remains with SEBI and it is unclear how it is exercised.

   These vast powers are conferred on the regulator on the basis that SEBI disgorgement is only 'remedial' and is returning the wrongdoer to status quo. The use of the term 'disgorgement' while at the same time emphasising the return to status quo creates some confusion between the related albeit distinct remedies of disgorgement and restitution. In this context, we study whether in practice what kind of remedy SEBI disgorgement actually is, regardless of its nomenclature. Further, as a legal matter, returning the wrongdoer status quo is critical as a point of distinction from SEBI penalties; if the wrongdoer is left worse-off, it could be argued that SEBI disgorgement is a penalty by another name.

3. The practice of disgorgement at SEBI : If SEBI's case for disgorgement is based on clawing back illegal gains and returning the wrong-doer to status-quo, do they actually do so? We use all the SEBI disgorgement orders between January 1, 2018, and July 15, 2021, and find that in 9% of the cases there is no finding that the noticee has made a benefit or avoided a loss, and yet noticees have been ordered to disgorge. In none of the cases is there a finding that the direction brings the noticee back to status-quo and does not leave them worse off - a critical element in the justification for SEBI disgorgement and its characterization as a remedial power. Further, it is interesting that SEBI disgorgement is usually used for insider trading, and fraudulent trading offences, for which the SEBI Act allows penalties to be issued up to three times the profits made. Why is disgorgement, and not penalties, being used in these cases?

Our results suggest that lawmakers and the SEBI Board must review how SEBI disgorgement is conceptualised and what goals it serves. It should scrutinise how disgorgement orders are being issued under the existing framework so that they are consistent with the justifications for remedial measures (such as, allowing deductions for legitimate expenses and a transparent and careful system to determine causation of the gains from the wrong). A holistic look at remedies available for securities law violations is required so that they serve all the goals required for stakeholders - deterrence, compensation, and restitution.

S. Vivek is a researcher with the Regulatory Governance Project at the National Law School of India University, Bengaluru. Renuka Sane is a researcher at NIPFP. Author names are in alphabetical order.

An analysis of the SEBI WhatsApp Orders: Some observations on regulation-making and adjudication

by Rajat Asthana and Renuka Sane and S. Vivek.

The idea of company insiders making huge profits on the basis of non-public information has always elicited a rich discussion on the regulation of insider trading. If the goal of regulation is to craft market participants' behaviour, both, the text of the regulations, and the subsequent enforcement actions of regulators should support this objective. When these are unclear or contradictory, merely having regulations on the book, is unlikely to help. At worst, this may even hinder market efficiency. It is important, therefore, to look at how regulations have been drafted, and to see whether there is a consistent communication of what the regulations mean. This includes questions on the clarity of the regulations, the process of regulation-making, as well as the predictability in enforcement.

In this article we use the example of recent orders in the "WhatsApp case" to demonstrate the problems in: (1) the process of regulation-making, and (2) adjudication, in the context of insider trading regulations. The orders raise several substantive questions. These relate to the scope of the term 'insider', meaning of Unpublished Price Sensitive Information (UPSI), and use of messaging platforms. However, in this article, we mainly focus on the issue of the working of the regulator.

India may have formal provisions against insider trading, and satisfy international standards in that regard. However, the substantive content of the regulations, the rationale for these regulations, the manner of prosecution by the regulator, and the imposition of penalties have all raised concerns on the clarity, consistency and predictability in the regulatory process. This may impose significant costs on regulated entities, and consequently, on cost of capital.

Background: The WhatsApp case

Insider trading in India comprises two types of offences: trading with unpublished price sensitive information ("UPSI") and communication of UPSI (even in the absence of trading). In November 2017, Reuters reported that information about financial results of listed companies was being exchanged on WhatsApp groups, in advance of such results being announced publicly. The news report identified 12 companies where the messages proved to be "prescient" - i.e., they appeared to accurately predict the actual results. Based on this news report, the Securities and Exchange Board of India (SEBI) initiated an investigation into the matter. Basis this investigation, separate showcause notices were issued to certain individuals who are part of the WhatsApp group, and it was alleged that the noticees had communicated UPSI, which even in the absence trading, constituted a violation of provisions of the Securities and Exchange Board of India Act, 1992 (SEBI Act) and the SEBI (Prevention of Insider Trading) Regulations, 2015 (Insider Trading Regulations).

The noticees set up a defense on the basis that the information that they shared on the WhatsApp group was not UPSI. The information had not been sourced from the relevant company or any insider. Further, the messages were not 'price sensitive information' or 'financial results' but in the nature of gossip or 'Heard on the Street'. Additionally, messages were exchanged about several companies - a few of which were consistent with the actual financial results, and many others which were not - and accordingly, the allegations were based on cherry-picked messages. It was also argued that the source of the messages on the WhatsApp group could be analyst reports which had predicted similar results, and therefore should be considered as generally available information (and not UPSI).

The SEBI Adjudicating Officer (AO) dismissed these defenses and held that the messages were UPSI. The AO reasoned that while the source could not be identified because the messages were being shared on WhatsApp, they were UPSI because: (1) the messages were shared just prior to the results being released publicly, and (2) they were so similar to the actual financial results, that it was unlikely to be a coincidence. Further, since the noticees did not clearly establish the analyst reports as the source of the messages, they are not entitled to the 'benefit of doubt' that the messages were in fact sourced from such reports. Accordingly, a penalty of Rs.15 lakh was imposed on the noticees.

On appeal, the Securities Appellate Tribunal (SAT) set aside the SEBI order. It held that SEBI had not given adequate consideration to some of the defences. It also held that for information to be UPSI, the recipient had to know that it was UPSI. The evidence available did not establish the state of mind of the recipients and accordingly, the SEBI order was set aside.

Standard-setting Choices

Standards for insider trading are not uniform across jurisdictions. For example, in the US, liability arises only if the person owes a fiduciary duty to the company or its shareholders or the source of the UPSI. Other jurisdictions such as the UK and Singapore, have adopted the 'parity of information' approach where the emphasis is on the information with the person trading, and not on how it was obtained or whether there was an intention to violate the law (Varottil, 2016).

In India, the language of Regulations 3 and 4 of the Insider Trading Regulations indicates a strict liability regime, where the focus is on the UPSI, and not on the intention behind the trade or the source of the information. Regulation 3(1) prohibits communication of UPSI and Regulation 4 prohibits trading when in possession of UPSI.

Committee reports on insider trading have recommended that communication of UPSI by itself should be an offence. While the offence is drafted broadly, the interpretive note provided in regulations appears to indicate that the emphasis is on the company to ensure that UPSI is not leaked. The High Level Committee to Review the SEBI (Prohibition of Insider Trading), 1992 under the chairmanship of Justice N.K. Sodhi dated December 7, 2013 (Sodhi Committee Report), observed that 'to maintain hygiene' and to 'ensure that UPSI is not handled lightly... and is not communicated except where necessary', communication of UPSI is to be prohibited (Sodhi Committee Report, 2014). The report of the Committee on Fair Market Conduct under the chairmanship of T.K. Viswanathan dated August 8, 2018 (TK Viswanathan Committee Report), observed that UPSI may be communicated for legitimate purposes. The report clarified the meaning of the term 'legitimate purpose', and also recommended maintaining a database of persons to whom such UPSI is being communicated, to prevent misuse.

However, neither the Insider Trading Regulations nor the committee reports distinguish between persons who have a duty to keep the information confidential (such as directors and officers of the company), and outsiders who may chance upon this information but do not have any such obligation. In Singapore, for example, it is presumed that connected persons were aware that the information is UPSI; however, this presumption is not 'available' for others including tippees. In the absence of such guiding principles or specific rules, these critical questions are left entirely to the AO's discretion.

Further, the SEBI Board made certain modifications to the draft regulations suggested by the Sodhi Committee Report, but the reasons for such modifications are not available publicly. One of the changes was to delete the clear language in the draft regulations that research reports should be considered as generally available information. While there may be good reasons for the SEBI Board to have made this modification, the absence of reasons for this choice leads to confusion about how information in research reports should treated. For example, if it were clear that information in research reports is generally available information, then similar numbers appearing in a Whastsapp group should not have raised UPSI concerns.

Lack of clarity on reasons for specific legislative choices could also lead to different views being taken by various adjudication officers and the appellate tribunal.

Adjudicatory Discipline

There will always be some uncertainty inherent in legal rules, despite best efforts during the standard-setting process. Disagreement among judicial officers on the interpretation of the law is expected to be settled by appeals to higher tribunals/courts. However, for this process to work, judicial officers will have to look to previous interpretations and record reasons if a new interpretation is preferred in a specific case, especially if a higher tribunal has already indicated a particular interpretation. How has uncertainty been resolved in the WhatsApp orders?

The SEBI AO order states that it was not possible to identify the original source of the messages shared on the Whastapp group. Inquiries with the relevant companies also did not establish any leak of the financial information. The noticees were not clear as to how they received the messages, but they suggested that the messages could have been sourced from analyst reports. How should information in the hands of unconnected third parties be evaluated?

The committee reports do not provide an answer in the context of the communication offence. However, in the context of the trading offence, the Sodhi Committee Report states that SEBI will be required to demonstrate that: (1) trading took place, and (2) that there can be a reasonable inference of the person being in possession of UPSI at the time of execution of the trade. If the trade is by an 'outsider' i.e. a person not connected to the company, then SEBI has to further demonstrate a prima facie case that the noticee was in possession of UPSI at the time of trading (Sodhi Committee Report).

The AO order states that since the information is closely aligned to the actual results, and the noticees have not been able to demonstrate how they came to be in possession of the information, it is to be presumed that the information is UPSI. Further, while the source of the information could not be traced, the noticeees cannot be given the 'benefit of doubt' given the 'gravity of consequences' resulting from the sharing of such information.

In terms of the AO's interpretation, the Insider Trading Regulations do not require the source of the information to be identified for a violation to be established. However, this issue has been considered earlier by both - SEBI and the SAT. The SAT has held that the source of the information is an important element in establishing UPSI (Samir Arora v. SEBI). The AO orders have neither accepted that principle nor sought to distinguish that precedent based on specific facts. Further, while there are references in the AO orders to judicial decisions on circumstantial evidence being sufficient in certain cases, this issue was not in dispute. The AO orders do not cite any precedent to justify how mere similarity of some information with the actual results is sufficient for it to be classified as UPSI. Further, while the AO order cites various extracts from the Sodhi Committee Report, there is no reference to the portion, which states (albeit in the context of trading), that it is SEBI's obligation, to prima facie show how an unconnected person was in possession of UPSI.

Additionally, it is worth noting the approach in some other SEBI orders on insider trading issued around the same time: One held that the noticee was not liable for insider trading (even though the noticee had UPSI and had traded) since the intention behind the Insider Trading Regulations is that the person in possession of UPSI should not benefit compared to the general investor. In another, even though a director had access to UPSI and benefited from trading, it was held that although price sensitive, the information was wrongly disclosed by the company and therefore was not UPSI; and that the director's conduct did not indicate that he intended to maximise profits (a defense that the SEBI Board expressly rejected while adopting the other recommendations of the Sodhi Committee Report). In a third case, a company official had traded when the trading window was closed, but it was held not to be in violation of the Insider Trading Regulations as there was no material to show that the trading was on the basis of the UPSI (although this is not the requirement under the Insider Trading Regulations). If any one of these principles had been applied in the WhatsApp orders, the result could have been different.

Further, while the SAT records its earlier judgment emphasizing the importance of the source of UPSI, it sets out a new test for subjective knowledge of the recipient. Again, there is no reference to precedent or to the background reports for setting out this new test. Indeed, the SAT could have set aside the SEBI order by merely reiterating the principle in its earlier judgment and avoided setting out a new test.

Penalty

The AO's order on penalty also demonstrates that when there are gaps in the law, officials use their discretion completely. Section 15J of the SEBI Act sets out the factors which are to be considered when an AO imposes penalties:

1. Amount of disproportionate gain or unfair advantage, where quantifiable, as a result of the default;

2. Amount of loss caused to investors as a result of the default; and

3. Repetitive nature of the default.

In imposing a penalty on the noticees, the AO is forced to concede that none of these factors apply in this case. By merely communicating UPSI, no loss or advantage had been caused to anyone. The AO then proceeds to impose a penalty of Rs. 15 lakh, as such acts may compromise the confidence of investors in the market.

Evidently, the considerations for imposing the penalty do not relate to the different types of offences. In Adjudicating Officer, SEBI v. Bhavesh Pabari, the Supreme Court held that the factors set out in Section 15J are not exhaustive, particularly in the context of offences such as failure to furnish information and returns, which will typically not involve the factors set out above. It is arguable if this holding entirely applies in the context of insider trading where these factors are typically relevant. In any event, even if these factors do not apply, the order should state what other factors outside of Section 15J have been considered relevant. Without these reasons, it is not clear how the penalty amount of Rs. 15 lakh was calculated. These are concerns not specific to the individual penalty imposed in this case but for the overall design of the regulations.

Implications for the design of the legal framework

The learnings from the WhatsApp case has implications for the design of the insider trading framework in India:

1. Standard-setting: Lack of clarity on why certain choices were made at the time of standard-setting makes it challenging to interpret the principles inherent in the regulations. Further, even where the SEBI Board has deviated from some recommendations of the expert committee, the reasons for such deviation have not been disclosed. This information is critical, not only from the perspective of transparency, but also as a guide to officials as to the purpose of creating an offence, when they adjudicate cases in connection with such matters.

2. Adjudicatory process: While the common law judicial tradition is well suited to clarify existing principles in light of changes in technology and markets (Report of the Financial Sector Legislative Reforms Commission), this requires officials to record their interpretation of law and explain if that is different from an earlier interpretation. Similarly, while imposing penalties, the factors considered should be made explicit to ensure clear communication to stakeholders and consistency among orders.

3. Taking stock: More than five years have passed since this iteration of the Insider Trading Regulations were issued. It is not possible to think of every situation at the drafting stage, particularly for an area that is constantly changing. Further, there have been changes to some portions of the regulations pursuant to the TK Viswanathan Committee Report. However, a comprehensive review of the effectiveness of the regulations, and a transparent discussion of the various choices made in framing the regulations, will benefit all stakeholders.

Conclusion

The problems of the insider trading legal framework discussed in this article connect to an emerging literature on the problems of regulatory governance in India. For example, Burman and Zaveri (2018) study the process of public consultation in regulation making across three regulators in India and find that much more needs to bedone. Others have argued that there is little guidance given to regulators on how to translate the principles of law into practice (Burman & Krishnan, 2019; Sundaresan, 2018; Goyal and Sane, 2021). This leads to a situation of weak state capacity in India (Roy et. al., 2019).

Ultimately, if the goal of regulation is to (dis)incentivise market participants from (not) behaving in a particular manner, then the text of the regulations, and subsequent actions of regulators should support such an objective. If the text and the subsequent actions of the legal regime are weak, unclear, confusing, or inconsistent, then the mere existence of a legal framework may at best not help, and at worst, actually hinder the working of the market. It is also important to study how the text of the law was arrived at - whether there is adequate rationale provided on the choices made, whether public consultations have been undertaken, and whether sufficient guidance is provided to both; the regulator, and the regulated entities, so that there is a shared understanding of the objective, and the process of the legal framework. It is also critical to ensure that the regulator moves towards a consistent interpretation of the regulations that allows for predictability, instead of each order interpreting the regulations in their own way.

References

Burman, A., & Krishnan, K. (2019). Statutory regulatory authorities: Evolution and impact.

Burman, A., & Zaveri, B. (2018). [https://bit.ly/32eDCdX]Regulatory responsiveness in India: A normative and empirical framework for assessment. William & Mary Policy Review, 9 (2), 1-26.

Roy, S., Shah, A., Srikrishna, B. N., & Sundaresan, S. (2019). Building state capacity for regulation in India. Devesh Kapur and Madhav Khosla (eds.), Regulation in India: Design, Capacity, Performance, Oxford: Hart Publishing.

Samir Arora v. SEBI, (2004) SCC Online 90.

Sodhi Committee report - Part II, paragraph 43, page 27; SEBI Board Agenda dated November 14, 2014 - paragraph 2.2.

Sundaresan, S. (2018). Capacity building is imperative. Column titled Without Contempt in the editions of Business Standard dated August 2, 2018.

Varottil, U. (2016), "Due Diligence in Share Acquisitions: Navigating the Insider Trading Regime", NUS working paper at page 9 (April 2016).

Rajat Asthana and S. Vivek are researchers with the Regulatory Governance Project at the National Law School of India University, Bengaluru. Renuka Sane is a researcher at NIPFP. Author names are in alphabetical order. We thank two referees for useful comments. Views are personal.

Executive discretion in regulating private schools in India: Evidence from Delhi

by Bhuvana Anand, Jayana Bedi, Prashant Narang, Ritika Shah and Tarini Sudhakar.

Students in India are increasingly switching to private schools. For 2017, U-DISE data shows that nearly 40% of students are enrolled in private schools. However, the growth in private schools has been sluggish; between 2012 and 2015, annual growth for private schools hovered around 3% and in 2016, dropped to 1.71% (U-DISE 2016-17).

State education departments play a critical role in the governance of private schools. They write and apply rules, recognise schools, conduct inspections, impose penalties, and resolve disputes. Despite this, there is little to no evidence on how they carry out these functions and their impact on the growth and quality of these schools.

We studied three regulatory touchpoints between the state and private schools -- licensing, inspections and fee regulation -- for Delhi, in a recent paper: Challenges of executive discretion in the regulation of private schools, by Anand et. al., in Anatomy of K-12 governance in India, Centre for Civil Society, 2019.

We used government administrative data, field observations and analysis of the regulatory framework. On close examination, we found instances of excesses in executive discretion. While necessary to an extent, the misuse of discretion can negatively affect public welfare: in this case, school, students and parents.
Discretion in state education departments vis-a-vis private schools appeared in the following forms:

1. Overreach in the making of rules;
2. Ad-hoc and arbitrary rule-making;
3. Poor procedural fidelity and administrative opacity; and
4. Opaque, inconsistent and subjective exercise of punitive measures.

For example, consider the function of inspection. The Private School Branch of the Directorate of Education is supposed to inspect all private schools every year but only 60 schools are inspected in a year. As we reviewed the approach to the few inspections that do happen, we found that the method does not fulfil the spirit of the Delhi School Education Act and Rules (DSEAR) 1973. Rule 192 states that every inspection of a private school should be “as objective as possible”. The inspection proforma, however, is populated with measures and constructs that cannot be measured objectively. One such question is: did the teacher ask “thought-provoking” and “well-distributed” questions? Not surprisingly, the interpretation of these terms and the recorded answers vary across inspectors and schools (Figure 1). Besides, it is not clear how constructs such as “proper blackboard summary” link to the quality of education.

These inspections are also not typically followed by punitive action. DSEAR 1973 allows the Director to take any action against a non-compliant school but no school has been de-recognised in the last five years in Delhi. While officials cited the fear of student displacement, schools pointed out that they often bribe officials.

What drives this subjective/opaque application of punitive measures? What are the standards of quality? Do the standards adequately measure what they intend to do? What is the consequence of this on schools and quality of education? Where does a school go for appeal? Our research raises questions on the functioning of the state department—pertinent to any debate on education reform. We argue that there is a need for administrative reform and that the coercive power of government on private action ought to be within the constraints of law, guided discretion and due process.


The authors are researchers at the Centre from Civil Society. This paper was presented at the APU-NIPFP workshop Strengthening the Republic #1, January 11, 2020.

Problems with evidentiary standards for proving securities fraud in India

by Nidhi Aggarwal and Bhargavi Zaveri.

Introduction

Did O.J. Simpson kill his wife? A criminal jury said no, a civil jury said yes. The standard of proof applied by the two juries made all the difference to the outcome of the case (Vars 2010).

In India, the securities regulator adopts a very low standard of proof for cases involving wrongdoing in the securities market. For many people, standard of proof related questions are procedural and semantic exercises in the dispensation of justice. However, the standard of proof adopted by a judge has direct impact on the outcome of the case and over time, the quality of the investigation conducted by the investigative agency. When the standard of proof is low, there is a high chance that initiating an investigation will induce an adverse order. This creates substantial discretion in the hands of the investigator, to choose the persons against whom State power will be directed. This runs against a basic theme of liberal democracy, of containing executive discretion. The ability of the executive to direct punishment upon chosen ones is inconsistent with the rule of law. It creates policy risk for persons who may consider participating in the Indian financial markets, and creates a bias in favour of participation by politically connected persons.

There are three reasons why the standard of proof in securities fraud cases in India are low. First, the Supreme Court has held that the standard of proof which SEBI must meet to establish securities fraud is the 'preponderance of probability' standard. This is lower than the standard of proof required to establish a crime under criminal law. In civil proceedings, there are usually two versions of the facts. The court, on the basis of the evidence before it, chooses that version which it thinks is 'more probable', that is, it will accept a version which a prudent man will act upon the supposition that it exists. On the other hand, in criminal cases, the prosecutors must satisfy the court that the existence of a fact is not only probable, but that its existence is beyond reasonable doubt. Simply put, the prosecution must satisfy the court that 'a reasonable alternative version is not possible' (185th Report of the Law Commission). Courts have explicitly acknowledged that it is not possible to mathematically define the degree of probability for meeting a certain standard of proof and there is an inherent subjective element within each of these standards. (State of UP v. Krishna Gopal and Anr.)

The other two reasons are inter-connected. SEBI exercises regulation-making, executive and quasi-judicial powers in connection with the securities market. It defines what conduct would constitute fraud for the purpose of exercising its enforcement powers. The concept of fraud under the SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003 (PFUTP Regulations) - a regulation that defines fraudulent conduct in the securities market - is wider than what is understood as fraud in common law and the codified law applicable to fraud in India. It dispenses with critical elements such as intent, deceit and damages. A wider definition of fraud sets the bar very low for establishing securities fraud before a court or tribunal. SEBI is also responsible for conducting investigations of suspected fraud and makes decisions on whether the conduct investigated meets its definition of fraud. This violates the constitutional scheme of the separation of powers that applies to areas of public administration which are not governed by a technocratic regulatory agency. As an example, the Indian Penal Code defines what constitutes theft, the investigation is conducted by the executive agencies and the decision on whether the investigated conduct amounts to theft (as defined in Parliamentary law) is made by the judiciary.

The concentration of all three powers in a single body creates scope for bias towards a lower standard of proof. Empirical work done on the cases investigated by the Securities Exchange Commission, the securities regulator in the United States, is indicative of such bias. The SEC is empowered to choose whether to pursue a proceeding before one of its own internal administrative law judges or an independent federal court. Reportedly, while the SEC enjoyed a 90% success rate in its own hearings, it had only a 69% success rate against defendants in federal court. (here and a perma link here)

In February 2018, a judgement of the Supreme Court further diluted the standard of proof for securities fraud in India in a case involving synchronised and reverse trades executed on the exchange. The Supreme Court reversed the decision of the Securities Appellate Tribunal which had held that although the trades in question might have been synchronised, they were not manipulative and "market manipulation of whatever kind, must be in evidence before any charge of violating these Regulations could be upheld." The Supreme Court dispensed with the need to show manipulation and relied on the notion of "market integrity" as a standard for adjudging the conduct of market participants. SEBI has extensive powers to sanction wrongdoing in the securities markets, such as the power to bar access to the market, suspend professional licenses and impose hefty monetary penalties. The Supreme Court's ruling has serious implications for the manner in which these powers are exercised as it effectively introduces a new standard of proof of 'market integrity' to be met by persons accused of securities market fraud.

What is market integrity?

The notion of market integrity is both un-defined and hard to measure. World over, there is considerable debate on its meaning in the context of financial regulation (Austin, 2016). Given the subjectivity of the concept, using market integrity as a standard of proof is equivalent to using 'public interest' or 'public good' as a standard for establishing wrongdoing. It leaves tremendous scope for discretion and creates the potential for differential standards of enforcement across a range of practices, depending on the adjudicator's view of whether or not a particular trading practice affects market integrity. This creates uncertainty in the manner in which the law will be applied and enforced and has adverse implications for the rule of law. Ambiguity in the grounds of enforcement and the standard of conduct that could invite legal sanctions, is detrimental to the development of the market as well.

In this article, we advocate the use of empirical approaches for establishing wrongful conduct in the securities markets. We do this by demonstrating the empirical evidence that should have been used to support a claim of fraud in the very same case where the Supreme Court lowered the standard of proof by relying on the vague and problematic ground of market integrity. In a world of electronic trading, empirical evidence of fraud and its impact on the market is not hard to collect and investigators and courts must rely on such evidence instead of holding market participants to a vague and subjective notion of market integrity and unfairness, which the world at large is struggling to define.

Judgement of the Supreme Court in Rakhi Trading

In February 2018, the Supreme Court in the case of Securities and Exchange Board of India v. Rakhi Trading Private Ltd. upheld an order passed by the Securities and Exchange Board of India (SEBI) that levied a penalty on some traders who had synchronised their trades off the exchange before placing them on the exchange. The trades in question were a series of orders placed on the F&O segment of the Nifty index. The modus operandi was to place an order for Nifty options, which matched with a particular party and subsequently reverse the position taken by placing an opposite order, which also matched with the same party. SEBI penalised the party placing such orders on the ground that these "transactions were in the nature of fictitious transactions resulting in creation of misleading appearance of trading in these options." The SEBI order did not elaborate the manner in which the synchronised trades sought to manipulate the price of either the option itself or the underlying securities, which in this case, was the basket of securities included in the Nifty index.

The parties against whom this order was passed appealed against the order before the Securities Appellate Tribunal (SAT). SAT confined its review to whether the synchronised trades in the F&O segment of the Nifty index artificially manipulated the underlying cash segment, which in this case is the Nifty index itself. It observed that:

"To say that some manipulative trades in Nifty options in the F&O segment could influence the Nifty index is too farfetched to be accepted. The only way Nifty index could be influenced is through manipulation of the prices of all or majority of the scrips in the cash segment that constitute Nifty."

This in line with precedent case-law laid down by SAT on the requirement to show manipulative conduct to demonstrate that the synchronised trades constituted fraud under the PFUTP Regulations. On an appeal by SEBI against this order of the SAT, the Supreme Court reversed the order of the SAT without explaining how the synchronised trades in question affected the price discovery system or created a misleading impression of volumes, but emphasised the notion of market integrity as under:

"According to SAT, only if there is market impact on account of sham transactions, could there be violation of the PFUTP regulations. We find it extremely difficult to agree with the proposition...SAT has missed the crucial factors affecting the market integrity, which may be direct or indirect (emphasis supplied) ...By synchronization and rapid reverse trade, as has been carried out by the traders in the instant case, the price discovery system itself is affected."

The problem with synchronised trades

Synchronised trading involves pre-negotiating the trade off the exchange and subsequently placing the order on the exchange such that it matches with the counterparty with whom the trade was pre-negotiated. To synchronise trades on an exchange platform, the buyer and seller of the pre-negotiated trade will enter their respective orders at the same time (with same price and quantity) to maximise the chance of matching their orders against each other. To ensure that the order does not match against another counterparty, the first order may be placed away from the touch, that is, at a price significantly different from the ongoing bid / ask price.

By itself, synchronised trading is not a harmful practice. In fact, block trades for which exchanges have a block trading window are synchronised trades. It is difficult to synchronise trades on liquid securities on the exchange because such orders run the risk of matching against other counterparty(ies). However, even on relatively illiquid securities, synchronised trading is not risk-free. The probability of getting hit by another order (especially a market order) on the opposite side of the book is low, but not zero.

How can synchronised orders be used to manipulate the market? Synchronised trades could create misleading, artificial trading interest in a security. High volumes and significant price changes on an otherwise illiquid security may cause participants to believe that there is some news on the security. This may induce them to buy those securities based on unexplained changes in prices and volumes. This is especially possible in an illiquid scrip, which may be perceived to be suddenly liquid if a series of transactions are executed on such a scrip. While the SEBI order levying the penalty does not specify exactly what was manipulated, evidence of manipulation could be demonstrated in either or all of the following ways:

1. Manipulation of Nifty index: One way of determining manipulation in the Rakhi Trading case is by analysing the changes in the value of the underlying security, the Nifty index. The SAT order almost exclusively focused on the possibility of the synchronised trades having manipulated the value of the Nifty index. The order rightly concludes that price manipulation on the index can happen only if an equivalent position is taken on the spot market on all the 50 constituent stocks of the index. Neither the SEBI order nor the Supreme Court order show any evidence of a position by Rakhi Trading on the spot market. This leaves the scope of manipulation on the Nifty index value to the price transmission from derivatives market to the spot market. Empirical evidence on price transmission from derivatives market to spot market suggests that such transmission is subject to the liquidity of the derivatives instrument (see Fleming et al, 1996, Aggarwal and Thomas, 2019). We examine the liquidity of the relevant Nifty options and also examine if the volumes traded by Rakhi Trading in the options segment were significant enough to impact the value of the underlying Nifty index.
2. Volatility in option premium: Manipulation of stock price increases the volatility in returns on such stocks (Aggarwal and Wu, 2006). If the synchronised trades on the Nifty options were manipulative, we would expect that the real price discovery process on option premium would be hampered, resulting in higher volatility in the premium of the Nifty options in question. This manipulation can be established by examining the volatility of the premium on the Nifty options on which the synchronised trades were executed.
3. Jump in traded volumes: Similar to price efficiency, manipulative trades on a security create a misleading impression and induce other market participants to buy the security. This misleading impression will manifest itself through higher traded volumes on that security on the days of such trades. We examine if this was the case by examining the traded volumes of the Nifty options traded by Rakhi Trading around the dates on which such trading occurred.

Size of the market for the relevant Nifty options

Rakhi Trading executed synchronised trades on 13 specific Nifty option contracts (hereafter referred to as "the relevant Nifty options") on four days of the year 2007, namely, on March 21, March 22, March 23 and March 30 (hereafter,"the event days").

We begin by a simple comparison of the liquidity and volatility of the relevant Nifty options on the event days and compare it with other days between March 15, 2007 and March 31, 2007 (hereafter, "non-event days"). Such a comparison should be the beginning of the court's enquiry when dealing with an order punishing a market participant for securities market fraud. Table 1 provides basic summary statistics on the traded volumes (a measure of liquidity) and volatility of the relevant Nifty options.

Table 1: Volumes and volatility of the relevant Nifty options on event days and non event days

	Event days			Non Event days
	Total Volumes	Volatility	Rakhi Trading Volumes	Total Volumes	Volatility
		(%)			(%)
Min	9,550	0.97	2,000	50	0.10
Mean	26,142	6.19	10,015	7,712	2.25
Median	25,750	5.08	10,700	3,925	0.37
Max	38,600	14.85	11,900	50,050	17.62
SD	7,752	3.86	2,477	10,718	4.39

The key observations from Table 1 are as follows:

1. First, the traded volumes of the relevant Nifty options fluctuated significantly on a daily basis on the event and non-event days, ranging from 9,550 to 38,600 on the event days, and 50 to 50,050 on the non-event days.
2. Second, in comparison to the average daily traded volumes on a liquid Nifty option, Table 1 shows that the relevant Nifty options were relatively illiquid. For a frame of reference, the maximum traded volumes on one single Nifty option in March 2007 was 9.2 million.
3. Third, the volatility (measured by the Parkinson's range measure) of the relevant Nifty options was in the range of 1-15% on the event days, while it was in the range of 0-18% on the non-event days.

Did the synchronised trades manipulate the Nifty index?

Table 2 gives a picture of the size of the overall Nifty options market on the event days and compares it for non-event days based on traded volumes. It also shows the traded volumes of the stocks which constitute the Nifty index for these dates. The last column of the table shows the volumes and contracts traded by Rakhi Trading on the event days to provide a perspective on the possible influence of its trades on the overall options and underlying spot market.

Table 2: Size of overall Nifty options market and proportion of synchronised trades

		Non-event days	Event days	Rakhi Trading volumes
All Nifty Options	Traded volumes (in Rs. millions)	49,978	61,041	277
	Contracts (in `000s)	262	316	1.35
Nifty stocks	Traded volumes (in Rs. millions)	36,228	37,932	NA

The key observation from Table 2 is that on the event days, the volumes traded by Rakhi Trading on the Nifty options were less than one percent of the average traded volumes on the stocks that constitute the Nifty index on the spot market. The minuscule proportion of the volumes traded by Rakhi Trading in the Nifty options market relative to the total traded volumes on the stocks constituting the Nifty index on the spot market, re-affirms the finding of the SAT that the synchronised trades executed by Rakhi Trading could not have possibly manipulated the underlying Nifty index.

However, Table 2 also shows that the volumes and number of contracts on the Nifty options segment on the event days were higher than on non-event days. This might or might not have been due to the synchronised trades executed by Rakhi Trading. In the next few paragraphs, we zoom in our analysis on the specific Nifty options which were involved in the synchronised trades executed by Rakhi Trading and examine if those trades did manipulate the individual options traded by Rakhi Trading.

Did the synchronised trades manipulate the option premium?

To test the claim of manipulation of option premium, we examine the volatility of the premium of the relevant Nifty options, and compare it with the volatility of the premium of other Nifty options with similar liquidity. We call the former as the treated set, and latter as the control set. We identify the control set as the options on which the traded volumes were in the same range as that on the ``treated" set, to ensure comparability across the two sets. If there was indeed manipulation on the treated options, we expect the volatility of the treated set to be higher than that of the control set.

We obtain a total of 50 unique options in the control set which we compare with data on the treated set on the event days. Table 3 presents summary statistics on the volatility of the premium for the options in the treated set and control set for our period of analysis.

Table 3: Summary statistics on volatility of options premium on the treated and control sets (in %)

	Treated	Control
Min	0.97	0.25
Mean	6.19	4.78
Median	5.08	2.91
Max	14.85	35.17
SD	3.86	5.09

We observe that the average volatility of the treated set was slightly higher than that of the control set. However, a simple t-test of comparison of means of the treated and control set volatility shows that the difference between the volatility of the two sets is not statistically significant. In a regression analysis (not shown here), we also control for other factors that affect volatility of the option premium of the treated and control sets. We do not find any evidence of significant difference across the two sets even after controlling for other factors such as strike price, days to expiry, value and volatility of the underlying. The analysis finds that the price range in which the option premium varied for the treated set was similar to that of the control set. Thus, we find that the option premium on the Nifty options that were traded by Rakhi Trading was not manipulated.

Did the synchronised trades manipulate the volumes?

We also examine the question whether the synchronised trades in the relevant Nifty options led to higher volumes in these options thereby creating a possibly misleading impression of volumes. For this, we analyse the traded volumes on the relevant Nifty options, after excluding the volumes arising out of synchronised trades themselves. We compare the traded volumes of the relevant Nifty options on the event and non-event days (Table 4). If the synchronised trades did result in higher trading activity from other market participants, we expect to see significant difference in the traded volumes on the event and non-event days.

Table 4: Summary statistics on traded volumes of options traded by Rakhi Trading

	Event days	Non-event days
Min	0	50
Mean	5,342	5,170
Median	4,500	2,450
Max	15,400	21,350
SD	5,736	5,762

Table 4 shows that the traded volumes on the Nifty options involved in the Rakhi Trading case were, on an average and on a median scale, slightly higher on the event days compared to the non-event days. However, a statistical test (t-test) of the comparison of means finds no significant difference across the two sets. A regression analysis on the event and non-event set confirms this finding. This indicates that Rakhi trading trades did not lead to any jump in volumes in the options so traded.

Trading for tax evasion or tax planning

An ancillary concern expressed by the Supreme Court was that Rakhi Trading conducted the trades in question for tax planning or avoidance. While this may or may not be true, the securities markets regulatory framework should not be used for punishing tax evasion. Cases of trades that SEBI has reason to believe were meant for tax avoidance, must be reported to the tax authorities, which is the appropriate forum for addressing questions of tax evasion. The objective of the securities market regulatory regime is not to deal with tax evasion, but to protect investors and develop the securities markets. More importantly, a regulator has scarce resources and dedicating investigative and adjudicatory capacity for dealing with tax evasion cases is not the best use of these resources.

Conclusion

Our empirical analysis finds that the synchronised trades did not manipulate the underlying Nifty index, the premium on the relevant Nifty options or the traded volumes of the relevant Nifty options. However, we recognise that our analysis is limited to daily data. An analysis of this kind must be underpinned by examining the intra-day data around the time of synchronised trades. By using such data, the regulator can further make a case for whether the trades in question were indeed manipulative.

The objective of this article is not to establish the guilt or innocence of any specific market participant. By using publicly available inter-day trading data on the security involved in the Rakhi Trading case, we make a case for using empirical strategies to establish fraudulent conduct under the Indian securities regulatory regime. As demonstrated above, the advanced nature of the securities market infrastructure in India and the availability of data ensures that this is not difficult. The use of empirical evidence to substantiate charges of fraudulent conduct will ensure that enforcement orders pass the muster of the appellate forums without having to compromise on evidentiary standards for establishing guilty conduct. More importantly, backing enforcement with robust underlying evidence will help the regulator build the trust of the regulated and testify to the high standards of proof that our society should place for the deprivation of liberty.

References:

Stock market manipulations by Aggarwal R and Wu G, The Journal of Business, 2006.

When stock futures dominate price discovery by Aggarwal N and Thomas S, Journal of Futures Markets, 2019.

What exactly is market integrity? An Analysis of One of the Core Objectives of Securities Regulation by Austin J, William and Mary Business Law Review, Vol.8(2), 2017.

Trading costs and the relative rates of price discovery in stock, futures, and option markets by Fleming J, Ostdiek B and Whaley R, Journal of Futures Markets, 1996.

State Of U.P vs Krishna Gopal & Anr 1988 AIR 2154.

185th Report of the Law Commission of India on a Review of the Indian Evidence Act, 1872.

Toward a General Theory of Standards of Proof, Frederick E. Vars, Catholic University Law Review, Vol. 60(1) (Fall 2010).

 

Nidhi is faculty at IIM-Udaipur and Bhargavi is a researcher at IGIDR.

Concerns about compliance with IRDAI regulations by insurance companies

by Sumant Prashant and Renuka Sane

Before choosing to buy any product, we want to know what the product is actually offering for the price, and how it suits our requirement and taste. For this comparison to work, we need information that a) describes truthfully all the features, or at least the material features, of the product and b) allows us to compare similar features across competing products. As the Bose Committee Report pointed out, when a financial, and especially an insurance product advertises its product features, it is not clear that the advertisement correctly represents the product. Sometimes advertisements are blatantly misleading. Sometimes, they are just hard to decipher. This environment of opaque disclosures has contributed to episodes of mis-selling, and losses to customers.

To address the problem of misleading advertisements, IRDAI issued a Master Circular on advertisements on 13th August 2015. The Master Circular aims to achieve two objectives - (a) make advertisements/sales material more accurate, comprehensive and reliable for the benefit of insuring public and; (b) set out minimum standards to be followed by all insurance companies for advertising and soliciting insurance business. In this article we summarise the Circular, and evaluate compliance by five randomly picked advertisements.

The IRDAI Master Circular on Advertisements

The Master Circular divides advertisements into two categories based on their intended purpose:

• Institutional Advertisements are meant to promote the brand image of the insurer company.
  
  
• Insurance Advertisements are meant to solicit insurance business and therefore provide more details about the product, such as name and benefits of the product and financial performance of the insurer company. Insurance Advertisements are further divided as
  
  
  • Invitation to Inquire advertisements, which only provide basic information about the product and advise the customer to refer to a more detailed brochure.
    
    
  • Invitation to contract advertisements, which contain detailed information about insurance products and induces prospective or existing consumers to purchase them.
    
    

Of these, Insurance Advertisements are critical in influencing the purchase decision of a customer. They also have the potential of being misused by insurance companies through projection of exaggerated benefits or non-disclosure of important terms and conditions of a product. The Master Circular, therefore, provides detailed do's and dont's for Insurance Advertisements. Some of the requirements for an advertisement are:

1. The product should be identifiable as an insurance product, disclose risks, limitations and exclusions of the product.
   
   
2. The benefits of a guarantee, when advertised, should also mention the cost and charges of the guarantee. If conditions of guarantee are elaborate, the advertisement should be accompanied by conditions applicable to the guarantee in specific font size.
   
   
3. If promise, projection or past performance are mentioned, this should be accompanied by assumptions, sources of information and the statement that past performance is not an indication of future performance.
   
   
4. If tax benefits are mentioned, this should be accompanied by statement that tax laws are subject to change.
   
   
5. If a ranking or award is advertised, this should have been awarded by an agency independent of the insurance company which is advertising.
   
   
6. Viewers of Internet advertisements should be able to view all the key features of the product.
   
   
7. Insurer's website should flash a cautionary notice about spurious calls and fictitious offers.
   
   
8. In case of ULIPs, the asset mix of various underlying funds, approved asset composition and pattern should be placed on website on half yearly basis.
   
   
9. In promoting product combinations, all particulars of each product should be disclosed with an advice to refer to the sales brochure.
   
   

Evaluating Compliance

We examined 5 advertisements posted recently on the Facebook pages of leading insurance companies that fall into invitation to inquire category of advertisements, to ascertain the effectiveness of the Master Circular. Though these advertisements provide a weblink through which more details about the products can be accessed, they still have to comply with requirements of the invitation to inquire category of advertisements. The requirements placed by IRDA of these advertisements is less demanding, relative to the invitation to contract category of advertisements. We also focus on those aspects of the Master Circular that are clearly written and leave no ambiguity regarding their interpretation. The Table below shows how well the five advertisements we studied comply with the Master Circular. We find that:

1. Some of the requirements which seem easy to implement, like mentioning the registration and UIN number have not been satisfied.
   
   
2. Some advertisements did not mention that the product is an insurance product.
   
   
3. Some advertisements did not publish an unique identifiable reference number.
   
   
4. Some of advertisements did not follow the font and appearance requirement provided in the Master Circular.
   
   
5. Some advertisements did not include the disclaimer mandatorily required by regulations.
   

Here is the summary of the analysis of five advertisements:

	AD 1	AD 2	AD 3	AD 4	AD 5
Registration number	No	No	No	No	Yes
Product identified as insurance product	Yes	Yes	No	Yes	Yes
Unique Identifiable reference number	Yes	No	No	No	Yes
Mandatory disclaimer	No	No	No	No	Yes
Font	N.A.	N.A.	N.A.	No	Yes

N.A. means "Not Applicable"

Conclusion

Many insurance companies appear to be violating the IRDAI Master Circular on Advertisements.