SEBI drops WhatsApp insider trading case, but it needs to do more to stem the rot

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It was not surprising when SEBI closed the case against persons alleged to have shared price sensitive information through WhatsApp without levying any penalty. There was hardly any credible evidence that they indulged in insider trading or knowingly shared price sensitive information. What’s surprising is that though it appeared clear that price sensitive information of leading companies was getting shared in advance in the market, a holistic investigation was not made to get to the root of this issue.

It may be recollected that there were several reports at the end of 2017 that price sensitive information such as financial results were being shared much earlier to their official declaration by companies. SEBI also found that stock prices moved in the direction of what the price sensitive information warranted. Thus, profits galore were made through blatant insider trading.

SEBI reportedly conducted raids on suspected persons and seized mobiles and other electronic devices. After data mining of messaging applications and devices, it found that there indeed was various information received by such persons and forwarded to others. SEBI compared the information shared for selected companies with actual results published later and found that the information received/forwarded/shared was eerily accurate. There was no doubt left in SEBI’s mind that price sensitive information was circulating in the market in advance.

Insider Trading Laws

SEBI decided that strong action was warranted. But to understand what SEBI did next, and how the matter ended in the recent anti-climax, one first needs to understand the fortress of a law in the form of insider trading regulations set up by SEBI in 2015.

Insider trading is notoriously difficult to catch. The process of proving that insider trading indeed took place requires several hoops to be jumped through and one miss and the whole case fails. The person concerned has to be shown to be an insider and inside information is available to a variety of persons in the company or connected with the company. It is difficult to prove in a given case whether a particular person had access to inside information. Then there is the difficulty of showing whether a particular piece of information was material and hence price sensitive. And whether it was published in a manner which allowed the public to have access or whether it was selectively published.

Then there is the situation of a person found to have inside information but there is no way to prove whether he is an insider or whether he received such information from an insider (as we will see later, these became the critical questions in the present cases).

To bypass this complex process, the SEBI Regulations make a series of ‘deeming provisions’. In other words, certain situations are artificially assumed to be true unless proved otherwise. In some cases, these assumptions cannot be even rebutted – they are taken to be true. For example, several persons are deemed to be insiders (relatives, directors, associate companies, etc.). Several categories of information are deemed to be price sensitive.

Merely being in possession of price sensitive information makes that person’s dealing to be insider trading. Price sensitive information is deemed to be published only if done in a particular manner. Then there is abundant Supreme Court made law which is favorable to SEBI.

SEBI, in such matters, has to only prove that it is more likely that the party is guilty than he is not (the so-called “preponderance of probability” test). Thus, even the benchmark of proof is kept lower.

Cherry-picking Data

To SEBI, the mere fact that the persons had on their devices unpublished price sensitive information made such persons insiders and the fact that such persons had no links with the company or any insiders did not make any difference in law. Since sharing of inside information is as much as an offence as dealing in shares while in possession of such information, SEBI held that the persons were guilty and levied stiff penalties. The accused strenuously made several points. They said that there was no link between them and the company or the insiders. They showed that they had received the information from persons who were not insiders.

Importantly, they used to receive a multitude of information from various persons, which information could best be described as ‘heard on the street’ – which are just rumors or informed guesses. They had no means to decide of the, say, 100 items of information received, which one was true and which one was a guess. They showed that they received endless items and shared them and some of them were actually false. They accused SEBI of cherry picking while mining the information and only picked those drops in this sea of information which fitted their theory that the parties were guilty, while ignoring the remaining data which were rumors. They pointed out that they shared all these information without any discrimination —garbage in garbage out, so to say — and left it to the recipients to judge for themselves the value, if any, of these assorted information. But SEBI did not budge.

Needle in the Haystack

When the parties appealed to the Securities Appellate Tribunal, it took a realistic view of the situation and saw the bigger picture. It pointed out that only a miniscule proportion, which was also not identifiable separately by code or otherwise, was price sensitive information. The SAT accepted the deeming fiction of law that mere possession of price sensitive information makes a person an insider. But for this purpose, the person has to know that it is inside information. If the information that is found, on hindsight, to be factual, but at that time was a part of a large flow of other snippets, then the information is not inside information for the recipient. It remains like the proverbial needle in the haystack for the receiver as well as the person to whom it is forwarded. Hence, SAT concluded, applying the same well settled principle of preponderance of probability that it was more probable than not that the persons did not have knowledge that the information was price sensitive. SAT thus set aside the order. A few days back, the Supreme Court dismissed the appeal filed by SEBI against the SAT order.

SEBI then, recently, passed a series of orders in other cases, accepting the SAT order and dropping the penalty proceedings against other parties.

Insider Trading Still Prevalent

That may seem to be the end of the matter since the parties got justice. But one would be then missing the bigger picture. Sure, the snippet of information, as far as the parties were concerned, was the needle in the haystack, but from the larger perspective the fact remains that such information was out in the open. It means wrongs are taking place. SEBI has said that it has inquired with the companies but they could not find any leaks. But that can only mean that something is missed. After all, the information cannot be out in the open with such accuracy, without someone sharing it. If this is happening for several reputed companies and these are the cases allegedly detected, the real situation could be much worse. SEBI has said that technology places a limitation since the source of WhatsApp messages cannot be found out. But that cries out for some other solution.

SEBI took steps including seeking an expert committee report. One doubts whether this has had any effect and fears of the reported systemic rot continues.

On other hand, it is seen that parties who were demonstrably guilty faced costs, stress and even a level of unfair ignominy with adverse orders passed against them. This produces a chilling effect on other persons who may be sharing rumors/guesses/analyses, etc. This is counterproductive since the industry is such that it thrives on informed guesses. Now people may be very hesitant to share such guesses/speculation and analysis.

All in all, one hopes, while these cases have ended with a whimper, SEBI aggressively goes after the sources of such leaks and tackles the systemic issues with a multidisciplinary approach taking technical experts too on Board. Otherwise it will erode steadily the credibility of the markets.