Prohibition of Manipulative and Deceptive Devices

Prohibition of Manipulative and Deceptive Devices | Overview

• Prevention of Money Laundering
• Standard of Proof Under SEC 12a
• Manipulative and Deceptive Devices
• Insider Trading
• Takeover Regulations
• Takeover Regulation Amendment Committee Report (Trac Report)

This essay discusses the Prohibition of Manipulative and Deceptive Devices. There are a lot of securities issued by the companies in the stock market, where the public in general who wants to invest their money in these securities. The trading in these securities is done with the help of brokers or intermediaries.

To prohibit such players from using any manipulative or deceptive devices for making more profit, SEBI was set up to regulate the securities market and to safeguard the investors from any of the illegal activities of the remaining players of the market. Such illegal activity includes insider trading, manipulative and deceptive devices and so on.

Before the introduction of section 12A, insider trading and fraudulent activities were prevented with the help of Sec 11(2)(e), 11(2)(g) and 11(2)(h) read with sec 30 of the SEBI Act, 1992. Not only this but the substantial acquisition of shares and takeovers were also regulated by the various guidelines that SEBI had framed under the above-mentioned sections.

PREVENTION OF MONEY LAUNDERING

Sec 2(1)(y) of the Prevention of Money Laundering Act, 2002 provides that the total value of 30 lakh or more is involved in an offence that is committed under Sec 12A, it will come under the category of scheduled offence as referred under part B thereof and henceforth, appropriate actions in terms of the statute may also be undertaken for violating sec 12A from a different perspective.[1]

STANDARD OF PROOF UNDER SEC 12A

SAT has observed that any finding of breach of the requirement of due diligence has to be maintained by the preponderance of probabilities standard – a greater degree of the suit than that is required in a civil suit, yet falling short of the proof that is required to sustain a conviction in criminal prosecution.[2]

In addition to this, it was also held by SAT in connection with insider trading that the concept of ‘proof beyond reasonable doubt’ is not able to find any application to an enquiry or investigation conducted by SEBI because of the very good reason that it does not arise out of any criminal case.[3]

It was also observed by SAT that within the standards of ‘preponderance of probabilities’, the standards for the preponderance of probabilities in the context of insider trading must be higher because the allegations of insider trading are one of the most serious allegations in the context of the securities market.[4]

Similarly, it has been observed by SAT in the context of the matters relating to fraudulent, manipulative and unfair trade practices that “ … if there is no reasonably strong evidence, an individual cannot be held guilty and punishment can be awarded. Mere suspicion, conjuncture or surmise cannot be used as a means to support the findings of guilt.”[5]

With the help of Videocon International Ltd. & Ors. v SEBI,[6] SAT has thrown light on the need of adducing ‘reasonably good evidence’ with the objective of sustaining the charges of market manipulation. Further, it was observed by Supreme Court in the context of SEBI ( Substantial Acquisition of Shares and Takeovers) Regulations, 1997 that the standards of proof that are required for proving the concert are that of the ‘balance of probabilities’.[7]

MANIPULATIVE AND DECEPTIVE DEVICES

Subsections (a), (b) and (c) of sec 12A speaks about the prohibition on fraudulent and unfair trade practices. In addition to this, sec 11(2)(e) is also empowering SEBI to undertake those measure which prohibits fraudulent and unfair trade practices. Subsections (a), (b) and (c) of sec 12A are mirrored by the Regulations 3(b), (c) and (d) of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003. It appears that these provisions are taken from the anti-fraud provisions that exist in the US securities laws because the language of these provisions is similar to those of US provisions.

The interpretation of the provisions in Indian laws is different from that of the US, even though there exist textual similarities. ‘Deliberate intention’ is one of the requirements in the context of the actions, which are private in nature, as per the interpretation laid down by US Supreme Court in Ernst & Ernst v. Hochfelder.[8]

On the other hand, SAT clarified the position of mens rea by observing that any state of mind is not a requirement as per the words ‘any manipulative or deceptive device or contrivance’. No further intention or state of mind is a necessity as long as the contrivance or device is manipulative per se.[9] The contention that to reach the finding of ‘fraud’, it is a requirement to prove the presence of independent breach of a statutory provision or to circumvent a prohibition imposed by law, which was rejected by SAT.[10]

INSIDER TRADING

Insider Trading is prohibited with the help of subsection (d) of section 12. Besides this, the prohibition of insider trading is included in the wide ambit of subsection (e) though it cannot be interpreted as including some instance of fraudulent and unfair trading such as back running/ front running as well.

The securities market is regulated in the context of Inside Trading with the help of Securities and Exchange Board of India (Insider Trading) Regulations, 1992. The principal Insider Trading Regulations were published in the Gazette of India on 19.11.1992 vide S. O. LE/ 6308/ 92 (E).

The Act has not defined the meaning of ‘insider trading’. The prohibition as prescribed by subsection (e) is basically on dealing with securities and communications in such a manner which is not in consonance with the provisions of this Act or regulations or rules made thereunder.

In the US, insider trading forms a part of general laws made on fraud and according to SAT, it provides help only in appreciating the circumstances in a better way wherein a specific type of trading can result into insider trading otherwise “the cases that arise in India [have] to be considered within the framework laid down by the Insider Trading regulation of SEBI which are very specific in nature.”[11]

The prohibition imposed by Regulation 3 of PIT Regulations is as follows:

• On insiders from dealing in securities while they possess unpublished price sensitive information;
• On insiders from counselling or communicating such unpublished price sensitive information to any other individual except in the ordinary course of employment, business or profession or under any other law.[12]

Prohibition is also imposed on procuring the unpublished and price-sensitive information in circumstances other than ordinary course of employment, business or profession or under any other law.[13]

There are various provisions against insider trading under Regulation 3B of PIT Regulations and sec 15G of the SEBI Act, 1992. There are two defences available to a company viz., the defences of takeover complaint acquisition and Chinese wall, are the defences to ‘prohibition on a company possessing unpublished price sensitive information to deal in securities of another company’. The burden of proof of the availability of defences is on the entities.

TAKEOVER REGULATIONS

Much prior to the introduction of the provision of 12A, SEBI has laid down regulations governing the substantial acquisition of shares and takeover by virtue of the authority derived from sec 11(2)(h). Initially, the regulation was laid down in November 1994 which got repealed and replaced in 1997 on the ground of the report of a committee set up in November 1995 headed by Justice P. N. Bhagwati.[14] The general principles, which were laid down by the Bhagwati Committee, should be used to guide the operation and interpretation of the regulations are as follows:

1. All shareholders should be treated equally and equal opportunities should be made available to them.
2. Interests of shareholders should be protected.
3. The acquirer should fairly and truthfully disclose all material information in all offer documents and public announcements.
4. Acquirer or any other party should not furnish any information to an offer exclusively to any one group of shareholders.
5. Shareholders will be provided with sufficient time to make an informed decision.
6. An offer will be announced only after considering it very carefully and responsibly.
7. Highest standard of accuracy and care has to be exercised by the acquirer and all other intermediaries while preparing the offer documents.
8. Recognition by all those persons who are connected with the process of substantial acquisition of shares that there are bound to be limitations on their freedom of action and on the matter in which the pursuit of their interests can be carried out during the offer period.
9. Refraining all the parties to an offer from leading to the creation of a false market in securities of the target company.
10. The target company is not in a position to take any action which can frustrate an offer without the approval of shareholders.

These principals remain sacrosanct and cardinal to the takeover regulations whatever form they may be in.

The primary motive of Takeover Regulation is to make sure in the cases of acquisition of control or acquisition of shares beyond stipulated limit, public shareholders have to be given an opportunity to exit at a fair price (as dete4rmined by the Regulations), as well as the public disclosures which are made as regards changes in shareholdings, both periodically as well as on event basis. However, Subsection (f) of Section 12A looks over only the first aspect i.e. acquisition beyond stipulated limits.

TAKEOVER REGULATION AMENDMENT COMMITTEE REPORT (TRAC REPORT)

This committee was formed under the leadership of Shri C Achuthan and the report was submitted by this committee in July 2010.[15] The committee recommended for completely rewriting of the regulations and almost all the suggestions, after scrutinizing the public comments, barring a few have been approved by SEBI with some modifications.[16]

Some of the major recommendations made by the committee which got included in the Regulations are as follows:

1. To increase the limit for the open offer trigger from 15% to 25%.[17]
2. As long as the minimum public sharing threshold is not violated, the annual creeping acquisition of 5% should be permitted above the 25% threshold.
3. Indirect acquisitions should be treated as a direct acquisition where the target company is a part of the predominant part of the acquired business.

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[1] A master circular was issued by SEBI on ‘ Anti Money Laundering (AML) Standards/ Combating the Financing of Terrorism (CFT) / Obligations of Securities Market Intermediaries under the Prevention of Money Laundering Act, 2002 and Rules framed thereunder. (SEBI Circular No. CIR/ISD/AML/3/2010 dated 31.12.2010)

[2] Imperial Corporate Finances and Services Pvt. Ltd. v SEBI, [2005] 61 SCL 197 (SAT)

[3] Sameer C Arora v SEBI, Appeal No. 83/ 2004, SAT Order dated 15.10.2004

[4] Dilip S Pendse v SEBI, Appeal No. 80/ 2009, SAT Order dated 19.11.2009

[5] Sterlite Industries Ltd. v SEBI, Appeal No. 20/ 2001, SAT Order dated 22. 10. 2001. See also, BPL Limited v SEBI, Appeal No. 14/ 2001, SAT Order dated 20. 06. 2002

[6] Appeal No. 23/ 2001, SAT Order dated 20.06.2002. See also, Nirmal Bang Securities Pvt Ltd v The Chairman, SEBI, Appeal Nos. 54- 57/ 2002, SAT Order dated 31.10.2003; KM Venkateshwaran v SEBI, [2006] 67 SCL 42 (SAT); Brahaspati Financier Ltd. v SEBI, [2006] 69 SCL 250 (SAT)

[7] Technip SA v SMS Holdings Pvt Ltd., (2005) 5 SCC 465

[8] 425 US 185 (1976): In this case, the auditors were sought to be held liable on the ground of inexcusable negligence for the detection of embezzlement of amounts were meant to be secured in an escrow account without any charges of deliberate participation.

[9] Pyramid Saimira Theatres Ltd. v SEBI, Appeal No. 242/ 2009, SAT Order dated 07.04.2010. For this observation, SAT has taken the support of SEBI v Shri Ram Mutual Fund, (2006) 5 SCC 361, by extending its applicability to all provisions of the Act as well as the Regulations made thereunder. It was also observed that there is no need for people to share their gains made by illegal means under Regulation 3(b) of the FUTP Regulations, 2003. See also, Parsoli Corporations Ltd. v SEBI, Appeal No. 146/ 2010, SAT Order 12.08.2011 where the absence of motive, loss to anyone else and profits to the alleged wrongdoer was considered as irrelevant factors for recording a finding.

[10] Himani Patel v SEBI, Appeal No. 154/ 2008, SAT order dated 07.09.2009; See also, Shri Shadilal Chopra v SEBI, Appeal No. 201/ 2009, SAT Order dated 02.12.2009

[11] Sameer C Arora v SEBI, Appeal No. 83/ 2004, SAT Order dated 15.10.2004

[12] AO Order No. PB/AO- 15/ 2011. In respect of Mr Naval Choudhary, dated 28.02.2011 where a husband (insider) was penalized for communicating the information to his wife.

[13] Technically, Regulation 3 of PIT Regulation is drafted in a manner that ‘procuring’ unpublished price sensitive information may be argued that no person should be prohibited other than the one who is procuring the information is an insider. But such inconsistency may be ignored with the help of purposive construction. For instance, SEBI Order No. WTM/ KMA/ ISD/ 167/ 11/ 2009, In the matter of soliciting insider information, dated 18.11.2009, where a person used to solicit unpublished price sensitive information on his blog in return for a share in the profits between Rs. 10k and Rs. 1 Lakhs.

[14] Justice P. N. Bhagwati report on takeovers.

[15] Report of the Takeover Regulations Advisory Committee.

[16] Agenda note for item no. 13, in respect of 138^th meeting of the SEBI Board, dated 28.07.2011 read with the SEBI press release No. 119/ 2011 dated 28.07.2011

[17] Nizam pasha, Putting Trac Report under Scanner, Business Standards, 24.11

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