SEBI should not ignore basic principles in suspicious trading investigation

The Unlawful Suspected Trading Activities draft rules were posted for public comments on May 18. These define questionable trades as trades that involve a substantial change in risk or reward and that exhibit repetitive trading patterns in stocks within a given time period. In cases where these trades coincide with material non-public developments in those underlying companies, SEBI now seeks prerogative to survey the evidence and charge the parties with “unlawful suspicious trades”. . It is up to the accused’s court to prove innocence by demonstrating a variety of counter-facts, such as the absence of underlying non-public material information, the actual reliability of risk-reward patterns of trades, etc. In its present form, all that the draft rules need for SEBI to assert its claim is a convergence of certain identified circumstances, after which the burden of disposing of the case falls on the defendants.

Apart from the form, method and manner, this proposed law clearly looks to bridge two gaps – the legal and the verifiable.

legally, narrow terra nullius Lies between the realms of insider trading (centered around information asymmetries) and market fraud (interfering with the operation of ordinary market forces). While the existing rules on Fraudulent and Unfair Trade Practices, or FUTP regulations, are fairly comprehensive, they cannot cover all instances of suspicious activity detected by surveillance.

Even from an evidence point of view, the FUTP rules require SEBI, as the party bringing the allegations, to bear the burden of producing evidence and making its case. While the Prohibition of Insider Trading, or PIT, rules allow reversals in certain cases, it has been the subject of various Supreme Court judgments, which have laid down SEBI’s obligation to produce detailed evidence and concrete material to establish the allegations. confirms correct. SEBI has reasons to introduce this new law. As the regulators themselves acknowledge, the rise of encryption, sophisticated messaging platforms, etc. has made the job of regulators – and indeed, law enforcement in general – around the world much harder. This affects the accuracy with which it can compare evidence. It goes to the credit of SEBI that it has overcome this hurdle so far and has invested heavily in sharpening its technical toolkit and teams. In fact, some recent market-fraudulent orders are drawing attention to the subtlety in their approach. It is a commendable exercise by SEBI to delve into the maze of data, money trails and other layers of inter-connectedness, especially in situations involving extensive trading networks. However, such successes are often counter-balanced by cases where the regulator faces charges with limited, linear evidence that does not fully measure up to established judicial prescriptions on the standard of proof.

These draft rules have been perceived to some extent as a one-stop antidote. By shifting the burden of proof onto the trades, which involve a confluence of factors such as “abnormal” gains, and deviation from historical risk patterns, among others, SEBI will be deemed guilty unless rebutted by the defendants. The use of subjective standards such as “effectively refuted”, “extensive documentary evidence”, “abnormal profit”, and “substantial change in risk”, all of which are parameters that are impossible to objectively measure in a market that many consider a The game considers outliers.

In order to reverse the burden of proof as a rule, not the exception, that too through rules and legislatively sanctioned statutes, this approach revisits several fundamental common law principles. One could argue that in practice, this would also invoke the principle against dubious punishment. That said, there have clearly been a number of important investigations that may have gone by the wayside, and the lack of evidence left the trails cold for SEBI to see a clear use case in such a powerful tool today.

Procedural safeguards are necessary to protect the basic structure of securities enforcement, as understood under current jurisprudence. It will also ensure that the draft rules do not actually supersede or abrogate the existing PIT and FUTP rules or well-established precedents under those laws. The rights of the accused to access all investigative material should be hard-wired in the draft rules, as outlined by the Supreme Court takano vs sebi, These rules should also clarify the standard of proof that the defendants will be held to, which must be in line with the persuasive standards applicable to SEBI to discharge its own evidentiary burden. To avoid double whammy, such matters should not be subject to ex-parte interim orders, to be taken up only after offering a hearing. There is also a need for a time bound process with a limited period for initiating the investigation. Only when the draft rules are accompanied by the promise of due process can we balance the competing interests here at play.

Shruti Rajan is Partner, Financial Regulation & Enforcement, Trilegal.

Updated: June 11, 2023, 11:23 PM IST