Prove your innocence: Insights into the proposed securities trading regulations

Posted On - 28 July, 2023 • By - Souvik Ganguly


Market manipulators have started adopting technology in order to illegally benefit from the securities market in India. The actions undertaken include using apps that encrypt communication, the use of mule accounts among other such measures that have a detrimental impact on capital markets. As a result of such modern methods being adopted, SEBI has been facing difficulty in meeting the requisite standard of proof during adjudications. Under the currently existing ‘preponderance of probabilities’ test, a high probability of a violation must be proven by SEBI, before any action can be taken against the accused. A consultation paper recently released by SEBI seeks to address this issue faced by it.

SEBI has proposed to issue new regulations called the SEBI (Prohibition of Unexplained Suspicious Trading Activities in the Securities Market) Regulations, 2023 (PUST Regulations). Certain new concepts have been proposed under the PUST Regulations which also overlaps with existing concepts under the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003, and the SEBI (Prohibition of Insider Trading) Regulations, 2015. The newly introduced concepts are:

1. Material Non-Public Information (MNPI), i.e., information related to a security or a company which is generally not available has the potential to affect the price of such security, if made available. The concept of MNPI appears to have largely been borrowed from the securities laws of the United States of America.

2. Unusual Trading Pattern, i.e., ‘repetitive’ trading activities which involves buying and selling of securities over a short duration of time along with securing of abnormal profits or averting abnormal losses.

3. Suspicious Trading Activity, i.e., an unusual trading pattern undertaken when in possession of MNPI.

4. Unexplained Suspicious Trading Activity, i.e., any Suspicious Trading Activity, the rationale for which is unexplained, or there is a failure to rebut the ‘suspicious’ nature of such Suspicious Trading Activity.

Investigation regime

The draft PUST Regulations, intends to put into place the following process to investigate market manipulations:

1. If the investigating agency has reasonable grounds to believe that a person is conducting Suspicious Trading Activity, it may direct an investigation into the matter.

2. The investigating agency will have to establish the foundational facts of the Suspicious Trading Activity, i.e., it will be required to prove to a prima facie extent that the person had participated in ‘Unusual Trading Patterns’ while in possession of MNPI, pursuant to which it will be presumed that the accused has engaged in Unexplained Suspicious Trading Activities.

3. An opportunity will subsequently be provided to the accused to rebut the said presumption by taking the prescribed defences, such as the information based on which the trades were undertaken are not MNPI, or that the trades were not of repetitive nature.

4. If the accused is unable to rebut the said presumption, a contravention under the PUST Regulations will be established.

5. In case the accused is able to rebut the presumption, the investigating agency will have the ability to make its case for proving the commission of the said offence.

As can be seen from the above, under the draft PUST Regulations, 2023 a reverse burden of proof is proposed to be cast on an accused person, who will be presumed to be guilty of undertaking Unexplained Suspicious Trading Activity unless proven otherwise. While the draft PUST Regulations identify certain defences that may be taken by the accused person to rebut the said presumption of guilt, ‘detailed documentary evidence’ is required to be furnished to substantiate such defence, which in most cases may be the equivalent of proving a negative fact. It is generally considered easier to prove a positive fact by adducing evidence compared to a negative fact.

One can also be certain that if the PUST Regulations are notified in its current form, the procedure prescribed under the PUST Regulations for imposition of a rebuttable presumption of guilt on an accused person will be tested against the constitutional safeguards of ‘procedural due process’ before the Indian courts.

Our thoughts

There appears to be some lack of clarity on the applicable penal provisions for any person found guilty of undertaking Unexplained Suspicious Trading Activity. The Securities and Exchange Board of India Act, 1992 (SEBI Act) prescribes a penalty for both insider trading as well as fraudulent and unfair trade practices under sections 15G and 15HA. However, no penalty has been prescribed for undertaking Unexplained Suspicious Trading Activity. The penalty prescribed under the residuary provision may apply, or an amendment may be introduced into the SEBI Act to specifically prescribe the penalty for a violation under the PUST Regulations.

Further, it also remains to be seen whether a prosecution for violation of the PUST Regulations, will be initiated by SEBI under section 24 of the SEBI Act which provides for imprisonment as a consequence of such violation, particularly keeping in mind the presumption of guilt sought to be imposed on accused persons, or if in such prosecutions, SEBI as the investigating agency will still have to prove its case beyond reasonable doubt.

Other consequences of the failure by an accused person to rebut the presumption of guilt, could also include a finding that such persons do not satisfy the ‘fit and proper persons’ criteria prescribed under a multitude of financial services laws, which includes the SEBI (Intermediaries) Regulations, 2008, as well as the prevalent banking and insurance laws. SEBI has adequate powers under the SEBI Act to disqualify persons from holding the position of a director of a listed company or its subsidiaries, even by way of an interim order.

SEBI by way of these draft regulations proposes to put in place a system, which requires persons accused of undertaking Suspicious Trading Activities to provide “detailed documentary evidence” in order to rebut the presumption of guilt, where in earlier cases SEBI as the investigating agency had been unable to furnish sufficient evidence to satisfy the test of preponderance of probability. While SEBI has been provided with wide powers under the SEBI Act to take steps and make new regulations for protection of interests of the investors, an argument may be made that SEBI would be better placed to revamp its investigation techniques and to adopt enhanced technology solutions, instead of putting the burden of proof on the market participants to establish that trades undertaken by them are in compliance with the prescribed regulations.

Authors: Souvik Ganguly, Renjith Nair and Krishna Nair

The information contained in this document is not legal advice or legal opinion. The contents recorded in the said document are for informational purposes only and should not be used for commercial purposes. Acuity Law LLP disclaims all liability to any person for any loss or damage caused by errors or omissions, whether arising from negligence, accident, or any other cause.