WhatsApp insider trading case is dropped by SEBI, but more needs to be done
Fighting the systemic rot of insider trading requires a comprehensive and multidisciplinary strategy.
The fact that SEBI dropped the charges against those accused of using WhatsApp to share price-sensitive information was expected. There was rarely any solid proof that they engaged in insider trading or willfully provided knowledge that may have affected prices. Unexpectedly, despite it becoming clear that top corporations’ price-sensitive information was being disclosed to the market beforehand, a thorough inquiry was not carried out to determine the root of this issue.
Towards the end of 2017, many stories claimed that companies were disclosing price-sensitive information, such as financial results, far earlier than they had officially announced. Additionally, SEBI discovered that stock prices followed the direction that the price-sensitive information called for. Thus, obvious insider trading generated enormous gains.
Mobile phones and other electronic gadgets were reportedly confiscated during SEBI raids on suspected individuals. Following the data mining of messaging platforms and devices, it was discovered that these people did, in fact, receive and transmit a variety of information. The SEBI discovered that the information received, transferred, and disseminated was startlingly accurate when comparing the information given for particular businesses with actual outcomes reported subsequently. There was no longer any question in SEBI’s view that price-sensitive information was already being shared in the market.
Insider Trading Laws
Strong action was deemed necessary by SEBI. But in order to comprehend what SEBI did next and how the situation came to a recent anticlimactic conclusion, one must first comprehend the fortress of law, namely the insider trading laws put in place by SEBI in 2015.
It is infamously difficult to detect insider trading. To prove that insider trading truly took place, a number of obstacles must be overcome; if even one is not met, the case as a whole fails. Since many people in the firm or related to the company have access to inside knowledge, it must be demonstrated that the individual in question is an insider. Whether a certain person had access to inside knowledge in a particular situation is difficult to demonstrate.
Then there is the challenge of demonstrating whether a certain piece of information was significant and hence price sensitive. And if it was released in a way that allowed everyone to access it or if it was released just to certain people.
Another situation is when someone is found to have inside knowledge, but it is hard to tell whether they are insiders themselves or whether they learned the knowledge from insiders. The SEBI Regulations include a number of “deeming provisions” to get around this convoluted procedure. In other words, until shown otherwise, some circumstances are intentionally presumed to be true. In certain instances, these presumptions are assumed to be accurate and cannot even be refuted. For instance, numerous people are regarded as insiders (relatives, directors, associate companies, etc.). It is believed that some types of information are price sensitive.
Simply having access to price-sensitive knowledge qualifies someone’s transactions as insider trading. Price-sensitive information is only regarded as published if done in a certain way. Then there are several laws created by the Supreme Court that are supportive of SEBI. In these situations, SEBI merely needs to demonstrate that it is more probable than not that the defendant is guilty (the so-called “preponderance of the evidence” test). As a result, even the standard of proof is lowered.
According to SEBI, it made no legal difference whether a person had ties to the firm or any other insiders or not because they were insiders just by virtue of having unpublished price-sensitive information on their devices. Since disclosing insider information is illegal in the same ways that trading stocks while in possession of such knowledge is, SEBI found the individuals guilty and imposed harsh punishments. The accuser argued his claims vehemently. They claimed that there was no connection between them and the business or the insiders. They demonstrated that they had acquired knowledge from outsiders.
Importantly, they used to get a lot of information from different people that was best characterized as “heard on the street”—basically, rumours or educated guesses. They lacked the tools necessary to distinguish between the actual information and guesswork among the, let’s say, 100 pieces of information they had received. They gave examples of how they distributed several products they had received, some of which turned out to be fake.
They said that SEBI engaged in “cherry picking” while mining the data, selecting only those tidbits from the vast ocean of data that supported their premise that the parties were at fault and ignoring the rest material, which was only gossip. They emphasized that they disseminated all of this information without any restrictions—trash in, rubbish out—and that it was up to the recipients to choose whether or not it was useful. But SEBI remained firm.
The Haystack Problem
When the parties appealed to the Securities Appellate Tribunal, it viewed the issue realistically and in the context of the whole. It made a note of the fact that just a little fraction, which was also not distinguishable individually by code or other means, was pricing. The SAT recognized the legal fiction that merely owning knowledge that is price-sensitive qualifies one as an insider. However, for this to work, the person must be aware that it is insider knowledge.
If information is discovered to be accurate in retrospect but was included in a big flow of other tidbits at the time, it is not inside information for the receiver. It continues to be like the cliché needle in a haystack for both the recipient and the person it is forwarded to. Applying the same widely accepted preponderance of probability approach, SAT came to the conclusion that it was more likely than not that the people did not realize that the information was price sensitive. SAT thus ignored the order. A few days ago, the Supreme Court rejected SEBI’s appeal of the SAT ruling.
In subsequent cases, SEBI has issued a number of rulings acknowledging the SAT order and halting the penalty proceedings against other parties.
Insider Trading is Still Common
Since the parties received justice, it would appear that’s the end of the problem. But in that case, the greater picture would be overlooked. Although the parties may have thought that the tidbit of information was the proverbial “needle in a haystack,” the truth remains that it was available to the public. It implies that wrongdoing is occurring. According to SEBI, it contacted the firms but was unable to discover any leaks. However, that can only imply that something was overlooked.
After all, the information couldn’t be that accurate and publicly available without being shared. The actual issue may be far worse if this is the case for several reputable firms, and these are the ones that have reportedly been found. According to SEBI, technology has limitations since it is unable to determine the origin of WhatsApp conversations. But that begs for a different approach.
SEBI took action, including requesting a report from an expert committee. One question is if this has had any impact and if continued systemic rot concerns are there. On the other hand, it is evident that parties who were clearly at fault endured expenses, worry, and sometimes even a measure of undeserved ignominy as a result of adverse rulings made against them. This chills other people who could be spreading rumours, theories, analyses, etc. This is detrimental since the business depends so much on educated predictions. People may be reluctant to disclose their analyses, speculations, and assumptions at this point.
Overall, one hopes that although these instances have been resolved amicably, SEBI actively pursues the sources of such leaks and aggressively addresses systemic problems with a multidisciplinary strategy that includes technical expertise. Otherwise, the markets‘ confidence would be slowly eroded.
Edited by Prakriti Arora