Why Was SEBI’s Order in the WhatsApp Leak Case Overruled?

A popular pun that went around on social media last year when the lockdowns were in effect, was this:

“Now that markets are in lockdown, what will the traders be doing?”

“Insider trading.”

As more and more businesses begin to conduct themselves inside in a virtual environment with the help of digital apps (like messaging platforms), a greater amount of proprietary information becomes documented and accessible as opposed to the word-of-mouth communication before.

This has presented a new opportunity/headache for market regulators like SEBI. Because even if they have more credible evidence to proceed against insider trading violations now, the means and resources to do so are limited.

On March 26th, the Securities Appellate Tribunal (SAT), SEBI’s adjudicatory wing, overturned a previous ruling related to insider trading charges in the infamous “WhatsApp leak story” and, in a way, redefined the law on this matter as we know it. Let’s see how this old case has presented new questions about the standards to prove insider trading.

The WhatsApp Leak Saga

In November 2017, SEBI passed three orders charging the employees of some stockbroking firms who had “forward(ed) as received” messages on WhatsApp concerning unpublished price sensitive information (hereinafter referred to as UPSI). The information was about the unpublished quarterly results of a few (12 to be exact) companies that were circulated on WhatsApp and reported in the media.

SEBI took cognisance and launched an investigation. It was proved that the employees of these firms had released UPSI to various clients and other entities who weren’t legally qualified to receive those prior to their disclosure on the stock exchange, which was still 15 days away.

Now, the basis on which SEBI charged these employees was the “uncharacteristic accuracy” of the information that was circulated and the financial disclosures that followed 15 days later. The employees’ argument that the accuracy of figures was a result of diligent market estimation through careful study of data and stock patterns was dismissed as hogwash.

It would be fair to say that now SEBI has pulled a U-turn on its previous assessment. The nuance (so-called hogwash) that the accused had asked for previously, has been acknowledged.

What Does the Present Law Say?

The model law against insider trading in India is the SEBI (Prohibition of Insider Trading Regulations), 2015. There are three things you ought to show to prove that an information is UPSI:

• The information must not be generally available, that is, not available in the public domain.
• The information must be of such nature that it can materially affect the priceand value of securities, if and when made generally available.
• The information must not be just speculative market gossip but authoritative and substantially proprietary in nature.

The first two conditions are quite straightforward and easy to prove by linking the accused to the release of information. The third condition, however, is highly subjective and is popularly referred to as the “heard-on-street” (hereinafter referred to as HoS) defence that is used by the accused to disprove allegations. It is basically the locker room talk-equivalent of financial markets that can either be a solid ground to establish charges or a cloak to escape charges (double-edged sword alert!).

The HoS defence raises one important point. If we place the same evidentiary value on unauthenticated information that is exchanged among individuals with negligible credibility, as we do on revenue figures, PAT, EBITDA and cash flow statements that are backed with sound accounting principles, then the rule of law becomes a utopia, not a constitutional reality.

Market Chatter versus Market Cheating

If market behaviour (and Wall Street dramas) have taught us anything, it is that traders have a lingo of their own. So how does one separate information built on carefully-studied field-based data and one that is derived from discrete and compromised sources?

One way is by looking at the source. Unfortunately, even after seizing as many as 190 mobile devices, SEBI couldn’t make any substantial headway on tracking the source of the inside information. (Why? We’ll get to that shortly).

The other way is by looking at the “chain of communication”. If there are enough people on the chain who are currently or likely to be in a position to have access to the UPSI, you’re looking at an inside information thread.

But hold on. Even here, it’s not as simple as it sounds.

Say, X is a financially illiterate person who isn’t aware of how security markets work. But, he is on the message chain. Can he be charged? Would it matter if he is related to anyone (say, Y) in possession of UPSI, who also happens to be an expert in market finance? Can Y be charged instead?

These matters are highly circumstantial which are determined on a case-by-case basis. The ultimate standard of proof is taken as whether the communication of privileged information has been actually used for trade or benefit of any kind.

Which is why the indictment of Shruti Vohra and Parthiv Dalal (employees of Wipro who were penalised with ₹45L ($61,993) and ₹15L ($20,664) respectively) in the WhatsApp Leak case was questioned. SEBI’s indictment was based purely on prima facie evidence (the circulated messages). But as a general principle of law, the exceptions or defence are as important as the offences themselves. Otherwise, words like “self-defence”, “mental incapacity”, “intoxication”, “grave and sudden provocation” etc would fall on deaf ears!

Change of SEBI’s Heart

In the latest development, SAT has overruled the previous judgment which didn’t completely take into account some of these exceptions.

Owing to the fact that there were many other messages of similar nature which didn’t equate to the published financial results and SEBI had failed to establish if any of the accused had passed on the UPSI to other parties beyond a reasonable doubt, the charges had lost ground.

The Personal Privacy Angle

Why wasn’t SEBI able to uncover the source of the leak? End-to-end encryption, that’s why!

This issue is not limited to insider trading but the larger debate vis-a-vis messaging governance and the right to personal privacy. In February, the Government notified a new rule requiring WhatsApp and other messaging platforms to disclose the “first originator of mischievous messages”.

To be fair, the wall of encryption is the last thread against unrestrained state surveillance on citizens, if it were so. At the same time, encrypted apps and their role in evading illicit communication from regulatory compliance is constantly on the rise.

The most centred approach to deal with this conflict is for SEBI to acquire better technology to help in structured data analysis that can curb market manipulation without jeopardising civil rights at the same time.

(Originally published March 30th 2021 in transfin.in)