Insider trading -- Legal fallout in the Sterlite case

D. Sampathkumar

STERLITE Industries or its promoters may or may not be guilty of manipulating the company's share prices as alleged by SEBI in its original order.

But the recent decision of the Securities Appellate Tribunal (SAT) overturning SEBI's order is undoubtedly a setback to the latter's effort at controlling market manipulation.

Clause 4 (a) of the SEBI Regulation on `Prohibition of Fraudulent and Unfair Trade Practices' states: ``No person shall effect, take part in or enter into, either directly or indirectly, transactions in securities with the intention of artificially raising or depressing the prices of securities, and thereby inducing the 'sale' or 'purchase' of securities by any person.''

Incidentally, there is clearly evidence of some loose drafting here. The reference to inducement should ideally have been sequenced as 'purchase' and 'sale', in that order, and not as 'sale' and 'purchase'. The distinction is important because if you are accusing someone of artificially raising prices, then his objective is clearly one of inducing a person to 'buy' the security at inflated prices and, similarly, if the accusation is one of artificially depressing the prices, the objective would have been to induce that person to sell the shares in question.

Of course, this is a minor technical issue and the language as it stands might still support both types of fraudulent transactions. But the point is that regulation of fraudulent transactions in securities is as yet, a virgin territory in the regulatory framework of securities markets in the country.

Now SEBI has held that the Sterlite management has indirectly effected transactions in its shares that were at artificially inflated prices. According to SEBI, the trail of market manipulation began with Sterlite's associate company MALCO advancing a sum of Rs 5 crore to a Dil Vikas Finance Company Ltd., which was used by its associate company as seed capital to acquire Sterlite shares.

The company to which MALCO lent money, alleges SEBI, is linked to a clutch of stock brokers/market intermediaries controlled by Harshad Mehta (of 1992 Securities Scam fame). These intermediaries indulged in rampant speculative buying and selling, causing the Sterlite share price to go up during April-June 1998. So the management of Sterlite stood accused, in SEBI's view, of indirect share manipulation as it advanced a sum of money to an outfit associated with stock market entities who, in turn, indulged in manipulative share transactions.

SEBI has also gone on to claim that the Sterlite management's complicity in the whole affair has been further strengthened by the involvement of MALCO in the stock exchange sponsored bailout package for intermediaries caught with speculative positions in the Sterlite scrip. It may be recalled that the Bombay Stock Exchange faced a payment crisis when some of its members were stuck with huge open long positions in Sterlite shares and were unable to meet their payment commitments.

In the event, MALCO stepped in and advanced monies to Dil Vikas Finance to enable the latter to buy out the open positions of these brokers. In SEBI's eyes, the initial guilt by association is, thus, reinforced by participation in a damage-control exercise mounted by the stock exchange administration.

The Sterlite management disputed this assessment and appealed before the SAT, against the SEBI ruling. It contended that the money advanced by MALCO was a straightforward inter-corporate deposit/loan and the amount was used by the borrower to acquire government securities. It had nothing to do with a sister company El Dorado buying shares in Sterlite.

El Dorado, in turn, bought a part of these shares on behalf of yet another associate company and the balance for a client who has had regular dealings with it. Moreover the amount of purchase consideration involved in the purchase of Sterlite shares which has attracted SEBI scrutiny is more than the inter-corporate loan of Rs 5 crore advanced by MALCO to Dil Vikas Finance. As such, there is no nexus between the Sterlite management and the offending purchase of Sterlite shares.

There is even less of a nexus between the company and the Damayanti Group -- the entity linked to Harshad Mehta and the one really at the centre of the flare-up in prices in April-June 1998. The company contended that all that SEBI was able to produce by way of proof is a piece of paper recovered from the office of Damayanti Group that showed Harshad Mehta's investment of 1,50,000 shares in Sterlite as lying with Dil Vikas Finance the company. And Dil Vikas Finance happened to be the company that obtained a Rs 5-crore loan from MALCO earlier.

The Tribunal accepted the company's argument and ruled that SEBI has not made out a case against the company that it had indulged in fraudulent share transactions. So where does SEBI go from here? It must recognise that there are no short cuts to establishing a case of insider trading, should there be one. If it is SEBI's case that promoters had caused some market entities such as Harshad Mehta in the instant case, to indulge in manipulative share dealings, it needs to do two things.

One, it must first establish that the sum total of transactions entered into by them had the effect of creating a false market in the shares of the company. Two, get the actual perpetrators to implicate with at least reasonable circumstantial evidence that they (promoters) were a party to the conspiracy. Trying to fasten the charge on promoters without actually going after those who directly participated in such deals and by focussing on isolated share deals, is poor legal tactics and is certain to backfire.

The sequence of events in the instant case culminating in the Tribunal exonerating the Sterlite management nevertheless leaves many questions unanswered. For instance why would somebody borrow at 15 per cent as Dil Vikas Finance appears to have done only to invest in government securities where the best yields even at the longest end, did not exceed 12 per cent?

Why does MALCO feel obliged to bail out a set of brokers who had taken speculative positions in a sister company of the group, even if it was the stock exchange administration which had made the request? A third question is, why does MALCO choose to support speculators in the Sterlite stock when there were equally pressing claims against two other sets of brokers who had speculative positions outstanding in the shares of BPL and Videocon?