Insider trading in the stock market remains one of the trickiest domains to navigate, both for market participants and the regulator. Two individuals employed in the capital market have found themselves on the wrong side of the law, although they can appeal SEBI’s order.

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Their experience should be a warning, especially if you are part of a WhatsApp group that shares stock market information and gossip. Think twice before forwarding earnings estimates of companies. If they mirror actual results, SEBI can haul you up for possessing unpublished price sensitive information as defined in the insider trading law. It doesn’t matter whether or not you traded in the stock in question.

This quandary for market gossipers has arisen after SEBI fined two employees of Mumbai-based stock broking firms Rs 30 lakh each for having received and shared the financial results of Bajaj Auto and Gujarat Ambuja Cements ahead of the numbers being formally announced by the companies. The actual results mirrored the estimates shared by them! The SEBI order raises quite a few interesting points.

Does it matter how the information was obtained?

The duo Shruti Vora and Neeraj Agarwal argued in their defence that SEBI was unable to prove that they had any connection with the person who had forwarded them the message, or any connection with a company insider who had access to the financial results. They routinely received such messages of estimates and it was more in the nature of market gossip, they said.

“It is a well-known fact that nobody gives undue weightage to HOS (heard on the street) while making investment decisions as it is pure speculation/gossip from unverified sources. However, a lot of traders and investors rely upon HOS to get a pulse of market and make their decisions on the basis of several factors, one of which is HOS,” Vora said in her submission to the regulator.

However, SEBI invoked insider trading regulations while penalizing the duo, saying the rules defined an insider as a person having access to UPSI regardless of how one came in possession of or had access to such information. What this means is mere possession of such information and passing it on was enough to bring you within the ambit of the insider trading law.

But earnings estimates are common feature in every earnings season, aren’t they?

Yes. But the regulator has made a distinction between when general information is publicly available and when it is not.

“I primarily note that the information of the nature of HOS that is published in the newspaper or by the brokerage houses estimating the results are in the public domain and there is generally no disparity in the access to such information,” the SEBI Adjudicating Officer B J Dilip said in the order said, adding,

“However, such information when being circulated among a closed group as in the instant case, such group and the people forming part of the information communication chain alone become privy not only to the content of the information, but also to the knowledge of very existence of such information.”

That is, a broadly circulated research report with estimates or news published by a media outlet is different from estimates being shared in a closed group.

Less public the access to such estimates, more is the risk of it being labelled as UPSI.

Even on estimates made by broking analysts, the SEBI order made some nuanced observations.

The Adjudicating Officer agreed that it was a common practice of broking houses to arrive at estimates based on several factors including financial modelling, management guidance, global factors and meetings with management of listed companies.

“I am of the opinion that such information generated as above by the brokerage houses may not constitute UPSI even if the same subsequently matches with the result announced,” the SEBI order.

The SEBI order then quoted from the Justice Sodhi Committee report, the portions that made it clear that a research report available to all clients would be considered non-discriminatory but a report priced such that few could afford it would make it discriminatory.

Vora and Agarwal argued that the estimates for Bajaj Auto and Gujarat Ambuja earnings were based on research. But the SEBI order said that was not enough to make it generally available. It said the research should have been done based on public information and after that, it should be available on a non-discriminatory basis. Here, the two defendants were unable to prove that the information was based on research, in the first place.

This could make it very tricky for analysts in general if their estimates match the numbers declared by companies and they (analysts) are unable to prove, based on publicly available information, how they came by these estimates.

Often, informal guidance by company officials play a key role in analysts arriving at their estimates.

Even if analysts can show they had access to public information, but these estimates are not available on a non-discriminatory basis, that could be construed as an offence. So, a high-priced earnings estimate service backed by research, with an elite group of subscribers, will still have some explaining to do if the estimates match the actual results.

Merely not having profited from the information is no defence

SEBI also has taken a dim view of the Vora’s and Agarwal’s argument that they did not profit from the information. “The regulation does not exempt the person from the guilt of communicating merely on the fact that no trades had taken place based on the UPSI thus

communicated,” the SEBI order said.

Among her various arguments, Vora said that a part of her job was to accumulate information about movements in the market, possible stock prices, news about important elements in the financial world and communicate those to the institutional clients. SEBI was of the view that neither Vora nor Agarwal was required to share information prior to the announcement of results, as a part of their job description.

But the regulator may be a bit out of touch with market reality.

Broking firm executives will tell you that to convince most fund managers to buy a particular stock, or trade through the broking firm, they expect to be provided non-public information.

This following observation by SEBI should make many fund managers think twice before pressing sales people and research analysts at broking firms for information that is not publicly available. It says that the integrity of the stock markets hinges on participants who conform to the standards of transparency, good governance and ethical behaviour and do not resort to fraudulent activities. If UPSI is shared on a discriminatory basis in the guise of sharing market gossip or rumours, a few people with access will benefit and it will adversely affect investor confidence.

It remains to be seen if the order will hold in a higher court should either Vora or Agarwal appeal against it. In the meantime, it will have many stock market participants wondering about the subtle difference between information and market gossip and the risks they face of finding themselves on the wrong side of the law.

Also read: Three lessons for investors from Franklin Templeton debt funds debacle

First Published:May 3, 2020 4:13 PM IST