Expanding the Net: The New Scope of “Connected Person” in Insider Trading

Introduction

In the changing landscape of India’s financial markets, the Securities and Exchange Board of India has continually worked to improve market integrity and promote fair information dissemination. As part of its ongoing regulatory evolution, the Securities and Exchange Board of India (SEBI) introduced the Securities and Exchange Board of India (Prohibition of Insider Trading) (Third Amendment) Regulations, 2024¹, which came into force on 6-12-2024. A central feature of this Amendment is the redefinition and expansion of the term “connected person”, a cornerstone concept in insider trading regulation.

The revised framework significantly broadens the scope of who can be presumed to have access to unpublished price sensitive information (UPSI). Notably, the amendment changes the definition of “relative” and adds a rebuttable presumption against a broader group of individuals. This expansion aims to close enforcement gaps, particularly in light of judicial scrutiny and changing market practices. However, it raises significant concerns, including the possibility of regulatory overreach, increased compliance burdens, and a dilution of the standard of proof in insider trading investigations.

This paper critically analyses the expanded definition of “connected person”, exploring the legislative intent, enforcement challenges, and broader implications for market participants. It also assesses the coherence of these changes with established legal principles and international best practices. Ultimately, the paper offers recommendations aimed at striking a more balanced approach, ensuring regulatory efficacy without unduly burdening legitimate actors in the securities market.

Expansion of the definition of “connected person”

According to the SEBI (Prohibition of Insider Trading) Regulations, 2015 (PIT Regulations)² the concept of a “connected person” plays a crucial role in determining individuals who are likely to have access to UPSI. Regulation 2(1)(g) defines an “insider” as either a connected person or an individual who possesses or has access to UPSI.³ In its Consultation Paper issued on 29-7-2024, SEBI suggested a major overhaul of the insider trading framework, which resulted in the Securities and Exchange Board of India (Prohibition of Insider Trading) (Third Amendment) Regulations, 2024.⁴

A significant reform is the broadened definition of “connected person”. By aligning the definition with that of a “related party” as per the Companies Act, 2013⁵ and adopting the wider “relative” definition from the Income-tax Act, 1961⁶ SEBI aims to close loopholes that previously enabled indirect disclosures of UPSI.

Amendments to the definitions of “connected person” and “relative” under the SEBI (Prohibition of Insider Trading) Regulations, 2015

(1) Regulation 2(1)(d)(i)⁷

The amended Regulation 2(1)(d)(i) enhances clarity and accuracy of the language while maintaining its initial purpose. It encompasses any individual who is currently associated with a company or has been in the last six months prior to the relevant transaction, in any capacity, whether through contracts, fiduciary roles, employment, or otherwise, directly or indirectly. This connection may occur through frequent communication with the company’s officers, holding a position that allows access to UPSI, or through any professional or business relationship that could reasonably be expected to provide access to such information.

(2) Regulation 2(1)(d)(ii)⁸

A significant aspect of the amendment is the broadened definition of “deemed connected persons” as outlined in Regulation 2(1)(d)(ii). Two new categories have been inserted:

(i) Regulation 2(1)(d)(ii)(k): “a firm or its partner or its employee in which a connected person specified in sub-clause (i) of clause (d) is also a partner; or”⁹

This represents a change from the previous clause (j), which applied solely to companies where directors or their relatives held a 10% interest. The amended provision eliminates the ownership threshold, addressing loopholes that permitted the misuse of UPSI via professional connections.

(ii) Regulation 2(1)(d)(ii)(l): “a person sharing a household or residence with a connected person specified in sub-clause (i) of clause (d);”¹⁰

This provision broadens the regulatory framework to encompass individuals living in the same household as a connected person, regardless of any family ties. This inclusion signifies SEBI’s recognition that close physical proximity and daily interaction might enable the inadvertent or informal sharing of UPSI.

(3) “Immediate relative” substituted with “relative”

The amendment to Regulation 2(1)(f)¹¹ substitutes “immediate relative” with “relative” in Regulation 2(1)(hc), eliminating the requirements of financial dependency and involvement in trading decisions.

According to the updated definition, a “relative” means the following:

(i) the spouse of the person;

(ii) the parents of the person and their spouse;

(iii) the siblings of the person and their spouse;

(iv) the children of the person and their spouse;

(v) the spouses of person listed at sub-clause (iii); and

(vi) the spouses of person listed at sub-clause (iv)

(4) Shift in burden of proof

The amended note specifies that the family members of a “connected person” are also categorised as connected persons according to these regulations. It introduces a rebuttable presumption that a connected person has access to UPSI. Notably, these amendments shift the burden of proof on deemed connected persons when alleged under Regulation 4(1)¹². They are required to demonstrate, according to Regulation 4(2)¹³ that they did not have access to UPSI, which could widen the scope of regulatory oversight to include a larger group of individuals and entities.¹⁴

Judicial development: Balram Garg v. SEBI and its role in shaping the amendments

The Supreme Court’s ruling in Balram Garg v. SEBI¹⁵ represented a crucial turning point in the development of insider trading law in India. This ruling served as a judicial impetus for the amendments introduced in 2024, aimed at addressing the enforcement shortcomings highlighted by the Court.¹⁶

Facts: The situation originated from trading activities involving the stock of PC Jewellers Ltd. (PCJ), an Indian jewellery firm established by the three brothers: P.C. Gupta (Chairman), Amar Chand Garg (Vice Chairman) and Balram Garg (Managing Director). In 2011, Amar Chand and his family exited the business through a family agreement, which significantly reduced their shareholding and severed their formal connections with PCJ.

In 2015, a further rift developed within the Gupta family when P.C. Gupta’s son, Sachin Gupta, and daughter-in-law, Shivani Gupta, distanced themselves from the business. They resigned from their positions and formed a family agreement that entailed transferring 1.6 crore shares from P.C. Gupta and his wife to Sachin’s family.¹⁷ Although this agreement dissolved their formal associations, the Guptas continued to reside on the same extensive property, albeit in separate structures. Notably, Amit Garg, son of Amar Chand Garg, along with Balram Garg, also lived in different buildings on the same land.

In April 2018, PCJ initiated discussions about a share buyback. The Board approved this buyback on 10-5-2018, notifying the stock market on that same day. The discussions that began on 25-4-2018, created a period of unpublished price sensitive information (UPSI-1) leading up to the public announcement.¹⁸ In July 2018, the buyback was aborted due to State Bank of India’s (SBI’s) refusal to provide a no-objection certificate. This situation prompted another phase of UPSI to occur between July 7 and July 13 (UPSI-2) before the announcement of the cancellation. During this interval, Shivani Gupta sold her PCJ shares, receiving assistance with trading from Sachin Gupta and Amit Garg. Furthermore, Quick Developers Pvt. Ltd. (QDPL), wholly owned by Amit and his spouse, created short positions ahead of the public announcement of UPSI-2. These transactions attracted the attention of SEBI for investigation.¹⁹

SEBI and Securities Appellate Tribunal (SAT) proceedings: The SEBI determined that the trades carried out during the UPSI-1 and UPSI-2 periods violated Regulation 4 of the PIT Regulations, which prohibits trading while possessing UPSI. Notably, SEBI acknowledged that none of the individuals involved Sachin, Shivani, Amit, or QDPL²⁰ qualified as “connected persons” under the PIT Regulations, since they did not have formal ties to PCJ, did not meet the statutory definition of “immediate relatives”, nor exhibited any financial dependence.

However, SEBI determined that the accused met the criteria of “insiders” as defined in Regulation 2(g)(ii), which includes any individual who possesses or has access to UPSI. Leaning significantly on circumstantial evidence, namely, the timing of transactions, the proximity of residences, and familial connections. SEBI concluded that Balram Garg must have communicated with UPSI them. Consequently, it found Balram Garg violated Regulation 3²¹, which prohibits the communication of UPSI.

The SAT upheld SEBI’s findings, and determined that the circumstantial evidence was adequate to demonstrate the violation.²²

Supreme Court judgment: Following an appeal, the Supreme Court reversed the rulings of the SAT and SEBI. The Court made the following observations:

(1) The Court ruled that an individual cannot be assumed to have shared UPSI solely based on being a relative or living in the same household. The existence of relationships or physical closeness, or proximity alone, cannot be sufficient grounds to infer any wrongdoing.²³

(2) To presume individuals as presumed insiders based on their relationships, SEBI must demonstrate that these individuals either relied financially on or sought advice from the connected person. It is SEBI’s responsibility to provide substantive evidence to support these claims.²⁴

(3) The Court placed significant emphasis on the evidence of familial estrangement, highlighting the necessity of evaluating the true nature of relationships instead of depending on labels.²⁵

(4) Relying solely on trading patterns, timing, or proximity to family was considered inadequate to determine that insider trading took place. This needs to be backed up by direct evidence of communication or access to unpublished price-sensitive information (UPSI).²⁶

(5) Even if people resided on the same property, the characteristics of the living arrangements, such as separate buildings, different floors, etc. should be considered before making conclusions about the communication of UPSI.

(6) Notably, the Court dismissed the use of “preponderance of probabilities” as the suitable standard for these cases. It highlighted that SEBI is required to provide direct evidence, like call records, emails, or witness statements, to prove violations. This marked a shift from previous legal precedents, such as in SEBI v. Kishore R. Ajmera²⁷ where insider trading could be inferred solely from behavioural patterns.

The judgment in Balram Garg case²⁸ served as both a rebuke and a roadmap. The existing legal framework was found inadequate to tackle contemporary insider trading methods that function through informal and frequently unclear means. Acknowledging this gap, SEBI published a Consultation Paper in July 2024, which was followed by amendments to the PIT Regulations.

Critique of SEBI’s amendment: A step backwards

Although the amendments are a significant move forward, they pose the danger of excessive regulation, potentially hindering market efficiency. Consequently, despite assertions of progress, these amendments could inadvertently be regressive, weaken the integrity of the legal framework, lead to additional uncertainties, and place unnecessary burdens on individuals without adequate justification.

The key loopholes and critiques of the amendments are as follows:

(1) The amendment aims to harmonise the definitions of “related party” and “relative” with those found in the Companies Act of 2013²⁹ and the Income-tax Act of 1961³⁰. It does not, however, provide the rationale for this harmonisation. The goals of tax or corporate governance laws and insider trading laws are essentially different, and importing definitions without supporting context runs the risk of distortion of enforcement objectives and regulatory intent.³¹

(2) The broadened definition of “connected person” and the substitution of “immediate relative” with “relative” widens the pool of individuals implicated in insider trading.

(3) Globally, regulations on insider trading highlight the need for context-specific and evidence-driven approaches. The Financial Conduct Authority in the UK uses a “person in possession” test, which emphasises actual access to and usage of insider information. Likewise, the European Union’s Market Abuse Regulation mandates a direct connection between holding information and engaging in trading activities. SEBI’s transition to status-based presumptions differs from these established norms, which may result in a rigid framework that is not well-adapted to the intricacies of today’s financial systems.

(4) The possibility of being classified as a connected person might discourage talented individuals from pursuing positions that could expose them to unpublished price sensitive information (UPSI), negatively impacting talent mobility and corporate governance.

(5) The amendment shifts the burden of proof from SEBI to the accused individuals. Granting SEBI, the power to designate individuals as connected persons without needing to establish actual communication of UPSI could lead to potential misuse and overreach. What is required is an enhancement of SEBI’s investigative abilities and powers, enabling it to build a stronger case when alleging violations, rather than shifting the burden of proving innocence onto individuals.³²

(6) The amendments dilute the evidence-based criteria established under Regulation 2(1)(d), which previously mandated a significant expectation of access to unpublished price sensitive information (UPSI) backed by solid evidence rather than mere relational proximity. The Supreme Court has underscored that liability for insider trading must be founded on direct evidence of UPSI possession and intent, dismissing assumptions based solely on familial or social connections. SEBI’s decision to extend presumptive UPSI possession based on relational or residential connections poses a risk of undermining this framework, potentially resulting in excessive enforcement and inefficiencies in the market.

(7) The inclusion of individuals “sharing a household or residence” with a connected person creates additional ambiguity. This may include people such as tenants, flatmates, or domestic staff who might not have significant access to UPSI. The ambiguity in defining “household” may result in interpretive uncertainty, potentially placing SEBI and market participants at risk of unwarranted litigation and compliance issues.³³

Way forward

To mitigate the risks associated with the expanded definitions of “connected person” and “relative”, SEBI must supplement the amendments with clear, stakeholder-specific guidance. These should define what constitutes access to UPSI and simplify compliance obligations for various types of individuals.

SEBI, in particular, could implement a modified trading plan regime for relatives that includes periodic disclosures or safe harbour provisions, allowing legitimate trades to take place without imposing excessive compliance burdens. A risk-based approach, which focuses enforcement on those in close proximity to UPSI, can improve efficiency even further.

Finally, a balanced regulatory framework is required to avoid deterrence of market participation. Clearer guidance will ensure that the goal of reducing insider trading is met without impeding capital market activity or investor confidence in a globalised financial environment.

Conclusion

The amendments made by SEBI to the Insider Trading Regulations indicate a significant shift in regulatory focus, aiming for increased clarity and broader coverage in addressing insider trading, especially through the revised definition of “connected persons”. While the amendment enhances the legal framework by clarifying ambiguities and closing loopholes, there is a potential risk of overreach if not implemented and interpreted with caution. Although the broader definition is well-intentioned, it should be supported by clear guidelines, consistent legal precedents, and measures to prevent regulatory overreach in order to avoid hindering legitimate business activities. Ultimately, the success of these reforms will depend not only on their textual rigour but also on their practical application and the extent to which they can prevent misconduct without undermining market fluidity or fairness.