INTRODUCTION

The appeal arises from an interim order dated 15 June 2020, passed by the Securities and Exchange Board of India (SEBI) against Udayant Malhoutra, the CEO of Dynamatic Technologies Ltd. Malhoutra was ordered to deposit a sum of Rs. 3,83,16,230.73 into an escrow account. It was said that this amount represented the notional loss that Malhoutra was seeking to avoid by allegedly trading on the basis of unpublished price-sensitive information (UPSI) relating to the company’s financial results.

The issue arose from Malhoutra’s alleged insider trading on 24 October 2016, on selling 51,000 shares of Dynamatic Technologies Ltd. It was claimed that Malhoutra had inside information connected with the unaudited financial results of the quarter ending 30 September 2016, which hadn’t been released to public yet. This information, being of such a nature and magnitude, would have led to a change in stock price, and Malhoutra allegedly used it as a means to avoid suffering a loss in the market.

On 11 November 2016, the stock price of Dynamatic Technologies Ltd. fell when the company released the financial results, which confirmed the adverse effect of the results on the company’s financial position. The SEBI investigation into the matter suggested that Malhoutra had an unfair advantage by trading on the basis of information that was not yet available to the general public, thus breaching the regulatory framework governing insider trading under the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015.

The interim order issued by SEBI intended to secure the sum which, according to Malhoutra’s alleged insider trading, he had made or otherwise was liable to lose. Directing him to deposit the said amount into an escrow account, SEBI would secure any gains or losses resulting from the alleged insider trading that could then be preserved, pending further investigation or final orders in the case. The order was based on the assumption that the figure is the notional loss Malhoutra might have suffered had he not traded as alleged.

The appeal challenges the interim order on the grounds that the claim of notional loss is not substantiated, and the directions to deposit such a significant amount are unjustified. The outcome of the appeal will hinge on whether the interim order was justified under the circumstances and whether SEBI’s actions were consistent with the regulatory framework for addressing insider trading violations.

FACTS

The case revolves around a complaint from the CEO of Dynamatic Technologies Ltd. Udayant Malhotra had sold shares in the company as an insider on the basis of nonpublic, price-sensitive information with regard to unaudited financial results of the quarter ending 30 September 2016. On 24 October 2016, according to the charges, Malhoutra sold 51,000 shares of the company while still in possession of inside information about the company’s performance, which hadn’t been divulged to the public at that time. When the company made its official declaration of the financial results on 11 November 2016, the stock price fell by a significant margin, which indicates the material effect of the results on the market value of the company.

An investigation by SEBI was initiated into the matter in 2017, as SEBI suspected that Malhoutra used the unpublished price-sensitive information to avoid a notional loss by selling the shares before the results were announced. In this inquiry, in November 2019, SEBI asked Malhoutra to provide information, expecting to collect evidence to link the sale of the shares to the possession of insider information.

On 15 June 2020, the Whole Time Member of SEBI issued ex parte interim order wherein she directed Malhoutra to deposit an amount of Rs. 3,83,16,230.73 in an escrow account. This amount was essentially the notional loss she is said to have avoided by making the sales on the strength of inside information. The interim order was passed in the absence of Malhoutra, as it is normal in cases of alleged insider trading, where SEBI can act swiftly to prevent any further gains from the insider trading activity.

The SEBI order was on the premise that the amount represented the notional loss Malhoutra sought to avoid by trading on the basis of confidential information, thus violating the provisions of the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015. The decision to direct the deposit into an escrow account was made to secure the amount pending a full investigation and final determination of the case.

Malhoutra challenges the ex parte interim order, contending the basis of the claim with the unsubstantiated loss and contending that interim relief was undeserved. The appeal will result in deciding the appropriateness of actions by SEBI and the interim relief deserved under the circumstances.

ISSUE RAISED

The primary legal issues that arose in this case were:

1. Whether the ex parte interim order can be sustained under SEBI regulations, keeping in view the delay between the alleged insider trading in 2016 and the passing of the interim order in 2020, during the COVID-19 pandemic.
2. Whether the urgency and necessity of the interim order passed by SEBI without proper hearing of the respondent can be justified, particularly in light of the principles of natural justice and the absence of hearing prior to the order.
3. Whether the ex parte interim order of SEBI directing the deposit of a notional loss amount into an escrow account is justifiable under the SEBI (Prohibition of Insider Trading) Regulations, in light of the passage of time between the alleged violation and the action taken by SEBI.
4. What threshold is appropriate in determining urgency in the determination of an interim order, and does the COVID-19 pandemic affect the necessity or determination of urgency that requires action to be fast-tracked in this case?

PETITIONER’S ARGUMENTS

• The arguments of SEBI in favor of the ex parte interim order were based on the regulatory framework and urgency to take swift action so that market integrity is not violated. SEBI argued that it had explicit authority under the SEBI (Prohibition of Insider Trading) Regulations, 2015, to pass an ex parte interim order in insider trading cases. According to SEBI, the provision for such orders is meant to enable the regulator to act in time when there is a likelihood of market manipulation or an unfair advantage derived from unpublished price-sensitive information (UPSI), even before the completion of a full investigation.
• The urgency of the order, SEBI submitted, lay in the respondent, Udayant Malhoutra, dissipating or diverting the notional gain he was claimed to have made through insider trading. Insider trading undermines fairness and transparency in securities markets; it was necessary to prevent Malhoutra from benefiting from his unjust action. The regulator further pointed out that the notional gain avoided by Malhoutra from his sale of 51,000 shares, based on inside knowledge of the company’s financial results, could result in a substantial market distortion if not addressed swiftly.

• Moreover, SEBI pointed out that the ex parte order was required to be passed for the larger interest of the financial market so that Malhoutra does not exploit the situation for his personal gains. SEBI argued that allowing Malhoutra to retain the notional gain, pending a full investigation, would amount to allowing an unfair enrichment at the expense of other market participants who traded without such insider knowledge. SEBI, by getting the alleged notional gains deposited into an escrow account, tried to ensure that the status quo was not disturbed, and the potential beneficiary of the illegal activities was not allowed to benefit when the investigation was going on.

• The regulator also noticed that the ex parte interim order was issued just as a precautionary step. In such cases where insider trading is suspected, it is very important to act in a timely manner to prevent further damage to market participants and preserve the integrity of the financial markets. SEBI further pleaded that such delay in the investigation of this case, being a matter of complexity and because of the COVID-19 pandemic, further justified urgent action for the protection of investor interest and maintenance of confidence in the securities markets.

RESPONDENT’S ARGUMENTS

• The respondent, Udayant Malhoutra, advanced several arguments challenging SEBI’s ex parte interim order. He further submitted that no urgency could be justified to issue such an order, particularly in light of the three-year time gap between the alleged insider trading in 2016 and the SEBI action in 2020. He submitted that such delay completely vitiated any possible argument of immediate damage to the market or loss of investor confidence and rendered it unfair to pass such an order without giving him a reasonable opportunity for a proper hearing. He pointed out that the inaction of SEBI during this long period negated any justification for bypassing procedural fairness.
• Secondly, Malhoutra highlighted the inappropriate timing of SEBI’s order during the COVID-19 pandemic. He argued that the pandemic caused significant disruptions, including restrictions on physical hearings, making it unfair to impose a substantial financial burden without a transparent and fair process. He urged SEBI to consider the unique challenges posed by the pandemic before resorting to an ex parte decision, which added undue hardship.
• Thirdly, he argued that the action of SEBI was arbitrary and disproportionate. Malhoutra cited that the inquiry had been going on for years without any urgency in the findings or conclusion. He argued that there was no immediate or even tangible threat to the market as the company’s financial results were disclosed publicly in 2016, and the stock price had already been adjusted.
• In summary, Malhoutra argued that the proportionality of the interim order was in question when it demanded Rs. 3,83,16,230.73 as a notional loss without justification, claiming it to be too excessive and unsubstantiated. He claimed that this was a punitive order because he was penalized with the order without having enough chance to defend himself against such actions by SEBI. In that, it has breached due process as well as the right to a fair hearing.

JUDGEMENT

On 27 June 2020, the Securities Appellate Tribunal (SAT) set aside SEBI’s interim ex parte order. The Tribunal held that the urgency was not established to merit the order, especially because of the long gap from the alleged insider trading in 2016 till the interim order was passed in 2020. The SAT observed that SEBI had not established the justification for immediate action, which was required in this case, considering that the investigations had been pending for nearly three years, and details from the respondent were received in November 2019. The Tribunal, thus, held that ex parte orders by SEBI should be made sparingly and only in cases of the utmost urgency, which the facts did not establish. According to the Tribunal, its order reflected its opinion that such an ex parte order was inappropriate because not supported by any immediate threat to or harm to the market.

The Supreme Court, in its judgment, upheld the decision given by the Securities Appellate Tribunal (SAT), agreeing that there was no justification for SEBI to pass the ex parte interim order in the case. The Court concurred with the view taken by the Tribunal that the significant delay between the alleged insider trading in 2016 and the interim order in 2020 undercut the urgency typically required for such actions. The Court pointed out that though SEBI has the power to pass interim orders when urgency demands, the case at hand did not present such an exigency. It held that SEBI failed to prove an immediate need for intervention as the investigation had been pending for a few years and information was sought from the respondent in 2019 without further developments. The Court has made it very clear that the power vested with SEBI to issue ex parte orders is to be used with utmost caution only in situations of “extreme urgency,” as mentioned earlier by the Tribunal, while making rulings in its judgments.

It further held that such orders are extraordinary measures in order to save the market from impending harm, but there was no compelling reason in this case to skip the normal procedure, wherein the respondent gets an opportunity for a hearing. Upsetting the order passed by the Tribunal, the court clarified the boundaries of powers in regulation: SEBI shall not resort to interim orders without sufficient reason, mainly when there is no apparent need for action. Judgment placed importance on procedural fairness and natural justice, which should be granted, more so when large amounts of money and reputations were at stake in such proceedings.

CONCLUSION

The Supreme Court dismissed SEBI’s appeal and upheld the Securities Appellate Tribunal (SAT)’s decision to set aside the ex parte interim order against Udayant Malhoutra. The Court’s judgment underscored the critical importance of adhering to procedural fairness, particularly when exercising powers to issue interim orders without a prior hearing.

The Court held that the authority to pass ex parte orders under the SEBI (Prohibition of Insider Trading) Regulations, 2015 is meant only for cases where there may be a genuine and immediate case of urgency in preventing further damage to the market or investor interests. However, in this case, the Court noted that there was no pressing need for immediate action, especially given the significant delay between the alleged insider trading in 2016 and the interim order issued in 2020. The Court emphasized that such powers are extraordinary and must be exercised sparingly, only in cases of “extreme urgency,” as SAT had rightly observed in its decision.

In dismissing the appeal filed by SEBI, the Supreme Court reinforced the principle that powers of regulation need to be exercised in consonance with principles of natural justice and procedural fairness. While holding that the ex parte order was not well supported due to the absence of a proper justification on part of SEBI, no immediate threat or risk which made such an order indispensable was reflected.

This case serves as a reminder that regulatory authorities must balance the need for swift action with the obligation to ensure fairness and transparency. It also sets a precedent for ensuring that extraordinary powers, such as issuing ex parte orders, are not misused or applied in situations where the urgency is not evident. This decision strengthens the safeguards against arbitrary regulatory actions, and it ensures that procedural rights are upheld even in cases involving allegations of market misconduct.