Buying
and selling of securities of any company is a legal activity for everybody.
When it comes to insiders such as directors, managers and workers of a company,
they can also buy or sell securities of their companies by abiding company’s policy
and SEBI’s regulation. Regulation on insider trading clearly says that it will
be considered illegal if the insiders of public limited company trade on the
basis of price sensitive undisclosed information to make profit or avoid loss.
They are expected to trade in securities of their companies for the intention
of maintaining the status for long period of time. Trading frequently or
entering into reverse transaction at small interval (i.e. less than 6 months)
is considered illegal insider trading.
Insider trading is mal practices of those who are
directly related to a company or body corporate or has any relation with the
company. These persons use their position to get price sensitive information
related to value of shares etc. which is unpublished. Insider
trading per se is obtaining information from non-public sources, viz.
private acquaintances, friends, colleagues and using it for purposes of
enhancing one's financial advantage. Sometimes, such a practice can be
conducted fraudulently, as when one who has obtained the information has
a fiduciary duty to share it with clients but fails to exercises[1].
The SEBI
(Prohibition of Insider trading) Regulations 1992 provide mechanism to deal
with this problem. But this regulation is not sufficient to tackle insider
trading completely so, a separate authority and a separate law is needed to
tackle insider trading in India. The Satyam scam is latest example to show the
lacunas in law and lack of effective machinery in India to prohibit insider
trading. The SEBI (Prevention of Insider Trading) Regulation, 1992 is being
inspired from the United States.
WHAT IS
INSIDER TRADING:
As per the dictionary
meaning insider trading is: “trading to one’s own advantage through having
inside knowledge.[2]
Investopedia defines the insider
trading, “The buying or selling of a
security by someone who has access to material, nonpublic information about the
security.”[3]
The term “insider” is defined in
clause (e) of regulation[4]as:
“Insider means any person
who, is or was connected with the
company or is deemed to have been connected with the company, and who is
reasonably expected to have access, by virtue of such connection, to unpublished price sensitive information[5]
in respect of securities of the
company, or who has received or had access to such unpublished price sensitive
information.”[6]
Insider
trading is seen as an abuse of an insider’s position of trust and confidence
and as harmful to the securities markets because outsiders can be cheated by
insiders who are not able to deal on equal terms. As a result, the ordinary
investor loses confidence in the market. Essentially, insider trading involves
the deliberate exploitation of unpublished price sensitive information obtained
through or from a privileged relationship to make profit or avoid loss by
dealing in securities of a company when the price of securities would be
materially altered if the information was disclosed.
Insider
trading is lead to some persons to make extra gains in stock market through use
of some information like information on expected dividends, expected decline or
rise in profits, any information on merger, acquisition potential threats etc
or any other price-sensitive information.[7]
It
is the trading of a corporation's stock or other securities (viz. bonds or
stock options) by individuals with access to non-public information about the
company. In most countries, trading by corporate insiders such as officers, key
employees, directors, and large shareholders may be legal, if this trading is
done in a way that does not take advantage of non-public information[8].
“Insider
trading” refers to transactions in a company’s securities, such as stocks or
options, by corporate insiders or their associates based on information
originating within the firm that would, once publicly disclosed, affect the
prices of such securities. Corporate insiders are individuals whose employment
with the firm (as executives, directors, or sometimes rank-and-file employees)
or whose privileged access to the firm’s internal affairs (as large
shareholders, consultants, accountants, lawyers, etc.) gives them valuable
information. Famous examples of insider trading include transacting on the
advance knowledge of a company’s discovery of a rich mineral ore (Securities
and Exchange Commission v. Texas Gulf Sulphur Co.[9]),
on a forthcoming cut in dividends by the board of directors (Cady, Roberts
& Co.), and on an unanticipated increase in corporate expenses (Diamond
v. Oreamuno[10]).
In
other words, insider dealing covers a situation where a person buys or sells
securities when he, but not the other party to the transaction, is in
possession of confidential information because of some connection and such
information would affect the value of those securities. Furthermore, the
confidential information in question will generally be in his possession
because of some connection which he has with the company whose securities are
being dealt in or are to be dealt in by him (e.g. he may be a director,
employee or professional adviser of that company) or because someone in such a
position has provided him, directly or indirectly, with the information.
INSIDER
LAWS IN VARIOUS COUNTRIES:
The
purpose of such a comparison is to point out the international trends and
standards in connection with the control of this pernicious practice. The
regulation began in the United States at the wake of the twentieth century,
when judges in several states became willing to rescind corporate insiders’
transactions with uninformed shareholders. One of the earliest (and
unsuccessful) federal attempts to regulate insider trading occurred after the
1912–1913 congressional hearings before the Pujo Committee[11],
which concluded that “the scandalous
practices of officers and directors in speculating upon inside and advance
information as to the action of their corporation may be curtailed, if not
stopped.”
IN UNITED KINGDOM:
In
UK, insider trading was made a specific criminal offence in 1980 and was
incorporated in the Company Securities Insider Dealing Act, 1985 which
was re-enacted in 1993 and is contained in Part V of the Criminal Justice
Act of 1993 (CJA).
Under
the UK regulations “inside information[12]”
means information which relates to particular securities or the issuer of
particular securities and is specific or precise and has not been made public
and if it were made public would have a significant effect on the price of any
securities.
Interestingly,
under the law[13]
as it exists in the UK, only individuals can be held liable. In India, individuals as well as
corporations can be guilty of the offence. In this regard the law in India
is similar to the law in the US where corporate liability is recognized under
certain circumstances.
UK
regulations state that information can be said to have been made public if it:[14]
- is published in accordance with the rules of a regulated market for the purpose of informing investors and their professional advisors;
- is contained in records which by virtue of any enactment are open to inspection by the public;
- can be readily acquired by those likely to deal in securities
In
UK, insider trading is considered a criminal offence and hence, the standard of
proof required for conviction is high. The mens rea therefore assumes significance. Indian laws do
not seem to take the ‘intent’ of the offender into account.
IN
UNITED STATES OF AMERICA:
The United States has been the most successful in prohibiting
insider trading and the first country to tackle insider trading effectively.
The market crash due to protracted lack of investor’s confidence in securities
market and then the great depression in the US economy led to the enactment of
the Securities Act, 1933 in which the
provisions relating to prohibition of fraud in the sale of securities were
included, which were greatly braced by the subsequent Act viz. Securities Exchange Act, 1934. The Securities
and Exchange Act, 1934, enumerates the provisions relating to the protection of
interest of investors against Insider Trading.
The
laws in United States regarding insider trading mainly depends upon the mental
element of the insider, as per the case of Chiarella v. United States[15]
it was held that in order to show the violation under the Securities Exchange Act
it is necessary to prove that insider breached his fiduciary duty fraudulently.
The
laws in USA relating to Insider Trading are primarily contained in section
16(b) of the Securities Exchange Act, 1934 which states as follows in the
relevant part:
Section 16(b) of the Securities
Exchange Act, 1934 prohibits
the purchase and sale of the shares within 6 months period involving the
directors, officer, and stock holder owing more that 10% of the shares of the
company. The rationale behind the incorporation of this provision is that
it is only the substantial shareholder and the person concerned with the
decision and management of the company who can have access to the price
sensitive information and therefore there should be bar upon them to transact
in securities.
In
1984 with the case of Dirks v. Securities Exchange Commission[16]
the Supreme Court of United States of America said that the tippers (person who
is a receiver of second hand information) will be held liable if they had
reason to believe that the tipper had breached fiduciary duty in disclosing
confidential information and the tipper has received any personal benefit from
the disclosure.
IN CHINA:
Following the regulation of insider
trading in the U.S., the notion of insider trading has been widely introduced
to many other jurisdictions, including China for two reasons: firstly, the U.S.
was the first jurisdiction to enact insider trading regulation and today the
U.S. continues to lead the world in the regulation and enforcement[17]. The U.S. experience has been largely
viewed as the “gold standard” for many emerging markets. Secondly, the U.S.
insider trading regulation has served as a core influence on China’s regulatory
framework.
IN NEPAL:
Section
91(1) of Securities Act, 2007 provides that ‘if any
person deals in securities or causes any other person to deal in securities on
the basis of any insider information or notice that are unpublished or
communicates any information or notice known to such a person in the course of
the discharge of his or her duties in manner likely to affect the price of
securities such a person shall be deemed to have been committed an insider
trading in securities, thereby prohibiting dealing in securities, causing any
other person to deal in securities and communicating any information or notice
in a manner likely to affect the price of securities.
Section
91(2) of Securities Act 2007 provides that ‘notwithstanding anything contained
in sub-section (1), any transactions already carried on shall not be deemed to
be affected at all merely by the reason that an insider trading has been committed
thus making the transaction out of the purview of the Acts on the ground of
retrospective effect.
Securities
Act 2007 under section 92 provides persons likely to be involved in insider
trading are:
a) a
director, employee or a person, who can obtain any information or a notice in
the capacity of a shareholder of that body corporate,
b) a
person who can obtain any information or a notice in the capacity of a
professional service provider to that body corporate,
c) a
person who can obtain any information or a notice having a direct or indirect
contact with the person or source as specified in clauses (a) and (b).
IN AUSTRALIA:
Under
the Corporations Act, it is an offence to trade using inside information, or
communicate inside information to others, who will or are likely to, trade on
the inside information. The prosecution must prove that you:
·
possess information which is likely to
have a material effect on the value of a particular financial product;
·
know (or ought reasonably know) that the
information is not generally available;
· trade in that particular financial
product; or you tell someone else about the information knowing that the other
person will trade in the product.
IN INDIA:
Securities
market in India came into existence in 1875 with establishment of Bombay Stock
Exchange. The history of Insider Trading in India relates back to the 1940’s
with the formulation of government committees such as the Thomas Committee of
1948, which evaluated inter alia, the regulations in the US on short swing
profits under Section 16 of the Securities Exchange Act, 1934. Thereafter,
provisions relating to Insider Trading were incorporated in the Companies Act,
1956 under Sections 307 and 308, which required shareholding disclosures by the
directors and managers of a company.
Due
to inadequate provisions of enforcement in the companies Act, 1956, the Sachar
Committee in 1979, the Patel Committee in 1986 and the Abid Hussain Committee
in 1989 proposed recommendations for a separate statute regulating Insider
Trading. In 1979, the Sachar Committee
said in its report that directors, auditors, company secretaries etc. may have
some price sensitive information that could be used to manipulate stock prices
which may cause financial misfortunes to the investing public. The companies
recommended amendments to Companies act 1956 to restrict or prohibit the
dealings of the employees.
The Patel Committee in 1986 in India defined Insider Trading as, “Insider trading generally means trading in the
shares of a company by the persons who are in the management of the company or
are close to them on the basis of undisclosed price sensitive information
regarding the working of the company, which they possess but which is not
available to others.”[18]
The concept of Insider Trading
in India started fermenting in the 80’s and 90’s and came to be known and
observed extensively in the Indian Securities market. The rapidly advancing
Indian Securities market needed a more comprehensive legislation to regulate
the practice of Insider Trading, thus resulting in the formulation of the SEBI
(Insider Trading) Regulations in the year 1992, which were amended in the year
2002 after the discrepancies observed in the 1992 regulations in the cases like
Hindustan
Levers Ltd. vs. SEBI[19],
Rakesh
Agarwal vs. SEBI[20]
etc. to remove the lacunae existing in the Regulations of 1992. The amendment
in 2002 came to be known as the SEBI ([Prohibition of] Insider Trading) Regulations, 1992.
Insider
trading is considered as commiting the offence. The SEBI has the full authority
to investigate the malpractice on the basis of complaints from the investors or
intermediaries or suo-motu. The SEBI can carry on the inspection of books of
account, other records and documents of a suspected person. It has the power to
issue directions to the suspected person not to involve in the securities in
any specific manner. According to Section 24 of the SEBI Act, it has the power
to initiate criminal prosecution against the responcible person.[21]
The
regulations of 1992 seemed to be more punitive in nature. The 2002 amendment
regulations on the other hand are preventive in nature. The amendment requires
all the listed companies, market intermediaries and advisers to follow the new
regulations and also take steps in advance to prevent the practice of insider
trading. The new regulations include mandatory disclosures by the Directors and
other officers of listed companies and also by the persons holding more than 5%
of the company’s shares[22]. Insider trading practice
is also required to be curbed during vital announcements of the company. These
preventive measures ensure the reduction of the cases involving the practice of
Insider Trading and also informing the persons who indulge in such practices,
of the laws relating to Insider Trading.
The
new regulations particularly emphasize on the delegation of powers on the
entities themselves to conduct internal investigations before they present
their case before the SEBI in relation to insider trading. The guidelines
provide for a definite set of procedures and code of conduct for the entities
whose employees, directors and owners are most expected to be in a position to
take an undue advantage of confidential inside information for their personal
profits.
CASE LAW:
Galleon
Hedge Fund Case[23]
The
most well-known of all the cases of insider trading at the global level is the Galleon Hedge Fund Case. The Galleon
Group manages a series of funds that specialize in the technology and
healthcare industries. The founder of the Galleon Group, Raj Rajaratnam, is the
559th richest person in the world with a net worth of USD 1.3
billion, as per Forbes magazine.
However he has been charged along with some others in a case related to the USD
20 million hedge fund insider trading scam, the largest insider trading case in
the history of the United States. About 20 persons, including four Indians,
were charged. Rajaratnam was arrested and charged with using inside information
to trade shares including those of Google Inc, Polycom Inc, Hilton Hotels Corp.
and Advanced micro Devices Inc, according to complaints. A complaint was filed
before the U.S. Supreme Court asking the Court to pass orders to disgorge the
alleged gains earned by way of insider trading, to restrain the accused from
acting as officers or directors of any issuer of securities and to pay a civil
monetary penalties under U.S. Securities Laws. He was alleged to have made more
than USD 20 million by using inside information form tipsters at companies
ranging from chip-maker Intel to rating
agency Moody’s and consultancy firm McKinsey.[24]
Hindustan lever Ltd. v. SEBI[25]
This is the case that studies insider trading by Hindustan Liver Limited (HLL), when the
company wanted a merger with its sister concern Brooke Bond Lipton India
Limited (BBLIL). This was the first ever case of insider trading in India which
was taken up by SEBI to scrutinize the manner of the involvement of a big
company, HLL. SEBI tried to establish an insider trading case against HLL
management observed that it could be conclusively stated that while entering
into the transaction for the purchase of 800,000 shares of BBLIL from the Unit
Trust of India, HLL was acting on the basis of privileged information in its possession,
regarding the impending merger of BBLIL with HLL.
On 4
August 1997, SEBI issued a show cause notice to HLL claiming that there was
prima facie evidence of the company indulging in insider trading, through the
use of ‘unpublished price sensitive information’ prior to its merger with Brooke Bond Lipton India Limited
(BBLIL). SEBI found HLL guilty of insider trading because it bought the shares
of BBLIL form Unit Trust of India with the full knowledge that two sister concerns
were going to merge. Since it bought the shares before the merger was formally
announced. SEBI held that HLL was using unpublished price sensitive
information to trade, and was therefore, guilty of insider trading. SEBI
directed HLL to pay Unit Trust of India Rs 34
million in compensation, and also initiated criminal proceedings against the
five common directors of HLL and BBLIL.[26]
Rakesh Agrawal v. SEBI[27]
Another
interesting case is that of ABS Industries. The promoter and MD, Rakesh
Agrawal, was charged in 2001 with insider trading for allegedly
purchasing his own company’s shares from the market prior to takeover deal
between ABS and Bayer of Germany. SEBI directed Agrawal to deposit INR 3.4
million to compensate ABS’ investors, besides initiating adjudication
proceeding. Agrawal challenged the SEBI order before SAT, which partially
turned down the SEBI’s ruling of imposing the penalty on Agrawal and declined
to issue any order related adjudication. SEBI later contested the SAT order in
the Supreme Court, which settled the case through a consent order, with Agarwal
paying a monetary penalty.[28]
Dilip Pendse v. SEBI[29]:
This was perhaps the simplest case
of Insider Trading which was handled by SEBI and it had no difficulties in
punishing the offenders. The facts were that Nishkalpa was a wholly owned
subsidiary of TATA Finance Ltd (TFL), which was a listed company. D. P. was the
MD of TFL. On 31/03/2001, Nishkalpa had incurred a huge loss of Rs. 79.37 crore
and this was bound to affect the profits of TFL. This was basically the
unpublished price sensitive information of which Pendse was aware. This
information was disclosed to the public only on 30/04/2001. Thus any
transaction by an Insider between the period 31/03/2001 to 30/04/2001 was bound
to fall within the scope of Insider Trading; ‘D.P.’ passed on this information
to his wife who sold 2, 90,000 shares of TFL held in her own name as well as in
the name of companies controlled by her and her father-in-law. It was very easy
for SEBI to prove Insider Trading in this cake walk or vanilla case.
PENALTIES FOR
INSIDER TRADING UNDER SEBI ACT:
The SEBI Act has basically given
two options to the board:
1. The
first being to refer the complaint for adjudication and the adjudicator may
impose a penalty not exceeding 5 lakhs rupees. The aggrieved party may prefer
an appeal to a Securities Appellate Tribunal and if necessary to the High
Court. The Act makes it clear that no civil court has jurisdiction over the
adjudication proceedings.
2. The
second option for the SEBI is to file a criminal suit against the alleged
offender before the court not inferior to the Metropolitan magistrate or
judicial magistrate. The court can impose a fine not less than 2000 rupees and
an imprisonment that shall not be less than one month but no exceeding 3 years
or with both.
SHORTCOMINGS OF SEBI REGULATIONS FOR
INSIDER TRADING:
There
have been many lacunae in the SEBI Insider Trading Regulations that have been
observed over the years, eventually making it tough for the investors to repose
their confidence in the laws designed to safeguard their rights and interests
against the practice of insider trading. SEBI has time and again encountered
difficulties in establishing and proving a case (beyond reasonable doubts in
case of criminal proceedings) to convict the person/s accused of insider
trading, substantially owing to the lack of evidence.
One of
the most famous cases highlighting the vulnerability of the SEBI’s 1992
regulations in this regard is Rakesh Agarwal v. SEBI[30]. In this famous case, Rakesh Agarwal, the Managing Director
of ABS Industries Ltd. (ABS), was involved in negotiations with Bayer A.G (a
company registered in Germany), regarding their intentions to takeover ABS.
Therefore, he had access to this unpublished price sensitive information. It
was alleged by SEBI that prior to the announcement of the acquisition, Rakesh
Agarwal, through his brother in law, Mr. I.P. Kedia had purchased shares of ABS
from the market and tendered the said shares in the open offer made by Bayer
thereby making a substantial profit. The investigations of SEBI affirmed these
allegations. Bayer AG subsequently acquired ABS. Further he was also an insider
as far as ABS is concerned. By dealing in the shares of ABS through his
brother-in-law while the information regarding the acquisition of 51% stake by
Bayer was not public, the appellant had acted in violation of Regulation 3 and
4 of the Insider Trading Regulations. Rakesh Agarwal contended that he did this
in the interests of the company. He desperately wanted this deal to click and
pursuant to Bayer’s condition to acquire at least 51% shares of ABS, he tried
his best at his personal level to supply them with the requisite number of
shares, thus, resulting in him asking his brother-in-law to buy the aforesaid
shares and later sell them to Bayer.
The
SEBI directed Rakesh Agarwal to “deposit Rs. 34,00,000 with Investor Education
& Protection Funds of Stock Exchange, Mumbai and NSE (in equal proportion
i.e. Rs. 17,00,000 in each exchange) to compensate any investor which may make
any claim subsequently.” along with a direction to “(i) initiate prosecution
under section 24 of the SEBI Act and (ii) adjudication proceedings under
section 15I read with section 15 G of the SEBI Act against the Appellant.”
On an
appeal to the Securities Appellate Tribunal (SAT), Mumbai, the Tribunal held
that the part of the order of the SEBI directing Rakesh Agarwal to pay Rs.
34,00,000 couldn’t be sustained, on the grounds that Rakesh Agarwal did that in
the interests of the company (ABS), as is mentioned in the facts above.
Similarly,
in the case of Samir C. Arora v. SEBI[31],
Mr. Arora was prohibited by the SEBI in its order not to buy, sell or deal in
securities, in any manner, directly or indirectly, for a period of five years.
Also, if Mr. Arora desired to sell the securities held by him, he required a
prior permission of SEBI.
Mr.
Arora in the Securities Appellate Tribunal contested this order of SEBI. SAT
set aside the order of SEBI on grounds of insufficient evidence to prove the
charges of insider trading and professional misconduct against Mr. Arora.
The
above mentioned cases throw light on the inability of SEBI in proving its cases
so as to prove the allegations of Insider Trading. Most of this can be
accounted to the lack of evidence in cases relating to Insider Trading in India
which make it difficult for the prosecution to prove the criminal liabilities
that may be imposed on the person accused of Insider trading. Unlike the
balance of probabilities that is required in proving a civil liability, a case
involving criminal liability requires the allegations to be proved beyond
reasonable doubts.
CONCLUSION:
Insider trading is one of the
menaces, which is difficult to tackle, and the manipulators try to find one way
or other that we can see by the HLL instance. Even after the formation of SEBI
(Insider Trading) Regulations 1992, insider trading is still rampant in the
stock markets, and clearly therefore the SEBI regulations need to be made more
comprehensive. Though SEBI has introduced the Regulations in 2002 to control
these kinds of activities which cause harm to the general investors. And we
have also seen that these SEBI regulations doesn’t have transnational
jurisdiction so it is suggested that the SEBI should come up with amendment on
the line or better than that of Securities Exchange Commission. So in future
there will be no problem. There is required greater investor education as to
the intricacies of insider trading and its ills to make an investor aware of
his rights. And the SEBI should also incorporate civil remedies against the
insiders so that it would be not difficult as in case of criminal liability.
After doing this project work, I
have come to the conclusion that whatever laws or the mechanisms be devised by
the regulatory bodies, for the preservation of price-sensitive information and
for the prevention of insider trading, the situation can never be made foolproof.
This is because for the efficient conduct of the affairs of a company or a
firm, it is essential that certain people be in possession of the price
sensitive information and other trade details which are not disclosed. And, it
becomes the duty as well as the responsibility of these people to ensure that
this information is not leaked or are not used for making undue profits. The
Indian law i.e. the SEBI Act seems to be totally inadequate. There is no
mention in the regulations about the enforcement of criminal sanction against
the directors of the foreign company, listed in domestic exchange, which has
indulged in insider trading, as the SEBI Act shall not be applicable to the
territory outside India and it shall be an extraterritorial application of this
Act.
So, according to me, in order to
curb the menace of insider trading and for the preservation of price sensitive
information, the people holding the concerned positions i.e. the directors,
officers and other members of the company should themselves take voluntary
steps and should set high standards of ethical behavior, because this is
something which can’t be imposed in any manner or the compliance of which be
made mandatory.
