Sunday, August 11, 2013


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 which is unpublished.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.


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have been connected with the company, and who is reasonably expected to have access, by virtue of such connection, to unpublished price sensitive information[5] in respect of securities of the company, or who has received or had access to such unpublished price sensitive information.”[6]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.

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 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.


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.


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.


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).


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.

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.


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.

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.

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.

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.

1 comment:

  1. I am happy to find your distinguished way of writing the post. Now you make it easy for me to understand and implement the concept. Thank you for the post.
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