By Sonakshi Das & Sanjana Sahu
Editor’s Note: Insider Trading can simply be defined as Trading in the shares of a company by the person 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. India’s encounter with insider trading was first seen in the 1940s. To combat this, Sections 307 and 308 were incorporated in the Companies Act of 1956. Section 307 provided for maintenance of a register by the companies to record the directors’ shareholdings in the company. Section 308 prescribed to the duty of the directors and persons deemed to be the directors to make disclosure of their shareholdings in the company. This paper goes on to discuss the various committee reports with regards to insider trading, the laws and provisions dealing with it, judicial pronouncements and also presents a comparative analysis between Insider trading laws in USA, UK and India.
CHALKING THE PHASES OF INSIDER TRADING LAWS IN INDIA
The entire debate on the intricacies of insider trading dwindles in between two extreme comments; one remark by a former president of the Bombay Stock Exchange in 1992 stating that “There is no other kind of trading in India, but the insider variety”, and the statement by Mr. Arthur Levitt, the then Securities Exchange Commission (“SEC”) Chairman in 1998, “Insider trading has utterly no place in any fair-minded law-abiding economy”.
India’s encounter with insider trading was first seen in the 1940s. The Thomas Committee Report in 1948 cited instances of directors, agents, officers, auditors possessing strategic information regarding economic conditions of the company regarding the size of the dividends to be declared, or of the issue of bonus shares or the awaiting conclusion of a favorable contract prior to public disclosure.
Thus, Sections 307 and 308 were incorporated in the Companies Act of 1956. Section 307 provided for maintenance of a register by the companies to record the directors’ shareholdings in the company. Section 308 prescribed to the duty of the directors and persons deemed to be the directors to make disclosure of their shareholdings in the company. Thereafter, by the Companies Amendment Act, 1960 had extended this requirement to the shareholdings of a company’s managers as well. However, these provisions could not curb this practice of insider trading due to which the directors or managing agents making unfair use of inside information could go scot free. The absence of specific regulations in this aspect despite the recommendations of the Thomas Committee was a major deterrent.
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. This Committee opined that Sections 307 and 308 of the Companies Act were insufficient to curb insider trading.
The Patel Committee in 1986 defined Insider Trading as “Trading in the shares of a company by the person 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”. The Patel Committee also recommended that the Securities Contract (Regulation) Act (“SCRA”), 1956 may be amended to make exchanges curb insider trading and unfair insider trading and unfair stock deals. Section 21 of the SCRA mandated compliance of the conditions prescribed under the listing agreement between the company and the stock exchange. Each stock exchange can formulate its own terms and conditions of the listing agreement.
The Abid Hussain Committee in 1989 recommended that insider trading be convicted under civil and criminal laws and also that SEBI formulate the regulation and governing codes to prevent unfair deals.
The recommendations of the various committees and the needs of rapidly advancing securities market gave way to the formulation of a comprehensive legislation known as the SEBI (Insider Trading) Regulations, 1992 which after subsequent amendment in 2002 to plug certain loopholes revealed in the cases of Hindustan Lever Ltd. v. SEBI and Rakesh Agarwal v. SEBI, came to be known as SEBI ([Prohibition of] Insider Trading) Regulations, 1992 and which prohibited fraudulent practice and a person involved in insider trading to be held guilty for such malpractice.
Recently, the Securities and Exchange Board of India (SEBI) panel in 2013, headed by former Chief justice of India N. K. Sodhi suggested that trades by promoters, employees, directors and their immediate relatives would need to be disclosed internally to the company. The Justice Sodhi Committee on Insider Trading Regulations made a range of recommendations to the legal framework for prohibition of insider trading in India and focused on making this area of regulation more predictable, precise and clear by suggesting a combination of principles-based regulations and rules that are backed by principles. The Committee also suggested that each regulatory provision may be backed by a note on legislative intent.
As on date, SEBI, the market watchdog, regulates insider trading through the SEBI Act and the Insider Trading Regulations.
INSIDER TRADING: DEFINED AND DEBATED
The Patel Committee in India in 1986 defined insider trading as “the trading in the shares of a company by the person 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”
SEBI had amended the definition of ‘insider’ under Regulation 2(e) in 2008 vide the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2008. In the present statute, Regulation 2(e) of SEBI ([Prohibition of] Insider Trading) Regulations, 1992 defines an “insider” as any person who,
- is or was connected with the company or is deemed to have been connected with the company and is reasonably expected to have access to unpublished price sensitive information in respect of securities of a company, or,
- has received or has had access to such unpublished price sensitive information.
Trading which is generally read under the wide ambit of dealing in securities has been defined under Regulation 2(d) which says “dealing in securities” means an act of subscribing, buying, selling or agreeing to subscribe, buy, sell or deal in any securities by any person either as principal or agent;
Finally, in terms of definitions, the Justice Sodhi Committee seeks to clearly define the expression “trading” in order to distinguish it from the wider expression “dealing”. “Trading” means the acquisition and disposal of securities. Hence, creating a security over the shares of a company would not amount to “trading” in those securities.
In simple terms, Insider trading can be defined as a malpractice wherein trade of a company’s securities is undertaken by people who by virtue of their work have access to the otherwise non public information which can be crucial for making investment decisions. When insiders, e.g. key employees or executives who have access to the strategic information about the company, use the same for trading in the company’s stocks or securities, it is called insider trading and is highly discouraged by the Securities and Exchange Board of India to promote fair trading in the market for the benefit of the common investor.
The rationale behind the prohibition of insider trading is “the obvious need and understandable concern about the damage to public confidence which insider dealing is likely to cause and the clear intention to prevent, so far as possible, what amounts to cheating when those with inside knowledge use that knowledge to make a profit in their dealings with others.”
INSIDER TRADING: RULES AND REGULATIONS IN INDIA
The Securities and Exchange Board of India, (“SEBI”), by powers vested on it through Section 30 of the Securities and Exchange Board of India Act, 1992, has come up with the Securities and Exchange Board (Prohibition of Insider Trading) Regulations, 1992, emphasizing on the prohibition on dealing, communicating or counseling on matters relating to insider trading.
The provision clearly states that no insider shall—
- either on his own behalf or on behalf of any other person, deal in securities of a company listed on any stock exchange when in possession of any unpublished price sensitive information; or,
- communicate or counsel or procure directly or indirectly any unpublished price sensitive information to any person who while in possession of such unpublished price sensitive information shall not deal in securities:
Provided that, nothing contained above shall be applicable to any communication required in the ordinary course of business or profession or employment or under any law.
The provision also states that no company shall deal in the securities of another company or associate of that other company while in possession of any unpublished price sensitive information. Any insider who deals in securities in contravention of the provisions of regulation 3 or 3A shall be guilty of insider trading. The power of investigation vests with the Board, which can elect one or a number of members to look into the book of accounts and take suo moto cognizance of any complaint received on behalf of or against an insider.
All listed companies and organizations associated with securities market, including other intermediaries, are mandated to frame a code of internal procedures and conduct in correspondence to the Model Code.
DISCLOSURE OF INTEREST OR HOLDING BY DIRECTORS AND OFFICERS AND SUBSTANTIAL SHAREHOLDERS IN A LISTED COMPANY
Initial disclosure is to be made by
- Any person holding >5% shares or voting rights in any listed company to disclose the number of shares or voting rights held by such person, on becoming such holder, within 2 working days of receipt of intimation of allotment of shares, or, acquisition of shares or voting rights, as the case may be.
- Any person being a director or officer of a listed company to disclose the number of shares or voting rights held and positions taken in derivatives by such person and his dependents (as defined by the company), within two working days of becoming a director or officer of the company.
- Any person holding >5% shares for voting rights in any listed company to disclose to the company the number of shares or voting rights held and change in shareholding or voting rights, even if such change results in shareholding falling below 5%, if there has been change in such holdings from the last disclosure made and such change exceeds 2% of total shareholding or voting rights in the company.
- Any person who is a director or officer of a listed company, to disclose to the company and the stock exchange where the securities are listed, the total number of shares or voting rights held and change in shareholding or voting rights, if there has been a change in such holdings of such person and his dependents (as defined by the company) from the last disclosure made under sub-regulation (2) or under this sub-regulation, and the change exceeds Rs. 5 lakh in value or 25,000 shares or 1% of total shareholding or voting rights, whichever is lower.
The disclosure is to be made within two working days of the receipts of intimation of allotment of shares, or, the acquisition or sale of shares or voting rights, as the case may be.
Disclosure by company to Stock Exchanges
Every listed company, within two working days of receipt, shall disclose to all stock exchanges on which the company is listed, the information received on the above in the respective formats specified in Schedule III.
COMPARATIVE ANALYSIS OF INSIDER TRADING LAWS IN THE USA, UK AND INDIA
The US has been one of the prime enforcer of Insider Trading regulations across the world. Recently, the US has been in the limelight with certain high profile and landmark insider trading cases coming to the forefront. One case being the conviction of Mr. Rajat K. Gupta, director on the board of Goldman Sachs group, where he was found guilty of conspiracy and securities fraud for leaking boardroom secrets to a billionaire hedge fund manager and the other case where Mr. Raj Rajaratnam was held guilty of insider trading.
The Financial Services and Markets Act, 2000 (“FSMA”) and the Criminal Justice Act, 1993 (“CJA”) provide the statutory framework for insider trading regime in the UK. However, none of the two Acts define insider trading. In India, SEBI watches over the security market through SEBI Act, 1992 and SEBI ([Prohibition Of] Insider Trading) Regulations, 1992. In United Kingdom only an individual can be held liable. CJA applies to only individuals because the term ‘individual’ is defined to exclude corporations and other entities. Thus, corporations and other entities will escape criminal liability if they indulge in insider dealing. In India individuals as well as corporations can be guilty of the offence. In this regard the laws of India and United States are similar to each other.
Indian regulations are silent on when and how information is considered to be public. According to United Kingdom regulation state that information can be said to have been made public if:
- It is published in accordance with the rules of a regulation market for the purpose of informing investors and their professional advisors;
- It is contained in records which by virtue of any enactment are open to inspection by the public;
- It can be readily acquired by those likely to deal in securities (a) to which information relates (b)or an issuer to which the information relates;
- It is derived from information which has been made public.
Even through Section 53(1) of CJ Act it provides defenses against insider trading. There is no specific code to tackle insider trading in United States of America; SEC ensures that the market remain honest in order to promote investor confidence and it aimed at controlling the abuses believed to have contributed to the crash or the great depression of 1929. For example as per section 16(b) of SEC prohibits short swing profits (profits realized in any period less than six months) by corporate insiders in their own corporation stock.
Under the UK, Insider Trading laws, it will be necessary for the prosecution to establish that the individual charged with the offence of insider dealing has intentionally dealt in the securities knowing that he is connected with the company. It is no defense that the accused obtained the information without having actively sought it. Hence, the criterion for mens rea has been laid down.
But in India, a person may be convicted of the offence regardless of whether he has committed it knowingly, deliberately or intentionally, once it is established that he is an ‘insider’ within the scope of the SEBI regulations and he has committed any one of the acts prohibited by Regulation 3 and 3A. In the United States, not every corporate insider who profitably trades in a manner consistent with undisclosed information is necessarily guilty of unlawful insider trading. The burden is on the government to prove that the trading arose out of the use of confidential information. Thus, if it can be shown that the trader planned to trade prior to learning of the confidential information, and that the trader acted in accordance with that pre-existing intent, rather than as a result of the recently-learned, undisclosed information, the trader may not be guilty of unlawful insider trading.
JUDICIAL INTERPRETATION AND APPLICATION
1. Manoj Gaur vs. SEBI
Following the announcement by Jaiprakash Associates Ltd. (“JAL”) to consider interim dividend and rights issue for the year 2008-2009, Mrs. Urvashi Gaur and Mr. Sameer Gaur, wife and the brother of the executive chairman, Mr. Manoj Gaur, bought 1,000 shares and 7,400 shares respectively, when the trading window was closed. SEBI adjudicated that Mr. Manoj Gaur was in possession of Unpublished Price Sensitive Information (“UPSI”) regarding the financials of JAL and Mrs. Urvashi Gaur and Mr. Sameer Gaur dealt in the securities of JAL on the basis of such UPSI. The issue arose as to whether or not,
- The executive chairman was in possession of UPSI, leading to purchase of the disputed securities?
- The executive chairman indulged in insider trading?
- There was violation of JAL’s code of conduct?
The Securities Appellate Tribunal (“SAT”) held that closure of trading window ipso facto does not mean that there was some UPSI. However, based on the facts SAT was of the opinion that the trial balances were available to the chairman and thus, he was subjected to financials of JAL. Secondly, SAT held that there is no concrete or sufficient evidence to establish that Mrs. Gaur and Mr. Sameer Gaur have acquired the shares of JAL, on the basis of / motivated by the UPSI in the possession of Mr. Manoj. Thirdly, the ‘Model Code’ prescribes that the employees/directors shall not trade in the company’s securities when the trading window is closed. Since, Mrs. Gaur and Mr. Sameer Gaur are not employees or directors of JAL, this restriction does not apply to them. However, the code of conduct, specifically prescribed by JAL prescribes that the code is applicable to all the connected persons and persons deemed to be connected under the Insider Trading Regulations. To that extent, Mrs. Urvashi Gaur and Mr. Sameer Gaur are guilty of breaching the code of conduct of JAL by trading in the securities of JAL when the trading window was closed.
2. Gujarat NRE Mineral Resource Limited vs. SEBI
FCGL Industries Ltd. (“FCGL”), an investment company, decided to acquire certain coal mining leases in Australia, in furtherance of which, it decided to dispose of part of its investment it had in Gujarat NRE Coke Ltd. (“Coke Company”). FCGL reported of its transactions to Bombay Stock Exchange (“BSE”), however, failing to disclose the disposal of its investment in the Coke Company. FCGL’s shares were sold to Matangi Traders and Investors Ltd. (“Matangi”) and Marley Foods Pvt. Ltd. (“Marley”), where the director and chairman of FCGL were the directors as well. The issue that arose was that, whether the decision by an investment company to sell its shareholding/investment in a company and subsequent sale would amount to PSI that needs to be disclosed to the public? If yes, whether trading in securities of FCGL by Matangi and Marley was based on such UPSI?
It was held by the SAT that FCGL is an investment company whose business is only to make investments in the securities of other companies. It earns income by buying and selling securities held by it as investments. This being the normal activity of an investment company, every decision by it to buy or sell its investments would have no effect, much less material, on the price of its own securities. If that were so then no investment company would be able to function because every time it would buy or sell securities held as investments, it would have to make disclosures to the stock exchange(s) where its securities are listed. Therefore, the decision by an investment company to sell its shareholding in another company is only a decision in the ordinary course of its business and not a UPSI.
CONCLUSION- SUCCESS RATE AND REFORMS
The Indian capital market regulator, SEBI, has been attempting to crack down on insider trading for a while, but it has hardly met with any major success so far. The lack of stringent punishments for economic offences in India or the absence of adequate powers to combat these crimes has helped people accused of insider trading to either walk scot-free or get away by paying a small fine.
Market regulator Securities and Exchange Board of India formed a panel to review insider trading rules to curb the rising menace of the illegal practice. In a welcome development, the Sodhi Committee has suggested fundamental changes to current regulations, aimed at improving predictability, clarity and deterrence. Investors in capital markets rely on the concept of fair dealing and efficient markets, and this is exactly where the malady of insider trading strikes, eroding investor confidence and the integrity of the price discovery mechanism. The draft SEBI (Prohibition of Insider Trading) Regulations, 2013, proposed by the committee, seek to reshape the definition of ‘insider’. The existing regulations are vague and open to discretionary interpretation, but the revised definition is both clearer and broader. The draft regulations define an insider in two ways: one, as any ‘connected person’, and two, as any outsider is in possession of unpublished price-sensitive information.
Interestingly, the definition of a ‘connected person’ which includes someone who has been in frequent communication with the officers of a company in a contractual or fiduciary capacity, means that a person not engaged with the company in a formal capacity can still be counted as an ‘insider’. The committee has also extended the definition of a ‘connected person’ to include persons occupying statutory positions – such as a judge authorized to adjudicate a case of the company – and public servants concerned with devising a policy that could affect the market price of a company. This extended definition gives SEBI sharper teeth, and is a departure from existing regulations, under which the element of formal position has often been deemed necessary.
The draft regulations, if notified, would apply to listed companies, and companies proposed to be listed on a stock exchange. Since SEBI has jurisdiction over these companies, including overseeing the implementation of the existing regulations, it would not be hard for the regulator to implement the new insider trading norms. An important feature that may be viewed as a major relief for investors, funds and other M&A players in the listed space is the recognition provided to the exercise of ‘due diligence’. Prior to any takeover or investment, information asymmetries mean that investors are understandably cautious about a company’s legal and financial health, and thus typically conduct due diligence on the company. Although, the legality of such an exercise was never red-flagged, it still remained a contentious point from an insider trading perspective, given that price-sensitive information is disclosed throughout the due diligence process.
However, in an encouraging move, the committee has carved out an exception for due diligence in particular cases. In transactions requiring a mandatory open offer under the SEBI takeover regulations, due diligence has been specifically permitted. In other instances as well, one can instruct due diligence; however, price-sensitive information revealed in the course of the exercise has to made publicly available two days before effecting the transaction. As an additional safeguard, the nod for this exercise would also have to be given by the board of directors of the target company, who would have to ensure that the said due diligence is in the best interest of the company.
Lastly, the probative burden of establishing an insider trading violation seems to be in congruity with the existing regulations. To prove an offence, the regulator would be required to merely show that trading was done while in possession of unpublished price-sensitive information – a standard that has been in effect since 2002 in the existing regulations. Yet, this standard has been recently read down to suggest that the trade should also have been ‘on the basis of’ such sensitive information. The Committee’s recommendations have provided a transparent and detailed approach to weed out the seeds of insider trading. However, such measures when applied practically shall deliver the results which shall be indicative of the success of reforms or identify the need for even more stringent measures.
Edited by Hariharan Kumar
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 See, At paragraph 63 of Chapter VI titled ‘The Indian Security Market as It Is’ of Report on the Regulation of the Stock Exchanges in India – 1948 (P J Thomas), available at http://www.sebi.gov.in/History/HistoryReport1948.pdf/, last seen on 04/09/2014.
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 (2004) 1 Comp LJ 193 SAT, 2004 49 SCL 351 SAT
 SEBI panel prescribes stricter norms for Insider Trading, The Hindu (11/12/2013), available at /http://www.thehindu.com/business/Industry/sebi-panel-prescribes-stricter-norms-on-insider trading/article5448127.ece/, last seen on 04/09/2014.
 Supra 1.
 See, Regulation 2(c) of SEBI ([Prohibition of] Insider Trading) Regulations, 1992.
 Insider Trading, Investopedia, available at /http://www.investopedia.com/terms/i/insidertrading.asp/, last seen on 04/09/2014.
 Attorney General’s Reference No.1 of 1988 (1988) BCC 765.
 See, Regulation 3, Chapter II, The Securities and Exchange (Prohibition of Insider Trading) Regulations, 1992.
 Inserted by the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2008 w.e.f. 19-11-2008.
 Substituted by the SEBI (Insider Trading) (Amendment) Regulations, 2002, w.e.f. 20-02-2002. Prior to its substitution clause (ii) read as under:-
“(ii) communicate any unpublished price sensitive information to any person, with or without his request for such
information, except as required in the ordinary course of business or under any law”
 Inserted by the SEBI (Prohibition of Insider Trading) (Second Amendment) Regulations, 2002, w.e.f. 29-11-2002.
 See, Regulation 3A, Chapter II, The Securities and Exchange (Prohibition of Insider Trading) Regulations, 1992.
 See, Regulation 4, Chapter II, The Securities and Exchange (Prohibition of Insider Trading) Regulations, 1992.
 See, Regulation 4A, 5, Chapter II, The Securities and Exchange (Prohibition of Insider Trading) Regulations, 1992.
 As enumerated in Clause 12(1), Chapter IV, The Securities and Exchange (Prohibition of Insider Trading) Regulations, 1992.
 Schedule 1 to the Regulation of 1992.
 In Form A, Inserted by the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2003 w.e.f. 11-07-2003.
 In Form B, Substituted by the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2008 w.e.f. 19-11-2008. Prior to substitution sub-regulation (2) read as under:-
“(2) Any person who is a director or officer of a listed company, shall disclose to the company in Form B, the number of shares or voting rights held by such person, within 4 working days of becoming a director or officer of the company.”
 In Form C, Inserted by the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2003 w.e.f. 11-07-2003.
 In Form D, as annexed in The Securities and Exchange (Prohibition of Insider Trading) Regulations, 1992.
 US v. Rajat K. Gupta ,11 Cr. 907 (JSR).
 US v. Rajaratnam, No. 622 F.3d 159 (2d Cir. 2010).
 Supra 15.
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 Appeal No. 64 of 2012 (Securities Appellate Tribunal, 3/10/2012).
 Securities Appellate Tribunal, 18/11/2011.
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