Introduction:
The concept of insider trading deals with the trading of securities by the insiders of the companies. It is usual for insiders to acquire unpublished price-sensitive information (hereinafter referred to as “UPSI”) about the company while discharging their duties. They are duty-bound to protect them, but in some cases, the insiders misuse the information by dealing in securities to obtain profit or avoid losses. Although insider trading cannot entirely be eliminated, efforts have been made to prevent it. Over time, countries have voiced their opposition to these activities. The United States of America was a pioneer in effectively combating insider trading. In the United Kingdom, directors are subject to numerous duties and requirements to manage the transfer of private information. In this regard, India has also adopted a number of laws, including the SEBI Act, 1992, and the SEBI (Prohibition of Insider Trading) Regulations, 2015. The authors in this article have made an attempt to analyse Regulations 3 and 4 of the SEBI (Prohibition of Insider Trading) Regulations, 2015, with the relevant case laws.
Definition of Insider:
In general parlance, an insider is a person who is a part of the company, as they may possess confidential information about the company. As per Regulation 2(g) of the SEBI (Prohibition of Insider Trading) Regulations, 2015, the term “insider means any person who is
i) a connected person; or
ii) in possession of or having access to UPSI.”
In order to comprehend the meaning of insider, it is also necessary to grasp the meaning of connected person, UPSI, and publicly available information.
As per Regulation 2(d)(i) of the SEBI (Prohibition of Insider Trading) Regulations, 2015, the term connected person means “any person who is or has during the six months prior to the concerned act been associated with a company, directly or indirectly, in any capacity including by reason of frequent communication with its officers or by being in any contractual, fiduciary or employment relationship or by being a director, officer or an employee of the company or holds any position including a professional or business relationship between himself and the company whether temporary or permanent, that allows such person, directly or indirectly, access to unpublished price-sensitive information or is reasonably expected to allow such access”.
The Regulation 2(d)(ii) states a list of persons who shall be deemed connected persons, but such a presumption is deemed legal fiction and is rebuttable.
The Regulation 2(n) defines UPSI as “any information, relating to a company or its securities, directly or indirectly, that is not generally available which upon becoming generally available, is likely to materially affect the price of the securities and shall, ordinarily including but not restricted to, information relating to the following: –
(i) financial results;
(ii) dividends;
(iii) change in capital structure;
(iv) mergers, de-mergers, acquisitions, delistings, disposals and expansion of business and such other transactions;
(v) changes in key managerial personnel”.
It is to be noted that the above list is illustrative in nature and is not an exhaustive one.
Under Regulation 2(e), generally available information means “information that is accessible to the public on a non-discriminatory basis”. Information published on the website of a stock exchange, would ordinarily be considered generally available.
Extracts from the SEBI’s whole time member’s order regarding the definition of insider:
a) SEBI’s Whole-Time Member Order stated in 2021 that “the ways in which the association can take place to term a person as a “connected person” mentioned under Regulation 2(d)(i) are only illustrative in nature and are not exhaustive in nature.”
b) SEBI’s Whole-Time Member Order stated that “insiders can be by way of their association in any capacity, including social capacity through frequent interactions on social media. Since the directors and their close relatives regularly liked each other’s images on the social media application, i.e., Facebook, they were seen to be connected in this case.”
c) SEBI’s Whole-Time Member Order stated in 2021 that “if a cousin brother is not financially independent neither consults any connected persons regarding trading, he will not be coming within the definition of a connected person under the umbrella of an immediate relative.”
Regulation 3: Communication Or Procurement of Unpublished Price-Sensitive Information:
Regulation 3 prohibits the acquisition and communication of price-sensitive information that has not been published. The elegance of the legislation resides in the fact that it forbids both communication and procurement. It states that:
“No insider shall communicate, provide, or allow access to any unpublished price-sensitive information, relating to a company or securities listed or proposed to be listed, to any person including other insiders except where such communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations”.
“No person shall procure from or cause the communication by any insider of unpublished price-sensitive information, relating to a company or securities listed or proposed to be listed, except in furtherance of legitimate purposes, performance of duties or discharge of legal obligations”.
Let’s understand the concept of Regulation 3 through a series of questions.
What is prohibited?
Communicating, providing, or allowing access to any UPSI or procuring any UPSI is prohibited. Even communication of UPSI to any other insider is prohibited as per the Regulation.
What is the nature of information?
The information shall be either related to the company that is listed or proposed to be listed.
What are the exceptions to the general rule?
The communication or procurement of UPSI is allowed in the following instances:
a) Legitimate purpose
b) Performance of duties
c) Discharge of a legal obligation
d) The board of directors makes an informed decision, and it is in the best interest of the company to share the information in cases where there is an obligation to make an open offer.
e) Even though the transaction does not involve an obligation to make an open offer, if the board of directors is of the view that sharing UPSI is in the company’s best interest, then such communication or procurement of UPSI is permitted. However, the board of directors should mandatorily ensure that such UPSI is publicly disclosed prior to the aforesaid transaction to facilitate uniform dissemination of UPSI.
What are the measures taken to curb or prohibit insider trading?
There are various measures provided under the SEBI (Prohibition of Insider Trading) Regulations, 2015. Some of them are:
a) Regulation 3(2B) of the SEBI (Prohibition of Insider Trading) Regulations, 2015, imposes an obligation of the company to send notice to such persons who are in receipt of UPSI pursuant to “legitimate purpose” and directing such persons to maintain confidentiality of such information.
b) The board of directors of a listed company shall formulate a policy for determining “legitimate purposes” as a part of the “Codes of Fair Disclosure and Conduct” formulated under Regulation 8 of the SEBI (Prohibition of Insider Trading) Regulations, 2015.
c) Regulation 2(5) of the SEBI (Prohibition of Insider Trading) Regulations, 2015, states that the board of directors of the company shall ensure that a structured digital database (SDD) is maintained internally by the company. It shall contain information such as the nature of UPSI and the names of such persons who have shared the information, as well as the names of such persons with whom information is shared under this Regulation, along with the Permanent Account Number.
d) Section 15G of the Securities and Exchange Board of India Act, 1992, imposes hefty penalties as a deterrent for insider trading violations.
Regulation 4: Trading When in Possession of Unpublished Price-Sensitive Information
Under Regulation 4 of the SEBI (PIT) Regulations 2015, trading in securities while in possession of UPSI is prohibited. In some cases, the insiders undertake the trading of securities not for the reason that they possess UPSI but for the sole purpose of trading. Hence, Regulation 4 states certain cases where trading is permitted, and Regulation 5 deals with trading plans, where insiders can trade by submitting a prior trading plan.
Regulation 4 of SEBI (PIT) Regulations 2015 prescribes that an insider shall not trade in securities, which are listed or proposed to be listed on stock exchange, when in possession of unpublished price-sensitive information, except in the following situations:
1) It is an off-market transaction between the insiders.
Provided that:
a) both were in possession of the same UPSI.
b) there should be no breach of Regulation 3;
c) both the parties have made a conscious and informed trade decisions;
d) the information was not obtained under Regulation 3.
2) The persons who were in possession of UPSI carried out the transaction through block deal mechanism.
Provided that:
a) there should be no breach of Regulation 3;
b) both the parties have made conscious and informed trade decisions;
c) the information was not obtained under Regulation 3.
3) The transaction carried out must be bona fide, pursuant to a statutory or regulatory obligation.
4) The transaction took place while exercising the stock option, where the exercise price was predetermined.
5) Non-individuals can undertake trading:
Provided that:
a) the individuals taking trading decisions are different from the individuals who are in possession of UPSI, and
b) the individuals who are taking the decision to trade must make precautionary arrangements to prove that they were not in possession of UPSI while taking those decisions and have not breached the provisions of the SEBI (PIT) Regulations, 2015.
6) The trades were undertaken pursuant to a trading plan framed under Regulation 5.
Judicial Pronouncements:
A) Hindustan Lever Ltd. v. SEBI
a) In this case, two weeks prior to the merger of Hindustan Lever Ltd. (HLL) and Brooke Bond India Ltd. (BBIL), Hindustan Lever Ltd. (HLL) purchased 8 lakhs shares of Brooke Bond India Ltd. (BBIL) from the Unit Trust of India (UTI). SEBI undertook an investigation and alleged charges of insider trading against the executive directors and company secretary of Hindustan Lever Ltd. (HLL).
b) Arguments for HLL:
i) HLL argued that to constitute information as UPSI, it should satisfy two conditions: firstly, the information should not be published, and secondly, it should be price-sensitive information.
ii) HLL further added that the information about the merger of two companies appeared to have been generally speculated and was probably already discounted by the market. Hence, such information is not an UPSI.
c) The appellate authority, on the basis of the facts and the arguments submitted, decided that the information was not a UPSI because it was generally known and also did not materially affect the price of the securities of BBIL. Hence, there was no violation of insider trading.
B) Dilip Pendse v. SEBI
a) In the above case, Mr. Dilip Pendse was the managing director of Tata Finance Ltd. (TFL). Tata Finance Ltd. (TFL) had a wholly owned subsidiary named “Nishkalpa”.
b) The subsidiary company of TFL, i.e., Nishkalpa, incurred huge losses, which were about to affect the balance sheet of TFL.
c) Having the information regarding the losses of Nishkalpa, Mr. Dilip Pendse shared this information with his wife, who sold her and her father-in-law’s shares of Nishkalpa and gained significantly. The information was an UPSI because it was not published and was also price-sensitive information.
d) Subsequently, SEBI imposed a penalty on Mr. Dilip Pendse and found him guilty of insider trading.
C) Rakesh Agarwal v. SEBI
a) In the given case, the managing director of ABS Industries Ltd. signed an agreement with Bayer AG, a German business, to purchase 51% shares of ABS Industries Ltd.
b) Subsequently, Mr. Rakesh Agarwal sold a significant portion of the shares he held in ABS Industries Ltd. through his brother-in-law.
c) SEBI held Mr. Rakesh Agarwal guilty of insider trading, and he further appealed against the decision of SEBI before the SAT.
d) Later on, SAT decided that the act of Mr. Rakesh Agarwal was in the best interest of the company (as Bayer AG was not willing to acquire the company unless it could obtain a minimum of 51% of the shares), and he had no intention to make any gains.
e) SAT further held that even though PIT Regulations do not deal with mensrea as a component of insider trading that does not mean that the motive needs to be ignored. Hence, it was held that Mr. Rakesh Agarwal was not guilty of insider trading.
D) The Kishore Biyani Case:
a) In 2017, UPSI was involved in the Composite Scheme of Arrangement that involved Future Retail Limited, Bluerocke Services Private Limited, Praxis Home Retail Private Limited, and their shareholders
b) It led to the demerger of several Future Retail operations and was anticipated to boost the company’s stock price. Insiders, namely FCRL Employee Welfare Trust and Future Corporate Resources, traded while aware of this arrangement.
c) Kishore Biyani, founder and CEO of Future Group (brick-and-mortar retailers) and founder of retail businesses such as Pantaloon Retail and Big Bazaar, authorized the trades that Future Corporate Resources and FCRL Employee Welfare Trust traded while possessing UPSI.
d) SEBI ordered Future Corporate Resources, Kishore Biyani, and Anil Biyani to collectively disgorge a sum of over Rs 17.78 crores, with interest at a rate of 12% per year from April 20, 2020, until the date of actual payment. SEBI further prevented the notices from accessing FRL stocks for two years.
e) However, the SAT has postponed SEBI’s order that prevented Future Group CEO Kishore Biyani from accessing the securities market and directed the deposit of Rs 11 crores as an “interim measure.” Further, SAT quashed the order of SEBI.
E) SEBI v. Abhijit Rajan
a) When GIPL and Simplex Infrastructure Limited (“SIL”) were given contracts by the National Highways Authority of India (“NHAI”), Mr. Rajan was the company’s chairman and managing director of GIPL.
b) GIPL and SIL entered into two shareholders’ agreements, which were later terminated by GIPL’s board on August 9, 2013.
c) On August 22, 2013, Mr. Rajan sold shares in GIPL before this information was revealed to the stock exchanges on August 30, 2013. Following an investigation, the SEBI ordered Mr. Rajan to disgorge his illegal earnings after finding him guilty of insider trading in accordance with the 1992 Regulations.
d) In his defense, Mr. Rajan claimed that the trade was required as part of a corporate debt restructuring in order to keep the parent company of GIPL from going into bankruptcy.
e) The SAT overturned the SEBI’s decision on appeal, and the proceedings before the Supreme Court arose from the SEBI’s appeal of the SAT’s order.
f) Despite the fact that the information in question was price-sensitive, the Supreme Court concluded that Mr. Rajan’s sale of shares under the circumstances is comparable to a “distress sale” and cannot be interpreted as insider trading.
F) Securities Exchange Commission v. Rajat Gupta (INTERNATIONAL SCENARIO)
a) Rajat K. Gupta provided his business associate Rajaratnam, the founder and managing partner of Galleon Management, with access to confidential data worth billions of dollars, which Rajat had obtained while serving on the board of directors of Goldman Sachs Group, Inc.
b) The complaint claims that in September 2008, Gupta disclosed important, confidential information about Berkshire Hathaway Inc.’s $5 million investment in Goldman Sachs. Rajaratnam used the knowledge he received from Rajat to trade Galleon hedge funds profitably.
c) Rajat and Rajaratnam’s actions were illegal under Section 17(a) of the Securities Act of 1933, Exchange Act Rule 10b-5, and Section 10(b) of the Securities Exchange Act of 1934. Based on the same evidence, Gupta was convicted in a different criminal prosecution on one count of conspiracy and three counts of securities fraud.
d) Gupta was sentenced to two years in prison, one year of probation, and a $5 million USD fine on October 24, 2012. A Securities and Exchange Commission (SEC) ruling mandated that Rajaratnam pay pre-judgment interest in addition to his portion of the gains and losses he was able to prevent as a result of insider trading.
G) Rakesh Jhunjhunwala, wife, five others settle Aptech insider trading case with SEBI
a) The claim was made that Utpal Seth and Rakesh Jhunjhunwala had access to undisclosed price-sensitive information (UPSI) about Aptech’s entry into the preschool market and had shared it with other applicants.
b) On the basis of the UPSI, Rakesh Jhunjhunwala, Rekha Jhunjhunwala, Rajesh Kumar Jhunjhunwala, Shushila Devi Gupta, Sudha Gupta, and Ushma Seth Sule are alleged to have traded in the scrip of Aptech during the UPSI period.
c) The information was considered UPSI for the period starting from March 14, 2016 to September 7, 2016. On September 7, 2016, after market hours, Aptech announced on the stock exchange platform about its entry into the preschool industry.
d) The insiders who traded the scrip’s while in possession of UPSI had to pay more than ₹37 crores, which was made up of interest charges, settlement money, and the disgorgement of ill-gotten earnings. Rakesh Jhunjhunwala paid ₹9.5 crores as part of the settlement, ₹5.86 crores for the disgorgement of ill-gotten gains, and ₹3.10 crores in interest.
H) Shruti Vora, Neeraj Kumar Agarwal, Parthiv Dalal, and Aditya Omprakash Gaggar v .SEBI
a) The case involves facts wherein the appellants forwarded messages on several WhatsApp groups of the financial results of some entities within one or two days of the company finalizing the financial results.
b) The contentions set forth by the accused were the concept of “heard on the street” (“HOS”), which is a common practice among traders, market analysts, institutional investors, etc.
c) SEBI imposed a penalty of Rs. 15 lakhs each on all the appealants, stating that it was not their duty to send such messages.
d) On appeal, SAT set aside the order of SEBI on the grounds that SEBI couldn’t find the origin of the messages and was only pursuing those who forwarded them. Information may only be labeled as a UPSI if the person receiving it was aware that it was a UPSI, and SEBI has to establish “preponderance of probability” under the circumstances.
a) In this case, three persons were held guilty of insider trading by SEBI on the basis of circumstantial evidence.
b) On appeal, SAT set aside the order of SEBI on the ground that circumstantial evidence cannot be the sole reason to charge a person, or else any person with the possibility of circumstantial evidence would be charged with insider trading.
The Responsibility of Professionals in Curbing Insider Trading:
In order to maintain compliance and prevent insider trading, the company secretary plays a critical role. He is in charge of following all legal compliances, monitoring any malpractice, and keeping track of all legal documents and other paperwork pertaining to legal affairs.
In order to prevent insider trading, the company secretary will serve as a compliance officer, making sure that all legal requirements are met. The company secretary must possess in-depth knowledge of the relevant laws, rules, and modifications in order to carry out the responsibilities of a compliance officer.
a) Recently, the Securities Board of India (SEBI) penalized the compliance officer of Kwality Ltd. with a fine of Rs. 2 lakhs for failing to monitor and report instances of insider trading by promoters, directors, and designated persons of the company.
b) In 2020, the Securities Board of India (SEBI) imposed a penalty of Rs 5 lakhs on the compliance officer of Edelweiss Financial Services for not closing the trading window during the existence of the UPSI.
End Notes:
Insider trading is a major concern in both the Indian and worldwide financial markets. Illegal insider trading motivated by greed and the misuse of confidential information, poses the most serious dangers to market integrity, investor trust, and general economic stability.
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The authors have tried their level best to cover all the relevant aspects related to the topic and in case of any suggestion or improvement; the authors can be reached through mail id: learnlaw16@gmail.com
DISCLAIMER: This article is based on the relevant provisions and to the best of my knowledge at the time of preparation of this article and in no event, the author shall be liable for any direct and indirect result from this article and this is only a knowledge sharing initiative provided solely for information, this article is not a piece of professional advice or recommendation.
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