Concept of Insider Trading
If a person overhears material information from employees of the Company. As long as he has no connection with such employees, cannot regarded as Insider Trading.
Mere Communication of Appointment or Removal of few directors or employees of the Company which does not affect the price and worth of the securities of such Company, shall not constitute Insider Trading.
Insider Trading means dealing in securities of the Company on the basis of Confidential Information i.e. Unpublished Price Sensitive Information which if it had been published would have materially affected price of the securities of the Company.
Discussion on Insider Trading invariably bails down to conflict between fairness and efficiency. The Stock Market is able to work in an efficient way when all investors have same information, which creates “Level Play Field”. It is notably unfair to permit trading of securities where individuals are differently informed.
Necessity to Regulate Insider Trading and Informed Speculation
A debate rages in the financial community whether insider trading is good or bad for markets? Whether it is favorable for Corporates? Whether it is gainful or lossmaking pace for investors?
Critics of Insider Trading claims that it makes the market more efficient. As insider and others with non-public information buy or sell the shares of the Corporates and prospective investors can do the same, it could be win-win situation for everyone.
Whereas discussion against the statement clarifies that Insiders can be in position to rob other investors who does not have non-public information. For instance, buying or selling call or put options on the basis of information. If non-public information became widely known before insider trading occurred. The market would integrate that information, resulting in accurately priced securities.
Critics also claims that Laws against insider trading, especially when vigorously enforced, can result in innocent people going to prison. As rules become more complex, it becomes harder to know what is or is not legal and accidentally break the law. However, it cannot be deprived of the fact that Insider Trading is significantly breach of fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security.
Investors with nonpublic information would be able to avoid losses and benefit from gains. However, Public might perceive market as unfair and confidence in the financial system could undermine. Retail investors would not be able to invest in such rigged market.
Insider Trading encompasses legal as well as prohibited activities. Blanket prohibition of Insider Trading would not be reasonable as it would defy logic of freely tradable securities. However, distinction is required to be drawn between what is permitted and what is not.
Securities Market Scams and Insider Trading
Presence of Insider Trading cannot be denied in popular securities market scams in India. Insider Trading steps as foundation to following scams-
Harshad Mehta Scam- In 1998, SEBI initiated charge for insider trading against Harshad Mehta and the executives of three companies, namely Sterlite, BPL, and Videocon. Those companies resorted to insider trading to push their scripts prices. Share prices of those companies rose up to 137%, 232%, and 41% respectively though BSE Sensex.
Ketan Parek Scam- In 2001, Ketan Parek was found to be involved in Insider Trading, Circular Trading and Pump & Dump Trading. For which he was penalized and sentenced to rigorous imprisonment of one year.
Satyam Scandal– In this case, SEBI has directed Ramalinga Raju (former chairman and CEO of Satyam Computer Services) and four others to deposit with it a sum of ₹2,350 crore with interest for insider trading and unfair manipulation of the company’s financials and stock prices.
Legal Remedies to Prohibit Insider Trading
Before 1929, Access to inside information and its use for personal benefits were regarded as perks of office and the benefits of having reached a high stage in life.
United States of America was the first country to recognize detrimental effect of Insider Trading. In 1934 and 1942 Securities Exchange Act, 1934 (SEC) was enacted and Rule-10b-5 extends prohibition of fraud to Purchase Securities. On Nov 8, 1961 SEC holds “tipping” as violation of rule 10b-5 in Candy Roberts and Co.
In 1948, India has also recognized harm that Insider Trading can inflict upon rights of the public shareholders, corporate governance and the financial markets. Such recognition and actions are discussed in following phases-
First Phase – In 1948, The Thomas Committee had constituted under the chairmanship of Mr. P.J. Thomas. Pursuant to the recommendation of the Thomas Committee, sections 307 and 308 were introduced in the Companies Act 1956. This change paved way for certain mandatory disclosures by directors and managers, but was not very effective in achieving the objective of preventing insider trading.
Second Phase – In 1978, The Sachar Committee had constituted to recommend separate statue for curbing Insider Trading.
Third Phase – In 1986, The Patel Committee had 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.
Fourth Phase – In 1989, The Abid Hussain Committee had recommended that a person guilty of insider trading should be penalized, both in the form of civil and criminal proceeding.
On the basis of the recommendations made by these committees, a comprehensive legislation, ‘SEBI (Insider Trading) Regulations, 1992 was promulgated and brought in to force.
Fifth Phase – In order to plug certain loopholes revealed in the case of Hindustan Lever Ltd. v. SEBI and Rakesh Agarwal v. SEBI , regulation was amended and renamed as SEBI (Prohibition of Insider Trading) Regulations, 1992.
Sixth Phase–
Regulation 3 of SEBI (Prohibition of Insider Trading) Regulations, 2015 prescribes 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.
Regulation-4 of SEBI (Prohibition of Insider Trading) Regulations, 2015 prescribes that
The insider may prove his innocence by demonstrating the circumstances including the following: –
(i) The transaction is an off-market inter-se transfer between insiders who were in possession of the same unpublished price sensitive information without being in breach of regulation 3 and both parties had made a conscious and informed trade decision.
(ii) The transaction was carried out through the block deal window mechanism between persons who were in possession of the unpublished price sensitive information without being in breach of regulation 3 and both parties had made a conscious and informed trade decision.
(iii) The transaction in question was carried out pursuant to a statutory or regulatory obligation to carry out a bona fide transaction.
(iv) The transaction in question was undertaken pursuant to the exercise of stock options in respect of which the exercise price was pre-determined in compliance with applicable regulations.
(v) The trades were pursuant to a trading plan set up in accordance with Regulation 5.
Regulation-6 of SEBI (Prohibition of Insider Trading) Regulations, 2015 deals with general provisions relating to disclosures of trading by insiders
Initial Disclosures– Every promoter, member of the promoter group, key managerial personnel and director of every company whose securities are listed on any recognized stock exchange, shall disclose his holding of securities of the company as on the date of these regulations taking effect, to the company, within 30 days of these regulations taking effect.
Every person on appointment as key managerial personnel or a director of the company or upon becoming a promoter or member of the promoter group, shall disclose his holding of securities of the company as on the date of appointment or becoming a promoter, to the company, within 7 days of such appointment or becoming a promoter.
Continual Disclosures- Every promoter, member of the promoter group, designated person and director of every company shall disclose to the company the number of such securities acquired or disposed of, within two trading days of such transaction if the value of the securities traded, whether in one transaction or a series of transactions over any calendar quarter, aggregates to a traded value in excess of ten lakh rupees or such other value as may be specified.
Every company shall notify the particulars of such trading to the stock exchange on which the securities are listed, within two trading days of receipt of the disclosure or from becoming aware of such information.
Penal Provisions- As per Section 15G of the SEBI Act, 1992 If any insider who deals in a securities of listed entity on the basis of unpublished price sensitive information or communicates unpublished price sensitive information to any other person, or counsels or procures for any other person on the basis of unpublished price sensitive information, shall be liable to a penalty which shall not be less than ten lakh rupees but which may extend to twenty-five crore rupees or three times the amount of profits made out of insider trading, whichever is higher.
Appeal- Violation of the provisions of these regulations attract huge monetary penalty and may lead to criminal prosecution. However, those aggrieved by an order of SEBI, may prefer an appeal to the Securities Appellate Tribunal within a period of forty-five days of the order.
Corporate Code of Conduct
Schedule B of these regulations lays down the following minimum standards for Code of Conduct for listed companies to regulate monitor and report trading by designated persons-
1. The compliance officer shall report to the board of directors and in particular, shall provide reports to the Chairman of the Audit Committee, if any, or to the Chairman of the board of directors at such frequency as may be stipulated by the board of directors but not less than once in a year.
2. The code of conduct shall contain norms for appropriate Chinese Walls procedures, and processes for permitting any designated person to “cross the wall”.
3. The code of conduct shall stipulate such formats as the board of directors deems necessary for making applications for pre-clearance, reporting of trades executed, reporting of decisions not to trade after securing pre-clearance, and for reporting level of holdings in securities at such intervals as may be determined as being necessary to monitor compliance with these regulations.
4. The code of conduct shall stipulate the sanctions and disciplinary actions, including wage freeze, suspension recovery, claw-back etc. that may be imposed, by the listed company required to formulate a code of conduct for the contravention of the code of conduct.
5. Listed entities shall have a process for how and when people are brought ‘inside’ on sensitive transactions. Individuals should be made aware of the duties and responsibilities attached to the receipt of Inside Information, and the liability that attaches to misuse or unwarranted use of such information.
6. In case of group, separate code may be adopted for listed company and each of intermediaries as applicable to the concerned entity
Recent Attempts to Stock Manipulation and Insider Trading
WhatsApp Leak Case-
- During November 2017, SEBI took note of articles in mainstream media alleging circulation of unpublished price sensitive information (UPSI) on various private WhatsApp groups, including a ‘Market Chatter’ group, about certain companies ahead of their official announcements on stock exchanges.
- Consequently, SEBI has conducted search and seizure operations and found around 12 companies whose earnings data and other financial information got leaked on WhatsApp, out of which the leaks in relation to Ambuja Cements Limited, Bajaj Auto Limited and Bata Limited became the subject matter of the SEBI Orders.
- The accused in these orders had asserted that the data in the WhatsApp messages was not UPSI but ‘heard on the street’ (“HOS”). HOS is a practice in the brokerage circle wherein unverified market gossip and common parlances are shared in the media, including WhatsApp and other channels.
- Analyzing the concept of HOS in the instant case, the SEBI Orders have noted that as opposed to HOS:
(i) The information here was not generally available in the public domain, but was being circulated in a closed group; and
(ii) The information was not shown to be arising from any market research or publicly available data.
The regulator has further held that the accused, who are reasonably expected to be well acquainted with the working of the securities market and nature of sensitive information, cannot claim ignorance regarding the nature and materiality of information received and forwarded by them.
CNBC Show “Stock 20-20” Case-
- The stock market regulator found that CNBC Awaaz show host Hemant Ghai along with his wife Jaya Hemant Ghai and mother Shyam Mohini Ghai employed a scheme to conduct fraudulent or unfair trading based on the advance information pertaining to recommendations to be made in the show “stock-20-20″.
- On an analysis of the trading pattern in the trading account of Jaya Hemant Ghai and Shyam Mohini Ghai for the period between January 1, 2019, and May 31, 2020, high correlation of their trades was observed with the stocks recommended in the show. It thereby generated the proceeds of Rs 2.95 crore by carrying out fraudulent trading in respect of recommended stocks.
- Through such activities, they violated the provisions of Sebi PFUTP (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, the regulator said. These individuals have been “restrained from buying, selling or dealing in securities, either directly or indirectly, in any manner whatsoever till further directions”, the regulator said.
- Network18 group that runs CNBC Awaaz takes its commitment to honesty and integrity seriously. They refused to tolerate any behavior which does not conform to the highest standards of professional and ethical conduct. Mr Ghai was also a signatory to such code of conduct. And, they have terminated Mr Ghai within hours of becoming aware of the SEBI order”.
The Way Forward
In order to crack any case of insider trading, SEBI first needs to establish who is an insider, which is basically any person connected with company in any position, like key managerial personnel, board of directors, auditors, promoters and Connected Persons. Then, SEBI needs to understand what constituted as UPSI in any case and this could be anything which can affect the price of securities like merger or acquisition, any deal or financial information etc. Lastly it checks who traded on the basis of UPSI. Laws for prevention of insider trading have evolved and are evolving over the decades and there is more onus on companies now to protect UPSI.
Present laws are unable to make strict effect on insider trading malpractice due to fact that SEBI does not have basic investigative powers leading to low prosecution. For instance, SEBI does not have the power to tap phone records.
Robustness of these Regulations is yet to be tested and the pathway to bring India’s insider trading regime at par with that of developed markets globally seems blurred, if not dark.
References
1. SEBI (Prohibition of Insider Trading) Regulations, 1992
2. SEBI (Prohibition of Insider Trading) Regulations, 2015 and Amendments
3. Charted Secretary (November, 1992) (February, 2015)
4. Media News Reports by Money Life
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