Insider Trading in India – Deficiency from Prosecution to Conviction

Pratyush Mohanty And Simran Purohit

The Objective of this article is to understand the reason behind the zero or minimal conviction rate in offences relating to Insider Trading in India. As per a RTI Reply[1] received on 23^rd November 2019 there were zero convictions in offences related to Insider Trading between 2014-2019.

In a country like India where equities worth 150,000 Crore are traded on a daily basis it is impossible to imagine that a period of 5 year goes by without a single conviction of Insider Trading. As per SEBI reports Insider Trading accounted for 7% of the total of 155 cases that were investigated during the period 2012-2013, and it accounted for 10% of the total 125 cases during the period 2002-03. The above data clearly depicts that Insider trading has always been under the radar of the SEBI i.e. the Regulatory authority of the Indian capital market however when it comes to conviction the regulator has failed to achieve the purpose with which the Prohibition of Insider Trading Regulations were laid down in the year 1992.

Many things can be blamed for such poor regulatory state of Indian capital Market such as inadequate powers with the regulatory agency, a tumbling down judicial system and more importantly lack of will power amongst the enforcement agencies.

As we know Insider Trading refers to any individual profiting from any UPSI i.e. Unpublished price sensitive information as it is unfair and discourages the common people from participating in the capital market and eventually it affects the performance of the market as companies then find it very difficult to raise capital. Insider trading also affects the economy of the nation as it has the potential to take the market to such a speculative level without having any actual base and ultimately when the Individual or the institution involved gets out then it results in a drastic shakedown of the market which ultimately affects each and every industry of the economy.

TABLE OF CONTENTS

1. Overview of the Indian Insider Trading Regulations.

• Historical overview since 1992 regulations.
• Current scenario post the 2015 Regulations

2. Reasons behind no or minimal convictions.

• Lack of legislatorial scope of SEBI during prosecution
• Crumbling Judiciary

3. Overview of the Indian Provisions with that of US

• Power and scope of the SEC
• Landmark cases

4. Conclusion and recommendation

1. Overview of the Indian Insider Trading Regulations.

• Historical overview of Provisions of Insider Trading Regulations 1992.

India’s company law was enacted in the year 1956 where the Thomas Committee had clearly pointed out the need for a special legislation to deal with the unpublished price sensitive information or the insider information. However for a law to be enacted for this specific purpose it almost took few decades. In the meanwhile such market activities was regulated through section 307 and 308 of the companies act.

In the year 1979 it was the Sachar Committee who clearly recommended a need for setting up a special legislation to regulate the market discrepancies due to inefficiency of the existing provisions which resulted in the formation of the SEBI regulations in the year 1992. Further in the year 2002 an amendment came to the light in the name of SEBI (Prohibition of Insider Trading) Regulations 1992 with the main objective to curb the practice of Insider trading.

Post such code companies also had to form their own code of conduct to prohibit Insider Trading which included appointment of a compliance officer, mechanisms for preservation of Price sensitive information, reporting of share transactions and information to SEBI in case of any violation.

This code clearly defined the term “INSIDER”[2] as company directors, officers, or someone who had atleast 10% of company’s equity shares. This definition clearly helped the SEBI to determine the liability in case of any said violation under regulation 2(e)[5]. Further the connected person was also brought under this act through regulation 2(c) along with the term price sensitive information being defined under the said act so as to determine whether the information passed was capable of affecting the company’s performance in the capital market.

After the regulations coming into force many insider activities came under the preview of SEBI and cases were registered which included the case of:-

“Rakesh Agarwal vs SEBI”,[3] “In 2003 Rakesh Agarwal, MD of ABS Industries was in talks with Bayer A.G., a German based company regarding possible takeovers of ABS meanwhile the brother-in law of Rakesh Agarwal, Mr. I.P. Kedia purchased shares from the open market and sold them post the a formal offer of Bayer thereby making a substantial profit from the unpublished price sensitive information and thus resulting in violation of regulation of 3 and 4 of the insider trading regulations to which the Securities Appellate Tribunal held him guilty on charges of Insider trading.”

“Dilip Pendese vs SEBI”,[4] “Mr.Pendese was the managing director of TFL (Tata Finance Ltd) a listed company and in the financial year ending 31^st march 2001 the company had reported a loss of around 80 crores which was going to substantially affect the company’s share price in the upcoming quarter and the said information was made public on 30^th April 2001 however Mrs.Pendese sold around 3,00,000 shares between 31^st march 2001 and 30^th april 2001 that were in her and her father-in law’s name. SEBI held the trade done in the said period to be insider trading as the information was unpublished and charges were levelled against all the accused persons. However for the final verdict to come it took more than decade and all the accused could not be punished as this case highlights the fact that SEBI lacks a thorough investigative mechanism and a vigilant approach to such cases due to which culprits are able to escape easily from the clutches of law. In most of the cases, SEBI failed to adduce evidence and corroborate its stance before the SEBI court or the SAT.”

• Current scenario post the 2015 amendments.

Over the years SEBI has also realised its shortcomings and has tried to overcome them through various amendments at regular intervals and the new Companies act of 2013 has also compelled SEBI to further revisit the existing rules and regulations so as to tighten the clutches of financial Jurisprudence in India.

The major highlight of these amendments were in regards to the UPSI i.e. (Unpublished price sensitive information) as disclosure of any such information without any legitimate purpose was deemed to be illegal post such amendment. As the amendment didn’t define the term “Legitimate purpose”, hence all publicly listed companies under the newly introduced sub-regulation 3(2A) were required to frame a policy for determining legitimate purpose. This amendment has also introduced a sub-regulation 3(2B) under which any person to whom such UPSI is communicated shall be considered an insider and due notice must be given to such insiders so as to maintain complete confidentiality of such information.

Further the new amendment under regulation 3(5) makes it mandatory for publicly listed companies to maintain a structured digital database which shall contain the names of all such persons who are recipients of such UPSI along with their PAN (Permanent Account number) or any other identification as recognised by the law.

Earlier regulation 7(2) required the directors, promoters and the employees of listed companies to make certain disclosures to the company which were to be further passed on to the stock exchange, now the same has been amended and it states that all “designated persons” to make such disclosure as it aims to widen its ambit for ensuring fair practice in the capital market.

It is also relevant to note that along with PIT regulations amendments there was a minor change under the Prohibition of fraudulent and unfair trade practice regulation 2003 (FUTP) as to expand the scope of “dealing in securities” to include any acts that are knowingly designed so as to influence decisions with respect to trade that are presumed to be fraudulent or manipulative as per Regulation 4(2) of the FUTP Regulations. This amendment tried to cover PIT regulations while sealing the ambit for bringing in the liability for any such fraudulent act.

And lastly the new regulation 9A makes it compulsory the chief executive officer, managing director or such person of a publically listed company to appoint a compliance officer who shall internally keep a check and try to prevent insider trading.[5]

These PIT (Prohibition of Insider Trading) regulation amendments were brought with the objective to specifically cause some upheaval with respect to the compliance obligations of the publicly listed companies but in vain as the concrete mechanism so as to ensure a proper conviction in case of such violation has been utterly missing ever since the inception of the legislation.

2. Reasons behind no or minimal convictions.

• Lack of legislatorial scope during prosecution

Post the 1991 liberalisation Indian Capital market began growing at an ineffable rate and due to rapid globalisation which brought in huge foreign investments but along with that there was a rapid growth of some felonious activities in the Indian capital market and insider trading happened to be one of them.

During the same time there was a rapid growth in the telecom sector and various other technological advancements were also introduced in the capital market and market participants started using this opportunity for their own gain and this resulted in market getting setbacks at regular intervals while the regulator was still struggling with the existing laws and the same can be understood from the case of Hindustan Lever limited vs SEBI [6], In this case there was merger that was to take place between HLL(Hindustan Lever Limited) and BBLIL(Brooke Bond Lipton India Limited), however before happening of such merger on 25^th March 1996 HHL purchased 8 lakh shares of BBLIL from UTI(Unit trust of India). SEBI through its order dated 11^th march 1998 found such trade to be under the scope of insider trading as HHL was an insider under section 2(e) of the 1992 regulations as both HHL and BBLIL were both subsidiaries of Unilever and it was obvious that the directors and management had complete information about the said merger and were acting on an UPSI(Unpublished price sensitive information) as defined under section 2(k) of the said regulations.

HHL filed an appeal against the SEBI order before the SAT(Securities appellate tribunal) to which the authority agreed that yes HHL was an insider in the said case but for a successful conviction of insider trading another important element also needs to be satisfied which is of UPSI. As per the 1992 regulations for an information to be considered as UPSI it should “(i) not be publicly known or published by the company (ii) if published or known then it likely to affect the prices of the securities in the market”, to which SAT held that for an information to be publicly available or known doesn’t always need to be certified or authenticated by the company and as various news had already covered the merger in their respective platforms hence the information failed to qualify the test of UPSI. Post this case in the 2002 amendments SEBI brought into force “unpublished” means information which is not published by the company or its agents and is not specific in nature.”

“Explanation.—Speculative reports in print or electronic media shall not be considered as published information.”

However this amendment failed to clearly define the term “Generally available information” which became a loophole for various entities and it was finally under the 2015 regulations when the former term got a clear definition from the regulator. More importantly under the 2015 amendments for the test of UPSI SEBI got the appropriate power to decide on a case to case basis the intent and impact of published and non published information.

For a market whose sensex has gone from 5000 to 50000 in the last 2 decades the regulator needs to be more devised but what we interpret from the above case is that a loophole that was found in the year 1998 was rectified in the year 2015. Such Red Tapism in the law making body clearly depicts the zero or minimal conviction rate in cases relating to insider trading.

The year 2021 marks 3 decades of SEBI (PIT) regulations but over the said period SEBI has clearly failed to achieve the goals of the above said legislation due to lack of proper surveillance, failure in establishing links and gathering of evidence. As per the annual report of SEBI for the year ending 31.03.2018, SEBI has taken up around 85 cases for investigation in that particular year and could complete only 25 by the year end however with the conviction rate it failed substantively due to lack of link for the communication of the UPSI and linking them with any alleged trades. On an average over the last decade the average number of cases SEBI has completed in any particular year is 15.

Ensuring a successful conviction in case of Insider trading is very difficult in any type of jurisdiction and SEBI lacks some basic investigative powers such as power for phone tapping which becomes really important when trying to establish the link and showcase the evidence for tip-off. Even till 2014 SEBI didn’t even have the power to call for phone records it was post the Sharda[7] scam the government made the necessary amendments to the Indian telegraph rules, 1951.

However with respect to power for phone tapping SEBI till date doesn’t have the power to do the same despite recommendation from Viswanathan Panel[8] in which it was clearly recommended that to a ensure successful conviction, SEBI must be given the power with proper checks and balance,but, however the central government has time and again denied the same stating such move would lead to violation of right to privacy guaranteed under article 21 of the Indian constitution. Even in the case of Dilip Pendese [9] SEBI had put forward the point for access of phone call records as due to the lack of same all the accused could not be successfully convicted, but in vain.

• Crumbling Judiciary

As of 31^st March 2020,[10] 376 cases were pending before the SEBI for action which shows the high rate of pendency under SEBI which only deals with cases pertaining to securities.

As per a SEBI report released in 2018 with respect to cases already decided and in which penalties have been already imposed, nearly 2183 entities have failed to pay penalty imposed on them for various offences related to securities market. This includes both individuals and companies and some of these cases are two decades old.

Such lop-sidedness by SEBI in enforcement of orders passed clearly defeats the purpose of the maintaining the market fair and out of malpractices.

There have also been cases where the intent of SEBI was questioned due to certain incompetency. In the case of Ashok Dayabhai shah[11] the SAT(securities appellate tribunal) clearly said “We have no hesitation in stating that Sebi as a regulator in the instant case has not performed its duties and has kept the complaint pending for more than six years, which speaks volumes by itself. The tribunal fails to fathom why the complaint could not have been decided unless Sebi officials had a vested interest in not deciding the matter.” For a complaint to be not decided for a period of 6 years itself shows the penurious state of SEBI.

Another major setback for SEBI is the huge gap in human resources as compared to SEC (Securities and exchange commission) which has 15 times more and such paucity of staff is reflected in the number of enforcement actions which the SEC completes in a particular year. In FY 2016 SEC completed 868 enforcement actions while SEBI could complete only 330 with 1800 pending enforcement actions. The staff at SEBI needs to be increased substantially to improve the efficiency rate of monitoring and completing enforcement actions.

SEBI also needs to adapt a proactive strategy in collection of evidence so as to achieve a better conviction rate for which it requires crack-teams that integrate cross-functional expertise.[12] Further SEBI also needs to heavily invest procuring high-quality professional in fields such as technology, data-science and risk prediction for which SEBI needs to provide competitive compensation packages to attract the best talents for the organisation.

3. Overview of the Indian Provisions with that of US

• Power and Scope of SEC

In the US there is no specific code for insider trading as the same is covered under anti-fraud Rule 10b-5 of the securities exchange act 1934 which gives SEC the power to ensure that the market remains completely fair and out of fraudulent practices.

The jurisdiction of SEC expands to all securities as generally outside US, capital market regulators take into consideration only the listed securities however in the states Rule 10-B which states “it shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange, To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities and Exchange] Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.”[13] Considers purchase and sale of all securities whether listed or not which widens the ambit to prevent insider trading and makes it the most comprehensive and effective insider trading regulations in the world.

In US the Insider trading laws are broadly based on 2 theories, the classical theory and the recently evolved misappropriation theory which had helped in the expansion of the SEC’s power for better enforcement of insider trading rules[14]. The misappropriation theory rests the liability on a fiduciary-turned-trader’s deception of those who entrusted him with access to confidential information and upon which he further acted in sale or purchase of the said securities. Under this theory a person is liable for insider trading if he converts for his personal use any information that has been entrusted to him and further only two elements needs to be satisfied to a successful conviction under this theory (i) there should be a fiduciary relationship between the person who trades and the source of information (ii) trading must be in breach of duty which was to not misuse that said particular information. Further SEC has also solely undergone the task of bringing insiders when the said offenders were beyond its jurisdiction. Such belligerent approach has set standards for other countries to improve their scope of enforcement as a major problem in dealing with insider trading is the territorial prohibition as the information is passed on by individuals overseas upon which foreign nationals trade through dummy or shell companies and hence it becomes nearly impossible to gather the required evidence so as to convict them.

• Landmark Cases

Over the years SEC thorough its enforcement actions has set various precedents for other developing economies so as to strengthen their capital market regulation. Some of them are:-

In SEC vs Citi Group,[15] Around 2007 citi group had started a $1 billion security which had attracted a huge number of investors but citi group had failed to disclose regarding the help in selection of assets by the bank and that it had bet against them, as the recession stuck the security went bust which resulted in loss of around $700 million to the investors. SEC immediately got a whiff of wrongdoing and brought charges against the citi group which agreed to a $285 million settlement which was subsequently rejected by the New York court considering the amount which was too small and the court also stated that such settlements where the defendants get away without any admission of guilt or wrongdoing is against the interest of general public.

This case clearly highlights the deficiencies in the Indian approach for the capital market crimes. The clear manner and the speed through which the SEC and the court handled the case is clearly in contrast with the hotchpotch manner that is usually adapted by the SEBI or the Indian Judiciary.

In the case of Securities and Exchange Commission v. Rajat K. Gupta and Raj Rajaratnam[16], in 2008 warren buffet had entered into an agreement with Goldman Sachs to pay $5 Billion in exchange for preferred shares in the company. This news was supposedly to raise the share price of Goldman Sachs and it was not to be made public till the end of the day but the moment the board approved the said deal rajat gupta transferred the same information to his friend and a hedge fund manager Raj rajaratnam who immediately bought the shares of Goldman Sachs and on the very next trading day made profit or avoided losses of around $700 million. Rajat gupta was found guilty on four out of five counts and sentenced 2 years prison along with life time ban from stock market and a hefty penalty. This case is considered to be one of the biggest financial frauds since the ivan boskey bond case and the conviction in this case was possible only because of wiretapping the conversations of Mr. Rajat Gupta. Although the SEC doesn’t have the powers of wiretapping but that didn’t stop it from producing admissible record of evidence before the court of law which would help in the conviction. In the US however the justice department can obtain the power for wiretapping through the federal court of law however in case of India the same has been time and again denied to the authorities as wiretapping is a very crucial element in the investigation of Insider trading cases.

4. Conclusion and recommendation

For developing countries like India it is very important to ensure smooth operations of its security market as for the healthy development of its economy, it’s financial market should have the confidence of the investors and it should be free from any kind of unfair practice. Further for the investors to gain confidence in market the laws governing the same market should be airtight. Although there has been significant development in India’s securities law over the last 2 decades but what can be inferred from the above paper is that SEBI is currently lacking on 2 major heads i.e. detection and prosecution.

To overcome the problem of detection SEBI needs to learn and adapt the mechanisms adapted by the western regulators and more importantly bridge the human resources gap and further departmentalise and focus on each and every aspect individually. Like for example the SEC has various divisions such as Enforcement, Economic and risk analysis, trading and markets, corporation finance and examinations. Such departmentalisation helps in increasing the effectivity and efficiency of the organisation. With regards to prosecution the government needs to give a lot more powers to the SEBI so as to ensure proper conviction with stricter punishments and the judiciary should also have a positive intent towards the protection of investors along with a pro-active approach towards enforcement of securities law.

For achieving the goal of global financial centre India should also make the reach of the jurisdiction of its securities law beyond the territory of India so as to have a global stance as in a competitive world investors will prefer the markets where the regulators are most effective.

The securities market should always be treated like the Caesar’s wife i.e. “above suspicion.”

[1] Refernce No.- SEBIH/R/2019/50846 Dated 23^rd November 2019

[2] “Section 2(e)(5) of the Prohibition of Insider Trading Regulations.

[3] “(2004) 1 CompLJ 193 SAT, 2004 49 SCL 351 SAT”

[4] “SAT APPEAL NO 80 OF 2009”

[5] Securities and Exchange Board of India (Prohibition of Insider trading) (Amendment) Regulations,2019

[6] SEBI VS Hindustan Liver Limited (1998) 18 SCL 311 MOF

[7] https://economictimes.indiatimes.com/news/economy/policy/amendment-to-sebi-act-will-give-more-power-to-watchdog-related-to-ponzi-schemes/articleshow/39785617.cms?from=mdr

[8] https://www.sebi.gov.in/reports/reports/aug-2018/report-of-committee-on-fair-market-conduct-for-public-comments_39884.html

[9] Supra 4

[10] https://economictimes.indiatimes.com/markets/stocks/news/sebi-probed-161-new-cases-in-2019-20/articleshow/80879699.cms

[11] Ashok Dayabhai Shah & Ors. vs Sebi on 14 November, 2019,BEFORE THE SECURITIES APPELLATE TRIBUNAL,MUMBAI

[12] https://www.livemint.com/Opinion/P5feaU36POSSV97V9t0Y7J/Opinion–Bridge-the-human-resources-gap-at-Sebi.html

[13] https://udel.edu/~pollack/Acct351/handouts/Securities%20Exchange%20Act%20of%201934%20&%20Rule%2010(b)5.pdf

[14] United States v. O’Hagan, 1997 WL 345229 (US)

[15] SEC v. Citigroup Inc.,Case No. 10-cv-01277-ESH (D.D.C.)

[16] Securities and Exchange Commission v. Rajat K. Gupta and Raj Rajaratnam , Civil Action No. 11-CV-7566 (SDNY) (JSR)