INSIDER TRADING: JOURNEY OF LEGAL FRAMEWORK TO CHECK THE PRACTICE

Insider trading in India coexisted with trading since the inception of the stock market, only to be recognized as a prejudicial practice in the late ’70s. Sachar Committee (1977) set the ball rolling by mentioning in its report that company employees may have some price-sensitive information to manipulate stock prices, which may cause financial misfortunes to the investors. Since earlier, the laws under the Company’s Act and then under the SEBI Act it was regulated. However, many reports still claim, India has not been able to keep a check on the practice even though there were many amendments. The lastamendment came into effect on April 1, 2019.

Sachar committee constituted by the Government by the Ministry of Law, Justice and Company Affairs to suggest changes to the Companies Act, 1956 and the Monopolies Restrictive Trade Practices Act then. The modifications suggested concerning section 307 and section 308 of the Companies Act, 1956 are as follows:

Section 307 of the Companies Act

The report mentioned that the law should provide that an insider mentioned below should be prohibited from purchasing or selling shares of the company, either directly or indirectly, two months prior to the ‘closing of the accounting year ‘of the company and for a period of two months thereafter. This is roughly the period when the confidential information would be available to the insider.

8.28 We recommend the following modifications in section 307 to achieve the objectives:-

(i) Any Director– Statutory Auditor, Cost Auditor, Financial Accountant or ‘Financial Controller, Cost Accountant, Tax and Management Consultant or. Adviser and whole-time legal Adviser or Solicitor of the company and any private company, partnership firm/joint venture or trust in which the above category of persons have any pecuniary interest should, before actual purchase or sale, notify in writing the Board of Directors of the company his or their intention to buy or sell the shares of the company.

(ii) Full disclosure as to the number of shares, the price at which they were bought or sold shall be made by persons mentioned above to the shareholders of the company by annexing a suitable statement to the published accounts.

(iii) The requirements mentioned above should apply to the spouse and dependent children of persons mentioned above.

(iv) Any Director, Statutory Auditor, Cost Auditor, Financial Accountant or Financial Controller, Cost Accountant, Tax and Management Consultant or Adviser and whole-time Legal Adviser or Solicitor and any private company, partnership firm/joint venture or trust in which the above category of persons have any pecuniary interest should be prohibited from either purchasing or selling the shares of the company, two months prior to the closing of the accounting year of the company and for a period of two months thereafter. Such prohibition should extend for a period of two months prior to any Rights issue or Bonus issue also.

(v) If for any compelling reasons the Director, Statutory Auditor, Cost Auditor, Financial Accountant or Financial Controller, Cost Accountant, Tax and Management Consultant or Adviser and whole-time Legal Adviser or Solicitor and any private company, partnership firm/joint venture or trust in which the above category of persons have any pecuniary interest, desire to buy or sell the shares of the company within the prohibited period, he or they must give prior intimation in writing of the proposal to purchase or sell to the Board. If the Board does not, within the period of fifteen days from the date of receipt of such notice at the registered office of the company, refuse permission, the person concerned would be entitled to sell or purchase shares in the company within the prohibited period, as proposed.

(vi) The spouse and dependent children of the persons referred to above should also be subject to a similar disability during the specified periods.

An Explanation for section 195: Prohibition on insider trading of securities

Explanation.—For the purposes of this section-

(a) “insider trading” means—

(i) an act of subscribing, buying, selling, dealing or agreeing to subscribe, buy, sell or deal in any securities by any director or key managerial personnel, or any other officer of a company either as principal or agent if such director or key managerial personnel or any other officer of the company is reasonably expected to have access to any non-public price-sensitive information in respect of securities of the company; or

(ii) an act of counselling about procuring or communicating directly or indirectly any non-public price-sensitive information to any person;

(b) “price-sensitive information” means any information which relates, directly or indirectly, to a company and which if published is likely to materially affect the price of securities of the company.

(2) If any person contravenes the provisions of this section, he shall be punishable with imprisonment for a term which may extend to five years or with fine which shall not be less than five lakh rupees but which may extend to twenty-five crore rupees or three time the amount of profits made out of insider trading, whichever is higher, or with both.”

However, by way of the Companies Amendment Act, 2017- section 195 was omitted.

The reason why section 195 of the Act was added

“During the preparation of the Bill, it was observed that at present the offence of insider trading has not been defined in any statute. Though this term has been referred to and prohibited in the SEBI Act, 1992, the definition and other detailed requirements for ‘insider trading’ have been provided in relevant regulations framed by SEBI. Since regulation of insider trading is an important matter for good corporate governance, the provisions in this regard in the context of prohibitions for directors and KMPs have been provided in the Bill without referring to any regulatory provisions framed by SEBI. It is not the intention to modify the existing regulatory structure formulated by SEBI on this matter, which may continue as it is. Given the above, keeping in view the need and appropriateness for enabling provisions on offence relating to insider trading to be provided in the principal legislation for corporate entities, the provisions may not be considered to be deleted from the Bill..”

Further section 458 of Companies Act, 2013 dealt with “Delegation by Central Government of its Powers and Functions” to enforce the provisions contained in section 194 and section 195 delegated to Securities and Exchange Board for listed companies or the companies which intend to get their securities listed. However, by way of the Companies Amendment Act, 2017 the proviso was omitted.

The Securities Exchange Board Of India Act, 1992 was enacted to provide for the establishment of a Board to protect the interests of investors in securities and to promote the development of, and to regulate, the securities market and for matters connected therewith or incidental thereto.

CONNECTED PERSON

Regulation 2 (d) of SEBI (Prohibition Of Insider Trading) Regulations 2015 defines “connected person” as:

any person who is or has during the six months before 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.

Without prejudice to the generality of the foregoing, the persons falling within the following categories shall be deemed to be connected persons unless the contrary is established, –

(a) an immediate relative of connected persons specified in clause (i); or

(b) a holding company or associate company or a subsidiary company; or

(c) an intermediary as specified in section 12 of the Act or an employee or director thereof; or

(d) an investment company, trustee company, asset management company or an employee or director thereof; or

(e) an official of a stock exchange or of clearing house or corporation; or

(f) a member of the board of trustees of a mutual fund or a member of the board of directors of the asset management company of a mutual fund or is an employee thereof; or

(g) a member of the board of directors or an employee, of a public financial institution as defined in section 2 (72) of the Companies Act, 2013; or

(h) an official or an employee of a self-regulatory organization recognised or authorized by the Board; or

(i) a banker of the company; or

(j) a concern, firm, trust, Hindu undivided family, company or association of persons wherein a director of a company or his immediate relative or banker of the company, has more than ten per cent of the holding or interest”

UNPUBLISHED PRICE SENSITIVE INFORMATION

Regulation 2 (n) of SEBI (Prohibition Of Insider Trading) Regulations 2015 defines “unpublished price sensitive information” means 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, demergers, acquisitions, delistings, disposals and expansion of business and such other transactions;

(v) changes in key managerial personnel”

APPELLATE MECHANISM

Section 15T of the Act deals with Appeal to the Securities Appellate Tribunal states that any person aggrieved may prefer an appeal to a Securities Appellate Tribunal having jurisdiction in the matter.”

Section 15Y of the Act deals with Civil Court not to have jurisdiction.

Section 15Z of the Act deals with Appeal to the Supreme Court from order or decision of the SAT within sixty days from the date of communication of the decision or order of the Securities Appellate Tribunal to him on any question of law arising out of such order. Provided that the Supreme Court may, if it is satisfied that the applicant was prevented by sufficient cause from filing the appeal within the said period, allow it to be filed within a further period not exceeding sixty days”

United States Of America

Section 20 A of Securities Exchange Act, 1934 deals with the Liability To Contemporaneous Traders For Insider Trading: The total amount of damages imposed under the subsection shall not exceed the profit gained or loss avoided in the transaction or transactions that are the subject of the violation. The total amount of damages imposed shall also be diminished by the amount as per the law. No action may be brought after more than 5 years after the date of the last transaction that is the subject of the violation. This section shall not be construed to bar or limit in any manner any action by the Commission or the Attorney General under any other provision of this title, nor shall it bar or limit in any manner any action to recover penalties, or to seek any other order regarding penalties.”

Section 21A of the Act above also deals with, “Civil Penalties For Insider Trading”

(3) AMOUNT OF PENALTY FOR CONTROLLING PERSON.—The amount of the penalty which may be imposed on any person who, at the time of the violation, directly or indirectly controlled the person who committed such violation, shall be determined by the court in light of the facts and circ*mstances, but shall not exceed the greater of $1,000,000, or three times the amount of the profit gained or loss avoided as a result of such controlled person’s violation. If such controlled person’s violation was a violation by communication, the profit gained or loss avoided as a result of the violation shall, for purposes of this paragraph only, be deemed to be limited to the profit gained or loss avoided by the person or persons to whom the controlled person-directed such communication.”

United Kingdom

Financial Service Management Act, 2000

The Financial Service Management Act, 2000 was introduced to fill the gaps in the Criminal Justice Act dealing with insider trading. The Financial Service Management Act, 2000 made the offence of market abuse applicable to legal entities and natural persons. It also introduced the wider offence of market abuse: this covers insider dealing, disclosing inside information, dissemination of false and misleading information, employing fictitious devices, and market distortion. However, as a result of the exit of UK from European Union Many of the definitions for regulated activities and entities used in FSMA, will need to be fixed so that they reflect the UK’s position as a standalone regulatory regime outside of the single market for financial services since they are dependent on provisions in EU legislation, or use definitions based on an activity being carried out within the EU’s single market for financial services.

Rakesh Agarwal vs. SEBI (2004) 49 SCL 351 SAT

Facts of the Case: Bayer had to acquire a controlling stake in ABS in October 1996 by (a) 55,80,000 shares in the allotment made on a preferential basis by ABS (@ Rs.70/-). 20% shares from the existing shareholders @ Rs.80/- per share in a public offer. Before the acquisition of ABS by Bayer, Mr I.P Kedia, brother in law of the Appellant purchased 1,82,500 shares at the behest of the appellant which was funded by the appellant too. The shares were acquired based on unpublished price sensitive information relating to impending takeover of ABS by Bayer, available to the Appellant by his position as the Managing Director of ABS and also as the negotiator from the side of ABS, in the negotiations with Bayer.

Decision Of SAT:

“One of the indicators of that unfair advantage was making a profit. Consequently, if the dealing in securities was not with a view to misuse the information or gain unfairly from the use of the information or to use the information to make a profit, that dealing in securities was not prohibited or covered by Regulation 3. The impugned transactions were undertaken by the Appellant in the discharge of his fiduciary obligations as a director with a view to save the company and to ensure its survival as going concerned. The object of the transaction was clearly bonafide and to achieve the Corporate purpose.”

Samir C. Arora v. SEBI

The case relates to SEBI’s charges of insider trading against Samir Arora, a top fund manager in the late ‘90s. A decade ago, SEBI barred Samir Arora-the, former fund manager of Alliance Capital Management, from the securities market for five years, but within months, the order was set aside by the Securities Appellate Tribunal (SAT). In 2004, SEBI moved the Supreme Court challenging the SAT decision. On April 2, the apex court, in its final order, set aside SEBI’s appeal on the grounds that Arora has not been trading during the period he was banned from participating in the Indian stock market. Senior counsel C A Sundaram who appeared for Arora told the court that for all these years, the order passed by SEBI was not given effect to and Arora now operates his business from Singapore and, in these circ*mstances, there is nothing that deserves to be decided on merits in the appeal.

Issues: Whether Shri Samir C. Arora is guilty of violating the provisions of Regulation 3 of SEBI (Prohibition of Insider Trading) Regulations, 1992?

Decision Of SAT: “In respect of the third charge of insider trading we have come to the conclusion that even the price-sensitive information which the appellant is alleged to have somehow accessed did not turn out to be correct information because the merger was not announced on May 12, 2003. The information which finally turns out to be false or at least uncertain cannot even be labelled as information.

Supreme Court: Having regard to the fact that the Samir Arora has not traded in the Indian market for the period August 2003 to July 2005, we are satisfied that at this distance of time, there is no justifiable reason to interfere with the impugned order,” said a division bench comprising Justices RM Lodha and Shiva Kriti Singh.

Chintalapati Srinivasa Raju Vs SEBI (Civil Appeal No 16805 of 2017)

The issue involved is whether appellants who were Promoters and directors of the Satyam Computer Services Ltd. were liable as an “insider”. Having knowledge of undisclosed price sensitive Information (“UPSI”), as a result of which they stood to gain by selling their shares at an inflated value. SEBI vide an Order dated September 10, 2015, had debarred the appellants for a period of 7 years and also directed them to disgorge unlawful gains as quantified therein, in respect of violations of securities laws committed by them.

The Hon’ble Supreme Court concerning the definition of, “Insider” held that

“In the present case, the new 2015 Regulations also throw considerable light on the definition of “insider”, as an insider is now defined to mean only a person who is a connected person or a person who is in possession of or having access to unpublished price sensitive information. Obviously, post-2015, an “insider” need not satisfy the second test of the 1992 Regulations and it is enough that such a person be a “connected person” as defined. The disjunctive “or” contained in the 2015 Regulations must be contrasted with the expression “and” contained in the 1992 Regulations.”

Further concerning “access to price-sensitive information”, the court observed that, “ 11.Further, under the second part of Regulation 2(e)(i), the connected person must be “reasonably expected” to have access to unpublished price sensitive information. The expression “reasonably expected” cannot be a mere ipse dixit – there must be material to show that such a person can reasonably be so expected to have access to unpublished price sensitive information. Hon’ble Court in this regard, accepted the submissions of SEBI that in cases like the present, a reasonable expectation to be in the know of things can only be based on reasonable inferences drawn from foundational facts and inter alia reiterated its observation regarding the standard of evidence made in the matter of SEBI v. Kishore R Ajmera (2016) 6 SCC 368 that the test would always be that what inferential process that a reasonable/prudent man would adapt to conclude.

Further, Regulation 3 of SEBI (Prohibition Of Insider Trading) Regulations 2015 under clause (2B) considers, “Any person in receipt of unpublished price sensitive information pursuant to a “legitimate purpose” shall be considered an “insider” for purposes of these regulations and due notice shall be given to such persons to maintain the confidentiality of such unpublished price sensitive information in compliance with these regulations.”

To sustain investor’s confidence in the integrity of the security market, the practice of insider trading is prohibited in law. The rationale behind the prohibition of insider trading as quoted by Lord Lane in Attorney General’s Reference No.1 of 1988 (1988) BCC 765 is

“the obvious 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 dealing with others“

In India, time and again Committees were established by the Government of India to recommend and look into the regulatory framework for insider trading. In 1948, the Thomas Committee recommended the strengthening of disclosure mechanism under Company Law in line with the similar recommendation of the Cohen Committee in the United Kingdom.

In June 1977, the Sachar Committee opined that Section 307 and 308 of Companies Act, 1956 was insufficient to curb the malaise of insider dealing and recommended fuller disclosure of transactions by those who have price sensitive information and prohibition of dealings by such persons during specific periods.

The Government of India constituted the Patel Committee that recommended insider trading should be regulated and declared as an offence having statutory prohibition and prevent such activities, stock exchange authorities should be empowered, by law, to take disciplinary action themselves and to file civil and criminal proceedings against offenders so that they do not go unpunished. Another recommendation made by it was that persons misusing inside information also be compelled by law to surrender to the stock exchanges, the profit that they may have made or the amount equivalent to the losses that they have averted.

Abid Hussain Committee in 1989 was considered as the gateway to the introduction of insider trading laws in India and recommended that it could be tackled to large extent by appropriate regulatory measures and thus proposed that insider trading be made an offence with both civil and criminal penalties. It stated that the Securities and Exchange Board of India should formulate necessary legislation wherein it is empowered with the authority to enforce the provision.

THE CODE OF CONDUCT ON INSIDER TRADING

Schedule B of SEBI (Prevention Of Insider Trading) Regulations’2015 deals with Minimum Standards for Code of Conduct [for Listed Companies] to Regulate, Monitor and Report Trading by Designated Persons.

“4. Designated persons may execute trades subject to compliance with these regulations. Towards this end, a notional trading window shall be used as an instrument of monitoring trading by the designated persons. The trading window shall be closed when the compliance officer determines that a designated person or class of designated persons can reasonably be expected to have possession of unpublished price sensitive information. Such closure shall be imposed about such securities to which such unpublished price sensitive information relates. Designated persons and their immediate relatives shall not trade in securities when the trading window is closed.

The timing for re-opening of the trading window shall be determined by the compliance officer taking into account various factors including the unpublished price sensitive information in question becoming generally available and being capable of assimilation by the market, which in any event shall not be earlier than forty-eight hours after the information becomes generally available.

When the trading window is open, trading by designated persons shall be subject to pre-clearance by the compliance officer, if the value of the proposed trades is above such thresholds as the board of directors may stipulate.”

CASES WHERE UNPUBLISHED PRICE SENSITIVE REGULATION CAN BE COMMUNICATED

Regulation 3 (3) of SEBI (Prohibition Of Insider Trading) Regulations 2015 acknowledges the necessity of communicating, providing, allowing access to or procuring unpublished price sensitive information for substantial transactions such as takeovers, mergers and acquisitions involving trading in securities and change of control to assess a potential investment. However, as per sub-regulation 4 of regulation 3, imposes a mandate on the board of directors to require the parties to execute agreements to contract confidentiality and non-disclosure obligations on the part of such parties. Such parties are required to keep information so received confidential, except for sub-regulation (3), and shall not otherwise trade in securities of the company when in possession of unpublished price sensitive information.

The last change was effected in 2018 when SEBI (Prohibition of Insider Trading)(Amendment) Regulations, 2018 were inserted that came into effect from April 1, 2019.

The following changes were made :

Sub Regulation (5) of Regulation 3 states that “The board of directors shall ensure that a structured digital database is maintained containing the names of such persons or entities as the case may be with whom information is shared under this regulation along with the Permanent Account Number or any other identifier authorized by law where Permanent Account Number is not available. Such databases shall be maintained with adequate internal controls and checks such as time stamping and audit trails to ensure non-tampering of the database”

Sub Regulation 2A of Regulation 3: “The board of directors of a listed company shall make a policy for determination of “legitimate purposes” as a part of “Codes of Fair Disclosure and Conduct” formulated under regulation 8.”

Explanation to the defines “legitimate purpose” to shall include sharing of unpublished price sensitive information in the ordinary course of business by an insider with partners, collaborators, lenders, customers, suppliers, merchant bankers, legal advisors, auditors, insolvency professionals or other advisors or consultants, provided that such sharing has not been carried out to evade or circumvent the prohibitions of these regulations.

Sub Regulation 1 of Regulation 9 that deals with the Code Of Conduct state that,

“The board of directors of every listed company and [the board of directors or head(s) of the organisation of every intermediary shall ensure that the chief executive officer or managing director shall formulate a code of conduct with their approval to regulate, monitor and report trading by its designated persons and immediate relatives of designated persons towards achieving compliance with these regulations, adopting the minimum standards set out in Schedule B (in case of a listed company) and Schedule C (in case of an intermediary)] to these regulations, without diluting the provisions of these regulations in any manner.”

SEBI’S PROPOSED INFORMANT MECHANISM

SEBI, on 10th June, issued a ‘Discussion Paper’ proposing to reward informants who under the amnesty protection policy provide true, complete, credible, original, effective information on insider trading violations. The reward shall be paid from the Investor Protection and Education Fund (“IPEF”). The policy is being implemented by amending the SEBI (Prohibition of Insider Trading) Regulations, 2015.

The salient features of the discussion paper are as follows:

Voluntary Information Disclosure Form: The informant will have to submit the details of complete information of the act of the communication of the UPSI or trading in violation of the code of conduct if it has occurred, is occurring or he has a reasonable belief that it is about to occur. The source of the information must also be disclosed.

Office of Informant Protection (OIP): An independent office separate from the investigation and inspection wings may be established to devise the policy relating to the receipt of VIDF.

Confidentiality of the informant: It shall be protected through the OIP.

Reporting and Hotline: The OIP has to submit a report of its functioning on an annual basis to the Board. A hotline to guide people to file information shall also be set up.

Reward: The total amount of reward shall be ten per cent of the monies collected but shall not exceed ₹ 1 crore or such higher amount as may be specified. The informant would be eligible for a reward in case the information revealed by him is in compliance with the informant policy and leads to the disgorgement of at least Rs. 5 Crores as a result of such information.

Quantum of Reward: An interim reward not exceeding Rs 10 lakh may be given at the stage of issuance of the final order by the SEBI against the person directed to disgorge. The final reward shall be issued after the collection or recovery of the monies disgorged equal at least twice the final reward.

Exemption from disclosure under RTI under section 8(1)(g) and 8(1)(h) of the Right to Information Act, 2005.

PENALTIES FOR INSIDER TRADING

Section 15G of the Act deals with Penalty For Insider Trading-if any insider indulges in insider trading as per law prevailing 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.

Section 24 of the Act deals with Offences and states that, if any person contravenes or attempts to contravene or abets the contravention of the provisions of this Act or any rules or regulations made thereunder, he shall be punishable with imprisonment for a term which may extend to ten years, or with fine, which may extend to twenty-five crore rupees or with both. Further, sub-section, If any person fails to pay the penalty imposed by the adjudicating officer or fails to comply with any of his directions or orders, he shall be punishable with imprisonment for a term which shall not be less than one month but which may extend to ten years, or with fine, which may extend to twenty-five crore rupees or with both].”

In the last three decades of SEBI’s existence, the conviction rate has been very low. Over the years, laws for Prevention of Insider Trading laws have evolved, several changes by putting the increased onus on the companies to protect price-sensitive information. SEBI’s amnesty protection policy for informants on insider trading violations is also part of the Regulation. Despite all such efforts, SEBI lacks proper surveillance tools, challenges in establishing links and gathering evidence. Agreeing with the fact that Insider trading is tough to detect and punish in any jurisdiction as it is, but the fact that SEBI has not been empowered with proper investigative powers and tools is a major reason behind the low prosecution. Legal experts also say proving insider trading charges are very difficult because of the evidentiary requirements in such cases. In insider trading, you must have crystal clear facts. You cannot base your case on possibilities. SEBI must have a case on facts or strong evidence before it moves the higher court. Unlike in many countries, no insider trader in India has faced criminal prosecution, which may have emboldened offenders.

AUTHOR OF THE ARTICLEADV. SHRUTI KAKKARJunior Legal Research Associate, Indian Law WatchShruti is BA LL.B from Guru Gobind Singh University pass out. She has been in top three winner positions in several reputed competitions of law.

INSIDER TRADING: JOURNEY OF LEGAL FRAMEWORK TO CHECK THE PRACTICE - Indian Law Watch (2024)