INSIDER TRADING REGULATIONS AND THEIR ENFORCEMENT

This article is written by Dadhirao Prerana of 2^nd Year of B.A.LL.B. of PRRLC, Osmania University, Hyderabad, an intern under Legal Vidhiya

ABSTRACT

Have you ever come across words like spy agents, espionage and many more such words? Have you ever read any articles about spy agents that made you bristle with rage? Many spectators might have encountered news presenters presenting their pieces of information on secret agents, undercover agents, intelligence officers and many more. Does that make you infuriated when you hear news that these agents have betrayed their respective countries by selling authentic information to other countries? It would certainly make you flared up.

Just imagine you are the senior manager of a reputed company. You are tasked to give valuable information to the board of directors. The company relies upon your information given to the board of directors so that they can take wise steps for the betterment of the company. One day, your rivalry company has offered you money to disclose information about your company. One can either reject the offer for trust and confidential parameters towards your company or become a conspirator.

Insider trading is access to non-public, price-sensitive information about the securities of the company that subscribes, sells, buys, or deals, or agrees to do so or counsels another to do so as principal or agent. Price-sensitive information materially affects the value of the securities.

KEYWORDS

Insider trading, Security and Exchange Commission[SEC], White Collar Crimes, The Securities and Exchange Board of India[SEBI], The Companies Act,2013

INTRODUCTION

This article aims to give thought-provoking insights on insider trading, white-collar crimes and case laws to support the information. This article demonstrates the importance of keeping confidential information to their respective company. It further gives glimpse on legal consequences for choosing the path of becoming an insider trading. The legal statues with relevant sections helps the reader to understand this article better. The reader will also understand the concept of how insider trading is a threat to global market. It is always important to have proper corporate governance and good management. Every company comprises with board of directors, shareholders holders, employees, investors,senior management, and associated with the government for Licence and so forth. The board directors play a vital role in the corporation. The board of directors must have information and hold meetings with confidentiality so that they can build confidence among investors and shareholders of their respective company. It is unethical to divulge important information outside the company. It is immoral to disclose such data which could lead negative impact to the company. Insider trading is a controversial practice which includes illegal activities like purchasing or selling shares based on important secret information that gives some people a disproportionate advantage in the corporate world. This article focuses on impact, regulations, enforcement, examples that makes the reader comprehend on the concept of usage of confidential information, fiduciary duties and Unpublished Price Sensitive Information[UPSI] as well. The article fosters to explain the concept with the assistance of relevant legal statutes that are being enforced. The article also contains some of the landmark cases for better understanding of the concept.

MEANING

Insider trading refers to the trading of a security by someone who has knowledge of material nonpublic information on the corporate firm. It is very important to have certain rules and regulations for the smooth governance of the security market. Insider Trading is the practice of using unpublished price-sensitive information of a company to trade in the company’s securities. This type of information is capable of influencing company’s securities’ price in the market. Insiders are the  persons who have access to confidential price-sensitive information in the company. Any person having any kind of professional or business relationship may become a connected person is an insider. The insiders comply with fiduciary duties generally consisting of family members, service providers or any other person on whom the company can trust. There is existence of official relationship in a company, like  auditors, shareholders, consultants, board of directors bankers, government officials, stockholders and stock exchange employees, Chief Executive Officer[CEO] and many more business personalities are entitled in the corporate field.

UNPUBLISHED PRICE SENSITIVE INFORMATION[UPSI]

UPSI means exclusive information related to a company’s stock prices, mergers and acquisitions, financial statements, information relating to shares and dividends or any kind of sensitive activities that have not been shared with the public at large, officially. When insiders are able to access the UPSI, they illegally conduct trade dealings for their personal gains and it is an unfair trade practice.

For example, Texas Gulf Sulphur Company had discovered a site near Timmins, Ontario[Canada], rich with copper ore; company officials traded heavily in the stock before the disclosure of the find. The officials were sued by the Securities and Exchange Commission and by shareholders and the United States Court of Appeals in New York contended that the company must either disclose to investors or refrain from spreading illegal information into public domain until they have access to officially share the information in the public. The members in the company are bound to follow rules and regulations in order to practise fair mechanism in their workplace^[1].

The concept of Unpublished Price Sensitive Information[UPSI] can be further be comprehended through another example. The Chief Executive Officer[CEO] purchases stocks from other company with the knowledge that soon those prices will increase, but does not disclose to public about the prices would proliferate in the market. This is an act of unfair trade practice. For pursuing fair trade practices, insider information must not be utilized by the board directors or employees or senior management with malafide[bad intentions to deceive] intentions. In Samir C. Arora v. SEBI, it was established that in order to hold an insider liable for insider trading, the UPSI needs to be authentic. Disclosure of an UPSI which ultimately turns out to be false will not come under the ambit on PIT Regulations as it does not fulfil the test of information qualifying as an UPSI.

DEVELOPMENT

In the year 1909, through the case of Strong v. Repide, arose from the non-disclosure of sale of stock in Philippine Sugar Estates Development Company to  one of the directors of the firm , Supreme Court gave the judgment that an executive could not use privileged information for profit, it did not address the issue of who was an insider. In the year 1934,Rule 10b-5 became the key provisions to prosecute illegal insider trading during United States Congress Regime under Securities Exchange Act. In the year 1983,Supreme Court backs financial analyst warned of fraud who was associated with Equity Funding. The court said the duty of a person who receives an inside tip by tippee, had breached a legal duty to the corporation’s shareholders in passing the information along was the question to solve. In the timeline of recent times, Raj Rajaratnam, the billionaire investor in  hedge funds, had received the longest prison sentence ever for insider trading. Rajat Gupta, who had run  the consulting firm McKinsey & Company was sentenced to prison for leaking boardroom secrets to Mr. Rajaratnam. The Supreme Court in Washington said that gifts of confidential information from business executives to relatives violate securities laws.

COMMITTEES

• Bhaba Committee: The committee aimed at resolving fraudulent transaction by board of directors in share trading. It emphasized on establishment on obligation for board of directors. As a result, as furtherance of recommendation of committee Section 307 and 308 were included in the Companies Act,1956.^[2]
• Sachar Committee: The committee was established for the purpose of reviewing the Companies Act, 1956 and Monopolies and Restrictive Trade Practices Act [MRTP], 1969.The committee aimed at duties of insider. The insiders of the company must confess his actual intentions and follow fair practices. The insider’s dealings of shares must have records and be registered in the company.
• Patel Committee: The committee was formed  with the aim of effective review of the dealings of stock exchanges and making recommendations in the company. The committee recognised the  need for the legal statutes on insider trading in the country.
• Abid Hussain Committee: The committee suggested the declaration of insider trading to be a punishable offence. It advised SEBI to form regulations as well. With the  recommendations given by the committee, SEBI enacted regulations to curb the practice of insider trading: –

1. SEBI [Insider Trading] Regulation-1992
2. SEBI [Substantial Acquisition of Shares & Takeover] Regulations 1994.
3. SEBI [Prohibition of Fraudulent & Unfair Trade Practice relating to securities market] Regulations-1995.^[3]

• Kumar Mangalam Birla Committee: The committee aimed at curbing the insider trading. It gave a profound contribution to the enforceability of legislation toward corporate governance.

WHITE COLLAR CRIMES

White-collar crime is an offence committed by deceit or concealment to obtain or avoid losing money or property, insider trading, accounting scandals, securities fraud, public corruption, health care fraud, mortgage fraud, or to gain a personal or business advantage. Examples of white-collar crimes include securities fraud, embezzlement, corporate fraud, and money laundering etc. Entities like Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), the Federal Bureau of Investigation (FBI), and state authorities are involved in regulating white-collar crimes^[4].Penalties for committing a white-collar crime shall include prison, fines, and restitution. For example, Vietnam property tycoon sentenced to death in a multi-billion-dollar fraud case with an estimated $27 billion in damages^[5].

Bank Fraud: It means to engage in such activities in order to defraud a bank or using illegal means to obtain assets held by financial institutions.

Blackmail: To demand for money by threatening some person to cause physical injury or exposing his secrets.

Bribery: It refers to offering money, goods or any gift to someone in order to have control over his actions. It is a crime if someone offers or accepts a bribe.

Computer Fraud: It includes such frauds which involve hacking or stealing information of some other person.

Embezzlement: It deals with when someone entrusted with money or property uses it for his own use.

Insider-Trading: When someone uses confidential information to trade in shares of publicly held corporations and for personal gain.

Money-Laundering: The concealment of origin of illegally obtained money refers to money laundering.

Tax fraud: It is defined as evading tax by providing wrong information in tax forms or illegally transferring property in order to avoid tax.^[6]

CODE OF CONDUCT

The code shall be called code for trading in the securities of a company limited by an insider (code). The person listed below shall also be deemed to be connected persons if such persons have access to UPSI :

A. An immediate relative of connected person

B. A holding company or associate company or subsidiary company

C. An investment company, trustee company, assets management company or an employee or director thereof

D. An official of a stock exchange of a corporation

E. A member of board of trustees  or a member of the board of directors of the asset management company  is an employee thereof

F. A member of the board of directors or the employee, of any corporate institution as defined in Section 2 (72) of the Companies Act, 2013^[7]

G. An official or an employee of a self-regulatory organization recognised or authorised by the SEBI;

H.  A banker of the company

I. A concern, firm, trust, company or association of persons wherein a director of the company or his immediate relative or banker of the company, has more than ten percent of the holding or interest^[8].

Designated persons  shall consist of:

A. Promoters of the corporation

B. Important Managerial Personnels

C. Employees of Secretarial Services

D. Board of Directors

E. Chief Executive Officer

REGULATIONS AND ENFORCEMENT

The formulation of Securities and Exchange Board of India(SEBI)][Insider Trading] Regulation 1992 was response to the recommendations put forth by the committees in order to advance securities market. SEBI functions as the governing body for all stock exchanges within India and is obligated to safeguard the interests of investors in the securities market regulate the stock market through appropriate regulations. The 1992 regulations have undergone multiple amendments and were eventually replaced by new rules according to the needs of the rules and regulations in the dynamic corporate world. Indian authorities encouraged investments in the market through its various agencies like, the Company Law Board [CLB], Reserve Bank of India[RBI],Securities and Exchange Board of India[SEBI] and so forth. SEBI (Prohibition of Insider Trading) Regulations, 2015 which prescribes the rules relating to prohibition and restriction of Insider Trading in India. SEBI (Prohibition of Insider Trading) (Amendments) Regulations, 2018, are applicable to dealing in securities like buying, selling or agreeing to buy, sell or deal in any securities by any person either as principal or agent, by insiders on the basis of any private confidential information. The Ministry of Corporate Affairs and SEBI Regulations for Prohibition of Insider Trading (RPIT),are the two government bodies which are responsible for regulating insider trading in India. Section 195 of Companies [Amendment]Act,2013^[9] regulates prohibition of insider trading of the securities. Whereas, at present after the amendment of the act in the year 2017,the Section 195 of the Companies Act,2017 is removed. Regulation 2(c)  provides the functions and responsibilities of  Compliance Officer. Connected Person is enforced under the SEBI (Prohibition of Insider Trading) Regulations, 2015 under the Regulation 2(d) of the Act. Regulation 4 of the SEBI (Prohibition of Insider Trading) Regulation, 2015 deals with the Insider shall not trade in securities that are listed  to be listed on a stock exchange when in possession of unpublished price-sensitive information. The Regulation 9A of the SEBI (Prohibition of Insider Trading) Regulations, 2015 deals with designated persons in relation to internal control. Chief Executive Officer[CEO] or the Managing Director or any other analogous person ensures compliance with regard to internal control^[10].Article 19 (1) (g) of the Indian Constitution^[11]confers upon every citizen the fundamental right to engage in any profession or carry out any occupation, trade, or business but should refrain from doing morally wrong practices as restrictions are stipulated in Article 19(6) of the Indian Constitution^[12].The country can boast a dynamic capital market with appropriate legal provisions and statutes. With actions aimed at protecting investors, the country fosters stability in capital markets. Section 15G in The Securities and Exchange Board of India Act, 2015^[13] is for penalty for insider trading; shall be liable for  penalty of not be less than ten lakh rupees but which may extend to twenty-five crore rupees or three[3] times the amount of profits made out of insider trading, whichever is higher. The growing legal provisions in the country contribute towards the development of the capital market. For example, SEBI fines Abhijit Pawar Rupees 10 Lakhs for alleged insider trading on stock exchanges regarding acquisitions of controlling stake by Poonawalla Group.^[14]

CASE LAWS

The case of Tata Iron and Steel Co. Ltd. etc. v. Union of India and others (1992)^[15] the court held that the profit earned by the company in the first half of the financial year of 1992-93 was fifty crores and twenty-two lakhs rupees. This profit was less than the profit earned in the financial years of 1991-92 and 1990-91, which were ₹278.16 crores and ₹238.13 crores respectively. The huge difference in the profit of the company in three consecutive years was a clear indication that there has been commission by insider trading by the company.

In SEBI v. Cabot International Capital Corporation^[16] case, Bombay High Court held that there was no element of any criminal offence. Since the proceedings pertaining to Section 15G are neither criminal nor quasi-criminal, under the SEBI Act and Regulations is established regardless of the intention of the parties, and the ‘no mens rea, no penalty’ principle is erroneous.

In Rakesh Agarwal v. SEBI^[17] case, SEBI held that the accused was not guilty of insider trading. However, the appellate authority overruled the order that the motive/intention of the insider has to be taken into consideration. According to the authority, the insider did not intend to gain any unfair advantage and therefore, was not guilty. Therefore, the appellant who traded whilst in possession of UPSI and practiced legitimate corporate purpose.

In Hindustan Lever Limited v. SEBI^[18] case, SEBI held that they were subsidiaries of the same London-based Unilever under the same management, HLL and its directors had prior knowledge of the merger.

In Reliance Industries Ltd v. SEBI^[19] case, SEBI found that  huge purchase of shares between 5th November 2001 to 16th November 2001 had not been on the basis of any insider information, RIL had violated Regulation 7(1) of the Takeover Regulations, 1997 by not informing the target company and the Stock Exchanges about its holding having crossed the threshold of 5 percent on 5th November 2001.

CONCLUSION

In the dynamic era of the corporate world, it becomes difficult to strike the balance between ethical commitments and  confidential information. With the rise of competition in the market, trading of bonds, stocks and other products are increased, eventually insider trading emerges. But, with the constant amendments of legal statutes, it becomes easier to curb the malfeasance. The detrimental consequences will last for longer period of time to the respective company. The company must follow stringent rules and regulations to restrain distorting forces, like price-rigging, insider trading, a lack of transparency in company accounts, high transaction costs, excessive speculation, administrative lapses in stock exchanges, faulty primary markets, and a variety of other issues such as cornering, wash sales, curb market dealing and so on. Over the past two decades, the laws and comprehension of insider trading have evolved significantly. The insider trading should not bar from efficient and smooth functioning of corporate governance. It is important to mitigate insider trading which might affect the healthy relationships between the company and investors. Insider trading causes pessimistic impact in the market because of the unfair advantage being used in non-public material information domain. It leads to  unfair edge, which causes loss of faith in the integrity and fairness of the financial markets. Stock price manipulation and potential harm to investors without access to confidential information have negative repercussions by the company. Every company must strive to eliminate white-collar crimes, especially insider trading so that the company can have positive growth in the market. Therefore, it is important to maintain good records in business ethics for long term safety in a company. It is eventually a growth in the company if the management has built complete trust with the investors and shareholders. The insider trading must not become a hindrance in business with unjust behavior of the management.

REFERENCES

1. https://blog.ipleaders.in/a-study-on-insider-trading-regulation/#:~:text=Insider%20trading%20refers%20to%20the,governance%20of%20the%20security%20market[last visited on 12.04.2024]
2. https://corporatefinanceinstitute.com/resources/wealth-management/what-is-insider-trading/#:~:text=Hypothetical%20Examples%20of%20Insider%20Trading,the%20information%20is%20made%20public[last visited on 12.04.2024]
3. https://www.scconline.com/blog/post/2023/09/14/sebi-prohibition-of-insider-trading-regulations-2015-major-obstacles-implementation/[last visited on 12.04.2024]
4. https://indiankanoon.org/doc/977386/[last visited on 12.04.2024]
5. https://m.economictimes.com/markets/stocks/news/sebi-fines-abhijit-pawar-rs-10-lakhs-for-alleged-insider-trading/articleshow/106911954.cms[last visited on 12.04.2024]
6. https://www.nytimes.com/interactive/2016/12/06/business/dealbook/insider-trading-timeline.html[last visited on 12.04.2024]
7. https://www.linkedin.com/pulse/overview-insider-trading-related-laws-india-lawinsiderindia-y0anc?utm_source=share&utm_medium=member_android&utm_campaign=share_via[last visited on 12.04.2024]
8. https://www.mondaq.com/india/securities/401724/mens-rea-in-insider-trading–a-sine-qua-non[last visited on 12.04.2024]
9. https://blog.ipleaders.in/insider-trading-in-india-regulations-and-controlling-authority/[last visited on 12.04.2024]
10. https://www.investopedia.com/terms/w/white-collar-crime.asp#:~:text=White%2Dcollar%20crime%20is%20a,corporate%20fraud%2C%20and%20money%20laundering[last visited on 12.04.2024]
11. https://www.thehindu.com/news/international/vietnam-property-tycoon-sentenced-to-death-in-multi-billion-dollar-fraud-case/article68053795.ece[last visited on 12.04.2024]
12. Tata Iron & Steel Co. Ltd. Etc. vs Union Of India And Others And Industrial on 23 July 1996 (AIR 1996 SC 2462)
13. Securities And Exchange Board Of India vs Cabot International Capital … on 3 March 2004 [(2004) 2 COMPLJ 363 (BOM)]
14. Rakesh Agrawal vs Securities Exchange Board Of India on 3 November, 2003 {[2004] 49 SCL 351 (SAT)}
15. Hindustan Lever Limited v. SEBI (1998) 18 SCL 311 MOF https://lawdocs.in/listen-podcast/securities-law/hindustan-lever-limited-v-sebi#:~:text=SEBI%20held%20that%2C%20since%2C%20HLL,an%20insider%20as%20above%20defined.
16. Reliance Industries Ltd. vs Securities And Exchange Board Of India on 31 August, [2004] 55 SCL 81 (SAT)https://indiankanoon.org/doc/1617079/

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^[1]Dealbook,Timeline:HistoryofInsiderTradinghttps://www.nytimes.com/interactive/2016/12/06/business/dealbook/insider-trading-timeline.html [last visited on 12 April,2024]

^[2]TanishkaTiwari, LawInsiderIN,https://www.linkedin.com/pulse/overview-insider-trading-related-laws-india-lawinsiderindia-y0anc?utm_source=share&utm_medium=member_android&utm_campaign=share_via [last visited on 12.04.2024]

^[3]MeghaDalakoti, InsiderTrading,https://blog.ipleaders.in/insider-trading-in-india-regulations-and-controlling-authority/ [last visited on 12 April 2024]

^[4] https://www.fbi.gov/investigate/white-collar-crime [last visited on 12 April 2024]

^[5]https://www.thehindu.com/news/international/vietnam-property-tycoon-sentenced-to-death-in-multi-billion-dollar-fraud-case/article68053795.ece, The Hindu [last opened on 12 April,2024]

^[6]AdamHayes, WhiteCollarCrimes,https://www.investopedia.com/terms/w/white-collar-crime.asp#:~:text=White%2Dcollar%20crime%20is%20a,corporate%20fraud%2C%20and%20money%20laundering [last visited on 12 April 2024]

^[7] The Companies 2013, Act,§2(72),Act of Parliament,2013(India)

^[8] https://investor.thyrocare.com/policies-16-copy-copy/ [last visited on 12 April 2024]

^[9] The Companies [Amendment] Act,2013,§125,Act of Parliament,2013(India)

^[10]Taxmann,https://www.taxmann.com/post/blog/overview-of-sebis-prohibition-of-insider-trading-regulations [last visited on 12 April 2024]

^[11] Indian Constitution, art. 19,§1, sub-section (g)

^[12] Indian Constitution, art.19,§6

^[13] https://indiankanoon.org/doc/977386/  [last visited on 12 April 2024]

^[14]ReenaZachariah,https://m.economictimes.com/markets/stocks/news/sebi-fines-abhijit-pawar-rs-10-lakhs-for-alleged-insider-trading/articleshow/106911954.cms,Economic Times [last opened on 12 April 2024]

^[15] Tata Iron and Steel Co. Ltd. etc. v. Union of India and others AIR 1996 SC 2462

^[16] SEBI v. Cabot International Capital Corporation [2004] 51 SCL 307 (BOM)

^[17] Rakesh Agarwal v. SEBI (2004) 1 COMPLJ 193 (SAT)

^[18] Hindustan Lever Limited v. SEBI (1998) 18 SCL 311 MOF

^[19] Reliance Industries Ltd v. SEBI [2004] 55 SCL 81 (SAT)

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