NAVIGATING INSIDER TRADING REGULATIONS: A DEEP DIVE INTO THE INDIAN LANDSCAPE

This article is written by M. Bhavana of Nmims Deemed University, Jadcherla Hyderabad, an intern under Legal Vidhiya

ABSTRACT:

This article provides a thorough descriptive examination of the complex phenomena of insider trading, a topic that has frequently sparked lively debates across many nations and is still up for discussion today. Within the purview of this article, we will delve into the fundamental elements of insider trading, clarify these elements, examine the various profiles that qualify as insiders, consider mitigation strategies, consider the legal ramifications associated with such practices, and deepen our understanding by illuminating relevant case laws. This article seeks to provide a thorough and illuminating view of the complex world of insider trading and its numerous repercussions by navigating through these wide-ranging facets.

KEYWORDS: UPSI, Chinese wall, Connected Person, Trading window, Circumstantial evidence

INTRODUCTION:

The United States of America was the first country to make legislations to regulate insider trading. This decision has surprised many around the country because many people across the country and the world were making benefits by accessing insider information. Further, many such articles were published mocking the new legislation. However, over the years many jurisdictions across the world have recognized the need to restrict insider trading in one or the other form and according to made legislation. When the term insider trading is often heard it is always taken as cynical or gloomy. It is always been debatable when insider trading can be considered legal When an insider trades their assets appropriately and ethically, while accurately reporting it and assuring no harm to the interests of investors and shareholders, the individual is generally not deemed to have engaged in insider trading. Well, it’s debatable to prove whether the person had mens rea on his part or not. As a result, this essay provides a comprehensive and varied assessment of insider trading, diving into its different dimensions, regulatory rules, and robust approaches for both prevention and watchful monitoring.

Insider trading:

Insider trading is an unethical practice of buying or selling the securities such as equity and bonds by insiders of the company. [1]An  “insider” means any person who, (i) is or was connected with the company or is deemed to have been connected with the company and is reasonably expected to have access 10[***] to unpublished price-sensitive information in respect of securities of 11[a] company, or (ii) has received or has had access to such unpublished price sensitive information ;]. [2]SEBI in the matter of KLG capital services limited has affirmed that a person would qualify as an insider if he has or have a connection with the company on the virtue that he might have access to the UPSI (unpublished price-sensitive information), also any person who has access to UPSI. [3] According to SEBI, price-sensitive information is information that is not disclosed by the company or its agents, or that is not made available to the public through print or electronic media and is of such a high public interest that it warrants disclosure Any transaction which is made by an insider by utilizing information that is not known to the public, and through which he makes economic benefits then it is called insider trading. It is basically on the price-sensitive information that is unknown to other shareholders which helps in arriving at the trading decisions. In a scenario if the price-sensitive information is out in the public that would lead to a surge or plummet the share price in the market depending upon the economic situation in the market. During that short time, the insiders who receive the sensitive information might attempt to manipulate the share prices to reap their benefits. Any such transaction which is backed by a non-public official through using insider news is completely illegal.

DISCLOSURE AND TRADING RESTRICTION:

Typically the disclosure is made at two levels, one is the immediate level of disclosure and the other is the disclosure of the transaction which are undertaken. The former is made to prevent insider trading and the latter is for revealing insider trading. The company and insiders must disclose all price-sensitive information to the public by the earliest so that fair competition is established among all the shareholders. In the case of trading restrictions, the insiders are often restricted to trading with securities, direct or indirect selling during certain times to prevent them from taking advantage of certain sensitive information. Additionally, insiders can also be prohibited from dealing with securities for a certain period till the information is out to the general public. A stricter measure is made to encapsulate the trading window and to monitor it briefly before the insiders jump into action.

REGULATION AND PROHIBITION OF TRADING IN INDIA:

The first concrete attempt was the [4]Thomas Committee in the year 1948 which evaluated the threats that happened across various countries. Sections 307 and 308 were introduced under the Companies Act 1956. This has made it compulsory for directors and managers to disclose the information but was not successful for them to prevent insider trading. Subsequently, Sachar and Patel committee was formed in 1978 and 1986 to monitor insider trading. The committee said that the person who is in the company’s management and trading in the shares based on an undisclosed price regarding the company’s working, and the information they have is not available to the general public is known as an insider. They proposed many such enactments to curb insider trading.

Regulation 4 of the insider trading Regulations talks about the insider who deals with the securities in the violations of the provision of regulation 3 or 3A that deems that a person is liable for insider trading.

Regulation 3 of the insider trading regulations prohibit insider trading through:

1. If he deals in the securities listed under the stock exchange on his behalf or behalf of any other person, he uses information that has not yet come out to the general public.
2. Get the unpublished price-sensitive information directly or indirectly to any such person who should not deal in securities for some time.
3. Regulation 3 of Insider Trading Regulations prohibits insider trading by all insiders in general, whereas Regulation 3A talks about the specific Prohibition on insider trading.

The prohibition is 2 fold: 

1. Insiders cannot trade with a listed company when it has UPSI (unpublished price-sensitive information).
2. The person who has access to the UPSI cannot pass on the information to any other person who deals with securities of the listed companies.

[5] The US court has said unequivocally that insiders who get UPSI through their connection with the corporation for corporate purposes have a fiduciary duty to the company not to misuse or misappropriate the information for their gain in an illegal manner.

CONNECTED PERSONS:

 For the prohibition of insider trading and for the regulation we need to understand who the connected persons are, Regulation 2(c) of the insider trading regulation says that connected persons can be the director of the company by section 307(10) of the companies act 1956. The person who occupies the position of the officer or as the employee of the company and who can be expected to have UPSI. Regulation 2(e) states that any connected person who can or is reasonably expected to have UPSI can be an insider, and regulation 2(c) (ii) of the insider trading regulations classifies the person who is connected as having a professional or the business relation with an organization, to be expected as having access to UPSI. Insider and connected person are sometimes used interchangeably, but there is a distinction. An “insider” is frequently someone who has sensitive information within a certain entity, but a “connected person” is someone who has broader links and affiliations that provide them with influence or access to possibilities to get access to UPSI. In the case of Hindustan lever limited vs SEBI, Hindustan Lever Limited (HLL) purchased shares of Brook Bond Lipton India Ltd. before a merger announcement, prompting suspicions of insider trading. SEBI suspected HLL had prior knowledge due to its connection with BBLIL and Unilever. The Securities Appellate Tribunal (SAT) affirmed HLL’s insider status based on its effective management alongside BBLIL. SAT recognized even healthy company mergers could impact stock prices, supporting their price-sensitive nature. The SAT’s decision prompted regulatory developments. The definition of “unpublished” information was revised under Section 2(k) to exclude speculative media reports from its scope. Additionally, a new provision, Section 2(ha), was introduced to define “price sensitive information” encompassing merger-related details, regardless of their direct impact on securities’ market prices.

Subsequently, the 2015 regulations provided a more explicit definition of “generally available information,” specifying that it should be accessible to the public on a non-discriminatory basis. This clarification helped establish a clearer distinction between insider information and widely accessible data.

 Regulations 2(h) discuss the insider trading regulation concerning the connected persons:

Other companies linked with the same group or under common management, including subsidiaries, are included.  People in prominent roles in financial institutions such as brokers, investment firms, and mutual funds, as well as their workers and officials. Employees and board members of financial institutions such as banks. Officials or workers of organizations that assist in the regulation of financial markets. Relatives of any of the individuals listed above, or the connected person themselves. The financial institutions with whom the corporation conducts its business. Partnerships, trusts, families, or organizations in which the directors or people named in 5 or 6 have significant ownership or stake.

There have always been sensible questions that popped up in the corporate field regarding whether an insider deals with securities, there is no prohibition on the insider holding the UPSI in dealing with securities but if they make gains by dealing with securities relying on UPSI information is strictly prohibited. To determine in an insider trading investigation whether an insider has dealt in securities by using UPSI is quite challenging.

SEBI regulates and prohibits the communication of UPSI to any person except if it is required under law. SEBI makes it very clear that procuring any person to trade in the securities based on UPSI is prohibited and can lead to severe penalties including fines and imprisonment

Implementation of the policy:

By conducting the insider trading monitoring committee, the committee consists of

CFO (Chief financial officer), CS (Chief Secretary), and CHRO (Chief human resource officer).

1. Oversee the general administration of the Policy.
2. Evaluate and revise the list of Designated Persons every six months, updating the Board on any alterations.
3.  Initiate inquiries into alleged violations of the Code or SEBI Regulations.
4. Set up sanctions for Designated Persons who violate the Code.
5. Penalties for Code infractions that do not violate SEBI regulations are waived.

To enforce this Code and SEBI Regulations, collect information/documents from Designated Persons, workers, and their Immediate Relatives. Cooperation refusal is viewed as a major infraction.

• If necessary, notify the Securities and Exchange Board of India of violations and steps taken. Any legal actions that authorities may take will not be impacted by the Company’s activities.

The company can also delegate the compliance officer who is in charge of following the Board’s instructions when it comes to reporting to the Board, and more especially to the Chairman of the Audit Committee and the Insider Trading Committee. In addition to setting trading blackout windows, they also respond to inquiries about the Policy and take care of insider complaints. Their responsibilities also include maintaining records, keeping track of policy compliance, and overseeing the preservation of unpublished price-sensitive information. In addition to keeping Insider records, which include a “restricted list” for trading pre-approval, they also approve disclosures to stock exchanges. In addition to carrying out additional responsibilities delegated by the Insider Trading Monitoring Committee, they support SEBI regulations and supervise Karvy’s trading tracking.

Another such thing was done by the organizations to prevent insider trading that is the Chinese wall which is a crucial mechanism employed involving the segregation of different parts of the business to ensure that no sensitive information goes out from one section to another section of the business. This is particularly for those who involve in sales, marketing, and investment advice. This policy was drafted to mitigate the risks involved in insider trading within the corporation. While the Chinese wall policy can be effective perhaps its successful implementation, clear communication, and stringent monitoring. Additionally, it would require regular auditing and reviewing which can help ensure that this policy remains effective. 

It becomes important for the employees and the director to uphold confidentiality in the case of UPSI. They must refrain from sharing whether directly such information. Access to PSI should only be limited to the one who has a legitimate need for it, in this way organizations can significantly reduce the risk of the misuse. By rebousting security for both physical and electronic records with further enhance the protection.

[6]It is established by the Supreme Court On September 19, 2022, in the case of SEBI v. Abhijit Rajan, the Hon’ble Supreme Court (SC) held that the motive of the insider to make an unlawful gain, the direction of the trade made by the insider and the reason for which such trade was carried out, are all relevant factors which should be taken into consideration to prove an insider trading charge under the SEBI (Prohibition of Insider Trading) Regulations, 1992 (1992 PIT Regulations). This makes sense that the ulterior motive and unlawful gain is an important factor for saying that someone has violated the rules and regulations. Similarly in case of Rakesh vs SEBI, the motive behind the act of insider trading is necessary and plays an important role in awarding penalties.

LEGAL IMPLICATIONS OF INSIDER TRADING:

1. Inquiries and investigation:

If SEBI suspects that there is any violation of the code by any company regarding insider trading, it can put an inquiry on that particular company, by checking records, stock exchanges etc. If further things go into the investigation it will send the notice, and appoint the investigating committee who will have access to all records from the company or a particular insider. After the investigation, the committee will send their findings to SEBI. On this SEBI will make its decision. In the case of regulation in the market, SEBI has power alike the civil court. It has the power to ask the companies, brokers, and trustees to show their accounts and can conduct inquiries, and can impose fines or cease documents.

• Trading window:

Trading restrictions can be done during specific periods for the designed people and their immediate relatives. These restrictions are applied for mitigating the risk of insider trading. The compliance officer monitors this window to ensure that illegal or unlawful trading would not happen during the specific period of interval. Trading restriction involves a notional trading window this is a specific period where the designed people are allowed to trade. The compliance officer monitors and ensures that trading is not happening during the period of unpublished sensitive information that is still not in the public domain. The closed trading window is when the compliance officer suspects that the person has UPSI and closes or prohibits the window for them. Quarterly Trading Restriction is a specific trading restriction period established, starting at the end of each quarter and lasting until 48 hours after the financial results are declared. The compliance officer must confidentially maintain the list of these securities as in the restricted list, which shall be used as the basis for approving or rejecting requests for the pre-clearance of trades. This prevents trading in the lead-up to results announcements, reduces the risk of leaks, and ensures that trading decisions are made based on publicly available information.

PENALTIES FOR NON-COMPLIANCE AND VIOLATION OF RULES AND REGULATIONS:

1. Penalty for Asset Management Companies (AMCs):

If an AMC of a mutual fund breaks the rules on what it can or cannot do, it can be fined. The penalty starts from a minimum of one lakh rupees but can go up to one crore rupees, based on the number of days the violation continues.

• Penalty for Alternative Investment Funds (AIFs), Infrastructure Investment Trusts (InvITs), and Real Estate Investment Trusts (REITs):

If anyone doesn’t follow the rules set by the regulatory Board for AIFs, InvITs, and REITs or ignores the Board’s directions, they can be penalized. The penalty begins at one lakh rupees and can go up to one crore rupees or three times the gains made from the violation, whichever is higher.

• Penalty for Investment Advisers and Research Analysts:

Investment advisers and research analysts who don’t follow the regulations established by the Board can be fined. The penalty starts from one lakh rupees and can go up to one crore rupees, depending on the number of days the failure continues.

• Penalty for Stock Brokers:

Stock brokers who don’t follow specific requirements can face penalties. These include failing to issue proper contract notes, not delivering securities or payments as specified, or charging excessive brokerage. Penalties range from one lakh rupees up to one crore rupees or five times the excess brokerage, whichever is higher.

• Penalty for Insider Trading:

Insiders who trade or share sensitive information without authorization can be penalized. The penalty starts from ten lakh rupees and can go up to twenty-five crore rupees or three times the profits made from insider trading, whichever is higher.

• Penalty for Non-Disclosure of Share Acquisition and Takeovers:

Those who fail to disclose their shareholdings, make public announcements, or complete required actions during share acquisitions can face penalties. Penalties range from ten lakh rupees up to twenty-five crore rupees or three times the profits made from the failure, whichever is higher.

• Penalty for Fraudulent and Unfair Trade Practices:

Individuals engaging in fraudulent or unfair trade practices related to securities can be fined. Penalties range from five lakh rupees up to twenty-five crore rupees or three times the profits made from such practices, whichever is higher.

• Penalty for Altering or Destroying Records and Database:

Those who intentionally alter, destroy, or disrupt records or the electronic database can be penalized. Penalties range from one lakh rupees up to ten crore rupees or three times the profits made from such actions, whichever is higher. This includes unauthorized access, introducing viruses, and damaging the regulatory database.

CIRCUMSTANTIAL EVIDENCE:

 [7]The Supreme Court in SEBI v. Kishore R. Ajmera11 (Kishore R. Ajmera case) shed more light on this aspect and held that circumstantial evidence can be sufficient to establish the existence of insider trading if it leads to an “irresistible inference” that sensitive information was provided by the tippers to tippees. Among other evidence presented before the Court, it specifically used the pattern and timing of trade as circumstantial evidence in this case, including — the volume of the trade getting effected; the details of the buying and selling orders; and the amount of time between the different orders, etc…

Notably trade patterns and timing can establish insider trading when it creates an undeniable inference of tipper-tippee information sharing. The Supreme Court’s stance underscores the importance of considering contextual factors beyond direct proof in proving such violations.

[8]In V.K. Kaul v. SEBI14, telephonic conversations, bank transactions and the timing of trades and the prices at which they were executed, and Mr. Kaul’s attempts to conceal his telephonic conversations were all taken into account to conclude that Mr. Kaul had engaged in insider trading, despite the lack of sufficient direct evidence to the same result, The aforementioned cases have therefore also laid out the limits to be kept in mind while evaluating circumstantial evidence vis-à-vis insider trading. The aforementioned cases, therefore, demonstrate a measured and prudent use of circumstantial evidence…

FUTURE DEVELOPMENT:

The emerging trends in insider trading encompass the growing utilization of advanced technology, such as AI and ML, to detect suspicious trading patterns and behaviors, enhancing companies’ compliance efforts, alongside the complex challenge of regulating insider trading in a globally interconnected securities market. This market globalization necessitates coordinated cross-border collaboration among regulators to overcome jurisdictional complexities, time zone differences, and cultural barriers, while technology-driven surveillance continues to evolve, requiring ongoing innovation and international cooperation to effectively combat evolving forms of insider trading across diverse financial landscapes.

CONCLUSION:

The landscape of insider trading in India has undergone dynamic change from 1992 to 2022. Significant legal and regulatory measures have been enacted to counter this threat and maintain market integrity. These efforts reflect a commitment to adapt and evolve as the trading environment transforms. Initial regulations were refined through strategic amendments to address evolving tactics employed by wrongdoers. Insider trading crackdowns highlighted the imperative of stringent rules, encompassing both direct and indirect practices that could distort fair competition. Technological advancements presented new challenges. The regulatory framework responded with flexibility, incorporating provisions that accommodate innovative avenues for potential misconduct. This dynamic evolution underscores India’s dedication to combating insider trading in all its forms.

 REFERENCES:

1. “(…).” (…) – Dictionary, https://www.sebi.gov.in/acts/insideregu.pdf/. Accessed 10 August 2023.
2. Insider Trading Regulations – A Primer. (n.d.). Nishith Desai Associates. Retrieved August 10, 2023, from https://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Insider_Trading_Regulations_-_A_Primer.pdf
3. Indulia, B., & Bhardwaj, P. (2023, January 3). Evaluating the Standard of Evidence Used in Insider Trading Cases | SCC Blog. SCC Online. Retrieved August 12, 2023, from https://www.scconline.com/blog/post/2023/01/03/evaluating-the-standard-of-evidence-used-in-insider-trading-cases/
4. Nunn, D. B., Vaughn, C. D., & Pulignano, V. (2017, January 9). U.S. Supreme Court Clarifies Tipper-Tippee Liability under the Securities Laws. Nelson Mullins. Retrieved August 12, 2023, from https://www.nelsonmullins.com/idea_exchange/alerts/securities_alert/all/us-supreme-court-clarifies-tipper-tippee-liability-under-the-securities-laws

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[1]https://www.sebi.gov.in/acts/insideregu.pdf

[2]WTM/MSS/ISD/18/2009

[3] Adjudication Order dated February 28, 2011 in the matter of Mr. Naval Choudhary; and Adjudication Order dated February 28, 2011 in the matter of Mr. Neeraj Jain

[4] https://www.sebi.gov.in/sebi_data/commondocs/may-2019/HistoryReport1948_p.pdf

[5] . Chiarella v. US 455 US 222

[6] https://www.mondaq.com/india/securities/1285940/supreme-court-on-insider-trading-motive-to-unfairly-gain-based-on-upsi-is-relevant#:~:text=Abhijit%20Rajan%2C%20the%20Hon’ble,insider%20trading%20charge%20under%20the

[7] http://www.scconline.com/DocumentLink/UMsBmszR

[8] http://www.scconline.com/DocumentLink/we9OMpjF