‘Insider Trading’ is an unprincipled practice utilized to by those privy to certain unpublished information relating to the Company to profit at the expense of the general investors who do not have access to such information. The purpose of the current Regulations is therefore, to prevent insider trading by prohibiting dealing, communicating, counseling or procuring ‘unpublished price sensitive information’. The Company (Act) had earlier framed “The Code for Prevention of Insider Trading” as required by Regulations to be observed by the Directors and Designated Employees in the performance of their duties. This earlier code is now being amended to bring in line as required under regulation of the SECURITIES AND EXCHANGE BOARD OF INIDA (PROHIBITION OF INSIDER TRADING) REGULATIONS, 2015, where the Code of fair disclosure for the company has also been adopted by the Board of Directors, who would ensure that the management adheres to this code to make the Unpublished Price Sensitive Information (UPSI) of the Company would be available to the general public as soon as it is possible for the Company to do so.
It is well known that high standards of corporate governance and transparency are essential to the development of the capital markets. The expose of information concerning a company enables investors to take decisions regarding investments in securities of such a company. For prices of securities to accurately reflect appropriate information about a company including an essential precondition for efficient functioning of capital markets, such information should be equally available to all market participants at the same time. It is known that distortions in the market if company insiders possess superior information that they use to trade in the securities of their company, which is unavailable to the counterparties with whom they trade or the market general, and hence, the laws that prohibit insider trading are enacted. Apart from preserving the capital market efficiency, there are other justifications as well for regulating insider trading. Insider trading basically results to unfairness to investors who possess inferior information, it undermines investor confidence and integrity of the securities markets, and is also regarded as theft or misappropriation of information. Despite knowing about it, the opponents of regulating insider trading was eloquent about its virus, including the fact that it may result in greater market efficiency and operate as a form of compensating employees, thereby, motivating them to generate greater corporate performance that benefits all shareholders.
From a realistic point of view, insider trading is a noteworthy concern particularly for public listed companies in several situations. Selective information may be available to insiders within a company such as board of directors, senior officers as well as to external adviser, this could relate to negotiation of material contracts, information regarding board meetings, financial result, dividend declaration and the like as well as significant corporate transactions such as mergers and acquisitions, rights offerings and private placement of securities. From the past many years the regulations relating to insider trading and their enforcement have been substantially strengthened. In India, the first initiative to address this concern was made in 1947 through the establishment of the Thomas Committee, which were later on codified under various provisions of the Companies Act, 1956. Soon with the evolution of the corporate sector came in the establishment of Securities and Exchange Board of India (SEBI) in 1988 and in 1992 came in the SEBI Act along with SEBI (Prohibition of Insider Trading) Regulations, 1992. This led to a statutory evolution against the practice of insider trading in India. Although the initial years did not witness much prosecution, however, SEBI did initiate a high profile action against Hindustan Lever and a few had acquired shares of Brooke Bond prior to the announcement of the merger, an act that amounted to insider trading and also the laws kept on becoming stricter and tighter with time in order to cover every loophole available. In 2015 came in a major development when the SEBI brought in SEBI (Prohibition of Insider Trading) Regulations, 2015 which replaced the older regulations of 1992 and addressed most of the problems of the older regulation. In 2018, SEBI formed a committee under the Chairmanship of T.K. Viswanathan to take a deeper look into the problems of the new regulations and give its recommendations. On receiving the Committee’s report, SEBI made the latest amendments to these regulations in 2019 which are now the present laws against insider trading in India.
The role played by the demand and supply contributes in regulating the prices of the shares. This is to say that when people buy the shares of a particular company, the demand for the share increases thereby the price of the shares of that company increases in the stock market and vice versa. By investigating in a company’s share, an investor, i.e. the shareholder becomes an owner of that particular company to such extent as in relation to the value of shares held by him, and is thus, entitled to a share in the profits earned by the company, and such a share in profits that is distributed to the shareholder is known as dividends. The performance of a company is of foremost significance to the investors and the general public who might invest in the company. The Indian company law provides that a company should prepare an annual account showing the company’s trading results during the relevant arrear (section 210, Companies Act, 1956). Also it makes it necessary that the company publishes its assets and liabilities at the end of the period along with the financial results. This has been provided to ensure transparency in the functioning of the company which the shareholders also have the right to know. An Annual General Body Meeting (AGM) is kept with a view to ensure that the shareholders come together once in a year to ensure and review the working of the company. The information released in Annual Reports and Annual General Body Meetings relate to the performance of the company and hence play a valuable role in shaping the minds of existing and prospective shareholders.
The audience (general public) and shareholders get knowledge of such information only during AGM or Annual Reports or when the company announces it in a press conference etc. however, people in the company itself or otherwise concerned to the company are in possession of such information before it is actually made public. The apprehension of such UPSI in hands of people connected to the companies puts them in a dominant position over others who lack it. Such information can be used to make gains by buying shares at cheaper rates anticipating that it might rise. Similarly, it can be used to insulate themselves against losses by selling share before the prices fall down. Such transaction entered into by people having access to any unpublished information is called Insider Trading. Such trading is not based on a level playing field and can prove detrimental to the interests of the shareholders of the company. As a result, SEBI prohibited insider trading and laid down the SEBI Prohibition of Insider Trading Regulation.
The relevant provisions which govern insider trading in India are section 195 of the Companies Act, 2013 along with section 12A and 15G of the SEBI Act, 1992, and in addition to these provisions, the primary regulations which govern insider trading in India is SEBI (Prohibition of Insider Trading) Regulations, 2015. However, apart from prohibition, there are certain exceptions to insider trading that can be found in the SEBI (Prohibition of Insider Trading) Regulations, 2015. Section 12A(d) of the SEBI Act,1992 expressly prohibits insider trading while section 15G imposes a penalty of a sum ranging between ten lakhs to twenty-five lakhs rupees or a penalty of a sum which is three times the amount of profit made, whichever is higher. Section 195 of the Companies Act, 2013 also forbids insider trading in addition to defining what it is and states that a punishment of five years of imprisonment and/or a fine up to rupees twenty-five crores may be imposed on the defaulter.
Regulation 3(1) of the SEBI (Prohibition of Insider Trading) Regulations, 2015 lays down the first prohibition on insider trading and states that no insider shall communicate any UPSI relating to a company to any person. The term ‘any person’ also included other insider of the company as well. Therefore, it states that a person who is in possession of UPSI shall neither communicate such UPSI to outsiders nor insiders. However, it also point out an exception and states that such disclosure of information may be allowed in cases where such communication is made for legitimate purposes, performance of duties or discharge of legal obligations. On the recommendation of the T.S. Viswanathan committee, a few examples of legitimate expectations were added wherein such disclosure in ordinary course of business to partners, collaborators, etc., would fall under the exception. However, as mentioned under regulation 2B, any such person to whom the UPSI is disclosed to for legitimate purpose like lawyers, accountants, partners, etc. from that point will fall under the definition of insider trading and hence all prohibition of the regulation would also apply to them too. This concept can be seen to have been borrowed from the US concept of “constructive insiders” as laid down in the case of Dirks v. SEC. This case highlighted that any such person like lawyers, accountants, etc. who are de facto outsider will be elucidated as insiders from the point at which the UPSI was shared with them under ordinary course of business.
A further exception to this prohibition is sculpted out in sub-regulation 3 of regulation 3 wherein such UPSI is permitted to be disclosed or allowed access to in two circumstances. Firstly, in cases where due to the takeover regulations, obligations to make an open offer arise and the board of directors is of informed opinion that doing so would be in the best interest of the company. Secondly, in a case where no obligations arise however the board of directors feels that disclosing such information would be in the best interest of the company. In the latter case, the UPSI about a transaction should be made public atleast two days prior to the said transaction takes place. The principal thing to account here is that in both such cases the disclosure has to be made to the entire public and not a selective group. What this does it that it gives every person an equal opportunity to make full use of such information and eliminates the possibility of a few people benefitting from the information. Hence it purports to the motive of the regulation which was to avoid unlawful gain by a few.
A supreme point regarding this prohibition was highlighted by SAT in its judgement of Samir Arora v. SEBI, where Samir Arora was accused of revealing certain UPSI about a merger and eventually making a profit for himself. However, it was later found that the information disclosed by him was false or uncertain as at the day of disclosure no such merger decision had taken place. SAT ruled that since the information was false the prohibition of non-disclosure won’t be attracted as the information has to be true to constitute a UPSI and to attract a charge of insider trading.
The second prohibition against insider trading is laid down under regulation 3 sub-regulation 2 which prohibits any person i.e. member (insider) or outsider from procuring any UPSI related to a company. This prohibition goes in tandem with the first prohibition and restricts any person from getting access to UPSI regarding a company. The same exception of “legitimate purpose” has been carved out in this provision as well.
The most essential exception is the third exception that is laid down in regulation 4 which prohibits any person in possession of UPSI of a listed company from trading in securities of that company on the stock market. It was held by SAT in Chandrakala v. SEBI that if an insider deals in securities while in possession of UPSI then it would be presumed that he traded on the basis of such UPSI. However, six exceptions have been carved out to tis prohibition in regulation 4.
First, an exception has been made for an off-market inter-se transaction. These are transactions as concern between two people who are both ‘insiders’ and possess the same UPSI and have taken a conscious decision to trade. As a matter of fact both parties possess the same UPSI, there would be no unlawful gain to either as both of them have agreed to the transaction on the basis of same information i.e. UPSI. Second, the block deal window mechanism falls under the exception. Yet, such deals should again take place between two persons who both have the same UPSI as this would remove the risk of unlawful gains. Third is the exception wherein consequently the trading took place under statutory of regulatory obligations and therefore, when such trading was forced by legal requirements then the prohibition would not apply. The fourth exception provides with allowing transaction which are in furtherance of stock options. Hence, when the purchase price is pre- determined than such a prohibition on trading would not apply. This exception de facto leaves very less space for misuse and hence needs to be relooked. Fifth exception is applicable to non-individual insiders and states that when a group of insiders (where some possess UPSI) deal together, it should be justified that the insiders who indeed took the trading decisions were not in possession of UPSI and were different entities from those possessing such UPSI. Lastly, an exception is created for trades conducted on the basis of trading plan.
Trading plan is a term defined as an instrument which helps the people, who are continuously in possession of UPSI due to the nature of their job, to trade in securities. It is a tool whereby such people can plan for trades in future. What this does is that it creates a certain time lag between the trading decision and its execution due to which the UPSI which the person might possess while deciding would become publicly available and hence not lead to an unlawful gain by such person. According to regulation 5 such trading plan needs to be presented atleast six months prior to the execution of such proposed transaction. It is important to put our focus on fact that only the number of securities is decided in a plan and the value of such securities would be the value as listed on the stock market on the day of execution of the plan. Hence, in those six months, all the UPSI would be public and won’t lead to an unfair gain by the person. Also, such plan shall entail trading for a period of at least twelve months and shall have to be approved by a compliance officer who will then make a public disclosure of such plan. Such plan should also not protrude an already existing trading plan and nor shall entail any such transaction which shall lead to market abuse. It is also important to highlight that under regulation5 (4), the trading plan has been made an irrevocable instrument and once approved it has to be mandatorily enforced by the person irrespective of monetary nature i.e. profit or loss on the day of execution. However, if the UPSI which was possessed at the time of proposing the plan is still not made public on the day of execution, then such execution might be delayed.
Another issue that has exercised the minds of corporates and the regulators relates to whether a due diligence exercised can be permitted when an acquirer takes up shares in a listed company. During the analyzing process, the acquirer may come into possession of UPSI that has been disclosed by the company. This creates some incongruence because while the due diligence is an essential process to enable acquisition transactions that may be beneficial to shareholders, it results in a potential violation of the insider trading regime. Hence, in the 2015 regulations, SEBI has introduced specific safe harbor provisions that permit due diligence under controlled circumstances. The regime is bifurcated into two parts: - one where the acquisition results in a takeover offer for the company, and the other where there is no such offer. In the case of a takeover offer, the acquirer is entitled to have access to UPSI to carry out due diligence. The justification for this exception is that the acquirer makes an offer to buy shares from all shareholders who are entitled to equal treatment in terms of price. Although there is no particular need that UPSI needs to be made public before the acquirer acquires shares in the offer, necessary information needs to be disclosed to the shareholders as part of the offer in order to enable them to make a decision on whether they should divest or retain their shareholdings. In cases not involving a takeover offer, any UPSI disclosed by the company to an acquirer must be made generally available at least two trading days prior to the proposed transaction. In either case, the transaction must be subject to the fact that the acquirer shall keep the UPSI in confidence and shall not trade in the securities of the company prior to the disclosure, and also that the board of directors of the company ought to come to a conclusion that the transaction is in the interests of the company. This structure explained in the insider trading regime reconciles the interests of acquirers (who may wish to conduct due diligence) with those of other shareholders, as the acquirer must renounce any informational advantage (through a public disclosure) before it trades in the shares.
Section 3 and 3 A enumerates the various acts that an insider and company are prohibited to do so and further provides that an insider or company is prohibited to enter into. Contravention of this provision shall amount to insiders trading and is punishable as per section 24 of SEBI Act, 1992, which provides for a punishment of imprisonment for a term of up to 10 years or a fine of up to Rs. 25 Crores or both. These regulations forbid an insider and a company to ‘deal’ in certain circumstances. As per section 2(d), ‘deal’ is described as dealing in the securities to mean an act of subscribing, buying, selling or agreeing to do so by any person either as principal or agent.
An example of ‘insider trading’ can be that of when employees of law, banking, brokerage, and printing firms who were given such information to provide services to corporation whose securities they traded. Or, directors, corporate officer and employees who traded the company’s securities after learning of significant, confidentiality corporate developments.
Let us take an instance of a real-life story on Insider Trading in order to understand the concept in a better manner. Mr. Rajat Gupta, a former member of the board of directors of Goldman Sachs, was in news for a while as he was convicted of insider trading charges back in 2012. He was pressed with the charges of leaking board room meetings information about Goldman to Mr.Raj Rajaratnam, the founder of the Galleon Group and a big fund investor, who traded on the information. The information was inclusion of information about Warren Buffet’s $5 billion bailouts at the height of the crisis and prompted Mr. Rajaratnam, to barricade himself against the fluctuations in stock price. Even though Mr. Rajat Gupta was not believed to have had any real financial gain, as viewpoint of his attorneys, and that the two friends were discussing the deal in their position as investors themselves. However, the timing of it and the fact that the reveal took place before the public announcement leads to his conviction as a guilty of Insider Trading. In the same year, the Indian markets regulator, SEBI, imposed a heavy penalty of Rs. 42 lakh on a director of Acclaim Industries for clearly violating Insider Trading regulations. As per SEBI, Mr. Abhishek Mehta was managing director and promoter of the firm when the violation was observed. SEBI conducted an inquiry from January to December 2012 regarding the change in the shareholding of Mr. Abhishek Mehta after the company’s board approved the proposal of merger of the firm with Database Software Technology Pvt Ltd (DSTPL) in January 2012. During the investigation, SEBI observed that in February 2012, the Board of Acclaim Industries decided not to merge the firm with DSTPL. It was concluded that Mr. Abhishek Mehta violated insider trading norms by selling shares and reducing his shareholding in Acclaim Industries, when in possession price-sensitive information, SEBI said in an order dated January 25 and thereby imposed fine on him.
In the case of Amazon Insider Trading case, in September 2017, former Amazon.com.Inc (AMZN) financial analyst Brett Kennedy was charged with insider trading. In the said case, authorities said Kennedy gave fellow University of Washington alumni Maziar Rezakhani information on Amazon’s 2015 first quarter earnings before the release. Rezakhani paid Kennedy $10,000 for the information. In a similar case, the SEC said Rezakhani made $115,997 trading Amazon shares based on the tip from Kennedy.
On 18th January, 2019, SEBI decided to hold the promoters of the company, irrespective of their shareholding status, responsible for the violation of insider trading norms if they possess non-published price-sensitive information (UPSI) regarding the company in absence of any legitimate purpose. With this regard, SEBI clearly specified that the term ‘legitimate purpose’ will include sharing of non-published 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.
Thus, it can be concluded that the laws prohibiting the practice of insider trading have evolved to a great extent from its onset. The laws have just gotten stringent with every new legal statute and has showcased us that the authorities consider this malpractice as an alarming issue and have tried implementing new and stringent statutes to curb it. With this attitude of the authorities, it is implied that they take this issue seriously and any violation of the laws in this particular area will be dealt with great consequences. Therefore, it is important for every person engaging in stock trading to be aware of these prohibitions and exceptions as laid down in the legal statute and indulge in legal trading in order to avoid great deal of scrutiny and consequences in the future.
By Akshita Khanna