Insider Trading

"The concept of Insider trading is disappearing now as so many brokers are doing it and it is impossible to jail them all. Now it is called smart trading." quoted by Max Barry, a contemporary Australian author.

Insider trading is not a crime and it is completely legal unless and until the trader is not cashing upon some price sensitive and unpublished information which is not available to the general public. When a person having access to confidential information, uses the same for his individual gains, it becomes illegal.

According to the SEBI (Prohibition of Insider Trading) Regulations, 1992, "An insider means any person who is or was connected with the company or is deemed to have been connected with the company and is reasonably expected to have access to unpublished price-sensitive information in respect of securities of a company or has received or has had access to such price-sensitive information."

In simple terms, Insider trading refers to trading company's stocks or other securities, in breach of a fiduciary duty or other relationship of trust and confidence, while having access to the otherwise non public information which can be crucial for making investment decisions.For example, an executive of Company XYZ learns of a confidential merger between his company and another lucrative business. Knowing that the merger will require the purchase of shares at a high price, the executive buys the stock the day before the merger is going to go through. This is an illegal insider trading. However, once Company XYZ has announced the merger publicly, insiders may legally trade the shares based on the information.

The United States of America was the first country to tackle insider trading effectively. The Securities and Exchange Commission of the USA is empowered under the Insider Trading Sanctions Act, 1984 to impose civil penalties besides criminal proceedings. Like the USA, most of the countries have in place suitable legislation to restrict insider trading. In India, Securities and Exchange Board of India (SEBI), regulates insider trading through the SEBI Act, 1992 (SEBI Act) and the SEBI (Prohibition of Insider Trading) Regulations, 1992 (Insider Trading Regulations) issued under the SEBI Act.

While in almost every country, insider trading is tough to detect and prove, in India it seems to be particularly widespread because there are no tools available for regulators to keep it in check. Stock exchanges are meant to create information balance, so that same facts are available to everyone at the same time. However, the reality is extremely different from this, considering the rapidly growing insider-trading scams show. The recent conviction and sentencing of Rajat Gupta, who was indicted for conspiracy and securities fraud with Galleon Group LLC co-founder Raj Rajaratnam in the United States and sentencing of Mathew Martoma, the former portfolio manager for SAC Capital Advisors for carrying out one of the biggest insider trading schemes on record in USA has led to a renewed focus on the problem of insider trading in securities markets.

What lessons, if any, are there for India in dealing with insider trading, which is allegedly raging here? The Satyam scam is the latest example to show the lacunas in law and ineffective machinery in India to prohibit insider trading in India. It was observed in Samir C Arora vs. SEBI, that no punishment is too severe for those indulging in insider trading activities and such fraudulent trade practices and professional misconduct are absolutely detrimental to the interests of ordinary investors and are strongly deprecated under the SEBI Act, 1992 and the Regulations made there under.

Duties/ Obligations Of the company

Every listed company has the following obligations under the SEBI (Prohibition of Insider Trading) Regulations, 1992 
       
  • Appointing of a senior level employee usually the Company Secretary, as the Compliance Officer;
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  • Setting up of an appropriate mechanism and to frame and enforce a code of conduct for internal procedures,
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  • Abiding by the Code of Corporate Disclosure practices which are specified in Schedule (ii) to the SEBI (Prohibition of Insider Trading) Regulations, 1992
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  • Initiating the information received under the initial and continual disclosures to the Stock Exchange within 5 days of their receipts;
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  • Identifying the Price Sensitive Information
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  • Ensuring adequate data security of confidential information stored on the computer;
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  • Prescribing the procedure for the pre- clearance of trade and entrusted the Compliance Officers with the responsibility of strict adherence of the same.
  •  

Powers of SEBI [Securities and Exchange Board of India]    

Under the prevalent regulations, the Securities Appellate Board has been granted powers to issue any directions as it deem fit to protect the interest of investors.

Any insider who deals in securities in contravention of the above provisions shall be guilty of insider trading. The SEBI Act provides that any person who is guilty of insider trading shall be liable to penalty not exceeding rupees 5 lakhs.

If SEBI suspects that any person has violated any provision of these regulations, it may make enquiries to such persons or any other persons it deems fit, to form a prima facie opinion as to whether there was any violations of these regulations.

The SEBI can appoint one or more officers to inspect the books and records of insider or any other person. And it shall be the duty of the person to allow the inspection.

2002 amendment empowers the SEBI to direct the insider not to deal in the securities, prohibiting him to deal with the securities, restraining him to communicate or counsel any person to deal in securities, declaring the transaction in securities null and void and directing the adequate compensation to be given to investors.

The above regulations grant SEBI the power to initiate criminal prosecution against the insider; however, it overlooks the fact that the criminal prosecution is successful only when the offence is proved to have been committed by the offender beyond reasonable doubt.

Present penalties for insider trading

The SEBI act has basically given two options to the board:

Refer the complaint for adjudication and a penalty not exceeding 5 lakh rupees may be imposed by the adjudicator. The aggrieved party may prefer an appeal to a Securities Appellate Tribunal and if necessary to the High Court. This makes it clear that civil courts will have no jurisdiction over the adjudication proceedings.

The second option for the SEBI is to file a criminal suit against the alleged offender before the court not inferior to the Metropolitan magistrate or judicial magistrate. The court can impose a fine not less than 2000 rupees and an imprisonment that shall not be less than one month but not exceeding 3 years or with both.

Suggested Solutions

Many believe that tougher penalties would be a more active deterrent to insider trading. Some feel, stiffer prison sentences might aid at the margin. In reality, it only raises the stakes. A second solution for curbing insider trading is for organizations to offer ethics training and place a greater emphasis on ethical behavior. Although it will not on its own, curb the type of behavior that we have been witnessing lately. This brings us to the third and possibly more aggressive approach, track the money.

One such solution is the use of technology to tap into the networks. All the transactions and the links of directors, executives, major stake holders of a company to their relatives, friends, etc involved in trading can be monitored. By doing this, the number of suspects from thousands to a few can be reduced and can then be further investigated.

In addition to running more detailed analysis, we can look at a more enhanced, more automated, reporting techniques or surveillance within the company. Given the magnitude of such trades and level of officials involved, it would be vital to put an automated, extremely robust system in place to monitor and flag trading activities.

Overhauling of regulations by SEBI

The Securities and Exchange Board of India (SEBI) has recommended that trades by promoters, employees, directors and their immediate relatives has to be disclosed internally and should be run through a 360 degree analysis.

The panel on insider trading also suggested that trades exceeding INR 10 Lakh (or any amount specified by the Capital Market Regulator) within a calendar quarter be revealed to the stock exchanges.

Every entity issuing securities intended to be/listed on a stock exchange would be obligated to draft & publish a code of fair disclosure', governing disclosure of events and circumstances that would impact price discovery of its securities.

While amplifying the definition of insider, the term connected-personhas been re-defined precisely and immediate relatives are presumed to be connected persons, with a right to rebut the presumption.

There is a prohibition on insiders from providing/allowing access to or communicating Unpublished Price Sensitive Information unless required for discharge of duties or compliance with law.

Conclusion

It has been observed in the past that even though SEBI was bestowed with wide powers, it had been ineffective when it came to the task of administering the law. However, the 2002 regulations in India have further strengthened the 1992 regulations. Considering the stringent machinery in place, it is now believed that SEBI with more powers and investigation agencies for offences related to insider trading and market fraud would be able to deal with insider trading more efficiently and effectively.             
 

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