Author Name:   prerna_chopra

Insider trading denotes dealing in a company’s securities on the basis of confidential information relating to the company which is not published or not known to the public used to make profit or loss. It is fairly a breach of fiduciary duties of officers of a company or connected persons towards the shareholders...

 Insider trading laws in India

Insider trading denotes dealing in a company’s securities on the basis of confidential information relating to the company which is not published or not known to the public used to make profit or loss. It is fairly a breach of fiduciary duties of officers of a company or connected persons towards the shareholders.

The prevention of insider trading is widely treated as an important function of securities regulation.

*Section11(2)E of companies act,1956 prohibits the insider trading but does not define it.

*Prohibition of insider trading is necessary to make securities market-
· Fair and transparent.
· To have level playing field for all the participants in the market.
· For free flow of information and avid information asymmetry.

Insider is defined under the SEBI Prohibition of Insider Trading regulation2(e) as -
Insider is the person who is connected with the company,who could have the unpublished price sensitive information or receive the information from somebody in the company.

*Information deemed to be price sensitive are-
· Periodical financial results
· Intended decalaration of the dividends
· Issue of securities or buy-back of securities
· Any major expansion plans or execution of new projects
· Amalgamation and mergers or takeovers
· Any significant changes in policies, plans or operations of the company.

Insider trading is the trading of a corporation's stock or other securities (such as bonds or stock options) by individuals with access to non-public information about the company. In most countries, trading by corporate insiders such as officers, key employees, directors, and large shareholders may be legal, if this trading is done in a way that does not take advantage of non-public information.

However, the term is frequently used to refer to a practice in which an insider or a related party trades based on material non-public information obtained during the performance of the insider's duties at the corporation, or otherwise in breach of a fiduciary or other relationship of trust and confidence or where the non-public information was misappropriated from the company.[1]

In the United States and several other jurisdictions, trading conducted by corporate officers, key employees, directors, or significant shareholders (in the US, defined as beneficial owners of 10% or more of the firm's equity securities) must be reported to the regulator or publicly disclosed, usually within a few business days of the trade. Many[citation needed] investors follow the summaries of these insider trades in the hope that mimicking these trades will be profitable. While "legal" insider trading cannot be based on material non-public information, some investors believe[citation needed] corporate insiders nonetheless may have better insights into the health of a corporation (broadly speaking) and that their trades otherwise convey important information (such as about the pending retirement of an important officer selling shares, greater commitment to the corporation by officers purchasing shares).

The authors of one study claim that illegal insider trading raises the cost of capital for securities issuers, thus decreasing overall economic growth.[2] However, economists cannot be confident of this conclusion because data on illegal insider trading is not available; the nature of the activity renders it impossible to gather data.[3]

Insiders can easily profit using "open market repurchases." Such transactions are legal and generally encouraged by regulators through safe harbors against insider trading liability.

Legal insider trading
Legal trades by insiders are common, as employees of publicly traded corporations often have stock or stock options. These trades are made public in the United States through Securities and Exchange Commission filings, mainly Form 4. Prior to 2001, U.S. law restricted trading such that insiders mainly traded during windows when their inside information was public, such as soon after earnings releases.

SEC Rule 10b5-1 clarified that the prohibition against insider trading does not require proof that an insider actually used material nonpublic information when conducting a trade; possession of such information alone is sufficient to violate the provision, and the SEC would infer that an insider in possession of material nonpublic information used this information when conducting a trade. However, SEC Rule 10b5-1 also created for insiders an affirmative defense if the insider can demonstrate that the trades conducted on behalf of the insider were conducted as part of a pre-existingcontract or written binding plan for trading in the future.

For example, if an insider expects to retire after a specific period of time and, as part of retirement planning, the insider has adopted a written binding plan to sell a specific amount of the company's stock every month for two years and later comes into possession of material nonpublic information about the company, trades based on the original plan might not constitute prohibited insider trading.

Illegal insider trading
Rules against insider trading on material non-public information exist in most jurisdictions around the world, but the details and the efforts to enforce them vary considerably. Sections 16(b) and 10(b) of the Securities Exchange Act of 1934 directly and indirectly address insider trading. Congress enacted this act after the stock market crash of 1929. The United States is generally viewed as having the strictest laws against illegal insider trading, and makes the most serious efforts to enforce them.

Definition of "insider"
In the United States and Germany, for mandatory reporting purposes, corporate insiders are defined as a company's officers, directors and any beneficial owners of more than 10% of a class of the company's equity securities. Trades made by these types of insiders in the company's own stock, based on material non-public information, are considered to be fraudulent since the insiders are violating the fiduciary duty that they owe to the shareholders. The corporate insider, simply by accepting employment, has undertaken a legal obligation to the shareholders to put the shareholders' interests before their own, in matters related to the corporation. When the insider buys or sells based upon company owned information, he is violating his obligation to the shareholders.

For example, illegal insider trading would occur if the chief executive officer of Company A learned (prior to a public announcement) that Company A will be taken over and then bought shares in Company A while knowing that the share price would likely rise.

In the United States and many other jurisdictions, however, "insiders" are not just limited to corporate officials and major shareholders where illegal insider trading is concerned but can include any individual who trades shares based on material non-public information in violation of some duty of trust. This duty may be imputed; for example, in many jurisdictions, in cases of where a corporate insider "tips" a friend about non-public information likely to have an effect on the company's share price, the duty the corporate insider owes the company is now imputed to the friend and the friend violates a duty to the company if the corporate insider trades on the basis of this information.

Liability for insider trading
Liability for inside trading violations cannot be avoided by passing on the information in an "I scratch your back; you scratch mine" or quid pro quo arrangement as long as the person receiving the information knew or should have known that the information was company property. It should be noted that when allegations of a potential inside deal occur, all parties that may have been involved are at risk of being found guilty.

For example, if Company A's CEO did not trade on the undisclosed takeover news, but instead passed the information on to his brother-in-law who traded on it, illegal insider trading would still have occurred (albeit by proxy by passing it on to a "non-insider" so Company A's CEO wouldn't get his hands dirty).

Misappropriation theory
A newer view of insider trading, the misappropriation theory, is now part of US law. It states that anyone who misappropriates (steals) information from their employer and trades on that information in any stock (either the employer's stock or the company's competitor stocks) is guilty of insider trading.

For example, if a journalist who worked for Company B learned about the takeover of Company A while performing his work duties and bought stock in Company A, illegal insider trading might still have occurred. Even though the journalist did not violate a fiduciary duty to Company A's shareholders, he might have violated a fiduciary duty to Company B's shareholders (assuming the newspaper had a policy of not allowing reporters to trade on stories they were covering).

Proof of responsibility
Proving that someone has been responsible for a trade can be difficult because traders may try to hide behind nominees, offshore companies, and other proxies. Nevertheless, the Securities and Exchange Commission prosecutes over 50 cases each year, with many being settled administratively out of court. The SEC and several stock exchanges actively monitor trading, looking for suspicious activity.

Trading on information in general
Not all trading on information is illegal insider trading, however. For example, if while dining at a restaurant, one hears the CEO of Company A at the next table telling the CFO that the company's profits will be higher than expected and then buys the stock, one is not guilty of insider trading unless there was some closer connection between you, the company, or the company officers. However, information about a tender offer (usually regarding a merger or acquisition) is held to a higher standard. If this type of information is obtained (directly or indirectly) and there is reason to believe it is nonpublic, there is a duty to disclose it or abstain from trading.

Tracking insider trades
Since insiders are required to report their trades, others often track these traders, and there is a school of investing which follows the lead of insiders. This is, of course, subject to the risk that an insider is making a buy specifically to increase investor confidence or making a sell for reasons unrelated to the health of the company (such as a desire to diversify or pay a personal expense).

American insider trading law
The United States has been the leading country in prohibiting insider trading made on the basis of material non-public information. Thomas Newkirk and Melissa Robertson of the U.S. Securities and Exchange Commission (SEC) summarize the development of US insider trading laws. Insider trading has a base offense level of 8, which puts it in Zone A under the U.S. Sentencing Guidelines. This means that first-time offenders are eligible to receive probation rather than incarceration.

Common law
US insider trading prohibitions are based on English and American common law prohibitions against fraud. In 1909, well before the Securities Exchange Act was passed, the United States Supreme Court ruled that a corporate director, who bought that company's stock when he knew it was about to jump up in price, committed fraud by buying but not disclosing his inside information.

Section 15 of the Securities Act of 1933 contained prohibitions of fraud in the sale of securities which were greatly strengthened by the Securities Exchange Act of 1934.

Section 16(b) of the Securities Exchange Act of 1934 prohibits short-swing profits (from any purchases and sales within any six-month period) made by corporate directors, officers, or stockholders owning more than 10% of a firm's shares. Under Section 10(b) of the 1934 Act, SEC Rule 10b-5, prohibits fraud related to securities trading.

The Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988 provide for penalties for illegal insider trading to be as high as three times the profit gained or the loss avoided from the illegal trading.

SEC regulations
SEC regulation FD ("Fair Disclosure") requires that if a company intentionally discloses material non-public information to one person, it must simultaneously disclose that information to the public at large. In the case of an unintentional disclosure of material non-public information to one person, the company must make a public disclosure "promptly."

Insider trading, or similar practices, are also regulated by the SEC under its rules on takeovers and tender offers under the Williams Act.

Court decisions
Much of the development of insider trading law has resulted from court decisions.

In SEC v. Texas Gulf Sulphur Co. (1966), a federal circuit court stated that anyone in possession of inside information must either disclose the information or refrain from trading.

In 1909, the Supreme Court of the United States ruled in Strong v. Repide that a director upon whose action the value of the shares depends cannot avail of his knowledge of what his own action will be to acquire shares from those whom he intentionally keeps in ignorance of his expected action and the resulting value of the shares. Even though in general, ordinary relations between directors and shareholders in a business corporation are not of such a fiduciary nature as to make it the duty of a director to disclose to a shareholder the general knowledge which he may possess regarding the value of the shares of the company before he purchases any from a shareholder, yet there are cases where, by reason of the special facts, such duty exists.

In 1984, the Supreme Court of the United States ruled in the case of Dirks v. SEC that tippees (receivers of second-hand information) are liable if they had reason to believe that the tipper had breached a fiduciary duty in disclosing confidential information and the tipper received any personal benefit from the disclosure. (Since Dirks disclosed the information in order to expose a fraud, rather than for personal gain, nobody was liable for insider trading violations in his case.)

The Dirks case also defined the concept of "constructive insiders," who are lawyers, investment bankers and others who receive confidential information from a corporation while providing services to the corporation. Constructive insiders are also liable for insider trading violations if the corporation expects the information to remain confidential, since they acquire the fiduciary duties of the true insider.

In United States v. Carpenter (1986) the US Supreme Court cited an earlier ruling while unanimously upholding mail and wire fraud convictions for a defendant who received his information from a journalist rather than from the company itself. The journalist R. Foster Winans was also convicted, on the grounds that he had misappropriated information belonging to his employer, the Wall Street Journal. In that widely publicized case, Winans traded in advance of "Heard on the Street" columns appearing in the Journal.

The court ruled in Carpenter: "It is well established, as a general proposition, that a person who acquires special knowledge or information by virtue of a confidential or fiduciary relationship with another is not free to exploit that knowledge or information for his own personal benefit but must account to his principal for any profits derived therefrom."

However, in upholding the securities fraud (insider trading) convictions, the justices were evenly split.

In 1997, the U.S. Supreme Court adopted the misappropriation theory of insider trading in United States v. O'Hagan, 521 U.S. 642, 655 (1997). O'Hagan was a partner in a law firm representingGrand Metropolitan, while it was considering a tender offer for Pillsbury Company. O'Hagan used this inside information by buying call options on Pillsbury stock, resulting in profits of over $4 million. O'Hagan claimed that neither he nor his firm owed a fiduciary duty to Pillsbury, so he did not commit fraud by purchasing Pillsbury options.

The Court rejected O'Hagan's arguments and upheld his conviction.
The "misappropriation theory" holds that a person commits fraud "in connection with" a securities transaction and thereby violates 10(b) and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. Under this theory, a fiduciary's undisclosed, self-serving use of a principal's information to purchase or sell securities, in breach of a duty of loyalty and confidentiality, defrauds the principal of the exclusive use of the information. In lieu of premising liability on a fiduciary relationship between company insider and purchaser or seller of the company's stock, the misappropriation theory premises liability on a fiduciary-turned-trader's deception of those who entrusted him with access to confidential information.

The Court specifically recognized that a corporation's information is its property: "A company's confidential information... qualifies as property to which the company has a right of exclusive use. The undisclosed misappropriation of such information in violation of a fiduciary duty...constitutes fraud akin to embezzlement – the fraudulent appropriation to one's own use of the money or goods entrusted to one's care by another."

In 2000, the SEC enacted SEC Rule 10b5-1, which defined trading "on the basis of" inside information as any time a person trades while aware of material nonpublic information. It is no longer a defense for one to say that one would have made the trade anyway. The rule also created an affirmative defense for pre-planned trades.

Arguments for legalizing insider trading
Some economists and legal scholars (such as Henry Manne, Milton Friedman, Thomas Sowell, Daniel Fischel, and Frank H. Easterbrook) argue that laws making insider trading illegal should be revoked. They claim that insider trading based on material nonpublic information benefits investors, in general, by more quickly introducing new information into the market.

Friedman, laureate of the Nobel Memorial Prize in Economics, said: "You want more insider trading, not less. You want to give the people most likely to have knowledge about deficiencies of the company an incentive to make the public aware of that." Friedman did not believe that the trader should be required to make his trade known to the public, because the buying or selling pressure itself is information for the market.

Other critics argue that insider trading is a victimless act: a willing buyer and a willing seller agree to trade property which the seller rightfully owns, with no prior contract (according to this view) having been made between the parties to refrain from trading if there is asymmetric information. The Atlantic has described the process as "arguably the closest thing that modern finance has to a victimless crime".

Legalization advocates also question why "trading" where one party has more information than the other is legal in other markets, such as real estate, but not in the stock market. For example, if a geologist knows there is a high likelihood of the discovery of petroleum under Farmer Smith's land, he may be entitled to make Smith an offer for the land, and buy it, without first telling Farmer Smith of the geological data. Nevertheless, circumstances can occur when the geologist would be committing fraud if, because he owes a duty to the farmer, he did not disclose the information; for example, if he had been hired by Farmer Smith to assess the geology of the farm.

Advocates of legalization make free speech arguments. Punishment for communicating about a development pertinent to the next day's stock price might seem to be an act of censorship. If the information being conveyed is proprietary information and the corporate insider has contracted to not expose it, he has no more right to communicate it than he would to tell others about the company's confidential new product designs, formulas, or bank account passwords.

There are very limited laws against "insider trading" in the commodities markets if, for no other reason than that the concept of an "insider" is not immediately analogous to commodities themselves (corn, wheat, steel, etc.). However, analogous activities such as front running are illegal under US commodity and futures trading laws. For example, a commodity broker can be charged with fraud by receiving a large purchase order from a client (one likely to affect the price of that commodity) and then purchaseing that commodity before executing the client's order to benefit from the anticipated price increase.

Conclusion
*Insider terms includes both legal and illegal conduct. Illegal insider trading refers to buying or selling a security , in breach of fiduciary duty or other relationship of trust and confidence, while in possession of material, non public information about the security.

* It is the corporate officers, directors, and employees,friends, business associates, family members, brokerage,government employees and persons who took advantage of confidential information from their employers and who traded the corporations securities after learning of significant , confidential corporate developments.

Rakesh Agarwal, MD of ABS Industries Ltd. Was involved in negotiations with Bayer A.G,regarding their intention to takeover ABS.

As per SEBI Rakesh Agarwal had access to the unpublished price-sensitive information.SEBI alleged that prior to the announcement of acquisition , Rakesh Agarwal, through his brother-in-law, had purchased shares of ABS and tendered the said shares in the open offer made by Bayer. He contended that he did this in the interests of the company.SEBI directed Rakesh Agarwal to deposit Rs. 34,00,000 with Investor Education & Protection Funds of Stock Exchange,Mumbai and NSE. It was held that the SEBI order couldn’t sustained as he did this in the interests of the company.

The  author can be reached at: prernachopra@legalservicesindia.com

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