Author Name:   kirthanasingh

Laws relating to the menace of Insider Trading in India, UK and US. It also attempts to analyse the effectiveness of such regulations.

Insider Trading Laws In India In Comparison With Laws In UK And US

1. Introduction
In the year 2009, Mr. Rajat K Gupta, a former Goldman Sachs board member, while delivering a speech at a leading business school in India said, “Try to make other people successful, if you work on making other people successful, they will in turn make you successful beyond your dreams”. Being a man of his words, he endeavoured to make other people successful, but through illegal means.A few years later, he was charged by the US Securities and Exchange Commission with illegal insider trading and was convicted by a federal jury in the year 2012. Gupta had passed confidential information about Goldman Sachs and P&G to his friend Raj Rajaratnam, the head of the Galleon Group, a New York-based hedge fund management firm. This incident is a testament to the fact that regulation of insider trading is not merely a paper tiger.

In the light of this incident, an attempt has been made through this paper to analyse the Indian insider trading provisions in comparison with similar laws in the UK and the US. The purpose of such a comparison is to observe the international trends and issues regarding this morally and legally deplorable practice.

2. What Is Insider Trading?

Insider trading involves the deliberate exploitation of unpublished price sensitive information obtained through or from a privileged relationship for trading in shares and securities for the purposes of gain (or to avoid a loss) at the expense of the uninformed public when the price of securities would be materially altered if the information were disclosed.

Henry G. Manne defines ‘Insider Trading’ as:
“Insider trading generally refers to the practice of corporate agents buying or selling their corporation securities without disclosing to the public significant information which is known by them but which has not affected the price of the security.”

The misuse of confidential information is frowned upon for several reasons including:
1.It involves taking a secret and unfair advantage;
2.It gives rise to potential conflict of interests in which the company’s best interest may wrongfully take second place to the insider’s self-interest;
3.It brings the market into disrepute and may be a disincentive to investment;
4.It is unethical as it amounts to a breach of the fiduciary position of trust and confidence.

3. Regulating The Practice of Insider Trading

The US was the first country to formally enact a legislation to regulate insider trading through the Securities and Exchange Act, 1934. Over the years, most of the jurisdictions around the world followed suit and recognised the need to restrict the menace of insider trading in one form or the other and enacted legal restrictions to this effect.

3.1 India
In 1948, India took its first step towards restricting insider trading by constituting a committee to assess and recommend suitable restrictions that could be imposed on short swing profits. The first few legislations addressing insider trading were enacted in the year 1992 in the form of the Securities and Exchange Board of India (“SEBI”), Act 1992 (“SEBI Act”) and the SEBI (Prohibition of Insider Trading) Regulations, 1992 (“1992 Regulations”) issued under the Act.

By the virtue of the enactment of Companies Act, 2013 (“The Act”), the concept of prohibition of insider trading of securities was incorporated in Section 195. In the year 2015, SEBI replaced the 1992 regulations with the SEBI (Prohibition of Insider Trading) Regulations, 2015 (“2015 Regulations”) in order to revamp the existing capital market regulatory structure.

3.1.1 SEBI Act, 1992 and 2015 Regulations
Salient features of the 2015 Regulations are as follows:
·“insider” means any person who is either a connected person or is in possession of or having access to unpublished price sensitive information. Therefore, it includes persons connected on the basis of being in any contractual, fiduciary or employment relationship that allows such person access to “unpublished price sensitive information” (“UPSI”).

·UPSI has been defined as information not generally available and which may impact the price. This definition provides a test to identify price sensitive information, aligning it with the Listing Agreement and providing a platform for disclosure.

·The charge of insider trading has been extended to securities listed and proposed to be listed on stock exchanges. The 1992 Regulations were only applicable to listed securities.

·Notes to Interpretation: every provision under the Regulations is accompanied by specific notes setting out the legislative intent for which that provision has been formulated. As India continues to move from a ‘form approach’ to a ‘substance approach’, these notes will aid in capturing the spirit of the legislation and how to regulator is likely to view its enforcement.

·Restrictions have been placed on communication, procurement, and trading in securities when in possession of UPSI.

·The regulations provide for certain exceptions which include, in the conduct of due diligence, for off-market transactions, a trade executed in the absence of any leakage of information and trades executed in the pursuance of trading plans.

·Qualification criteria have been set for compliance officers who shall report to the Board of Directors of the company or the head of the organisation, as the case may be.

According to the SEBI Act, Insider Trading is punishable with a penalty of INR 250,000,000, or three times the profit made from insider trading, whichever is higher. Any person contravening or attempting to contravene or abetting the contravention of the Act may extend to 10 years or a fine, which may extend to INR 250,000,000 or both. The regulations also prescribe certain disciplinary sanctions that may be taken by companies or market intermediaries to require due compliance with the Regulations.

3.1.2 The Companies Act, 2013
Section 195 of the Act prohibits directors or key managerial personnel of a company from engaging in insider trading. According to the Act, “insider trading” means an act of subscribing, buying, selling, dealing or agreeing to buy, sell or deal in any securities by any director or key managerial personnel or any other officer of a company either as principal or agent if he is reasonably expected to have access to any non-public price sensitive information in respect of securities of a company.

3.2 Insider Trading in the US and the UK
3.2.1 United States
The US has been one of the leading enforcers of Insider Trading. As a follow-up action of the Great Depression of 1929, the Securities Exchange Act of 1934 was enacted. Provisions of the Exchange Act have enabled the Securities Exchange Commission (“SEC”) to prevent insider trading in the US.

The US courts have provided the requisite jurisprudence relating to insider trading in order to assist the SEC, which can be illustrated as follows:

1.The Classical or Disclose or Abstain theory: the insider must disclose UPSI to the public before making the trade or abstain from making the trade at all.This theory is applicable to directors, officials, employees or other associated or connected persons.

2.The Misappropriation theory: this theory is designed to protect the integrity of securities markets against abuses by outsiders to a company who have access to UPSI that may affect the company’s security price when revealed, but who otherwise owe no fiduciary or any other duty to the shareholders of the company.

The US Sanction Act, 1984, imposes fines up to three times the profit gains or loss avoided by use of such material UPSI. This Act also requires all directors, officers and beneficial owners of more than 10% of its registered equity securities to mandatorily file an initial statement with the SEC as well as with the exchanges on which the stock may be listed.The US laws and regulations are much more stringent in comparison to the Indian laws which are often criticized for being ineffective, lenient and poor in execution.

Insider trading enforcement actions in recent years highlight the SEC’s foray into newer areas, including actions taken against IT professionals and hackers who misappropriate sensitive corporate data, as well as providers of political intelligence.

3.2.2 United Kingdom
The Financial Services and Markets Act, 2000 (“FSMA”) and the Criminal Justice Act, 1993 (“CJA”) provide the statutory framework for insider trading regime in the UK. However, neither of the Acts defines the term ‘insider trading’.

The FSMA provides for a regime for preventing market abuse and also empowers the UK Financial Services Authority (“FSA”) to sanction anyone who engages in market abuse. Section 118(2) of the FSMA defines ‘market abuse’ as including behaviour where an insider deals, or attempts to deal, in a qualifying investment or related investment on the basis of insider information relating to the investment in question. In addition to this, it also applies to those who require or encourage others to engage in conduct that would amount to market abuse. Market abuse is regarded as a civil offence and therefore does not require that a person must have acted deliberately or recklessly.

The CJA, on the other hand, prohibits dealing in price-effected securities on the basis of insider information, encouragement of another person to deal in price-affected securities on the basis of insider information and knowing disclosure of inside information to another.Criminal sanctions for insider trading and market manipulations can incur custodial sentences of up to 7 yearsand unlimited fines.

Both the Indian and the UK laws have similar definitions of ‘price sensitive information’ as well as ‘insider’ (as far as civil liability is concerned). In India, one common statute applies for both criminal and civil liability whereas in the UK, both the liabilities are dealt under different statutes. In India, SEBI Act and the Companies Act specify a penalty of INR 250,000,000 or three times the amount of profits made out of insider trading; whichever is higher, for insider trading. Further, he may be punishable with imprisonment for a term, which may extend to ten years, or with fine or both.

4. Evaluation of The Effectiveness of Insider Trading Regulations

Out of the major issues that SEBI has to tackle, the regulation of insider trading has proved to be the most difficult. Experience of such regulation, which has attracted the unflattering label of ‘the unwinnable war’, prompts reconsideration of the issue.According to the Annual Report of SEBI for the year 2016-2017, Insider trading constituted 14% (34 cases) of the investigations taken up by SEBI in the year 2016-2017 as against 12 cases in the previous year. Insider trading is rampant and is increasing with each passing year. Also, as against 34 cases taken up for investigation, only 15 were completed. It is, therefore, a matter of serious concern.

Since the charges of insider trading are mostly based on circumstantial evidence, it is difficult to be detected and proved. Even in cases where it is detected, the rate of successful prosecution has been very low. Despite of the presence of a robust regulatory mechanism, SEBI lacks the required technological expertise, which is required to effectively carry out investigations. There has been an acute shortage of resources and manpower. As a result, the rate of successful prosecution is remarkably low.

Further, under the Indian law, there is no provision to impose a penalty or even ensue investigation on a foreign national who has committed the offence of insider trading. There is no mention about the extra-territorial applicability of the regulations. In this era of globalisation of securities trade, this is a huge drawback.

5. Conclusion
In the words of Deepak Chopra, “All great changes are preceded by chaos”.The recent actions taken by SEBI in the form of setting committees for suggesting measures for improving surveillance of the markets and for reprimanding Axis Bank to strengthen its internal system with regard to the recent WhatsApp leak caseare indeed commendable. The need of the hour is the continuous adaptation and modification of the present laws in order to make the practice of insider trading more deterrent so that insiders are prevented from indulging into such trades, thereby securing and augmenting investor confidence in the securities market.

End-Notes
# Henry G. Manne, “Definition of Insider Trading” in Fred S. McChesney (ed.) The Collected Works of Henry G. Manne 364 (2009).
# Nishith M. Desai and Krishna A. Allavaru,“Insider Trading: A Comparative Study” (1997)
# Regulation 2(1)(g)
# http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research Articles/India_s_SEBI_Approves_New_Regulations_on_Insider_Trading.pdf
# http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/sebi-finally-introduces-stricter-insider-trading-regulations.html?no_cache=1
# ibid
# Cady Roberts & Co, 40 SEC 907 (1961)
# United States v. Vincent F Chiarella, 445 U.S. 222 (1980)
# Section 16 of the Securities Exchange Act of 1934
http://globalinvestigationsreview.com/article/1149624/the-unrelenting-pace-of-sec-insider-trading-actions
# Noam Noked,Differences Between US and UK Market Abuse Regimes, 7 April 2012, available at http://blogs.law.harvard.edu/corpgov/2012/04/07/differences-between-us-and-uk-market-abuse-regimes/
# Section 52, Criminal Justice Act, 1993
# Section 61, Criminal Justice Act, 1993
# Section 123, Financial Services and Markets Act, 2000
# A.M.Louis, “The Unwinnable War on Insider Trading” Fortune 72 (1981)
# https://www.sebi.gov.in/reports/annual-reports/aug-2017/annual-report-2016-17_35618.html
# Amit Kumar Pathak, “How to Tackle Insider Trading in India : An analysis of current law and regulation through judicial decision” available online athttp://corporatelawreporter.com/2012/03/28/tackle-insider-trading-india-analysis-current-laws-regulations-judicial-decissions/
# http://www.firstpost.com/business/sebi-crackdown-on-whatsapp-leaks-is-a-step-in-preventing-rather-than-punishing-insider-trading-4279119.html

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