Insider Trading is an unfair practice of dealing in the securities of a company which involves the deliberate exploitation of unpublished price sensitive information. Insider trading occurs when information that affects the worth of the securities and shares of the company and the inclusion of details regarding the periodical financial results of the company, new projects, mergers, takeovers, amalgamations, issue and buyback of securities significant changes in policy, etc.
Henry G. Maine defines ‘Insider Trading’ as; “ Insider trading refers to the practice of corporate agents buying or selling their corporation securities without disclosing o the public the significant information which is known by them but which has not affected the price of the security.
An ‘insider’ can be any person who is directly or indirectly, in any contractual, fiduciary or employment relationship, by existing to be the director, officer or employee of an entity where securities are dealt in the market or publicly traded and having an access to unpublished price sensitive information directly or indirectly of the equivalent entity. Further, an insider who has particular knowledge of unpublished price sensitive information must not reveal such information to family, friends, relatives or business associates, or colleagues or companions of the entity (unless such colleague or companions have similar position within the entity and have right to access such unpublished price sensitive information) and any third party which is defined under Regulation 2(g) under SEBI Regulation, 2015. Further, adding to it Regulation 2(n) defines ‘Unpublished Price Sensitive Information’ as; as any information pertaining to the financial results, dividends, change in capital structure, mergers, de-mergers, acquisition, change in key managerial personnel of the entity which may affect the price of the shares or securities.
The Modus operandi initiates when insiders act as initiators of price change by receiving the information much earlier than others. An insider, first of all, buys the stock of the Company at the existing market price. He then spreads some price sensitive information relating to the Company to select group of people, who on the basis of such information will buy such stocks and would further spread the information. When this information reaches a large number of persons, it pushes up the sales volume and price of the stock. After a certain price of the stock is reached, insider sells his stock, as do the ones close to him before others do the same. As now everyone tries to sell his or her stock, its price will fall down. When information is available to everyone, the stock reaches back to its realistic price level, which results in huge loss to common investors.2 The reason behind the debarment of insider trading is “to necessitate and understand the damage of public confidence and investors protection from the clear intention of cheating with these of inside knowledge and using that knowledge to earn profit in disclosing the unpublished price sensitive information with outsiders.”
REGULATING THE PRACTICE OF INSIDER TRADING
Over many years, the jurisdictions around the world has been setting up laws an regulations or amendments to restrict the menace of insider trading in one form or other.
- The United States has formerly been the first to trace the notion of insider trading law. In 1909, US Supreme Court ruled in String v. Repide, 213 U.S. 419 (1909) that a director of a corporation owning lands in the Philippine Islands, and he was the one controlling the actions of the entity has been keeping his shareholders ignorant of sale to the government from whom he purchased, keeping the shareholders in disguise while selling his own shares would be fraudulent concealment to shareholders.
- Insider trading have evolved with the open market since its commencement. The United States was the first country to create the backbone of almost any regulation against insider trading as well as other types of securities fraud through Securities Exchange Act, 1934.
- Thereafter SEC (Securities Exchange Commission) was created to regulate the secondary trading of securities. It was enabled to prevent insider trading in the United States.
- In 1984, US Sanction Act, was regulated to impose fine up-to three times the profits gains or loss of material unpublished price sensitive information. This act mandates all the directors, officers and beneficial owners of more than 10% of its registered equity securities to file an initial statement with SEC as well as with the exchange on which the stock may be listed.
- “Constructively Insiders are lawyers, investment Bankers and others who receive confidential information from a corporation while providing service to the corporation.” This concept was generalized after the case of Dirks vs SEC in 1984, where no one was turned liable for insider trading as they disclosed the information for exposing a fraud and for no personal gains.
- The US regulations are more rigid than Indian laws which are often criticized. It affects company’s reputation and interest in the market. The investor tends to loose his trust once a company faces the problem of insider trading. It is important for the enforcement of actions against insider trading to protect general investors and to maintain public confidence in the financial system as a whole.
- In 1948, first concrete governmental attempt to regular restriction towards insider trading was formation of Thomas committee to recommend restrictions on short swing profits. Section 307 and 308 were introduced in Companies Act, 1956, this made it mandatory to have disclosure by directors & officers. By the virtue of enactment of Companies Act 2013, the concept of Prohibition of insider trading of securities was incorporated in Section 195. Further, Companies (Amendment) Act 2017, omitted Section 195 from the Act.
- In 1977, Sachar committee was constituted to review Companies Act, 1956 & Monopolies and Restrictive Trade Policies Act (MRPT), 1969, to modify the accounts and audit section with due emphasis on the professionalization of management.
- The High Powered Committee on Stock Exchange Reforms, the Patel committee in 1986 recommended that the Securities Contract (Regulation) Act 1956 be amended to make stock exchange manipulations including insider trading punishable.
- Thereafter in 1989, the Abid Hussain Committee, a working group on the Development of the Capital Market recommended the insider trading activities be penalized by civil and criminal proceedings and also suggested SEBI to formulate necessary legislation and governing codes to prevent unfair dealings.
- The Securities Exchange Board of India (Prohibition of Insider Trading) Regulation, 1992 was divulged by SEBI to prohibit the fraudulent practice of insider trading.
- In the year 2015, the 1992 regulation was replaced by Securities Exchange Board of India (Prohibition of Insider Trading) Regulation, 1992 in order to certain exceptions like in the conduct of due diligence, for off market transactions and revamp the existing capital market regulatory structure. Regulation 3 & 4 enumerates restrictions on communication and trading by insiders. These regulations prohibits any insider to communicate, provide, or allow access to any unpublished price sensitive information related to company or securities listed or proposed to be listed and shall not be traded when in possession of price sensitive information. The board of directors of a listed company shall make policy determination of “legitimate purposes” as a part of [“Codes of Fair Disclosure and Conduct.”]. Regulation 9A ensures that CEO, managing director or other analogous person of the company shall place effective system of insider controls to to prevent insider trading.
- Thereafter in September,2019, Securities Exchange Board of India (Prohibition of Insider Trading) Regulation, 1992 was amended by Securities Exchange Board of India (Prohibition of Insider Trading) (3rd Amendment) Regulation, 2019
- The amendment includes definition, rules regarding submission and receipt of original information to the Board.
- A unique and dynamite concept of Information Reward is added to the regulation upon the monetary sanctions recovered or collected which shall be 10% of the monetary sanction recovered and collected and shall not exceed one crore. The above reward shall be paid from Investor Education and Protection Fund (IEPF).
- The above information’s confidentiality, the application and rejection of claim of reward, protection against retaliation and victimization are inserted in 2019 Regulation.
- Creation of Informant Incentive Committee and its function along with public dissemination and incentivisation of informant.
MARTHA STEWART CASE
Over the several years, there have been business related scandals. Martha Stewart insider trading case was one of the scandalous and publicized case. Martha Helen Stewart, a famous businesswoman, writer, television personality, convicted felon and founder of Martha Stewart Living Omnimedia (MSLO). in 2004, she was convicted in ImClone stock trading case. She sold all of her 3928 shares of the bio-tech company, ImClone, two days before when FDA publically announced the rejection of ImClone’s primary pharmaceutical product, Erbitex in 2001. by selling shares prior to the announcement, she avoided 45,673 U.S. dollars in losses. ImClone’s shares dropped by 16%. on the report of United States Securities and Exchange Commission, Stewart received a non-public information from her stock broker Peter Bacanovic at Merill Lynch. Peter also worked for Sam Waskal, the then CEO of ImClone. Waskal has ordered the sale of his share in the company, an exact amount of 5 million U.S. dollars. Peter informed the same to Stewart which lead to the selling of her shares. She acted upon this non-public information. On July 2014, the District Court sentenced her to five months prison time in addition to two years period of supervised release, a portion of which she spent in home confinement for obstruction of justice and deception after insider trading charged were dropped and dismissal of embezzled securities charges. Stewart ordered to pay fines of 30,000 U.S. dollars. She was also neccesitated to step down as CEO from her company. Martha Stewart Living Omnimedia, for the period of 5years.
RAJ RAJRATNAM CASE
Raj Rajratnam was the founder of the Galleon Group, a hedge fund management firms. Earlier, Raj Rajratnam was analyst at the Investment Bank, Needham & Company in 1985. In 1992, he accustomed a hedge fund with other Needham clients, which he purchased with other investors sad acid renamed it as Galleon Group. Being the founder of the Galleon, he made it grew with approximate amount of 7 billions U.S. dollars in assets by 2008.
In 2009, Raj Rajratnam was arrested by Federal Bureau of Investigation for 14 counts of insider trading securities fraud and conspiracy. 18,150 wiretapped communications involving numerous insiders at companies including Intel, Advanced Micro Devices, Clearwire, Google, Hilton and Goldman Sachs. These electronic records and wiretapped conversations were recorded from ten telephones including home, office, mobile lines belonging to defendant.
The United States Attorney’s Office (USAO) filed a criminal case and SEC filed a civil case SEC v. Raj Rajratnam against Raj Rajratnam for the same allegations mentioned above of 14 counts of securities fraud and conspiracy. The insider tips regarding market takeovers or contracts served the defendant earn illegal profit of over 25 million U.S. dollars.
In May 2011, Raj Rajratnam was found blamable on all 14 counts, 5 counts of conspiracy and 9 counts of securities fraud and fine up to 10 million U.S. dollars, forfeit 53 million U.S. dollars and sentenced to 11 years of confinement. This was the longest confinement term for insider trading. The civil case that SEC filed against Raj Rajratnam, eh was ordered to pay a fine of 92.8 million U.S. dollars in November, 2011.
PENALTY AND CONVICTION
The liability regime of both the countries jurisdiction is some. Both the countries legislatures regulates insider trading in under criminal liability along with civil sanctions. Under the Indian law, Section 15G of the SEBI Act 1992, is an authorized provision for providing a civil penalty of insider trading cases and the SEBI relies on the identity of the violation and nature of the prohibited manoeuvre under this provision for staggering such penalties. Insider Trading provides penalty for 25 crore rupees or three times of insider trading which ever higher. Section 24(1) under criminal prosecution of insider trading provides for a punishment of a maximum of ten years imprisonment, or a maximum fine of 25 crore rupees or both. Section 24(2) also provides punishment to the concerned person if he/she is unable to pay the civil penalty.
In United States, the US Federal securities regulations do not provide any specific insider trading code. Section 10(b) of the Securities Exchange Act, 1934 etched Rule 10b-5 which is also known as anti-fraud rule to the SEC to impose the prohibition on insider trading. Rule 10b-5, prohibits the actions and business practices that move towards fraud or deceit on any personality or company, in relation to the sale and purchase of securities.under US Federal securities regulations criminal penalties of imprisonment for the violation of insider trading is twenty years and maximum fine for an individual is $5,000,000, and maximum fine on non-natural persons is $25,000,000. The Federal securities regulates civil sanctions on person who try to disgorge any profits gained and losses avoided with a penalty of an amount up to three times the profit gained or loss avoided as a result of violation of insider trading. The company including natural or non-natural persons face the civil penalty not more than $1,000,000 or three times of the profit gained or loss avoided.
The whilom SEBI (Prohibition of Insider Trading) Regulations, 1992 was repealed and replaced with SEBI (Prohibition of Insider Trading) Regulations, 2015. SEBI appointed T.K. Vishwanathan Committee in the present financial year and in commensurate with the suggestions made by the Committee, these Regulations have been amended by the way of SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2018 strengthen transparency, enforcement mechanism and to establish institutional responsibility. Appropriate actions are initiated for the infringement of provisions of SEBI (Prohibition of Insider Trading) Regulations, 2015, in accordance with the provision of SEBI Act, 1992 which includes direction for disgorgement of profit gains and loss avoided, any award of penalty by the adjudicating officer and prosecution proceedings for punishing the inadvertent. During the year 2018-19, final Orders in respect of all employees and promoters of Satyam Computer Services Ltd. and in the matter of Jagran Prakashan Limited on trading in shares of Jagran Prakashan Limited while in seizure of unpublished price sensitive information. Section 11(2)(f) of the SEBI Act, 1992, directs SEBI to promote investors’ education and foster training for intermediaries in the securities market. Along with investor awareness and financial literacy activities, SEBI also actively traces investor grievance redressal in securities market with a view to protect investor interests and enhancing the confidence of and participation of investors.
The effective functioning of the securities market, its improvement and development depends to extensively on the quality and probity of the market. Insider trading is one of the threat, which is strenuous to tackle, and the the exploiter finds one way or the other. Insider trading is pervasive and is increasing with each passing year. Since the charges of insider trading are mostly based on circumstantial evidence, it is hard to be detected and proved. Even in the situations where it is detected, the rate of successful prosecution is very limited. Despite of the existence of a vigorous regulatory mechanism, SEBI lacks the required technological expertise, which is required to effectively carry out investigations. SEBI regulations does not include transnational jurisdiction, so it is suggested that the SEBI should come up with amendment on the line or better than that of SEC. There is no provision to impose penalty or investigate on foreign national who has committed the offence of insider trading. There no mention about the extra-territorial applicability of the regulations. The Securities Exchange Act of 1934 in the United States allows the Securities and Exchange Commission to give a reward or bounty to someone who gives the Commission information that results in a fine of insider trading. Similarly, any inside information on insider trading in the stock market can egt the informant a reward up to one crore rupees from SEBI. An informant who is culpable but voluntarily cooperates and assists SEBI can also be eligible for reward and for a settlement in proceedings against him/her. The reward shall be ten percent of the money collected, subject to a maximum amount of one crore rupees.
Section 24, SEBI Act, 1992, “Offences:1) Without prejudice to any award of penalty by the adjudicating officer under this Act if any person contravenes or attempts to contravene or abets the contravention of the provision of this Act or of any rules or regulations made thereunder, he shall be punishable with imprisonment for a term which may extend to ten years, or with fine, which may extend to twenty-five crore rupees or with both. 2) If any person fails to pay the penalty imposed by the adjudicating officer or fails to comply with any directions or orders, he shall be punishable with imprisonment for a term which shall not be less than one month but which may extend to ten years with fine, which may extend to twenty five crore rupees or with both.”
Section 10(b), Securities Exchange Act, 1934: “To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the SEC may prescribe as necessary or appropriate in the public interest or for the protection of investors.”
Rule 10b-5, the rule made under section 10(b) says that, “It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange, a)To employ any device, scheme, or artifice to defraud, or, b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or, c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”
- Arun Kumar Singh and Anil Kumar, Insider Trading: Comparative Analysis Of India And USA, SSRN, http://ssrn.com/abstract=2552418
- Securities Exchange Board of India (Prohibition of Insider Trading) Regulation, 2015
- Securities Exchange Board of India (Prohibition of Insider Trading) (3rd Amendment) Regulation, 2019
- James H. Thompson, A Global Comparison Of Insider Trading Regulations, International journal of Accounting and Financial Reporting, 2013, Vol.3, No.1, Macrothink Institute, www.macrothink.org/ijafr
- SEBI Standardizing Reporting Circular, 2019
KIIT, School of Law