A COMPREHENSIVE OVERVIEW OF THE SEBI
(PROHIBITION OF INSIDER TRADING)
One of the fundamental and most general principles of law is that when any individual acquires any kind of special knowledge or information by virtue of his or her confidential or fiduciary relationship with another individual, he cannot use such knowledge or information to his own advantage or for his own personal benefit and must account for any such profit so derived. The concept of insider trading is based on this very principle.
When a director, member of management, employee of a company or any other person such as an internal auditor, advisor or a consultant buys sells or deals in the securities of a listed company while having knowledge of material inside information of such company not generally available to the public, he is said to commit insider trading. It essentially involves the buying or selling of security in breach of a fiduciary duty or any other relationship based on trust while in the possession of material information about such security not available to the public.
The Patel committee set up in 1986 in India in order to study insider trading defined it as follows:
“ Insider trading generally means trading in the shares of a company by the persons who are in the management of the company or are close to them on the basis of undisclosed price sensitive information regarding the working of the company, which they possess but which is not available to others.”
A legal everyday example of insider trading is where directors, officers or employees of a company trade in the stocks of their own companies within the confines of company policy and other regulations which govern such trading. However in order to facilitate the development of a stock market with stable growth and uniformity, it is imperative that such market be of a good quality. A stock market needs to inspire its investors in order to facilitate its development. If practices such as insider trading are not controlled, investors, both current as well as prospective will lose faith in the integrity of the market. The practice of insider trading leads to investors drawing the conclusion that the market is rigged and only those selected few who possess inside information make profits from it. The level playing field is hence corrupted and the market disturbed. Insider trading and other fraudulent trade practices lead to a loss in investor confidence thereby causing a detrimental effect on the market and if such a practice was to continue unpunished, it would have a severe and adverse impact on the market.
There is hence a strong need to prohibit such practices and sustain the faith of the investors in the integrity, quality and honesty of the market.
ORIGIN OF INSIDER TRADING
There was a time when inside information was considered to be a perk of working in an office in an exalted position and such information was used for personal gains. In the recent past, just three decades ago, insider trading was recognized as an offence, an injustice with far reaching consequences which was slowly destroying the confidence of investors in the stock market.
The first country to tackle insider trading was the United States of America. The lack of investor confidence in the securities market caused a market crash in 1929.The Great Depression of The United States Economy followed which led to the enactment of the Securities Act of 1933. This Act contained certain provisions prohibiting fraud in the sale of securities. A more comprehensive legislation came in the form of the Securities Exchange Act of 1934 which addressed insider trading both directly and indirectly by virtue of its provisions. It prohibited short swing profits made from any purchases and sales within a 6 month period by corporate directors, officers or stockholders owning more than 10% of a firm’s shares and also contained provisions prohibiting fraud related to securities trading. The Insider Trading Sanctions Act and the Insider Trading and Securities Fraud Enforcement Act followed in 1984 and 1988 respectively which provided for penalties as high as three times the profit gained or the loss avoided for illegal insider trading.
A large portion of the US law on insider trading, however, developed by virtue of court decisions. Prominent among them were SEC v. Texas Gulf Sulpur Co (1966), Dirks v. SEC (1984), United States v. Carpenter and United States v. O’Hagan (1997).
Most countries followed the example of the USA and set up effective sanctions in order to control insider trading.
In India, the recognition of insider trading as an injustice requiring immediate and effective sanctions came about in the 1940’s. The Thomas Committee was formulated in order to evaluate the regulations present in the USA on short swing profits under Regulation 16 of the Securities Exchange Act of 1934 and it was only then that provisions with respect to insider trading were incorporated in the Companies Act, 1956. The relevant Regulations were Regulations 307 and 308, which required shareholding disclosures to be made by both directors and managers of the company.
The ineffectiveness of the provisions made in the Companies Act lead to the setting up of other committees such as the Sachar Committee in 1979, the Patel Committee in 1986 and the Abid Hussain Committee in 1989. These committees jointly pointed out the pressing need for the enactment of a separate statute for insider trading.
In the 1980’s and 1990’s, the securities market was progressing at a rapid rate and the need for a comprehensive legislation to tackle the problem of insider trading was realised which ultimately resulted in the formulation of the SEBI (Insider Trading) Regulations of 1992. These regulations were intended to curb the menace of insider trading in securities. These regulations were also amended in the year 2002 and are now known as the SEBI (Prohibition of Insider Trading) Regulations of 1992. As the title suggests, these regulations were formed in order to prohibit the practice of insider trading in securities and restore the confidence of investors in the integrity of the stock market.
THE SEBI (PROHIBITION OF INSIDER TRADING) REGULATIONS, 1992
WHAT IS INSIDER TRADING
Insider trading is nowhere defined under the SEBI (Prohibition of Insider Trading) Regulations of 1992. In order to understand what insider trading involves, it is important to understand three terms closely associated with it and also defined under the Regulations.
According to the Regulations, "insider" means any person who, is or was connected with the company or is deemed to have been connected with the company, and who is reasonably expected to have access, connection, to unpublished price sensitive information in respect of securities of a company, or who has received or has had access to such unpublished price sensitive information; 
The above definition in turn introduces a new term "connected person".
The Regulation defines that a "connected person" means any person who-
(i) is a director, as defined in clause (13) of Regulation 2 of the Companies Act, 1956 (1 of 1956) of a company, or is deemed to be a director of that company by virtue of sub-clause (10) of Regulation 307 of that Act or
(ii) occupies the position as an officer or an employee of the company or holds a position involving a professional or business relationship between himself and the company whether temporary or permanent and who may reasonably be expected to have an access to unpublished price sensitive information in relation to that company;
Price Sensitive Information
Price Sensitive Information means any information, which relates directly or indirectly to a company and which if published, is likely to materially affect the price of securities of the company. It includes periodical financial results of companies, dividend declaration, issue or buy-back of securities, any major expansion plans or execution of new projects, amalgamation, mergers or takeovers, disposal of whole or substantial part of undertaking and significant changes in policies, plans or operations of the company.
Therefore insider trading in a nutshell involves an insider buying or selling the shares of a listed company while in the possession of any price sensitive information not available to the public.
PROHIBITION OF INSIDER TRADING
The purpose behind the enactment of SEBI (Prohibition of Insider Trading) Regulations, 1992 is evident from the name itself: to curb and ultimately eradicate the malpractice of insider trading plaguing the stock markets and restore the confidence of investors in these markets.
Regulation 3 of the Act clearly prohibits the dealing, communicating or counselling on matters relating to insider trading and is worded as follows:
“No insider shall-
- Either on his own behalf or on behalf of any other person, deal in securities of a company listed on any stock exchange [when in possession of] any unpublished price sensitive information; or
- Communicate, counsel or procure directly or indirectly any unpublished price sensitive information to any person who while in possession of such unpublished price sensitive information shall not deal in securities.
Provided that nothing contained above shall be applicable to any communication required in the ordinary course of business [or profession or employment] or under any law.
Regulation 3(A) of the Regulations also states as follows: “No company shall deal in securities of another company or associate of that other company while in possession of any unpublished price sensitive information.
However, there are certain cases where Regulation 3A does not apply. These exceptions can also be termed as valid defences to the allegation of insider trading. Regulation 3(B) provides that where a proceeding is initiated against a company in respect of Regulation 3(A), it is a valid defence to prove that it entered into the transaction in the securities of the listed company whilst the unpublished price sensitive information was in the possession of an officer or employee of the company provided that:
- The decision to enter into the transaction on behalf of the company was taken by a person or persons other than that officer or employee;
- The company had systems and procedures in place demarcating the activities of the company in such a way that a person entering into a transaction in securities on behalf of the company could not have access to information in the possession of another officer or employee of the company;
- The company had arrangements in place which a company could reasonably be expected to have in order to ensure that such information would not be communicated to the person or persons who made the decision and that no advice with respect to the transactions or agreement was given to that person or any of those persons by that officer or employee, these arrangements being in place at the time of entering into such transaction or agreement;
- Neither was the information communicated nor was such advice given.
In the abovementioned proceedings, it would also be a valid defence to prove that the acquisition of the shares of the listed company was as per the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997.
INVESTIGATION INTO THE OFFENCE OF INSIDER TRADING
The Prohibition of Insider Trading Regulations state that the Board i.e. SEBI has the power to carry out investigations where it suspects that any person has violated any of the provisions mentioned in Chapter III of these regulations. The Board has the power to carry out inquiries and inspections and the Regulations specify the procedure for such investigation. The Board may appoint an investigating authority to carry out such investigation where inspection of the books of account or the records and documents of the insider are necessary.
This chapter also provides for certain obligations which an insider has to abide by when subject to investigation by the Board. Regulation 7 specify these obligations which include production of books, accounts and other documents in the custody of the insider to the investigating authority for investigation as well as statements and information relating to the transactions in the securities market which the investigating authority may require. The insider must also provide reasonable access to the premises occupied by him and also extend reasonable facility to the investigating authority for examining any books, records, documents and computer data in the possession of the stock broker or any other person and also providing for copies of documents or other materials which the investigating authority considers relevant. The investigating authority is also entitled to examine or record statements of any member, director, partner, proprietor and employee of the insider and it is a duty of every director, proprietor, partner, officer and employee of the insider to give to the investigating authority all the assistance required in connection with the investigation.
The investigating authority then submits its investigation report to the Board after carrying out investigation as per the procedure provided for in these Regulations and the Board communicates its findings to the suspected insider after considering the investigation report of the authority. The suspected person must reply to such communication within 21 days and the Board may then take such measures as it deems fit to protect the interests of the investors and in the interests of the securities market as well as for the due compliance with the provisions of the Act.
The Board also has the power to issue certain directions under Regulation 11 which are as follows:
The Board may without prejudice to its right to initiate criminal prosecution under Section 24 or any action under Chapter VI A of the SEBI Act, 1992, to protect the interests of the investors and in the interests of the securities market and for the due compliance with the provisions of the Act, regulation made thereunder issue all or any of the following order, namely:
- directing the insider or such person as mentioned in clause (i) of sub-section (2) of section 11 of the Securities and Exchange Board of India Act, 1992 not to deal in securities in any particular manner;
- prohibiting the insider or such person as mentioned in clause (i) of sub-section (2) of section 11 of the Securities and Exchange Board of India Act, 1992 from disposing of any of the securities acquired in violation of these regulations;
- restraining the insider to communicate or counsel any person to deal in securities;
- declaring the transaction(s) in securities as null and void;
- directing the person who acquired the securities in violation of these regulations to deliver the securities back to the seller :
Provided that in case the buyer is not in a position to deliver such securities, the market price
prevailing at the time of issuing of such directions or at the time of transactions whichever is
higher, shall be paid to the seller;
(f) directing the person who has dealt in securities in violation of these regulations to transfer an amount or proceeds equivalent to the cost price or market price of securities, whichever is higher to the investor protection fund of a recognised stock exchange.
From these regulations with respect to investigation as well as the directions which the Board may issue, it is clearly seen that the Regulations are comprehensive and formulated in such a manner so as to effectively prohibit insider trading in securities.
DUTIES AND OBLIGATIONS OF THE COMPANY
Every listed company has certain obligations under the SEBI(Prohibition of Insider Trading)Regulations , 1992 such as the appointment of senior level employees (generally the Company Secretary) as Compliance Officers, setting up of an appropriate mechanism in order to deal with the offence of insider trading, framing and enforcing of a code for internal procedures, abiding by the Code of Corporate Disclosure practices as specified in Schedule II to these Regulations, initiating information received under the initial and continual disclosures to the Stock Exchange within 5 days of their receipts, specifying the close period, identifying price sensitive information, ensuring adequate data security of confidential information stored on the computer, prescribing the procedure for the pre-clearance of insider trading and entrusting the compliance officers with responsibility of strict adherence to the same.
These duties and obligations are placed upon a company in order to prevent the offence of insider trading occurring in the first place. Where these duties and obligations are duly complied with, the occurrence of insider trading is extremely unlikely. The principle behind these duties and obligations is that no company should be entitled to any gain or prevention of any loss by indulging in the practice of insider trading. Prevention is better than cure is seen as the mantra behind the enactment of these provisions.
PENALTIES FOR THE OFFENCE OF INSIDER TRADING
According to Section 15G of Chapter VI A of the Securities and Exchange Board of India Act, 1992, the regulator may impose a penalty of Rs. 25 crore or three times the amount of profit a company made from insider trading, whichever is higher. In addition to the aforementioned penalty, the regulator may also impose various restrictions on the company such as banning the accessing of securities market as well as dealing in securities of the company directly or indirectly.
Such a high penalty has been provided for in the Regulations in order to prevent potential first time offenders from indulging in the practice of insider trading and also because the monetary gain that a company or a person makes or the magnitude of loss that such company or person prevents due to insider trading are extremely high.
ILLUSTRATIONS OF INSIDER TRADING IN INDIA:
There are many glaring examples of insider trading in India which have occurred in the recent past, some of which have been mentioned herein below:
1. In March 1998, Hindustan Lever (now known as Hindustan Unilever) was charged for alleged insider trading along with its five directors at the time, SM Datta, KB Dadiseth, R Gopalakrishnan, A Lahiri and MK Sharma. Hindustan Lever and Brooke Bond Lipton were both subsidiaries of the same parent company, Unilever. The facts of the case involved Hindustan Lever purchasing a large number of Brooke Bond Lipton shares from UTI, prior to its public announcement relating to the merger of the two outfits. SEBI considered and held this information to be price sensitive and this was the first case where SEBI passed such an order on insider trading. At the time, the finance ministry was the appellate authority which dealt with appeals against SEBI orders. The Ministry of Finance reversed the decision and ruled in favour of Hindustan Lever. However SEBI filed an appeal against this decision in the Bombay High Court whose final verdict is yet to be pronounced.
2. In June 2001, a takeover deal was to take place between ABS and Bayer Industries. Prior to this takeover deal, SEBI alleged that the Managing Director of ABS Industries, Rakesh Agarwal was guilty of insider trading by purchasing a large quantity of his own company’s shares from the market. SEBI directed Mr. Agarwal to deposit an amount of Rs. 34 lakhs as monetary compensation to ABS investors and also initiated adjudication proceedings against the former promoter of the company. Mr Agarwal challenged the order in the Securities Appellate Tribunal (SAT) which partially turned down the penalty imposed by SEBI and did not take any action on the proposed adjudication proceedings. SEBI contested this order by filing an appeal in the Supreme Court. The case was settled vide a consent order wherein Mr. Agrawal paid a monetary penalty.
3. In April 2004, the former Asia-Pacific head of Alliance Capital Mutual Fund disposed of a large quantity of shares held by the fund under his management which ultimately caused a sharp decline in the valuation of Alliance which was duly noted by SEBI when this US based fund decided to sell its Indian interests and Mr. Arora was one of the contenders. He was banned by SEBI from dealing in securities of any listed company in any manner for a period of 5 years but the SAT ruled in his favour and set aside SEBI’s order on appeal. An appeal has been filed in the Supreme Court on which a verdict is still pending.
4. In November 2006, the former company secretary and Chief Financial Officer (CFO) of Wockhardt, Rajiv Gandhi, was charged along with his immediate family members for trading in the company’s shares on the basis of Wockhardt’s financial results which qualified as unpublished price sensitive information. SEBI imposed a monetary penalty of Rs. 5 lakhs on Mr. Gandhi. He did file an appeal before SAT but SAT too upheld SEBI’s order and held him guilty of insider trading. This case is unique because SEBI succeeded in obtaining a clear victory in it.
5. In December 2006, the then MD of Tata Finance, Dilip Pendse was held guilty of insider trading. He was charged with helping the former director of Niskhkalp Investment and Trading, (Niskhalp was a subsidiary of Tata Finance) J Talaulicar offload a large chunk of shares at a premium prior to the public announcement of Nishkalp’s big loss. He was barred from dealing in the securities market for a period of 2 years and a monetary penalty was also imposed on him. However Mr. Pendse did appeal before the SAT which set aside SEBI’s order. SEBI had approached the Supreme Court in this regard and a decision on this matter is still pending.
6. In very recent news, Reliance Industries Limited (RIL) could face a record fine for the offence of insider trading if SEBI establishes that RIL was involved in the offence. According to The Economic Times, February 14, 2011 edition, RIL has been looking to settle the case through plea bargaining or a consent order but its negotiations with the regulator have not made much headway due to the disagreement upon the amount of penalty. RIL had offered two paltry amounts which were not accepted to SEBI and hence penalty proceedings have been revived which had earlier been kept in abeyance. In a consent order, a company or individual accused of violating stock market regulations can end proceedings by paying a consent fee while neither admitting nor denying the guilt. According to Section 15G of Chapter VI A of the SEBI Act, 1992, the regulator may impose a penalty of Rs. 25 crore or three times the amount of profit a company made from insider trading, whichever is higher. In addition to the aforementioned penalty, the regulator may also impose various restrictions on the company such as banning the accessing of securities market as well as dealing in securities of the company directly or indirectly. The potential penalty that RIL may face could be as high as Rs. 1500 crore due to the magnitude of the profit made by the company. 
7. SEBI has barred Anil Ambani, chairman of Anil Dhirubhai Group, (ADAG) and four of its directors from investing in the markets up until December 2011 for insider trading and has also asked Anil Dhirubhai Ambani (ADA) group companies Reliance Infrastructure (RelInfra) and Reliance Natural Resources (RNRL), which has been merged with Reliance Power (RelPower), not to invest in the secondary markets other than mutual funds until December 2012. SEBI has also added however that the directives are not applicable to primary issuance, buybacks and open offers. Anil Ambani and his group companies RelInfra and RNRL settled the case with SEBI by paying a settlement amount of Rs. 50 crores. In the consent order, SEBI said, ADAG chairman Anil Ambani, Rel Infra's vice-chairman Satish Seth, director SC Gupta, whole-time director Lalit Jalan and director JP Chalasani have remitted Rs25 crore, while RNRL and Anil Ambani have remitted Rs25 crore without admitting or denying the charges levied upon them.
Insider trading is a practice which has originated in the world primarily due to the greed of corporate entities and their head honchos who are always considering the possibilities of making more profits no matter what acts they must perform in order to make them. Social responsibility is a great duty imposed upon such entities who though entitled to make their gains, must also consider the moral and ethical consequences of the acts being committed by them. By possessing price sensitive information and not disclosing it to the public only in order to ensure that such entities can make large gains or cover huge losses is a selfish, immoral act which it is impossible to condone. Investors invest huge sums of money in the stock markets based on their confidence in the quality and integrity of the market alone. The big corporations and companies may make profits and avoid losses in the short term by indulging in insider trading, but in the long run, insider trading will only cause a complete destruction of the faith that investors have in the market and ultimately cause a market crash which will have a detrimental effect on everyone. It is a pressing need in the world economy today to prevent this practice and ensure that the faith of the investors in the markets is preserved at any cost. The SEBI (Prohibition of Insider Trading) Regulations of 1992 are an important step taken by the Indian government in preventing this unjust practice.
RISHIKESH DESAI (IV BSL-LLB, ILS LAW COLLEGE, PUNE)
YOSHAM VARDHAN (IV BSL-LLB, ILS LAW COLLEGE, PUNE)
 Regulation 2(e) of the SEBI (Prohibition of Insider Trading) Regulations, 1992
 Regulation 2(c) of the SEBI (Prohibition of insider Trading) Regulations, 1992
 Regulation 2(h)(a) of the SEBI (Prohibition of Insider Trading) Regulations, 1992
 Regulation 3 of the SEBI (Prohibition of Insider Trading) Regulations, 1992
 Regulation 3(A) of the SEBI (Prohibition of Insider Trading) Regulations, 1992
 Regulation 4A of the SEBI (Prohibition of insider Trading) Regulations, 1992
 Regulation 6A of the SEBI (Prohibition of Insider Trading) Regulations, 1992
 Regulation 8 of the SEBI (Prohibition of Insider Trading) Regulations, 1992
 Regulation 9 of the SEBI (Prohibition of Insider Trading) Regulations, 1992
 Regulation 11 of the SEBI (Prohibition of Insider Trading) Regulations, 1992
 Economic Times, February 14, 2011 edition