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Manthan Saxena

4th year Bharati Vidyapeeth University’s New Law College Pune, Maharashtra

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The article comprehensively deals with the recent controversial judgement of Rajat Gupta on Insider trading in United States of America and its impact on Indian Securities market. The author has mainly focused on the circumstances of Rajat Gupta’s case, if such situation arises in India then how the laws in India will impact the trial. The author has also focused on Insider trading laws in United States of America and United Kingdom.

The episode of Rajat Gupta “Insider Trading”

‘SEC V. Rajat Gupta (Civil Action No. 11-cv-7566 (SDNY))’

On September 2008, Rajat Gupta disclosed to Rajaratnam material non-public information he learned as a member of Goldman Sachs Board of Director concerning Berkshire’s 5 billion investments in Goldman Sachs. Rajaratnam, in turn, caused certain Galleon hedge fund to trade on the basis of the material non-public information that Gupta disclosed. On September 22, after Goldman Sachs Board meeting, Rajaratnam received a call from Mr. Rajat Gupta’s office, afterward Galleon hedge fund purchased 1,00,000 Goldman Sachs shares.

The very next day Rajaratnam placed a call to Mr. Gupta and after the call Rajaratnam caused Galleon hedge fund purchased additional 50,000 Goldman Sachs shares. Through a Board meeting, Goldman Sachs approved the 5 billion preferred stock investment by Berkshire. As Gupta knew, Berkshire was a respected and influential investors and its decision to make such a large investment in Goldman Sachs would be favourably viewed by investor as a strong vote of confidence in the firm when the information was disclosed to public. Just after a Board meeting, Rajaratnam caused certain Galleon hedge funds to purchase more than 2, 17,200 Goldman Sachs shares. When Goldman Sachs publicly announced the Berkshire investment along with 2.5 billion stock offering its stock prices from $125.05 per share to $133.00. On the next day Rajaratnam liquidated Goldman Sachs shares generating a profit of $8, 00,000.

Mr. Gupta also disclosed the negative list for the fourth quarter of 2008, reporting a $2.1 billion loss, the first quarterly loss that Goldman Sachs had sustained. As a result of Rajaratnam’s trades on the basis of the material non-public information that Mr. Gupta provided, Galleon hedge funds avoided losses of more than $3.6 million.

The financial result for second quarter of 2008 were also disclosed to Rajaratnam, due to which total illicit profits made by the Galleon hedge funds by virtue of their trading on the basis of Gupta’s material non-public information concerning Goldman Sachs second quarter of 2008 results were nearly $18.5 million.

Non-public information of Procter & Gamble’s were disclosed to Rajaratnam who then passed the material non-public information to his Galleon colleagues, who then caused certain Galleon funds to trade on the basis of the information. Through this non-public information, the Galleon funds generated illicit profits of over $5, 70,000.


The Prosecution in this case majorly relied on phone tapping where Mr. Gupta tipped Rajaratnam about information which was not meant to be public at that time. Earlier the United States Court did not allow the wire tapping’s by stating that Government is not authorized to use wire taps to investigate the matters of Insider Trading.

Later U.S District Judge Richard Holwell allowed the tapping’s by stating that “Prior to the Rajaratnam case, you look at insider trading rings, and they are very small. Prosecutors would wind up getting one, two, three people. The Rajaratnam case showed that with wiretaps, you can sweep in rings of tippers, leading to a vast array of prosecution.”

The Government asked U.S Senior District Judge for a pre-trial ruling that tapes be admissible because they contains statements that were against Rajaratnam’s interest and were made in furtherance.

In Insider Trading cases the investigating agencies have to establish three basic elements. First of all, one has to have evidence of action in the market, whether a buy or a sell, then one has to prove that the insider had particular information that others did not have and then the investigators have to establish one caused the other. The key frustration for investigators often comes in establishing the cause and effect. Even in the high profile Raj Rajaratnam-Rajat Gupta case in the US, it is not clear if the authorities would have the conversation, taping of which incidentally was permitted to crack the insider trading case.

The case of Rajat Gupta challenged the powers of Securities Exchange Board of India where an Insider is prosecuted mainly on the basis of Telephone Tapping and no motive to secure profit.


According to laws in India the main issue would be that can such wiretapping amounts to violation of fundamental right of an individual or not?

In the case of People’s Union for Civil Liberties Vs Union of India and ans “Telephone tapping is a serious invasion of an individual’s privacy. With the growth of highly sophisticated communication technology, the right to hold telephone conversation, in the privacy of one’s home or office without interference, is increasingly susceptible to abuse. It is no doubt correct that every Government, howsoever democratic, exercises some degree of sub rosa operation as a part of its intelligence outfit but at the same time citizen’s right to privacy has to be protected from being abused by the authorities of the day. ”

“No person shall be deprived of his of his life or personal liberty except according to ‘procedure established by law’.”

Through the case of A.K Gopalan vs State of Madras the apex court interpreted that the words “procedure established by law” in Article 21 refers to only state made statues, if any statutory law prescribed procedure for depriving a person of his rights or requirement of Article 21.

In the subsequent cases such as R.C Cooper v. Union of India it was held that any law that deprives the life and liberty must be fair and just.

The apex court widened the scope of article 21 and has provided with the rights article 21 within itself, on of them are of ‘Right to Privacy’

The right to personal liberty takes in not only a right to be free from restrictions placed on his moment, but also free from encroachment on his private life. It is true that our constitution does not expressly declare a right to privacy as a fundamental right but the said right is an essential ingredient of personal liberty.

Before a person is deprived of his life and personal liberty the procedure established by law must be strictly followed and must not be departed from to the disadvantage of the person affected.

As the Constitution of India suggests it an essential requirement that a statute should be there so that a person’s phone can be tapped. A written statute provides power to a state and the words ‘procedure established by law’ are fulfilled making the act not against Article 21 i.e Right to Privacy.

Stating more in the case of People’s Union of Civil Liberties v. Union of India , The Court has ruled that telephone conversation is an important facet of a man’s private life. The right to hold a telephone conversation in the privacy of one’s home or office without interference can certainly be claimed as “right to privacy”. Conversations on the telephone are often an intimate and confidential character. Telephone conversation is a part of modern man’s life. Tapping of telephones is a serious invasion of privacy. “Right to privacy” would certainly include telephone conversation in the privacy of one’s home or office. This means that telephone tapping would infract Article 21 unless it is permitted under the procedure established by law. The procedure has to be just fair and reasonable.


The powers to tap phone lines are being mentioned under section 5(2) of Indian Telegraph act 1885 which states, “On the occurrence of any public emergency, or in the interest of the public safety, the Central Government or a State Government or any officer specially authorised in this behalf by the Central Government or a State Government may, if satisfied that it is necessary or expedient so to do in the interests of the sovereignty and integrity of India, the security of the State, friendly relations with foreign States or public order or for preventing incitement to the commission of an offence, for reasons to be, recorded in writing, by order, direct that any message’ or class of messages to or from any person or, class of persons, or relating to any particular subject, brought for transmission by or transmitted or received by any telegraph, shall not be transmitted, or shall be intercepted or detained, or shall be disclosed to the Government making the order or an officer thereof mentioned in the order: Provided that press messages intended to be published in India of correspondents accredited Central Government or a State Government shall not be intercepted or detained, unless their transmission has been Prohibited under this sub- section.”

Telephone tapping is permissible in India under section 5(2) of Telegraph Act 1885. The Court has held that this section is constitutionally valid. This section lays down the circumstances and the grounds when an order for tapping of a telephone may be passed. The constitutional validity of this provision has not been questioned, but no procedure for making order is laid down therein.

The Indian Telegraph Act 1885 carries few provision under which the Indian Government and its agencies can tap phones in India but these provision are not sufficient an outdated. As on the date there is no constitutionally sound lawful interception and phone tapping law in India. Phone tapping is permitted based on court order only and such permission is granted only if it is required to prevent a major offence involving national security or to gather intelligence on anti national terrorist activities. Though economic offences/ tax evasions were initially covered under the reasons of interception of phones, the same was withdrawn in 1999 by Government based on a Supreme Court order citing protection of the privacy of the individual.

In 1996 Judgment, The Supreme Court of India stated that “wire taps are serious invasion of an individual’s privacy”. The Court also set out guidelines for wire tapping by the government that who can and under what conditions phone lines can be tapped. Only the Union Home Ministry, or his counterpart in the state, can issue an order for a wiretap. The Government is also required to show that the information sought cannot be obtained through any other means. Recordings or transcript of the tapped phone calls are not generally accepted as primary evidence in Indian Court, such evidences are permitted under Prevention of Terrorism Act and the Unlawful Activities Act.

After the Judgment of Rajat Gupta’s case, the Indian market regulator i.e. Securities Exchange Board of India has sought approval from the government to use telephone call records as evidence in the insider trading cases.


When a person is talking on telephone, he is exercising his right to freedom of speech and expression. Telephone tapping, accordingly infracts Article 19(1) (a) unless it falls within the grounds of restrictions falling under Article 19(2).

The grounds mentioned in Article 19(2), that the competent authority under Section 5(2) of Indian Telegraph Act, 1885 is empowered to pass an order of interception after recording its satisfaction that it is necessary or expedient to do in interest of-

1. Sovereignty and integrity of India;

2. The security of the State;

3. Friendly relations with foreign state;

4. Public order;

5. For preventing incitement to commission of an offence

When any of the five situations mentioned above to the satisfaction of the competent authority requires, then the said authority may pass the order for interception of messages by recording reasons in writing for doing so. Thus, so far as the power to intercept conversation is concerned Section 5 clearly laws down the situation under which it can be exercised, but the substantive law as laid down in Section 5(2) must have procedural backing so that the exercise of power is fair and reasonable. The said procedure itself must be fair, just, and reasonable.

In absence of just and fair procedure for regulating the exercise of power under section 5(2) of the Act, it is not possible to safeguard the rights of the citizens guaranteed under Article 19 and 21. Accordingly, the court has itself filled in the gap by issuing procedural directions for exercise of power under S.5 (2) of Telegraph Act 1885.

Through Hukum Chand Shyamlal case the Court has laid down inter alia that an order of telephone tapping under section 5(2) shall not be made except by the Home Secretary, Government of India and Home Secretaries of the State Governments.



In the case of Securities Exchange Commission v. Roger .D. Blackwell , the honourable US District Court for the Southern court of Ohio states that for convicting some person liable for Insider trading it is not necessary that there should be direct profit motive in the mind of Insider.

A different judgment in the case of Raymond L. Dirks v. Securities and Exchange Commission , Where Mr. Ray Driks who worked as securities analyst found the insurance company for which he was working was involved in securities fraud. Mr. Driks disclosed this fraud to public. The SEC censured him for “insider trading” because he provided his clients with non-public information. The Supreme Court found Mr. Driks not guilty and stated that “Even though Mr. Driks client had profited from his action, Driks was not guilty because profit had not been his intent in uncovering the fraud.”

Circumstances plays an important role in the cases of Insider trading, on comparing both the above mentioned case Mr. Blackwell disclosed the information to those person with whom he was having fiduciary relations or family or friends, but in the case of Dirks, where the accused just acted as a whistleblower against the insurance company where he worked. Securities laws, whether in India or USA are formed to save the interest of the investors. The act of revealing the unpublished information of the insurance company by Raymond Driks was to save the interest of the investor and to gain any profit out it.


In India, according to SEBI (Insider Trading) Regulations there are two conditions need to be fulfilled to hold somebody guilty as an insider.

1. The “insider” must be a connected person with access to unpublished price sensitive information or he is a deemed to be a connected person.

2. He has traded in those securities on the basis of unpublished price sensitive information.

In the case of Rakesh Agarwal v. Securities Exchange Board of India , Mr. Rakesh Agarwal, the Managing Director of ABS Industries Ltd, was involved in negotiations with Bayer A.G, regarding their intention to take over ABS. Being the Managing Director he had access to the price sensitive information. Before announcement of the merger is made public Mr. Rakesh Agarwal through a collusive agreement with his brother-in- law to take over the shares of ABS from market, thereafter he tendered the same shares through the open offer making huge profit. Later Bayer AG acquired ABS and Mr. Agarwal was also considered as an insider.

In defence Mr. Agarwal denied the allegations levelled against him by SEBI stating that he has acted in such a manner for the benefits of the company and he has no intention to have personal gains. He wanted to acquire 51% shares of the company of ABS through Bayer and he wanted to plan to be executed in clinical precision. Taking into consideration of the defence taken Securities Appellate Tribunal held that Mr. Agarwal did that in interest of the ABS.


The Patel Committee in 1986 in India defined Insider Trading as “Insider trading generally means trading in the shares of a company by the person 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”. The Patel Committee also recommended that the securities contract (Regulation) Act, 1956 may be amended to make exchanges curb insider trading and unfair insider trading and unfair stock deals.

To strengthen the existing Insider Trading Regulations and to create a framework for prevention of insider trading, committee was constituted by SEBI under chairmanship of Mr. Kumar Mangalam Birla. The recommendations of the committee were considered by the SEBI Board and the amended regulations were notified .

The SEBI (Prohibition of Insider Trading) Regulation 1992, comprise of four chapters and three schedules encompassing the various regulations related to insider trading. Chapter I deal mainly with the definitions used in regulation. Chapter II provides for prohibitions on dealing, communicating or counselling by insider. It also contains the defences available to a company in proceeding against it on allegation of Insider trading. Chapter III narrates the investigating powers of SEBI under the regulation and also enumerates the prohibitory orders or directions that it can issue against the guilty in the interest of the capital market regulation. Chapter IV deals with the code of internal procedure and conduct to be followed by listed companies and other entities, disclosure requirements be followed by company. It also contains appeal provisions which an aggrieved person may like to follow against the orders of SEBI.

Hindustan Level Limited- The definition of insider was amended after the famous case of Hindustan Level Limited in 1998 in which the definition included those persons also who “has received or has had access to such unpublished price sensitive information”, and not just a person who is or was connected with the company. A concept of deemed connected person which included all the relatives of that particular connected person.



The rules regarding insider trading are contained in Securities Exchange Act 1934. There are other laws to prevent insider trading like Insider Trading Sanction Act 1984, the Insider Trading and Securities Fraud Enforcement Act, 1988. 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. The penalties are indeed burdensome and stringent in nature. It may be as high as three times the profit gained or the loss avoided from the illegal trading.

The Securities Exchange Act, 1934 imposed statutory curbs on Insider Trading, requiring public disclosures of insider’s transactions in the shares of their companies and providing for recovery of ‘shortswing’ profit by them. The act provided the remedial measures for protection of investors against sharp practices and fraudulent schemes by insiders in making short- term, speculative profit.

In USA the act of Insider trading was addressed through introduction of section 16(b) and 10(b) of Securities Exchange Act 1934. Section 16(b) prohibits short term profits by corporate insiders whereas Section 10(b) makes it unlawful for any person 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 regulation as the SEC may prescribe. These anti-fraud provisions make fraud or misrepresentation in connection with the purchase or sale of a security, an unlawful aspect.

The Insider trading law in USA is a part of the general law relating to fraud. Under the federal system prevailing in the USA, there were state laws know as “Blue sky” laws which contain anti-fraud provisions which are used to deal with insider trading.

In the case of Driks v SEC the Court held that the tippers 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 benefits from the disclosure. The Driks case also defined the concept of ‘constructive insiders’ who are lawyers, investment bankers who receive confidential information from a corporation while providing service.


There are four key ingredients where the regulations of Insider Trading apply in United Kingdom.

• It must relate to the securities and the particular issue of the securities and not just be concerned with the securities and issuer of securities in general. Thus information would constitute insider information if it relates to the particular industry even if it does not relate to the issuer.

• However, the information pertaining to the Government economic policy and bank rate would not come within the purview of the unpublished information.

• Information may be either specific or precise. The information regarding the takeover bid is specific information but the price at which the bid would take place is precise information.

• Information must not have been made public


The laws regarding insider trading in United Kingdom are divided into 3 parts.

1. Part V of Criminal Justice act 1993

2. Section 118 of Finance Services and Market act 2000

3. Companies Securities (Insider Trading) Act 1985

Part V of Criminal Justice Act 1993 provides for the offence of insider dealing that seeks to prevent individuals from engaging in three classes of conduct in certain circumstances like “it prohibits dealing in price- affected securities on the basis of inside information. It prohibits the encouragement of another person to deal in price- affected securities on the basis of insider information and it prohibits knowing disclosure of insider information to another.”

As per Section 52 which states

1. An individual who has information as an insider is guilty of insider dealing if, in the circumstances mentioned in sub-section (3) he deals in securities that are price affected securities in relation to information.

2. An individual who has information as an insider is also guilty of insider dealing if

a. He encourages another person to deal in securities that are price- affected securities in relation to information, knowingly or having reasonable cause to believe that the dealing would take place in the circumstances mentioned in sub section 3

b. He discloses information otherwise than in proper performance of the functions of his employment, office or profession, to another person

Section 57(1) of Criminal Justice Act 1993 provides that a person has information as an insider if and only if it is and he knows that it is inside information, and he has it and knows that he has it from an inside source. This act makes insider trading illegal on the basis of unpublished specific information likely to materially affect the market price of stock if the insider knew the information was price sensitive. Under British Laws the alleged offender will not be guilty of insider trading if he had neither knowledge nor any cause to believe that dealing would take place based on the information.

There were certain loop holes in Criminal Justice Act 1993, to fill these gapes Financial Services and Market act 2000 was passed to prevent insider trading, this act made the offence of market abuse applicable to legal entities and natural persons. FSA i.e Financial Services authority which is empowered to prosecute the criminal offence of market manipulation and the offence of insider trading

Even Section 118(2) lays down three tests which need to be satisfied to constitute market abuse:

1. That the behaviour must occur in connection which a qualifying investment traded on a prescribed market.

2. One or more of the following as misuse of information, false or misleading impression or market distortion

3. The behaviour must fall below the standard of behaviour that a regular user of the market would reasonably expect of a person in the position of the person in question. Behaviour will amount to market abuse only if it satisfies all three tests


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