Manthan Saksena
ABSTRACT
The project comprehensively deals with the different implications of the insider trading as well as the efficacy of the existing regulatory mechanism in the shape of SEBI (Prevention of Insider Trading) Regulation Act, 1992 to deal with this problem. The project has mainly focused on insider trading from Indian perspective.
The author has also focused on insider trading from the United States and United Kingdom perspective which has a stringent law in place to deal with the problem of insider trading. In fact the SEBI (Prevention of Insider Trading) Regulation, 1992 is being inspired from the United States majorly.
INTRODUCTION
The problem of Insider Trading is been bothering the debt and equity market for a long period of time, making the investors to feel unsafe in the securities market. Insider trading is an act through which an insider makes profit out confidential information which are not disclosed to any investor. An insider trader is always a very influential person who has a close connection to financial world. The mental element of an insider is significant because he is in position to dictate or at least influence when the public disclosure of price sensitive information is to be made. A certain person by virtue of their position being in more advantageous position than others with regard to price sensitive information. The main reason of passing insider trading laws is that the government wants to ensure that everyone involved in the stock market has equal information and that any information available to one active participant in the market is available to all participants.
As India got industrialised in 1992, the access to securities market became easier for both companies and investors and the practice of insider trading became prevalent. With the passing of Securities Exchange Board of India (Prohibition of Insider Trading) act 1992 much of the restrictions were put on such mal practice by company employees only. There are other certain laws. Besides the 1992 Regulations, insider trading is also prohibited under regulation 3 of Prohibition of Fraudulent and Unfair Traded Practices Regulations, 2003.
BRIEF HISTORY ON INSIDER LAWS IN INDIA
Securities market in India came into existence in 1875 with establishment of Bombay Stock exchange. In 1979, the Sachar committee said in its report that directors, auditors, company secretaries etc. may have some price sensitive information that could be used to manipulate stock prices which may cause financial misfortunes to the investing public. The companies recommended amendments to Companies act 1956 to restrict or prohibit the dealings of the employees.
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.
The Abid Hussain Committee recommended that insider trading to be convicted under civil and criminal laws and also that SEBI formulate the regulation and governing codes to prevent unfair deals.
Through the coming of SEBI (Prohibition of Insider Trading) Regulation 1992 and its subsequent amendment in 2002 which prohibited fraudulent practice and a person involved in insider trading to be held guilty for such malpractice.
MEANING OF AN INSIDER
Insider means any person who-:
Is or was connected with the company or is deemed to have been connected with the company and is reasonably expected to have access to unpublished price sensitive information in respect of securities of a company, or has received or has had access to such unpublished price sensitive information
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.
In the case of Dirks v. Securities Exchange commission , the petitioner Raymond Dirks, received material information from insider who wanted petitioner to report fraudulent practices in their company, petitioner tipped clients and investors by disclosing information to them. The Court held that “a tippee owns a fiduciary duty to shareholders if the tippee received material information from an insider that the breached his fiduciary duty by disclosing the information and the tippee knows the breach”.
The essential characteristic of insider dealing thus consist in an unfair advantage being obtained from information to the detriment of third parties, who are unaware and consequently the undermining of the integrity of financial market and investor confidence.
If a situation arises that you are standing in an elevator and overhear someone from fiscal talking on his cell phone about next year’s earning you cannot act upon that information. In order to trade stock you must wait for information to become available to general population. Some companies advise employees to wait as long as 24 hrs after the information made to public in order to avoid any conflict of interest.
Under the SEBI Regulations it is not necessary to prove that the insider was knowingly connected with the company or he knowingly indulged in insider trading. It would therefore prima facie seem that mens rea is not an essential ingredient of the offence of insider trading. Consequently, a person may be convicted of the offence regardless of whether he has committed it knowingly, deliberately or intentionally. He would be liable to be convicted and punished once it is established that he is an insider within the scope of the SEBI Regulations and, further, that he has committed any one of the three acts prohibited by regulation 3. Thus, it will not be necessary to establish mens rea, although it will be necessary to establish that the insider did any of the prohibited acts on the basis of unpublished price-sensitive information. There are no words suggesting the requirement of mens rea.
The insider trading Regulations do not contain the requirement of motive for conviction of insider trading. There is no requirement of motive as an essential ingredient for violation of regulation 3(1) if Insider trading regulation. The regulation also does not contain the requirement of knowledge and intention for conviction in insider trading.
PRICE SENSITIVE INFORMATION
The Hindustan Level Limited v. Securities Exchange Board of India in 1998 was perhaps the first under the regulation wherein SEBI’s findings on insider trading were set aside by Securities Appellate Tribunal, which held that there was no trade involved, based on inside information not being price sensitive as it was available to public domain.
Section 2(ha) of SEBI(Prohibition of Insider Trading) Regulation,1992 defines ‘Unpublished price sensitive information’ as any information which relates directly or indirectly to a company and which if published is likely to materially affect the price of securities of company”.
The prohibition contained in regulation 3 applies only when an insider trades or deals in securities on the basis of any unpublished price sensitive information and not otherwise. Although when an insider trades or deals in securities of a listed company, it may be presumed that he traded on the basis of unpublished price sensitive information in his procession, the contrary can be established for which burden of proving contrary to presumption lies on the insider. Where the insider shows that he did not trade on the basis of unpublished price sensitive information but on some other basis he cannot be said to have violated the provision of regulation 3.
Any information which is price sensitive should be announced quickly after it becomes know to management of issue. Such sort of information should be kept confidential until any public announcement is made by the issuer. If the degree of security cannot be maintained an announcement to the public should be made.
LAWS RELATED TO INSIDER TRADING IN USA
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 laws in United States regarding insider trading mainly depends upon the mental element of the insider, as per the case of Chiaralla v. United States it was held that in order to show the violation under the Securities Exchange act it is necessary to prove that insider breached his fiduciary duty fraudulently.
The laws in USA relating to Insider Trading are primarily contained in section 16(b) of the Securities Exchange Act, 1934 which states as follows in the relevant part:
For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer, any profit realised by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer (other than an exempted security) or a security-based swap agreement , involving any such equity security within any period of less than six months, unless such security or security-based swap agreement was acquired in good faith in connection with a debt previously contracted, shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction of holding the security or security-based swap agreement purchased or of not repurchasing the security or security-based swap agreement sold for a period exceeding six months.
Section 16(b) of the Securities Exchange Act, 1934 prohibits the purchase and sale of the shares within 6 months period involving the directors, officer, stock holder owing more that 10% of the shares of the company. The rationale behind the incorporation of this provision is that it is only the substantial shareholder and the person concerned with the decision and management of the company who can have access to the price sensitive information and therefore there should be bar upon them to transact in securities. Section 10(b) of the Securities Act 1933, SEC rule 10b-5 prohibit fraud related to trading in securities
In 1984 with the case of Dirks v. SEC the Supreme Court of United States of America said that the tippers (person who is a receiver of second hand information) will be held liable if they had reason to believe that the tipper had breached fiduciary duty in disclosing confidential information and the tipper has received any personal benefit from the disclosure.
The concept of “Constructive insiders” came into existence with this case only where constructive insider who is lawyers, investment bankers and others who received confidential information from a corporation while providing service to the corporation. Constructive insiders are also liable for insiders trading violation if the corporation expects the information to remain confidential, since they acquire the fiduciary duties of the true insider.
LAWS RELATING TO INSIDER TRADING IN UNITED KINGDOM
The laws regarding insider trading in United Kingdom are basically divided into three parts.
1. Part V of Criminal Justice act 1993
2. Section 118 of Finance Services and Market act 2000
3. The European Union Directive on market abuse
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
The European Union on market abuse came into force on 30th November 2001, with a motto to tackle market manipulation and insider trading in European countries.
COMPARISION OF INDIAN LAWS WITH OTHER COUNTRIES
United States has a comprehensive legislation on Insider trading. In India laws on insider trading came late in 1992 whereas in United States insider trading laws came late in 1933 in form of Securities Exchange Act 1933 after the great depression of 1929.
In United Kingdom only an individual can be held liable. In India individuals as well as corporations can be guilty of the offence. In this regard the laws of India and United States are similar to each other.
Indian regulations are silent on when and how information is considered to be public. According to United Kingdom regulation state that information can be said to have been made public if
1. It is published in accordance with the rules of a regulation market for the purpose of informing investors and their professional advisors;
2. It is contained in records which by virtue of any enactment are open to inspection by the public;
3. It can be readily acquired by those likely to deal in securities (a) to which information relates(b)or an issuer to which the information relates;
4. It is derived from information which has been made public.
Even through section 53(1) of CJ Act it provides defences against insider trading. It says that
An individual is not guilty of insider dealing if he shows-:
1. He did not at the time of dealing expect the deal to result in profit attributable of the fact that the information in question was price sensitive information in relation to the securities.
2. That he believed on reasonable ground that information had been disclosed widely enough to ensure that none of those taking part in the dealing would be prejudiced by not having information.
3. That he would have done what he did even if he did not have the information. Defences on the same lines are available to persons who are considered guilty of encouraging other persons to deal in securities or disclosing price sensitive information to others.
There is no specific code to tackle insider trading in United States of America, SEC ensures that the market remain honest in order to promote investor confidence and it aimed at controlling the abuses believed to have contributed to the crash or the great depression of 1929. For example as per section 16(b) of SEC prohibits short swing profits (profits realised in any period less than six months) by corporate insiders in their own corporation stock. But in India there is SEBI (Prohibition of Insider Trading) Regulation 1992 code is been formed to protect the interest of the investors.
Under the UK Insider trading laws, it will be necessary for the prosecution to establish that the individual charged with the offence of insider dealing has intentionally dealt in the securities knowing that he is connected with the company. It is no defence that the accused obtained the information without having actively sought it. Hence, the criterion for mens rea has been laid down. But in India the position is not the same in this regard. That is to say that a person may be convicted of the offence regardless of whether he has committed it knowingly, deliberately or intentionally, once it is established that he is an ‘insider’ within the scope of the SEBI regulations and he has committed any one of the acts prohibited by regulation 3 and 3A.But it is necessary to establish that the insider did any of the prohibited acts based on unpublished price sensitive information. In United States not every corporate insider who profitably trades in a manner consistent with undisclosed information is necessarily guilty of unlawful insider trading. The burden is on the government to prove that the trading arose out of the use of confidential information. Thus, if it can be shown that the trader planned to trade prior to learning of the confidential information, and that the trader acted in accordance with that pre-existing intent, rather than as a result of the recently-learned, undisclosed information, the trader may not be guilty of unlawful insider trading.