Sourabh Battar
INTRODUCTION
In a Company, Insider Trading is trading by Insider and Insider do not mean employees or key managerial person of a company, insider could be connected to the information of the company and securities of the company. Trading by insiders while in possession of unpublished price sensitive information thereby possibly gaining unfair advantage on the basis of information is received is called Insider Trading.
Prevention of insider trading is not a new concept to India. The Securities and Exchange Board of India longback introduces the preventive regulation for listed companies. However there were no provisions in The Companies Act, 1956, to deal with the insider trading. In India, the journey of regulating insider trading began in 1992 with the enactment of the Securities and Exchange Board of India Act and the regulation made there under called the SEBI(prohibition of insider trading) Regulation 1992. [1]The law imposes civil[2] and criminal sanction[3] against any person who engages in insider trading. In November 2014, the Securities and Exchange Board of India decided to substantially overhaul the 1992 regulations in the wake of the recommendations of Justice N.K.Sodhi Committee.[4] The 2015 regulations plug several loopholes ailing the 1992 regulations in an attempt to strengthen the regulatory framework of insider trading in India. [5]Now these provisions has became the part of the Indian company law.
Part II of this Paper describes concept of insider trading and regulatory framework in India. Part III traces the various theories across the world, which governs insider trading. part IV of the article begins by exploring the possibility of the sec 195 of the companies act to private companies. It is argued that, there is a need to regulate insider trading in private companies.
II. CONCEPT OF INSIDER TRADING AND REGULATORY FRAMEWORK IN INDIA
Currently, In terms of central made law. There are two Acts, which are having provisions an insider trading in securities market. One is SEBI Act, 1992. Since 1992, it has been delegating clearly provided a function of SEBI to prohibit insider trading in securities market. In 2013, a new Act comes , The Companies Act,2013, which incorporates a provision sec 195 and saying insider trading as far as listed company and proposed to be listed company concerned are going to be regulated by SEBI. It defines in the explanation what does insider trading mean and it says act of subscribing, buying, selling, dealing or agrreing to subscribe, 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 such director or key managerial personnel or any other officer of the company is reasonably expected to have access to any non-public price se nsitive information in respect of securities of company and act of counseling about procuring or communicating directly or indirectly any non-public price –sensitive information to any person.[6] So that means the law presupposes insider trading to be an offence not limited to buying and selling, but also to deal in securities . It also defines price sensitive information. It says 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.[7] The same concept has been used by SEBI on the basis of Justice Sodhi Committee Report in 2015 regulation. In 2015 regulation, Trading means and includes subscribing, buying, selling, dealing, or agreeing to subscribe, buy, sell, deal in any securities. If we see 1992 regulation dealing in securities was defined. The only difference is earlier dealing used trading, now trading use dealing. But per se in concept is not a diversion.
Insider Trading is trading by insider and insider do not mean employees or key managerial person of a company, insider could be connected to the information of the company and securities of the company. Trading by insiders while in possession of unpublished price sensitive information thereby possibly gaining unfair advantage on the basis of information is received is called Insider Trading. In own words Insider Trading means invest today on tomorrows news i.e. X Limited is a Pharmaceutical Company in India. Equity shares of X Limited are listed in the stock exchange. X Limited have been trying to get permission to sell one of his drug in United States for which it has made the application which is pending with the United State Authority for sometime. The U.S. Authority may or may not grant the permission , if the permission is granted, the sales and profit is x limited will multiply means, this permission would definitely triggered an movement in the share price of x limited. on 30th june, the share price was rs.100/share and on 1st july the U.S. Authority granted the permission and on 2nd july, because of the permission of the share price shoots up by 30% to rs.130/share. In this example before the permission is actually granted, some of the senior executive of x limited would aware that the U.S. Authority are expected to grant the permission shortly. They were also aware that once permission is received , share price of x limited will go up , so they had already bought the shares at the level of rs.100, which is before the announcement of receipt of permission on 2nd july. the news of permission became publish and share price shoot up to rs.130. These senior executive sold the shares and make profits seems very easy money making but these gains on the basis of unpublished price sensitive information which is unethical. These unpublished price sensitive information could be anything , it could be better financial results, takeover offers, proposed mergers/demergers, etc.
Before the SEBI Act 1992, insider trading was regulating even using the word insider trading. When we see the history, the companies act 1956 always mandated disclosures on appointment of a directors or an officer of a company. There were various committees Reports. Since P.G.Thomas Committee(1948), Sachar Committee(1979), Patel Committee(1986), Abid Hussain Committee (1989). All the committees in one way or another mandated various disclosures to the made by the people who are connected to the company and these people who were prominently and who were in a position to access some information or who were in the decision making capacity with in a company. So till now in the jurisprudence insider trading is probably an offence which can be committed by high profile people connected with the people and can take advantage of that information. Since that time company law mandated disclosures not only the people with in the company, but the people outside the company or the people who receiving such information.
III. THEORIES OF INSIDER TRADING ACROSS THE WORLD
IOSCO CORE Principles-
1. The objectives and principals of securities regulation published by the IOSCO (International Organization of Securities Commission) states that the objectives of good securities market regulation are- (1)-Invester protection. (2)-Ensuring that markets are fair, efficient, and transparent. (3)-Reducing system risk.
2. The discussion of these “core principles” state that “invester protection” in this context means “investor should be protected from misleading, manipulating, unfair practices, including insider trading.
Across the world there are various theories, which governs insider trading.
1. Classical theory of fiduciary duty-Under the classical theory, a corporate insider ( such as an officer or director) violates rules by trading in the corporations securities on the basis of material non public information about the corporation. such a classic corporate insider, who owes fiduciary duty to the corporation and its shareholders, has a duty either to obstain from trading or disclose such information before trading.[8]
2. Misappropriation theory-Misappropriation theory is designed to protect the integrity of the securities markets against abuses by outsiders to a corporation who have access to confedential information that will affect the corporations security price when revealed, but who owe no fiduciary or other duty to that corporations shareholders.[9]
3. Parity of information theory-
Economist and Lawyers are divided , whether insider trading should at all be regulated or not.
A School of thought- Insider Trading is Good.
In events of insider trading(1966) Harvard business review 113, prof. henry mann argues that, insider trading should not be regulated because-
1. Long term investors suffer no loss from it as they select stocks on the basis of fundamental factors.
2. There is no substantial relation between rigorous insider trading registration and public confidence in the markets.
3. Insider trading is the only way properly to compensate the entrepreneur who perform the function of innovation so necessary to the survival and growth of a free enterprise economy.
4. Knowledge of specific events or of the probability of future events that will ultimately cause a change in share prices.
Counter to Prof. Henry Maan School-
1. Insider trading does not reward efficient management as such it rewards the possession of confedential reside information, whether the information is favourable to the prospects of the corporation or not.
2. It leads to loss of efficiency due to the incentives that are created for the insider to conceal information dissemination missed information above the corporation which he engages In trading.
3. Managers and others with confedential information would have an incentive to manipulate its disclosures so as to produce sharp changes in crisis.
IV. DOES THE INSIDER TRADING PROHIBITION UNDER SECTION 195 APPLY TO PRIVATE COMPANIES AND IS THERE A NEED TO REGULATE INSIDER TRADING IN PRIVATE COMPANIES.
Section 195 prohibits directors or key managerial personnel of a ‘company’ from engaging in insider trading, without making any distinction between a public or private company. So the provision, prima facie, suggests that it is uniformly applicable to all companies – regardless of whether they are public or private, listed or unlisted.
However, a closer reading of the provision reveals another story. Section 195 defines ‘insider trading’ as the activity of dealing in ‘securities’ of a company where the term ‘securities’ has the same meaning as under the Securities Contracts (Regulation) Act, 1956.[10] In the SCRA, ‘securities’ only refers to marketable securities. There is settled judicial opinion that since there are restrictions on the transferability of securities of a private company, such securities are not marketable and hence do not qualify as ‘securities’ within the meaning of the SCRA.[11]This has led some people to argue that though Section 195 prohibits insider trading in a ‘company,’ it refers only to trade in ‘securities’ of public company and it cannot be made applicable to private companies.[12]
This view has also found favour with the Sodhi Committee, which observed that ‘any security that fits within definition of the term under the SCRA would be amenable to insider trading.’[13] Given that SEBI regulations are already in place to regulate insider trading in listed companies, the Sodhi Committee assumed that the only contribution of Section 195 of Companies Act 2013, to the existing insider trading regime is that it extends the coverage of law to companies who intend to get their securities listed on the stock exchange.[14] This assertion further derives its force from the fact that Section 458 of the Companies Act 2013 empowers the SEBI to prosecute insider trading in securities of ‘listed companies or those companies which intend to get their securities listed.’ [15]This has been used to argue that private companies are still not the subject of insider trading laws. [16]
Considering the proliferation of conflicting interpretations, it may be useful to consult the reports of the drafting committee for the Companies Bill to gain an insight into the true legislative intent behind the provision. Interestingly, during the process of drafting of the Companies Bill, several business associations (such as the Bombay Chamber of Commerce and Industry and Indian Merchants’ Chamber) had recommended that Section 195 be deleted from the Act to prevent its overlap with the SEBI Act and the regulations made there under. [17]Alternatively, it was suggested that an explicit exception be carved out to prevent its application to the private companies since the concept of insider trading has always been understood within the framework of listed companies only. [18]The Ministry of Corporate Affairs, responding to the suggestions, explained that since ‘insider trading’ is not defined in any statute (the SEBI Act or the SCRA), recognition of this concept in the ‘principal legislation for corporate entities’ is intended to empower SEBI to curb this pernicious activity.[19] The Ministry asserted that the intention is not to modify the existing regulatory structure formulated by SEBI and the provision should remain in consonance with the SEBI regulations.[20] The Ministry brushed aside any further demands for clarity in legislative drafting by stating that Section 458(1) of the Companies Act clearly empowers SEBI to enforce these provisions and accordingly, there ought to be no apprehension that the provisions under the Companies Act would be inconsistent with the SEBI regulations.[21]
This suggests that, contrary to popular perception, Section 195 of the Companies Act was perhaps never intended to extend the insider trading prohibition to private companies but merely to bolster the existing regime of insider trading in India. Nonetheless, given the amorphous language of Section 195, there would always be a lingering possibility of dragging private companies within the ambit of the provision. A clarification from the Ministry of Corporate Affairs can dispel this ambiguity, putting the speculation to rest. Unfortunately, such a clarification does not seem to be forthcoming in the near future, since, as recently as in June 2015, the Ministry of Corporate Affairs released a notification exempting private companies from certain provisions of the Companies Act 2013. But no such proposal was made with respect to Section 195 and the Ministry of Corporate Affairs once again missed an opportunity to clarify the issue.
It is believed that stock exchanges exist to provide a fair, level playing platform where the potential buyers and sellers of securities meet to enter into a transaction.[22] In case of a public listed company, members of the public buy or sell shares on a recognized stock exchange on the faith that the relevant information has been made available to all market participants and no person can take an unfair advantage because he has access to additional material information. Therefore, insider trading needs to be prohibited to preserve investor confidence and ensure the efficiency of the financial market. The Sodhi Committee’s report similarly argues that the prohibition of insider trading presupposes the existence of a price-discovery platform for security. There is no price discovery if the securities of a company are not listed and hence there cannot be a risk of speculative trading or misuse of corporate information involved in the transaction of securities of a private company.[23] the transaction is more often than not, a subject of direct negotiations between parties who know each other. In that sense, it is considered to be similar to a trade in any other good or product which ought to be governed by the principle of ‘caveat emptor’ (buyer beware) where neither party has an obligation to disclose any information to each other.
CONCLUSION
The 1992 Regulations and the 2015 Regulations, both have an expansive and open-ended definition of the term ‘insider,’ which includes anyone and everyone who has access to unpublished price-sensitive information such as lawyers, bankers, etc. regardless of whether or not they are connected to the company. In contrast to this, the Companies Act 2013 describes ‘insider trading’ only with reference to ‘director or key managerial personnel or any other officer of a company either as a principal or agent’ who is ‘reasonably expected to have access to any non-public price sensitive information in respect of securities of company.’ the Companies Act views insider trading as a breach of fiduciary duty. The provision is therefore applicable only to the directors/officers of the company who stand in a fiduciary position to the company and to the shareholders. When viewed from this standpoint, the regulation of insider trading in private companies is not entirely devoid of merit.
In fact, a closer look at the difference between a private and public company would reveal that the risk of insider trading is perhaps even greater in a private company than a public one. Public companies in India operate under a strict disclosure regime. They are legally obliged to make regular, complete disclosures about almost every aspect of their functioning under the Companies Act and various SEBI Regulations such as the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009. Shareholders in a public company are generally familiar with the annual reports which provide extensive information about the company, its financial position, new developments, etc. Further information about the company can also be accessed on the website of the stock exchange where it is listed. Accordingly, the members of the public including the shareholders are seemingly at a level-playing field in terms of the information that is known about the company. Essentially, this means that the possibility of insider trading in a public listed company would arise only at times when there is particular price-sensitive information which has yet not been disclosed to the public and is known only to some officials of the company. Given the elaborate and extensive disclosure requirements, it is argued that such undisclosed information is a rare commodity in the context of public companies.
Unlike public companies, private companies have scant reporting and disclosure obligations and at any given point of time, the information about the company is available only to the directors and persons in authority or employees depending upon their varying levels of responsibility within the company. This would mean that a member of the public intending to buy securities of a private company from an existing shareholder is bound to be at a huge disadvantage in terms of access to information and the shareholders are quite literally at the mercy of the directors.
In the case of listed companies and those intending to get listed, Section 458 of the Companies Act 2013 conveniently delegates the power of enforcement of Section 195 to the SEBI while the authority responsible for enforcing the rule in the context of private companies is still shrouded in mystery. The method of enforcing or detecting insider trading is also similarly vague and unclear. Listed companies have a centralized enforcement of insider trading laws whereby the SEBI detects cases of insider trading based upon unusual price and volume activity. In the context of private companies, absent a trade on stock exchanges, there is no understanding on how the regulatory authorities will oversee the enforcement of the provision and detect cases of violation.
Through the inclusion of insider trading provisions in the Companies Act 2013, the legislature has raised more concerns than it ever hoped to address. Section 195 of the Act is a site of complete confusion and uncertainty regarding (I)- the scope of the application itself and (II)- in the event that the provision is finally made applicable to private companies – regarding the mechanism of enforcing the statutory restrictions. Under the law as it stands today, the director of a private company entering into any transaction of securities of his company is potentially engaging in insider trading which could expose him to the liability of a heavy fine or maybe even imprisonment.
[1] Securities and Exchange Board of India (SEBI) Act of 1992,s.30.
[2] Securities and Exchange Board of India (SEBI) Act of 1992,ss.12(d),15(g).
[3] Securities and Exchange Board of India (SEBI) Act of 1992,ss.12(d),24.
[4] SEBI Board Meeting
[5] Report of the High Level Committee to Review the SEBI (Prohibition of Insider Trading) Regulations, 1992, Justice N.K. Sodhi
[6] The Companies Act,2013(Act 18 of 2013),s.195.
[7] The Companies Act,2013(Act 18 of 2013),s.195.
[8]Howard.J.Kaplan, Joseph.A.Natteo,et.al(eds),The Law of insider Trading,ABA Section of litigation 2012 section annual conference(18-20)April,2012.
[9] ibid
[10] The Companies Act 2013, s. 2(81).
[11] Norman J. Hamilton v. Umedbhai Patel, (1979) 81 Bom L.R. 340(India);
[12] Tulika Sinha & Arun Mattamana, The Viewpoint: Notified Sections of the Companies Act, 2013 – Analysis of Issues for M&A Transactions, (Jan. 3, 2014), http://www.barandbench.com/); ASSOCHAM White Paper, New Mergers & Acquisitions in the new era of Companies Act, 2013, (Feb. 2014), http://www.ey.com.
[13] Report of the High Level Committee to Review the SEBI (Prohibition of Insider Trading) Regulations, 1992, Justice N.K. Sodhi
[14] Report of the High Level Committee to Review the SEBI (Prohibition of Insider Trading) Regulations, 1992, Justice N.K. Sodhi
[15] Section 458 (1) reads:
[..] Provided that the powers to enforce the provisions contained in section 194 and section 195 relating to forward dealing and insider trading shall be delegated to Securities and Exchange Board for listed companies or the companies which intend to get their securities listed and in such case, any officer authorised by the Securities and Exchange Board shall have the power to file a complaint in the court of competent jurisdiction.
[16] Report of the High Level Committee to Review the SEBI (Prohibition of Insider Trading) Regulations, 1992, Justice N.K. Sodhi
[17] Report of the Parliamentary Standing Committee on Finance on Companies Bill 2009, Ministry of CorporateAffairs (Aug. 2010)
[18] Report of the Parliamentary Standing Committee on Finance on Companies Bill 2011, Ministry of CorporateAffairs (June 2012)
[19] Report of the Parliamentary Standing Committee on Finance on Companies Bill 2009, Ministry of CorporateAffairs (Aug. 2010)
[20] Report of the Parliamentary Standing Committee on Finance on Companies Bill 2009, Ministry of CorporateAffairs (Aug. 2010)
[21]Report of the Parliamentary Standing Committee on Finance on Companies Bill 2011, Ministry of CorporateAffairs (June 2012)
[22] Michal Fishman and Katheren Hagerty,Insider Trading and the efficiency of stock prices,Journal of Economics(1992).
[23] Report of the High Level Committee to Review the SEBI (Prohibition of Insider Trading) Regulations, 1992, Justice N.K. Sodhi