Insider Trading Regulation in India

 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 Trading by insiders while in possession of unpublished price sensitive information thereby possibly gaining unfair advantage on the basis of information is received is called Insider Trading.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

Buyback of Shares – A Judiciary Prospective

Buyback-of-Shares-Mandar D Rane

Introduction

When a Company has excess cash they may either use it for Investment, Acquisition of another company, repay debt or Buyback of shares. Buyback of shares in common parlance may be described as a procedure followed by a Company wherein it offers to purchase shares from its shareholders. Buyback of share is an indicator that a company believes its shares are undervalued and is very coherent strategy to give money back to its shareholders.

Section 68 Companies Act 2013(“Act”) deals with Buyback of securities. The section commences with a non- obstante clause i.e. “Notwithstanding anything contained in this Act, ….”.This would imply that, it gives an overriding effect to the said provision and is a complete code for buy-back of shares. Therefore the company desiring to buy-back its equity shares must follow procedure as set down in the provision. The section provides a detailed framework for a Company to Buyback its own shares. There is a clear distinction of the fund from which a buy-back can be financed. A buy-back exercise can be carried out only up to an amount up to 25 per cent of the paid-up equity capital in that financial year of the Company and the debt to paid up capital and free reserves ratio should not go beyond 2: 1.The shares to be bought back should be fully paid. There should be authorization in the articles of the company, a declaration of solvency and it shall be authorized by a special resolution of a company at its general meeting so as to ensure shareholder protection.

  1. Objectives of Buyback of Shares

 

  • Increase promoters stake:- Increase of promoter’s stake shows their confidence in the Company. Promoters holdings is diluted if, allotted ESOPs are exercised by employees .Due to dilution of their holdings the entity is prone to unwelcome takeover bids. Thus Buyback of shares assist in consolidating the stake and averting such bids.

 

  • Exit opportunity to shareholders:- Buyback of shares would provide an exit opportunity to institutional shareholders/large retail shareholders, which may otherwise not be available whilst at the same time safeguarding the interest of continuing shareholders as provided in Re: Abbott India Limited1 buyback casein 2007 where price at which the buy-back is proposed is Rs. 650/- and is higher than the book value of Rs. 141.65 per share

 

  • Increase in Earning per share: Buyback of share lead to a reduction in the number of Shares outstanding, which can lead to improvement in earnings per share as earnings is being distributed to few shares and an overall enhancement of value for shareholders continuing with the Company. For instance, if we consider a case of Deepak Industries Limited where the Company had proposed Buyback of 13,24,500 paid up equity shares. They projected EPS would surge from Rs. 34.06 to Rs. 45.42 as on March 31,2015 assuming full acceptance of Buyback offer.

 

  • Return to shareholders:- If there is no profitable utilization of the reserves, returning back its money to the shareholders out of its surplus funds and if the best possible price is being paid, than it would benefit the shareholders who would opt to divest their shares in the buy back.

 

  1. Pitfalls in Buyback of shares

  • Lack of Growth:- Buyback of shares is a signal to the Investors that there are no more profitable opportunities of Growth available in Business , rather than using excess cash for reinvesting or acquisition the Company adopts Buyback exercise and diverts it to shareholders.

  • Misleading Buyback Announcement:- Several Buyback of shares announcements are issued to generate investor interest and later disseminate the information regarding rejection of the Buyback of shares. It was held in In Re: Shalibhadra InfoSec Ltd2case in March 2008 where their Key personnel were is charged with having issued misleading and unsubstantiated advertisements regarding buyback of shares even when the company was not performing well. The announcement was issued with a view to create investor interest in the scrip even though the Company did not have sufficient resources to meet the buyback obligations.

 

  • Procedural Aspect:- The procedure set out in the Act shall be adhered strictly to protect the stakeholders. In case if any provision are not adhered to than it would attract penalty and officer in default are punishable with imprisonment. In Essar Bulk Terminals case3 in 2011 wherein the only observation raised by Regional Director was pertaining to the compliance with the procedure prescribed under Sec. 77 A of the Companies Act, 1956 for the buyback of the shares by the company.

 

  • Insider trading:- The most important concern is that Buyback of share is presumed as an indirect form of Insider Trading. In Continental Controls Ltd.’s case4wherein Buyback proposal was approved and later the said proposal was deferred. In the said case a close accomplice (i.e. person acting in concert) of the Managing Director of the Company heavily traded using the Buyback information after issuance of advertisement causing spurt in pricing of shares.Favourable conditions were created to operate in the market in the backdrop of such advertisements and sell the shares of the Company to the gullible public thereafter, another aspect that was pointed out was that the whole funding of Buyback was been accrued in future from a proposed technology transfer deal. It was held that such a said method of funding was not acceptable as per provision of Section 77A and such an information being a price sensitive information should have been disclosed to SEBI.

  1. Judicial decisions

Buyback of shares –Evasion of Tax?

Here we analyze a landmark judgement Capgemini India Private Limited’s case5 which was decided by High Court of Bombay in April 2015.

Capgemini India Private Limited (“Company”) decided to buyback 221,231 equity shares in accordance to provision of Section 391 read with Sections 100 to 103 of Companies Act 1956,which constituted 30% of issued , subscribed and paid up capital of the Company.

The Regional Director via an affidavit dated October 1, 2014 had raised objection and opposed sanction of the Scheme. Regional Director raised objection on grounds that buyback of shares can be effected only under Section 77A of Companies Act 1956/Section 68 of the Companies Act 2013.

The Regional Director further stated that, if the company effected buyback of shares via Section 77A/Section 68 of Companies Act 2013 than distributed income of would be chargeable to tax in accordance with Section 115QA of the Income Tax Act, thus the Scheme shall be rejected as it would amount to evasion of income tax and outflow of foreign exchange amounting to Rs. 248 crore.

The Company i.e. Petitioner contented, Regional Director has no locus standi in respect of tax matter particularly when Income Tax authorities have not broached any objections. Further it was argued that it is open for the Company to follow either of the procedure out of two available to effectuate Buy Back of shares and since the Company wants to buyback 30% paid up capital and free reserve it would not be possible under Section 77A/Section 68 as it is only permissible to buyback 25% of paid up capital and reserves of the Company, thus the Company can buyback only by following the procedure under Section 391 read with Sections 100 – 104 of the 1956 Act.

The petitioner placed reliance upon the case of SEBI V/s. Sterilite Industries (India) Limited6wherein it was held that, The legislative intention behind the introduction of section 77A is to provide an alternative method by which a company may buyback upto 25 per cent of its total paid up equity capital in any financial year subject to compliance with Subsections (2), (3) and (4). Section 77A is a facilitating provision which enables companies to Buyback their shares without having to approach the court and Prior to the introduction of section 77A, the only manner in which a company could buyback its shares was by following the procedure set out under sections 100 to 104 and section 391 of Companies Act 1956.

Thus Hon’ble High court sanctioned the Scheme of Arrangement with clarification the issues relating to Income tax that may arise out of the Scheme are left open to be dealt with and decided by the Income tax Authorities in accordance with law.

Noting’s: – Section 115QA was inserted via Finance Act 2013 wherein amount of distributed income (i.e. consideration paid by the company on buy-back of shares as reduced by the amount which was received by the company for issue of such shares) of the company on buy-back of shares was chargeable to tax. Buy Back of shares in accordance to Section 77A of Companies Act 1956.Thus if the Buyback of shares was carried out through Section 391 of Companies Act 1956 the said tax obligation was not triggered. Thus, Finance Act 2016 has amended Section 115QA of Income Tax wherein the provision will be applicable to buy back of unlisted share undertaken by the company in accordance with the provisions of the law relating to the Companies and not necessarily restricted to section 77A of the Companies Act, 1956.

Buyback of shares – Unilateral Purchase of Shares?

Here we analyze Godrej Industries Ltd.’s Case7 adjudicated at National Consumer Disputes Redressal Commission , Godrej Industries Limited (“GIL”) laid down a scheme for buyback of 40% of paid up capital of GIL.After sanction from High Court, GIL sent letter of offer to all its shareholders.

The Complainant held 45 shares, paid up value Rs.6.The Complainant was in receipt of a Cheque amounting Rs.810 (45 shares of Rs. 18) but was returned. The Complainant than sent a letter to GIL stating that she did not receive any buyback offer and nor did she exercise any option of buy back of shares. The Complainant further stated such an act amounted to a unilateral purchase of share and amounted to compulsory acquisition of shares.

The Complainant had stated that option form stated by GIL has not been received thus question of intimation would not arise and there is no evidence of actual delivery of the form. The Complainants counsel further argued that holding shares in Company is similar to possessing a property and the same could not be purchased by GIC in the manner, stated by them. They further stated that after Scheme was sanctioned no public notice was issued and implied consent for Buy-Back.

GIL counsel referring to Scheme of Arrangement stated unless the shareholder expressed its desire in written intimation to Company within 30 days of record date it is presumed that consent is accorded for Buyback of shares. They further stated that meeting of shareholders was convened via publication of notices and still the Complainant did not prefer any objection to the Scheme.GIC further contended that The Company had, therefore, acted in accordance with provisions of the Scheme and the procedure laid down in the Companies Act.

The decision was in favour of GIC wherein it was directed to make the payment along with interest.

Noting’s: – The basic issue in the said case revolved around whether a shareholder can be made to sell shares of a Company without consent and is the scheme unfair and against the interest of the shareholders. For the first instance in given case , as per the scheme if the shareholder did not exercise the option to retain shares within specified time limit , it was assumed that shareholder accorded for buying back the shares and the shareholder did not prefer any objection when scheme was known to shareholders through notices and publication. For second instance, since the scheme has been duly approved by the Court, the Company is well within their rights to proceed with the approved scheme and the Company has taken appropriate steps to apprise shareholders about the Scheme.

Buyback of shares – Reduction of Capital?

In the present case of Goldman Sachs (India) Securities Pvt. Ltd8which was a wholly owned subsidiary of Goldman Sachs (Mauritius) LLC. The Indian entity of Goldman Sachs had remitted certain amount to its parent entity under Buy Back of Shares Scheme which was over and above the face value as approved in General Meeting.

The Tax authorities contented that Buy Back carried out by the Company amounted to reduction of Capital. The tax authorities were of view that, such a remittance of an amount which is above face value represents income by way of Dividend and hence tax at source should be deducted. Following queries were deliberated in the said case:-

Does Buy Back Deal be termed as Colourable Device?

Since the deal entered in by the Entity is in compliance to applicable laws and does not violate any provisions of the Act. Even If the Buy Back transaction in said scenario leads to non-payment or lesser payment of Tax it cannot be held as a Colourable transactions.

Can Assesse be held in default for non-deduction of Tax at source?

Profit arising out of Buy Back is taxed as Capital Gain, the said Capital Gain arised is taxable at hands of parent company in Mauritius however under Indo – Mauritius Treaty capital gain is not taxable to parent Company. Since the Assesse is not liable to deduct tax as per provision of Income Tax Act it cannot be held as Assesse in Default, thus the penal provision of Income Tax would not be applicable.

Can Buy Back of share be equated to reduction of Capital?

Here we have to consider two provisions Section 2(22) (d) and Section 46A of Income Tax Act. As per Section 2(22) dividend is defined inclusively and as per sub-section (d) “dividend is any distribution to its shareholders by a company on the reduction of its capital…”to the extent to which the company possesses accumulated profits. Section 46A on other hand asserts the difference between the cost of acquisition and value of consideration received by the shareholder or the holder of others specified securities, as the case may be, shall be deemed to be the capital gains arising to such shareholder or holder of specified securities. Thus we conclude after considering both sections of the Act that Buyback of shares and reduction of capital are two different concepts and Buyback of shares by Corporate Entity cannot be characterized by deemed dividend but profits arising out of Buyback is taxed under the head Capital Gain.

Noting’s:In the said case two important issues were highlighted, firstly does Buyback of shares be considered as a colourable device, wherein it was stated that Non-payment of taxes by an entity in given circumstances could be a moral or ethical issue, however entities can be penalised only if any provision of law has been violated. Secondly, Is Buyback of share and Reduction of shares one and the same, it is pertinent to note that there is a vast difference between both. In addition to difference mentioned above, in case of Buyback of shares there are limitations on quantum of Buyback, the sources of funding and conditions as specified for Buyback. In Buyback of shares consent of members in suffice, however in case of Reduction of Capital must be approved by the Court, Creditors and Members.

Conclusion

As we have seen objectives and pitfalls of buyback of shares along with few judicial pronouncement pertaining Buyback of shares. Shareholders need to be extra vigilant in Buyback of shares proposal and scrupulous examine the Company’s financial position, even the regulatory authorities are trying their best to protect the interest of investors by issuing clarification on tax and procedural aspects of Buyback of shares.

References:-

1 In Re: Abbott India Limited on 24 January, 2007, Securities Appellate Tribunal, Bench – G Anantharaman

2 In Re: Shalibhadra Infosec Limited on3 March, 2008, Securities Appellate Tribunal, Bench – V Chopra

3 High CourtGujarat, EssarBulk Terminal Ltd, CompanyPetition No. 50 of 2011, Coram – HonourableMr. Justice Anant S. Dave

4 SEBI vs Continental Controls Ltd. on 14 February, 2008, Securities Appellate Tribunal, Bench – V Chopra

5 High Court Bombay, Capgemini India Private Limited, CompanyPetition No. 434 of 2014, Coram – S.J. KATHAWALLA, J.

6 High Court Bombay,SEBI vs Sterlite Industries (India) Ltd., 2003 113 CompCas 273 Bom, 2003 45 SCL 475 Bom

7 National Consumer Disputes Redressal , Ritu Bhargava vs Godrej Industries Ltd & Ors on 23 January, 2014

8 Income Tax Appellate Tribunal – Mumbai, Goldman Sachs (India) Securities on 12 February, 2016

Insider Trading

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.