Insider trading- Analysing the Indian Perspective

-Arjun Nihal Singh

Insider trading, the occurrence of which has become rampant in many industrialized
countries, the research seeks to examine the legal mechanism prevalent in India and
assess the extent to which it has been implemented by interpreting cases taken up by the
Courts. The research shall further draw a comparison between the legal frameworks of India
and USA pertaining to insider trading and shall highlight the merits and demerits of each by
analysing cases which have taken place at an international level which have led to the
breach of fiduciary duties by connected persons and mis-appropriation of large
amount of funds involving Raj Rajaratnam, the billionaire founder of the Galleon hedge
fund, which is one of the most controversial and widely deliberated issues in the field of
securities regulation followed by Rajat Gupta’s scam. The research shall also analyse
whether India would benefit from assimilating certain features from the legal system of the
United States, and if so which features would help India strengthen its regulatory
mechanism. The study shall be limited to the laws of these two jurisdictions only. Further,
the research will not be delving into the question of whether insider trading should be
legalized or not since that a question more of economics and less of law.

I. INTRODUCTION

Insider trading, in its essence, means dealing in the securities of a company on the basis of
certain confidential information relating to the company which is not published or not in the
public domain, i.e. ‘unpublished price sensitive information.’ Such information, had it been
published, would have materially affected the price and worth of the securities of that
company and includes information relating to the periodical financial results of the
company, any major expansion plans, new projects, mergers, takeovers,
amalgamations, issue or buyback of securities, significant changes in policy, etc. An
‘insider’ is a person who has received or had access to such information or is so connected
with the company that it is reasonable to expect that he would have had access to such
information. For instance, if the director of a company, has information that the company
has discovered oil on lands owned by it, before such information is released to the public,
and thereafter, in anticipation of the increase in the market value of the securities of the
company once such information is made public, purchases a large number of shares of the
company, he would be guilty of and liable
for insider trading.

Electronic copy available at: http://ssrn.com/abstract=2368299

Insider trading, classically involves the breach of a fiduciary duty by the officers of a
company or by connected persons including merchant bankers, share transfer agents,
trustees, brokers, investment advisors, bankers, brokers, sub brokers, etc. Once an insider
receives unpublished price sensitive information by virtue of his position in the company or
his connection with the company, he owes a fiduciary duty to the company not to abuse his
position and misuse such information. Moreover, insider trading also requires an element of
manipulation or deception by the insider i.e. he should have used such information to make
secret profits or unlawful personal gain. Insider trading is considered lawful when the
insiders (i.e. directors, employees, officers, executives) of the Company who are in
possession of price sensitive information, buy or sell securities of their own Company
within the confines
1
of Company’s policy and regulations governing this trade . The Modus operandi
initiates
when insiders act as initiators of price change by receiving the information much earlier
than others. An insider, first of all, buys the stock of the Company at the existing market
price. He then spreads some price sensitive information relating to the Company to select
group of people, who on the basis of such information will buy such stocks and would
further spread the information. When this information reaches a large number of persons, it
pushes up the sales volume and price of the stock. After a certain price of the stock is
reached, insider sells his stock, as do the ones close to him before others do the same. As
now everyone tries to sell his or her stock, its price will fall down. When information is
available to everyone, the stock reaches back to its realistic price level, which results in
2
huge loss to common investors . The rationale behind the prohibition of Insider Trading is
“the obvious need and understandable concern about the damage to public confidence
which insider dealing is likely to cause and the clear intention to prevent, so far as possible,
what amounts to cheating when those with inside knowledge use that knowledge to make a
3
profit in their dealings with others ”. SEBI, the market regulator, has to deal sternly with
companies and their Directors indulging in manipulative and deceptive devices, insider
trading etc. or else they will be failing in their duty to promote orderly and healthy
growth of the Securities market. Economic offence,
people of this country should know, is a serious crime which, if not properly dealt with, as
it

1
Thummuluri Siddaiah, Financial Services, Pearson Education India, 2011, pg 226
2
Ibid. pg 226.

Electronic copy available at: http://ssrn.com/abstract=2368299

3
Attorney General’s Reference No.1 of 1988 (1988) BCC 765 cited in Dr. K.R. Chandratre et al.,
Compendium on SEBI, capital issues and listing, Bharat Publishing House, 1996, pg 663.

Electronic copy available at: http://ssrn.com/abstract=2368299

should be, will affect not only country's economic growth, but also slow the inflow of
4
foreign investment by genuine investors and also casts a slur on India's securities market.

II. THE LEGAL REGIME TO CONTROL INSIDER TRADING IN INDIA

Insider trading is extremely detrimental to the growth of a healthy market. Even a small
quantity of securities traded on the basis of inside information may also affect the integrity
5
of the market .

The security market in India was developed through the establishment of the Bombay Stock
Exchange way back in 1875. The concept of Insider Trading can also be traced with its
establishment. It was realized that such a system is detrimental to the interest of the Indian
6
stock exchange . Before the establishment of Securities Exchange Board of India (SEBI),
Insider Trading was mainly tackled by the provisions under the Companies Act, 1956 that
required disclosure by directors etc. of the Company.

The first governmental effort to regulate Insider Trading was the formation of
Thomas Committee in 1947, which gave its recommendation in 1948 on the basis of which
7
the provisions relating to Insider Trading were incorporated in the Companies Act, 1956
in the shape of a disclosure requirement. Sections 307 and 308 were incorporated under the
Companies Act as a solution to reduce the problem of Insider Trading. These provisions
8
were modelled on the basis of Section 195 and 198 of the English Companies Act, 1948 . In
1977, the Sachar Committee was constituted to review the Companies Act, 1956 and
the Monopolies and Restrictive Trade Practices Act, 1969. In its report submitted in
1979, it stated that unfair profits, can, on occasion, be made in share dealings by the
use of confidential information, not generally available to the investing public, by certain
insiders having access to such price sensitive information. It recommended that amendments
be made to Sections 307 and 308 of the Companies Act, 1956 to prohibit and restrict
dealings by
insiders and their relatives.

Thereafter, the High Powered Committee on Stock Exchange Reforms, the Patel
Committee,
was constituted in 1984 and in its report submitted in 1986 recommended that the
Securities
Contracts (Regulation) Act, 1956 be amended to make stock exchange
manipulations
4
N. Narayanan v. Adjudicating Officer, SEBI, AIR 2013 SC 3191
3
5
Supra n. 2, pg 226
6
Byomakesh Nayak, “An Overview of Insider Trading Regulations in India”, available at
www.airweb world.com
7
Anand Kumar Tripathi, “The Concept of Insider Trading in India”, CLC/VI/2011, pg.174.
8
Anand Kumar, “Insider Trading and Regulatory Framework in India”, (2011) 3 Comp LJ, pg 118

4
including insider trading punishable. Thereafter in 1989, the Working Group on the
Development of the Capital Market, the Abid Hussain Committee, recommended inter alia, a
ban on insider trading and penalty for the same and that the SEBI, be asked to formulate the
necessary legislation which should give it authority to enforce the same. In 1991, a
consultative paper was issued by SEBI which made provisions for the curbing of insider
trading.

In 1992, the SEBI brought out certain regulations which are referred to as the Securities and
Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 [‘SEBI
Regulations’]. There were certain drawbacks in the Insider Trading Regulations as they were
short with only 12 Regulations and were not sufficient to deal with the problem of Insider
Trading, these Regulations suffered from the following major drawbacks, such as the
definition of ‘insider’ given in the Regulations is not happily framed it appears to be
an
9
ambiguous one ,the regulations did not contain any provision prescribing penalty
for
contravention of the provisions of the regulations thereof and the power to seize the
10
documents and to detain suspected offenders/violators under these Regulations .

Thus these regulations have been amended on a number of occasions, the latest being the
amendments made in the year 2011, wherein, Regulation 13 has been amended to
include Sub- Regulation (2A) and (4A). Under Sub- Regulation (2A) any person who is a
promoter or part of promoter group of a Listed Company is also required to disclose to the
Company the number of shares or voting rights held by such person, within two working
days of becoming such promoter or person belonging to promoter group. Further, Sub-
regulation (4A) requires a promoter or part of promoter group of a listed company to
disclose to the company and the stock exchange where the securities are listed, the total
number of shares or voting rights held and change in shareholding or voting rights, if there
has been a change in such holdings of such person from the last disclosure made and the
change exceeds Rs. 5 lakh in value or
25,000 shares or 1% of total shareholding or voting rights, whichever is lower. This
disclosure also has to be made within a period of two days. In the amendments made in
2008 provisions were made to prohibit the practice of insider trading and empower
SEBI to investigate the same including the power to make enquiries and inspections,
appoint an
investigating authority which shall submit a report to it, appoint auditors and give
5
directions.

9
Dr. K.R. Chandratre et al., Compendium on SEBI, capital issues and listing, Bharat Publishing House,
1996, pg 671-672.
10
Ibid.

6
It is no longer necessary for person to be connected to the Company to be an insider. Thus,
as per the amended definition, now insider is also a person who holds or has access to price
sensitive information, whether or not he is connected to the Company. Section 15G of the
SEBI Act, 1992 also provides a penalty of twenty five crores or three times the amount of
profits made out of insider trading whichever is higher. Thus, at present the SEBI Act, 1992
and SEBI Regulations together constitute the legal framework in place to combat insider
trading in the securities market. However, surprisingly these Regulations doesn’t define
11 12
Insider Trading but the terms ‘Insider’ , ‘Connected person’ , and ‘Unpublished Price
13
Sensitive Information’ have been defined in the Regulations. Thus, under the
amended
Regulations the definition of ‘unpublished price sensitive information’ was removed and
the terms ‘price sensitive information’ and ‘unpublished’ were separately defined under
section
14
2(k) and 2(ha) respectively .

The Companies Act, 1956 did not have any express provisions laid down for insider trading
other than section 307 and section 308 but under the Companies Act, 2013 a new section
15
has been added i.e. Section 195 .

The Companies Act, 2013 prohibits directors and key managerial personnel
from purchasing call and put options of shares of the company, its holding company and
its subsidiary and associate companies as if such person is reasonably expected to have
access to price-sensitive information (being information which, if published, is likely to
affect the
price of the company's securities). Earlier these provisions were contained in
regulations

11
Regulation 2(e)
12
Regulation 2(c)
13
Regulation 2(k)
14
Lalu John Philip, “Insider trading law – A Critical Analysis”, (2011) 103 CLA (Mag.) 41, pg
42.
15
Section 195: Prohibition on insider trading of
securities
(1) No person including any director or key managerial personnel of a company shall enter into insider trading:
Provided that nothing contained in this sub-section shall apply to any communication required in the
ordinary course of business or profession or employment or under any law.
Explanation.--For the purposes of this
section,-- (a) "Insider trading" means--
(i) an act of subscribing, buying, selling, dealing or agreeing 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 sensitive information in respect of securities of company; or
7
(ii) an act of counselling about procuring or communicating directly or indirectly any non-public price-
sensitive information to any person;
(b) "price-sensitive information" means any information which relates, directly or indirectly, to a company
and
which if published is likely to materially affect the price of securities of the
company.
(2) If any person contravenes the provisions of this section, he shall be punishable with imprisonment for a
term which may extend to five years or with fine which shall not be less than five lakh rupees but which may
extend to twenty-five crore rupees or three times the amount of profits made out of insider trading, whichever
is higher, or with both.

8
framed by SEBI, as the capital market regulator. Now, it has also been informed that
SEBI is expected to discuss changes in certain norms for listed firms so as to make them
16
in line with the rules in the new Act.
An analysis of the legal regime prevalent in India involves addressing five aspects: firstly,
the scope and ambit of the concept of ‘insider trading’ under the SEBI Regulations as they
stand today and the scope and ambit of the concepts of ‘unpublished price sensitive
information’,
‘insiders’, ‘connected persons’ and ‘persons deemed to be connected persons’ which define
the extent and applicability of these regulations; secondly, the procedure to
investigate instances of insider trading and the powers available under the SEBI Regulations
to combat insider trading; thirdly, the disclosure requirements under the SEBI regulations;
fourthly, the requisites as to internal procedure prescribed under the SEBI Regulations; and
lastly, the liability regime prevalent in India to penalise the practice of insider trading.
These five aspects have been dealt with separately hereafter.

III. THE SCOPE AND APPLICABILITY OF THE SEBI REGULATIONS

As aforementioned, first it is essential to examine who would qualify as an ‘insider’ under

the Indian law. Regulation 2(e) provides for the definition of an ‘insider’ which has been
defined in two clauses: firstly, a person who is or was connected with the company or is
deemed to have been connected with the company and who is reasonably expected to have
access to unpublished price sensitive information in respect of securities of a company, and
secondly, a person who has received or has had access to such unpublished price sensitive
information. To qualify within the first clause of the definition, it appears that one must
be (a) either a
‘connected person’ within the scope of Regulation 2(c) or a ‘person deemed to be a
connected person’ within the scope of Regulation 2(h) and (b) must be reasonably expected
to have access to unpublished price sensitive information. Regulation 2(c) has defined
a
‘connected person’ to include firstly, a director or a person deemed to be a director or
secondly, any person who (a) occupies the position of an officer of the company, (b)
occupies the position of an employee of the company (c) any person who holds a position
involving a professional or business relationship between himself and the company,
whether temporary or permanent and who may reasonably be expected to have access
to unpublished price

9
sensitive information in relation to that company. It has been further clarified that
a

16
http://www.mon daq.com/in dia/x/270182/Corporate+Commercial+Law (last visited on 6/10/2013)

10
connected person means a person who is a ‘connected person’ within the scope of the
definition for a period of six months prior to an act of insider trading.

The parameters of the definition of a person ‘deemed to be a connected person’ have been
even more widely defined and have brought within its ambit a whole range of individuals.
Secondly, the definition has as previously mentioned, by virtue of the 2002 amendment,
17
brought within its ambit intermediaries , investment companies, trustee companies, asset
management companies or their employees or directors, or an official of a stock exchange,
clearing house or corporation. Thirdly, the definition specifically brings within its ambit
the
following intermediaries: merchant banker, share transfer agent, registrar to an issue,
debenture trustee, broker, portfolio manager, investment advisor, sub-broker,
investment company or an employee thereof, a member of the Board of Trustees of a
mutual fund, a member of the Board of Directors of the Asset Management Company of a
mutual fund and any employee thereof who has a fiduciary relationship with the
company. Fourthly, a Member of the Board of Directors, or an employee, of a public
financial institution has been brought within the ambit of the definition. Fifthly, an official
or an employee of a self- regulatory organisation recognised or authorised by the Board of a
regulatory body is also deemed to be a connected person within the ambit of Regulation
2(h). Sixthly, a relative of all the aforementioned persons and by virtue of the 2002
amendment all relatives of connected persons have also been deemed to be connected
persons. Seventhly, the banker of the company has been included within the ambit of the
definition. Lastly, by virtue of the Second Amendment of 2002, Regulation 2(h) has also
been stretched to include a concern, firm, trust, Hindu undivided family, company or
association of persons wherein any ‘connected person’, relative of a connected person or
aforementioned categories of persons (one to five), or the banker of the company have more
than 10 per cent of the holding or interest.

It is essential to point out that to qualify as an ‘insider’ within the first clause of
Regulation
2(e), in addition to being a ‘connected person’ or a person ‘deemed to be a
connected person’, a person must also fulfil the requisite of being reasonably expected to
have access to unpublished price sensitive information. It has been observed that the
segregation of the first
clause of Regulation 2(e) from the second clause has had the effect of bringing
even
11
17
As per Section 12 of the SEBI Act an intermediary includes a stock broker, sub broker, share transfer agent,
banker to an issue, trustee of trust deed, registrar to an issue, merchant banker, underwriter, portfolio
manager and investment advisor.

12
‘outsiders’ of the company within the ambit of the ‘insider’ and hence has broadened
18
the definition beyond its desirable limits.

13