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Key takeaways

  • Insider trading is an unfair practise that needs to be avoided and controlled at all costs.
  • According to analysis of landmark judgements on insider trading, a more robust mechanism for investigation and prosecution is still required.
  • The responsibility to regulate and control malpractice of insider trading falls on everyone, not just SEBI.

What is Insider Trading

Insider trading is the act of trading, directly or indirectly, in the securities of a publicly listed company by anyone, who may or may not be managing the affairs of such company, on the basis of certain information, which is not available to the general public and which can affect the market price of the securities of such company. An insider who has access to crucial, price-sensitive information about a particular company may be prone to using it for his own financial gain, severely undermining the interests of a public shareholder who is not aware of it.

The term "insider trading" is not defined in the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992. The terms "Insider," "Connected Person," and "Price Sensitive Information" are defined, however.

According to regulation 2(e) - Insider is the person who is connected with the company, who could have the unpublished price sensitive information or receive the information from somebody in the company.

Periodic financial results, intended dividend increases, securities issuance or buybacks, major expansion plans or the execution of new projects, amalgamations, mergers or takeovers, and any significant changes to the company's policies, plans, or operations are all considered to be price-sensitive information.

Insider trading in India

  • 1948-The Thomas Committee was established as the first actual effort to control insider trading. It aided in the Securities Exchange Act of 1934's restriction of insider trading.
  • 1956- Secs. 307 and 308 were added to the Companies Act of 1956. Disclosures from directors and officers are now required as a result of this change.
  • 1979- The Sachar Committee recognised that the Companies Act of 1956 needed to be amended because employees could abuse company information and manipulate stock prices.
  • 1986- The Securities Contracts (Regulations) Act, 1956 should be amended, per the Patel Committee's recommendations, to make exchanges less conducive to insider trading.
  • 1989- The Abid Hussain Committee recommended that insider trading activities be subject to both civil and criminal proceedings, and that SEBI create rules and regulations to guard against unfair practices.
  • 1992- India banned insider trading as a fraudulent activity in establishing regulations for insider trading by the Security and Exchange Board of India (Insider trading) Regulations act, 1992. A person found guilty of insider trading in this case faces punishments under Sections 24 and 15G of the SEBI Act, 1992.
  • 2002- The Regulations were significantly altered and renamed SEBI (Prohibition of Insider Trading), Regulations, 1992.

Landmark judgements

Hindustan Lever ltd v. SEBI

Facts

Both Hindustan Lever Limited (HLL) and Brooke Bond Lipton India Limited (BBLIL) were managed by the same parent company, Unilever Inc. of the UK. On March 25, 1996, HLL paid UTI 8 lac shares of BBLIL at a price of 350.35 rupees each. 25 days after the purchase transaction, a merger announcement was made. HLL made a statement about the merger with BBLIL and informed the stock exchanges. Following the merger, the share price of BBLIL increased by Rs. 50 per share.

The market and the media both alerted SEBI about the leak of merger-related information and insider trading. Due to the investigations SEBI had conducted, it was discovered that HLL had violated the terms of the Insider Trading Regulations and the SEBI Act by purchasing BBLIL securities from UTI as an insider on the basis of unpublished price sensitive information (UPSI) regarding the pending merger. Consequently, UTI suffered losses.

By using its authority granted by Section 11 B of the SEBI Act in conjunction with Regulation 11 of the Insider Trading Regulations, SEBI ordered HLL to make up any losses that UTI had incurred. The losses incurred by UTI were estimated by SEBI to be worth Rs. 3.04 crores. The difference between the market price of the BBLIL shares at which UTI sold them to HLL before and after the merger announcement, excluding premiums, served as the basis for this calculation. UTI and HLL appealed the SEBI's decision separately to the appellate authority.

Issue

One of the main issues up for discussion before the appellate authority in this case was the definition of the term "Insider" under Regulation 2(e) of the Insider Trading Regulations.

In this regard, the appellate authority noted that the term "insider" should include the following three components:

  • The person must be an individual or other legal entity.
  • The individual must be related to someone else or be assumed to be related. The connection should be used to acquire UPSI.
  • The SEBI had also interpreted in its order the third requirement of acquisition of UPSI by the Insider by virtue of the connection with the Company by envisaging two alternative situations: Where the Insider is actually received or had access to such UPSI.

Judgement

The following reasons, however, led the Appellate Authority to overrule SEBI's decision:

  • Since the market was aware of and acknowledged the merger news, it was not a UPSI.
  • The price at which the transaction was completed could not be significantly impacted by information about a merger.
  • SEBI's decision to compensate UTI was procedurally flawed.
  • SEBI's directive to HLL to make up for UTI shortfalls

Because the order failed to specify the justification for the prosecution, SEBI failed to specify the rationale for the prosecution, and SEBI failed to use specific adjudication powers under Section 15 G of the SEBI Act, SEBI's direction for prosecution under Section 24 of the SEBI Act was inappropriate. Therefore, the Appellate Authority reversed SEBI's decision to charge HLL.

Dilip Pendse v. SEBI

The publicly listed company Tata Finance Ltd. (TFL), which owned Nishkalpa, The Managing Director of TFL was Pendse. Nishkalpa suffered a sizable loss of Rs. 79.37 crores on March 31, 2001, and this was bound to have an impact on Tata Finance Limited's earnings. In essence, Pendse was aware that this was Unpublished Price Sensitive Information (UPSI). Only on April 30, 2001, was this information made available to the general public. Therefore, any transaction made by an insider between March 31 and April 30, 2001, was bound to be considered insider trading. This information was given by DilipPendse to his wife, who then sold 2,90,000 shares of TFL that she owned in her own name as well as in the names of the businesses that she and her husband-in-law controlled. DilipPendse was charged by SEBI with insider trading.

The charges of insider trading against Pendse were, however, rejected by SAT in a recent ruling because they did not follow the fundamental rule of allowing cross-examination of a person whose statements the charges were based upon and because the case lacked the necessary evidence.

This case demonstrates how SEBI lacks an effective investigative system and a vigilant approach, which allows offenders to elude capture. In the majority of cases, SEBI failed to present evidence to support its arguments before the court. In contrast to the balance of probabilities required to establish civil liability, the allegations in a criminal liability case must be proven beyond a reasonable doubt. Therefore, a thorough investigation is required, and any gaps should be properly closed.

Securities Exchange Commission v. Rajat Gupta

According to the Securities Exchange Commission's (SEC) complaint, Rajat. K. Gupta gave his business partner Rajaratnam, the founder and managing partner of Galleon Management, access to billions of dollars' worth of confidential (insider) information that Rajat had acquired while serving on the board of directors of Goldman Sachs Group, Inc. According to the complaint, Gupta divulged significant, private information in September 2008 regarding Berkshire Hathaway Inc.'s $5 million investment in Goldman Sachs.

Rajaratnam traded profitably in Galleon hedge funds using the information he acquired from Rajat. Rajat and Rajaratnam violated Section 10(b) of the Securities Exchange Act of 1934, Exchange Act Rule 10b-5, and Section 17(a) of the Securities Act of 1933 by engaging in this behaviour. On June 15, 2012, Gupta was found guilty on one count of conspiracy and three counts of securities fraud in a separate criminal case based on the same facts.

On October 24, 2012, Gupta was given a punishment of two years in prison, one year of probation, and a fine of $5 million USD. Rajaratnam was required to pay pre-judgment interest on top of his share of the gains and losses prevented as a result of insider trading, according to a Securities and Exchange Commission (SEC) order.

Conclusion

Despite the fact that insider trading has a long history in the Indian market, the data shows that there aren't many cases that have been looked into. Only a few cases that open up get finished. In order to gather the required proof to support its claims, SEBI lacks the necessary investigative authority.

Insider trading is unethical behaviour that must be eradicated in order to maintain a fair and effective market. It presents a challenge for detection and prosecution because it is carried out covertly. To maintain the trust of investors and the integrity of the market, SEBI has been compelled to use any legal methods for the detection of insider trading activity. A robust mechanism for investigation and prosecution is still required in the aspect of insider trading.


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