This article is written by Ayushi Sinha, pursuing a Diploma in Companies Act, Corporate Governance and SEBI Regulations from LawSikho.

Introduction

Insider trading is a common place activity undertaken legally wherein the corporate insiders deal in the stocks of the company in consonance with the policies of the company and all related regulations governing their businesses. A person qualifies to be called an ‘insider’ if he is in possession of stock more than 10% of equity of the firm. Insider trading assumes illegality only when the insider trading is undertaken by either purchasing or selling of securities in abrogation of the fiduciary trust and assurance reposed on the company insiders who are privy to material information about the securities which is not otherwise known to public at large and uses the information to take financial advantage. It is an illegal practice/ malpractice as regards dealing on the stock exchange by virtue of having access to confidential information/ unpublished price-sensitive information (UPSI) and using the same to one’s own advantage or avoiding impending losses.

Promoters are accountable if they possess UPSI without any ‘legitimate purpose’ and share the same with partners, advisors or consultants, lenders collaborators, customers, suppliers, legal advisors, merchant bankers, auditors, insolvency professionals as long as that sharing has not been carried out to avoid or skirt the proscriptions of these regulations. In this context, it is mandated that BOD should maintain details of persons with whom UPSI has been shared. A promoter will not get the benefit of holding the UPSI as holding it for legitimate purpose unless he is holding a position in the Board of the company. Further, it must be explicitly conveyed to all with whom UPSI is being shared that it should not be misused or allowed to be misused for personal advantage/gratification. However, the mere flow of UPSI shall not be considered as offence under the SEBI (Insider Trading regulation) and will pass to be considered as being used for ‘legitimate purpose’ if the person Is part of the promoter group, is a nominee director on the board, is in the flow of information in accordance with an agreement not in contravention to the  SEBI Insider Trading regulations.

Obligations on companies

Following are the obligations under the SEBI (Prohibition of Insider Trading) Regulations, 1992 that are to be complied by all listed companies:

• a senior level employee to be appointed as the Company Secretary in the role of a Compliance Officer.
• a code of conduct for internal procedures to be set up with a clear mechanism to operate the provisions.
• to frame and administer the Code of Corporate Disclosure practices as stated in Schedule ii to the SEBI (Prohibition of Insider Trading) Regulations, 1992.
• to institute a mechanism to initiate the received information under the initial and continual disclosures to the Stock Exchange within five days on receiving the same. 
• to stipulate the close period.
• to classify and mention what tantamount to Price Sensitive Information.
• to safeguard acceptable data security of confidential information available digitally or electronically and safeguard against corporate data espionage.
• the procedure for pre-clearance of trade to be prescribed and Company Secretary should be entrusted with the responsibility and strict adherence of the same.

Consultants as insiders

The moot question is whether the scope of insider trading applies only to the directors, team members of management, personnel of the company or also includes internal auditor, advisor, consultant, analyst etc, who also by virtue of their engagement with company affairs have inside knowledge of material information that is not available to the public at large. The definition has even been interpreted to include associates from legal firms dealing with the company affairs, involved banking partners, brokerage firms in partnership and printing firms who share information about the traded securities for the purpose of concerning services. Even Government employee’s privy to the information by virtue of their position as the sanctioning authority or involvement during approval.

It is obligatory duty of the regulatory authority of the capital market to prevent such transactions as such dealings undermine the confidence of the investor as regards the fairness, and keeping in view that the insider trading destabilizes investor confidence in the impartiality and veracity of the securities markets. For example, with advance knowledge of a bonus issue one can obtain a substantial exposure in a particular security fully aware that the holding security would be bullish after announcement of bonus thus giving unfair advantage as against an outside investor who is not privy to such information.

USA pioneered to handle insider trading by promulgating the Insider Trading Sanctions Act, 1984 under which the Securities and Exchange Commission in USA is empowered to impose fines besides filing criminal charges. Of late, most countries have legislation to tackle this malpractice. Most countries have in place suitable legislation to limit the peril of insider trading.

SEBI (Insider Trading) Regulations 1992 framed under Section 11 of the SEBI Act, 1992, are implemented to check and restrain the peril of insider trading in Securities in India. From 20th February 2002, SEBI has modified these Regulations and renamed them as SEBI ‘Prohibition of Insider Trading Regulation, 1992’. It recognises and emphasizes that the quality, integrity and truthfulness of the capital market greatly influences the smooth transactions in the securities market and its development. 

The latter is contingent on how a market can unaided stimulate and motivate confidence of investors as any apprehension or anxiety regarding the market being rigged leads to loss of confidence and trust in the scrip/market. Believing that only a privileged few have access to inside business information and are misusing the same for profiteering is bound to dissuade the investors because of lack of level playing ground.

Hence, to sustain the investor’s assurance and trust, the practice of insider trading is prohibited, and such a malpractice should attract the severest of punishment. 

The challenge is that the term “insider trading is not straightaway defined under Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992. But it does define the term “insider, “connected person, what amounts to “price sensitive information”. As per the Regulations “insider” means any person who, is or was associated with the company or is deemed to have been a ‘connected person’ with the company, and who is sensibly expected to have access, linking, to unpublished price sensitive data with regard to scrips of a company, or who has already obtained or enjoyed access to suchlike unpublished information that is price sensitive.

The above definition introduces “connected person” as a new term: “connected person as per the Regulation is a person who is:

(a) a director, as well-defined in clause (13) of section 2 of the Companies Act, 1956 (1 of 1956) of a company, or is deemed to be a director of that company by way of sub-clause (10) of section 307 of that Act.

(b) holding position as an officer or an employee of the company or occupying a role regarding as a professional or has business relationship between himself/herself and the company which may be either temporary or permanent and has high probability of access to information which are UPSI as regards the company. 

If the information can materially alter the price of the securities once in the knowledge of an investor, the same is considered as information that is UPSI. Under Regulation 3 of the SEBI insider trading Act, all dealings with respect to announcement and tipping on issues relating to insider trading are prohibited. However, if any announcement or message is required to be made in the normal course of the business and is no way relevant or impacting directly or indirectly the valuation of the security, the same will not be considered as breach of fiduciary duty under insider trading regulations as it will not be considered as UPSI. 

Moreover, 3A prohibits dealing in the securities by any company of any other company or associate of that other company, in case they are privy to UPSI.

During February 2002, SEBI stiffened the Insider Trading Regulations. A new concept of ‘secondary insiders’ was brought in which includes consultants, investment bankers’ accountants, lawyers etc. also in the definition of ‘insider’.

On a periodic basis, substantial shareholders and Directors are required to disclose their holdings to the company. Even the relatives of ‘connected persons’ as defined aforesaid have been brought under the ambit in the New Regulations. The trust, companies, firms, etc. in which relatives of connected persons, company’s bankers and persons considered to be ‘connected persons’ holding more than 10%, have been brought under the purview of the Act. The term ‘Relative’ has also been defined under the New regulations in line with the definition under the Companies Act, 1956, which includes parents and brothers-sisters to husbands-wives of siblings and their grandchildren. Similarly, the definition of “connected person” has been expanded to include either a director or a deemed director and even an officer or an employee possessing professional or commercial relationship, whether temporary or permanent, with the company. In other words, there are two types of insiders categorised for the purpose.

Those in direct connection with the company are termed as ‘Primary Insiders’. As they are in direct link with the company, they are likely to have access and be in possession of UPSI. The litmus test in jurisprudence for determining the person as connected or not is founded in the impartial philosophies of fiduciary duty of the concerned person.

Conversely, any entity with indirect link with the company trading in the securities with unfair advantage of information is termed as Secondary insider. Often, they escape the clutches of the regulations as it is difficult to trace the path of their receipt of the tip or advantageous information and that too establish the traced path to the company in question. Practically speaking, the information flow is through the grapevine and informal networks of brokers, clients, acquaintances and never through established corporate networks or electronic channels leaving behind no evidence. Sometimes these individuals are in possession of strategic policy decisions which greatly impact valuation of the scrips in the exchanges.

In the event of flouting/ violation of any of the regulations under SEBI (Prohibition of Insider Trading) Regulations, 1992, following penalties /punishments can be imposed to both primary and/or secondary insiders. SEBI may impose a penalty of three times the amount of profit made out of insider trading or Rs 25 Crores, whichever is higher besides initiating criminal prosecution.

Conclusion

The regulations of 1992 have been made more stringent in the new 2002 regulations with wider inclusion of people in the definition of ‘insider’ and  ‘connected persons’. In the past the legislation on insider trading was lacking teeth for effective implementation and in general affected the morale of genuine investors in the capital markets. The Companies are now required to frame guidelines for internal implementation to listed companies and other entities are now required to frame internal policies and guidelines to preclude insider trading by directors, employees, partners, auditors, consultants etc. 

The foreign regulators are making efforts to enhance the trust and confidence of national investors in view of better marketability among the overseas investors by insisting on robust insider trading policies for the companies and ‘connected persons’, i.e., consultants among others in India. 

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