In this blog post, Rohan Chawla, a student of Delhi University and pursuing a Diploma in Entrepreneurship Administration and Business Laws by NUJS, analyses the Insider Trading Regulations of 1992 and 2015.
‘R’ is a director of a billion-dollar company. At a board meeting of the company, ‘R’ learned that a famous value investor & billionaire ‘W’ is going to invest in the company. The information is privy only to the directors of the company. Soon after the meeting, ‘R’ calls up ‘RJ’ who heads an investment firm. He says ‘RJ’ that ‘W’ will invest in the company in a couple of days. Seeing that the news would favorably impact the share price of the company, ‘RJ’ purchases the shares of the company with an intention to sell them after ‘W’ has made the investment. As expected, ‘W’ makes the investment. Subsequently, ‘RJ’ sells the shares and makes a profit of nearly a million dollars. ‘RJ’ could not have made this profit without the confidential information that he received from ‘R.’
This is not an imaginary story. The above briefly describes the events which led to the conviction of Rajat Gupta for insider trading and securities fraud. Insider trading involves the use of confidential information regarding a listed company for making beneficial transactions on the stock market. The confidential information is available only to “insiders” i.e.: people who are closely associated with the company – directors, employees, consultants, etc. and is not available to the average trader/investor/public. Given that the information is not known to the market (i.e., trader/investor/public), the impact of the information has not been factored into the share price of the company. The insider is aware of the information and knows it’s likely impact on the share price. When she uses this information by making favorable transactions in the securities of the company, she is said to have indulged in insider trading.
Insider trading is a serious offense when it comes to securities trading and is looked at very severely by stock market regulators. Insider trading creates an unequal playing field among investors; wherein some investors have access to such information which no other investor can access. In a certain sense, insider trading is a fraud committed by the insider on all the other investors. The insider makes illicit profits at the cost of others, and that gives motivation to the regulator to curb the practice. The whole system of the stock market is based on an efficient market hypothesis, which gets shattered through insider trading. As the justice system, the stock market must also be seen to be fair.
However, insider trading is not an easy offense to prove. Often, the insider does not trade in the shares directly as it would be a blatant violation of the law. Insiders use complex channels sometimes involving colleagues (as in Rajat Gupta’s case), domestic helps (as in Anil Kumar’s case), family members and promoter companies (like in Ramalinga Raju’s case), etc. Further, it is difficult to prove that it was only the confidential information that was the trigger for the dealing in securities and not something else.
It is in this light that regulators are expanding their arms when it comes to insider trading regulations. The law needs to be updated to accommodate more secretive communication and liberalised business environment.
Salient Features of the SEBI (Prohibition of Insider Trading) Regulations, 2015
- According to the regulations, an insider is someone who is either a connected person or is in possession/access to unpublished price sensitive information. In this regard, the definition of a connected person has been expanded and clarified. Included within the ambit are persons who don’t occupy a position in the company, but are involved in a contractual capacity with the company and are in touch with the company and its officers. They are in a position wherein they are aware of the operations of the company. Such a relationship (whether temporary or permanent) must allow (or reasonably expect to allow) access to unpublished price sensitive information.
- The definition of price sensitive information has also been modified. The modified definition clearly states that the types of information mentioned therein are merely illustrative, and other types of information may also be included. Among the illustrations, ‘changes in the major managerial positions has also been added.
- The 2015 regulations have also widened the prohibitions regarding communication and procurement of unpublished price sensitive information (UPSI). The new regulations state that an insider should not share UPSI not only on a listed company but also a company that is about to be listed.
- Further, they prohibit the insider from allowing others to access UPSI, thereby including indirect methods of sharing information. The communication with other persons includes other insiders and hence the dealing of information is intended to be a need to know basis. Inducement and procurement of UPSI have also been prohibited.
- Additionally, the 2015 regulations allow sharing of UPSI in cases of due diligence such as takeovers, mergers, and acquisitions. While sharing such information, the parties must enter into a confidentiality and non-disclosure agreement. Further, the parties shall not trade in the securities of the company when in possession of such UPSI.
- The 2015 Regulations explicitly prohibit trading in securities while in possession of UPSI. However, the regulations provide for certain situations through which the insider can prove his innocence. These are – off market transactions wherein, both parties make a conscious and informed decision or when no UPSI was communicated by the person possessing the information to the person making the trade or when the trade was in pursuance of a Trading Plan.
- The 2015 regulations introduce the concept of Trading Plans. There are certain persons who are perpetually in possession of UPSI. Such insiders may prepare a Trading Plan and present it to the Compliance Officer for approval. Once approved, the insiders can trade in accordance with the plan. This way, the impact of UPSI is neutralized as the trade was decided/finalized even before the availability of the UPSI.
- Changes with respect to disclosure requirements have also been made.
The new regulations have tried to address the problem of insider trading comprehensively. However, a lot needs to be done when it comes to implementing the regulations. As mentioned before, insider trading disturbs the underlining assumption that markets are efficient. If insider trading goes unchecked, then the losers in the market (especially retail investors) will lose faith in the market. To them, the market will appear like a loser’s game, and they would channelize their investments elsewhere. This is in complete contradiction to the message that most governments and regulators wish to propagate i.e., channelling part of individual savings towards the stock market (through mutual funds, index funds, SIPs or the like) as opposed to gold, real estate, fixed deposits, etc. So if the government wishes that more people invest larger portions of their savings in the stock market, then it would do well to curb insider trading.
This country has seen several financial scams where retail investors have been cheated and have lost their life savings. Be it Harshad Mehta, Ketan Parekh, Saradha Chit Fund scam or Speak Asia. Indians perceive the stock market either has a giant that eats up out money or a wizard that doubles it in no time. It is the time that changed. Funnily, both are products of information asymmetry.
- Report of the High-Level Committee to review the SEBI (Prohibition of Insider Trading) Regulations, 1992 – http://www.sebi.gov.in/cms/sebi_data/attachdocs/1386758945803.pdf
- What Sebi’s new insider-trading rules mean and where they fall short (Livemint) – http://www.livemint.com/Money/qMDHjPWNMJLza41fy8LWBO/What-Sebis-new-insidertrading-rules-mean-and-where-they-fa.html
- For a tabular comparison, one may also look at:http://taxguru.in/sebi/comparison-sebi-prohibition-insider-trading-regulations-2015-sebi-prohibition-insider-trading-regulations-1992.html
Raj Rajaratnam and Insider Trading:http://sevenpillarsinstitute.org/case-studies/raj-rajaratnam-and-insider-trading-2
Inside Job (Caravan Magazine – 01.11.2015):http://www.caravanmagazine.in/reportage/inside-job
Satyam scam: Sebi asks Raju, family, others to return Rs1,800crore(Livemint – 16.09.2015) – http://www.livemint.com/Companies/zKHpMJk0Y7dTxTLVIuIDcP/Satyam-scam-Sebi-asks-Raju-family-others-to-return-Rs1800.html
Hereinafter called the 2015 Regulation:http://www.sebi.gov.in/cms/sebi_data/attachdocs/1421319519608.pdf
For a summary of the disclosures, see page 5 of this note by Nishith Desai Associates – http://www.nishithdesai.com/fileadmin/user_upload/pdfs/NDA%20Hotline/Regulatory_Hotline/Salient_Features_of_the_Regulations.pdf
 Prevention of Insider Trading and Corporate Good Governance – SandeepParekh(pg 3): http://www.iimahd.ernet.in/publications/data/2003-01-03SandeepParekh.pdf
Read this article by Monika Halan, where she explains why Indians invest in gold. She says – “Regulatory and institutional failure is the reason people hoard gold and not because they are stupid”– http://www.livemint.com/Money/pfe6uBEWl7vh6gEC31P5MP/Why-do-we-count-gold-imports-in-the-current-account.html
10 years of financial scams – Sucheta Dalal:http://www.suchetadalal.com/?id=baebd5a4-0b2c-eda7-492e8a70763c&base=sub_sections_content&f&t=10+years+of+financial+scams