Saturday, September 3

Insider Trading - Detailed Analysis with Case Laws


Meaning of "Insider"

An insider is understood as a person having control over the management of affairs of the corporation and who has deep insight into the affairs of the corporate body and holding knowledge about "price sensitive information" relating to the performance of the corporate body that could have a decided impact on the movement of the price of its equity. Therefore he is at a vantage position with regards to a prospective trading in the shares of the company to the detriment of the common investors.

Taking this fact into account the Regulation prescribes several "do’s" and "don'ts" with reference to these "insiders". The effect of the regulatory measure adopted by SEBI is to prevent the insider trading in the shares of the company to earn an unjustified benefit for himself and to the disadvantage of the bonafide common shareholders.

Insider definition as amended by SEBI vides its Notification No. LAD-NRO/GN/2008/29/44801, dated 19.11.2008 means any person who,—

(i) 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with the company or is deemed to have been connected with the company and who is reasonably expected to have access to unpublished price sensitive information in respect of securities of a company, or

(ii) has received or has had access to such unpublished price sensitive information.

Insider Trading

Insider Trading generally involves the act of subscribing or buying or selling of the company's securities, when in the possession of any unpublished price sensitive information about the company. It also involves disclosing any unpublished price sensitive information about the company to others who could subscribe or buy or sell the company's securities. Insider Trading invokes severe civil and criminal penalties not only on the Insider but also on the company in certain circumstances under the Regulations issued in India under the Securities and Exchange Board of India (SEBI) Act, 1992.

It is not hard to see that when company insiders trade on the secondary market, they speed up the flow of information and forecasts into prices. Company insiders are in a unique position to make forecasts about the future risk and return of the shares and bonds of their company, hence they might often correctly perceive market prices to be "too low" or "too high". When they trade on the secondary market, they serve to feed their knowledge into prices, thus making markets more efficient.

Insider trading is often equated with market manipulation, yet the two phenomena are completely different. Manipulation is intrinsically about making market prices move away from their fair values; manipulators reduce market efficiency. Insider trading brings prices closer to their fair values; insiders enhance market efficiency.

 Violation of the provisions of the Insider trading — A serious offence
 
Regulation 2(ha) of the Insider Trading Regulations states that the information is deemed to be price sensitive information if it is likely to materially affect the price of securities of a company, if published. Hence actual change of price of the securities is not necessary. Schedule II of the said Regulations attempts to place all shareholders on the same footing with reference to the possession of price sensitive information. Since the price sensitive information, when not disclosed to the Stock exchanges where the shares are listed, gives unfair advantage to those who are in possession of it compared to those who are not in possession of the same.

Insider trading, which has the potential to disturb the confidence of investors and also the integrity of the securities market, is made impossible by disclosure of such price sensitive information at the point of time of creation of that information. Mere non-disclosure of such price sensitive information results in unfair disadvantage to those who are not in possession of that information. This unfair advantage may materialize in the form of disproportionate gain when the insiders in possession of price sensitive information make a profit while indulging in trading by using price sensitive information.

In the case of Ispat Industries Ltd. v SEBI decided on 1st Dec., 2005, it was held that the amount of disproportionate gain or unfair advantage to the notice and amount of loss caused to the investors as a result of the default cannot be quantified in view of the absence of availability of any data/material on record in

this regard in as much there is no allegation of actual trading by the notice on the basis of the said unpublished price sensitive information.

Securities laws provide for penalties for violating the provisions of the same. Adherence to regulatory framework is a sine qua non for healthy growth and safety of the securities market. Any violation of the provisions of the said regulations can be treated as a serious offence.

Therefore, imposition of quantum of penalty has to be decided keeping these factors also in mind, in addition to the factors laid down under section 15J of SEBI Act.

Meaning of “Connected Persons”

The Regulation defines that a "connected person" means any person who-

i. is a director, as 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 virtue of sub-clause (10) of section 307 of that Act or

ii. occupies the position as an officer or an employee of the company or 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 an access to unpublished price sensitive information in relation to that company;

Explanation: For the purpose of this clause, the words "connected person" shall mean any person who is a connected person six months prior to an act of insider trading.

It is further stipulated that a "person is deemed to be a connected person" if such person-

i. is a company under the same management or group or any subsidiary company thereof within the meaning of section (1B) of section 370, or sub-section (11) of section 372, of the Companies Act, 1956 (1 of 1956) or sub-clause (g) of section 2 of the Monopolies and Restrictive Trade Practices Act, 1969 (54 of 1969) as the case may be; or

ii. is an intermediary as specified in section 12 of the Act, Investment company, Trustee Company, Asset Management Company or an employee or director thereof or an official of a stock exchange or of clearing house or corporation

iii. is a merchant banker, share transfer agent, registrar to an issue, debenture trustee, broker, portfolio manager, Investment Advisor, sub- broker, Investment Company or an employee thereof, or, is a member of the Board of Trustees of a mutual fund or a member of the Board of Directors of the Asset Management Company of a mutual fund or is an employee thereof who have a fiduciary relationship with the company;

iv. is a member of the Board of Directors, or an employee, of a public financial institution as defined in Section 4A of the Companies Act, 1956; or

v. is an official or an employee of a self Regulatory Organisation recognised or authorised by the Board of a regulatory body; or

vi. is a relative of any of the aforementioned persons;

vii. is a banker of the company.

viii. relatives of the connected person;

ix.  is a concern, firm, trust, Hindu Undivided Family, company or association of persons wherein any of the connected persons mentioned in sub-clause (i) of clause (c), of this regulation or any of the persons mentioned in sub-clauses (vi), (vii) or (viii) of this clause have more than 10% of the holding or interest.

Meaning of "Designated employee"

Designated employee shall include officers comprising the top three tiers of the company management and the employees designated by the company to whom the trading restrictions shall be applicable, keeping in mind the objectives of this code of conduct.

Senior Vice President is an “Officer” under Insider Trading Regulations. The Securities Appellate Tribunal [SAT] has ruled that an “officer” as defined under Regulation 2(g) of the Insider Trading Regulations read with Section 2(30) of the Companies Act, 1956 is an inclusive definition and includes a person holding an appointment to an office which carries with it an authority to give directions to other employees. Officer has the power of directing any other person to do anything whereas an employee is the one who only obeys. Any person who occupies a position of responsibility in a company will be an “officer” in terms of the clarification issued by the Department of Company Affairs. Thus, on facts, senior vice president is an “officer” and the company is required to make necessary disclosure of change in shareholding pattern to the stock exchange under Insider Trading Regulations. [Sundaram Finance Limited v SEBI dated 16 September 2010 (SAT)]

Meaning of price sensitive information

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 company.

The following shall be deemed to be price sensitive information:

i. Periodical financial results of the company;
ii. Intended declaration of dividends (both interim and final);
iii. Issue of securities or buy-back of securities;
iv. Any major expansion plans or execution of new projects;
v. Amalgamation, mergers or takeovers;
vi. Disposal of the whole or substantial part of the undertaking;
vii. Any significant changes in policies, plans or operations of the company.

Some Cases of “Insider Trading” (Source: ET)

March,1998

SEBI pulls up Hindustan Lever (now Hindustan Unilever) and its then five directors SM Datta, KB Dadiseth, R Gopalakrishnan, A Lahiri and MK Sharma for alleged insider trading. The case involved HLL purchasing a sizeable chunk of Brooke Bond Lipton shares from UTI, prior to its public announcement related to the merger of the two outfits, which, according to Sebi, was price sensitive information. Both HLL and Brooke Bond were subsidiaries of the same parent - Unilever. It's the first case where Sebi passed an order on insider trading. Status: Sebi directed HLL to compensate UTI to the extent of Rs. 3.04 crore. HLL then approached the finance ministry, which was then the appellate authority on Sebi orders. MoF ruled in favour of HLL. Following this, Sebi filed an appeal in the Bombay HC. Status: The final verdict is yet to be pronounced.

June,2001

SEBI CHARGES ABS Industries MD Rakesh Agrawal with insider trading as he had allegedly purchased his own company's shares from the market prior to the takeover deal between ABS and Bayer. Status: Sebi directed Agrawal to deposit Rs. 34 lakh to compensate ABS investors, besides initiating adjudication proceedings against the former promoter. Agrawal challenged the Sebi order before SAT. SAT partially turned down the Sebi ruling of imposing penalty on Agrawal and declined to issue any order related to adjudication. Sebi later contested the SAT order in SC. Status: The case was settled through consent order with Agrawal paying a monetary penalty.

April,2004

SAMIR ARORA, former Asia-Pacific head of Alliance Capital Mutual Fund, was charged with indulging in unfair trade practices for disposing off a considerable quantity of shares held by the fund under his management which resulted in a sharp decline in the valuation of Alliance. Sebi noted that when the US-based fund decided to sell its Indian interests, Arora was one of the contenders. Status: Sebi banned Arora from dealing in securities in any manner for a period of five years. SAT comes to the rescue of Arora by setting aside Sebi's order. The regulator later moved the SC. Status: Pending.

November,2006

Rajiv Gandhi, former company secretary and CFO of Wockhardt, along with his immediate family members, was alleged to have traded in the pharma company's shares on the basis of unpublished price-sensitive information (Wockhardt's financial results). Action Taken: Sebi imposed a monetary penalty of Rs. 5 lakh on Gandhi. Though Gandhi moved SAT, the latter upheld Sebi's order. This is one case where Sebi had an unambiguous victory. Status: Closed.

December,2006

After five years of investigation, Sebi holds Dilip Pendse, former MD of Tata Finance, guilty of insider trading. Pendse was alleged to have helped J Talaulicar, former director of Nishkalp Investment and Trading, a subsidiary of Tata Finance, to offload a large chunk of the NBFC's shares at a premium, prior to the public announcement of Nishkalp's huge loss. Action Taken: Sebi imposed a monetary penalty on Pendse, besides debarring him from dealing in the securities market for 2 years. The former Tata Finance MD challenged the Sebi order before SAT, which set aside the regulator's order. Sebi later approached the SC. Status: The final word on this is yet to be written

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