Chapter Scheme Introduction Who is insider? What is Inside Information? When Information ceases to be inside?

de? Price sensitive information How does Insider Trading Work Who does insider-trading affect? Transactions, which gives indication of insider trading SEBIs efforts to curb insider trading The Difficulty in framing insider trading Laws Various case studies Finding and Analysis Recommendation and suggestions Conclusion Bibliography

INTRODUCTION: Insider trading is one of the most violent crimes on the faith of fair dealing in a capital market.The scope and stringency of the violation and penalties differ wildly from country to country.Trading by an insider of a company in the shares of a company is not per sea violation of law.For instance, a person (an investigative journalist for example may interview an insider andthus become one) may come across insider information by his perseverance in uncovering acorporate fraud and disclose the fraud. A person can create inside information by his futureactions, for instance a future tender offer bidder knows that the price of the target company willgo up by his actions. In fact trading by insiders, including directors, officers and employees of the company in the shares of their own company is a positive feature, which companies shouldencourage because it aligns its interests with those of the insiders. What is prohibited is thetrading by an insider in breach of a duty of trust or confidence in the stock of a company on the basis of non-public information to the exclusion of others. Insider trading violations may alsoinclude "tipping" such information and securities trading by the person "tipped". If insider trading is allowed unchecked in the capital markets, persons with insider information will havea consistent edge in trades executed with such information and those without the informationwill be consistent losers on the market. The latter category of people, which includes the vastmajority of investors, would slowly realize the loser game they are playing in this market for lemons and would believe that all transactions are thus biased against them. Slowly the typicalinvestor would desert the market, retarding or destroying important functions of the stock market like capital formation. In layman's language, the term "Insider Trading" is about trading with the use of insideinformation i.e. information that has not yet been disclosed to the public. In the fastestgrowing capital market system, stock exchanges occupy a very crucial position byenabling the corporate sector to mobilise capital from household savings and channelisesuch savings into productive areas of investment. The growth of securities market has brought the single most unfair and unhealthy practice viz, Insider Trading, by which persons connected with companies use unpublished price sensitive information to deal in the securities of a company with a view to make profits or avoid losses by use of such information.Although the precise explanation of Insider Trading is very difficult to define, thefollowing activities of an insider constitute insider trading: 1) Taking advantage of inside information with full knowledge of the facts by dealingfor his own account or for the account of a third party, either directly or indirectly, intransferable securities to which the inside information relates; 2) Disclosing inside information to a third party unless such disclosure is made in thenormal course of the exercise of his employment, profession or duties. Recommending or procuring a third party to deal in transferable securities.Transferable securities include shares; debt securities; securities equivalent to sharesand debt securities; contracts or rights to subscribe for, acquire or dispose of suchsecurities index contracts (i.e. a contract the purpose of which is to secure a profit or avoid any loss by reference to fluctuations in an index); future options and financialfutures in respect of such securities.

Who is An Insider? The concept of 'Insider' is very important one, and on this concept only, the whole playof insider trading rests. Broadly, there are two types of insidersPrimary Insiders andSecondary Insiders, A primary insider is a person who has access to inside information by virtue of his relationship to an issuer of securities. While a secondary insider is person who acquires inside information from a primary insider. The characterizations of an insider as any person who possesses inside formation because he has access to it by virtue of the exercise of his employment, professionor duties, brings out two types of insiders. One is internal insider who obtains insideinformation in the exercise of his duties as officer or employee of the company. Theother one is external insider who obtains information because his connection with thecompany on account of his employment and profession . Above explanations of an insider, bring a concluding definition of the insider and that iswhat explained by Greek law, "a person becomes an insider if he acquires confidentialinformation as a result of offering services under any capacity on a permanent or temporary basis to an issuer or for an issuer". The Securities Exchange Board of Indiahas given a very wide definition, which merely defines an insider as: The term "insider" is defined in clause (e) of regulation 2 as: "insider means any personwho, is or was connected with the company or is deemed to have been connected with thecompany, and who is reasonably expected to have access, by virtue of such connection, tounpublished price sensitive information in respect of securities of the company, or who hasreceived or had access to such unpublished price sensitive information. "The definition has two limbs. The two limbs form the two essential ingredients of thedefinition, both of which may be split and presented as follows: Insider means any person -Who, is or was connected with the company Or who is deemed to have been connected with the company, And Who is reasonably expected to have access, by virtue of such connection, to unpublished price sensitive information in respect of securities of the company, Or Who has received or had access to such unpublished price sensitive information. In order to brand a person an insider any one of the two tests stipulated in the first limb,and one of the three tests stipulated in the second limb, of the definition must be established. Clause (c) of regulation 2 defines the expression "connected person" and the following persons will be treated as connected persons:

a director or shadow director of a company, an officer or employee of the company, A person having professional or business relationship with a company, if he mayreasonably be expected to have access to unpublished price-sensitive information inrelation to that company.

Clause (h) of regulation (2) defines the phrase "deemed to have been connected", thesesecondary insiders are connected persons, but they are not directly connected with thecompanies. Person is deemed to be a connected person if such person (i) is a company under the same management or group or any subsidiary companythereof within the meaning of section (1B) of section 370, or subsection (11) of section372, of (he Companies Act, 1956 (1 of 1956) or sub-clause (g) of section 2 of theMonopolies 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 anofficial of a stock exchange or of clearing house or Corporation; Or (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 Directors of the Asset ManagementCompany of a mutual fund or is an employee thereof who have a fiduciary relationshipwith the company;(iv) is a member of the Board of Directors, or an employee, or a public financialinstitution 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 clause 3(1)above thisregulation or any of the person mentioned in sub-clause (5) ,(6),(7) here in abovehas have more than 10% of the holding or interest. Relatives of connected person shall be relative of another, if and only if, (A) They are members of Hindu Undivided Family; or

(B) They are husband and wife; or (C) The one is related to the other in the manner indicated below: What is Inside Information? When Information ceases to be Inside? These questions play a pivotal role in insider trading. The CS (ID) Act of UK uses theterm unpublished information as inside information, that is to say, the informationwhich is not generally known to those persons who are accustomed or would be likelyto deal in the relevant securities. French Law prohibits the exploitation of information before the public has knowledge of it. The ECD defines inside information as,"information which has not been made public of a precise nature relating to one or several issuers of transferable securities which, if it were made public, would be likelyto have a significant effect on the price of the transferable security or securities inquestion. This definition does not seem to be of a satisfactory nature because this definition on the one hand restricts inside information to that 'which has not been made public' and on the other hand it seems to be uncertain whether information ceases to beinside when it is published or when it becomes generally available to investors. Here,the 'information which has not been made public' must not be equated with information,which is not yet published. Further, in this context, it was rightly said in the case of Mitchell v. Taxes Gulf Sulpher Co. that (he information loses its insider status onlywhen a good faith investor acting with due care can obtain knowledge, a point in timewhich may well be after publication is effected. Materiality or non-materiality of the inside information is fundamental to the veryconcept of Insider Trading. Information is material only when, if disclosed, its effect onthe market price would be likely to be significant. Here, it must be understood that notall information unknown to the public is necessarily inside information, since otherwisemanagers and employees of undertakings would never be permitted to trade in thesecurities of their company, as they always possess unpublished information. It is,therefore, not sufficient that the information would influence most investors in arrivingat a decision whether to sell or buy but must also be likely have a material effect on themarket price of the particular security. The concept of certainty and specificity isrelated with the concept materiality. The information must be something more than asimple rumor, and must have a minimum degree of certainly. Price sensitive information Price sensitive information means any information, which relates directly or indirectly to acompany and which if published is likely to materially affect the price of securities of company. The following shall be deemed price sensitive information: i. ii. Periodical financial results of the company; 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; and vii. Significant changes in policies, plans or operations of the company.

(b) Listing Agreement requires all listed companies to immediately inform Stock Exchange(s) in respect of the following events, which are considered to be, pricesensitive: Change in the general character or nature of business Disruption of operations due to natural calamity Commencement of Commercial Production/ Commercial Operations Developments with respect to pricing/ realization arising out of changein the regulatory framework Litigation/dispute with a material impact Revision in Ratings Any other information having bearing on the operation/performance of thecompany as well as price sensitive information which includes but not restricted 10; (a)issue of any class of securities; (b)Acquisition, merger, de-merger, amalgamation, restructuring, scheme of arrangement, spin off or setting division of the company, etc; (c)Change in market lot of the company's shares, sub-divisions of equity shares of the company; (d)Voluntary delisting by the company from the stock exchange(s) (e) Forfeiture of shares; (f) Any action which will result in alteration in the terms regardingredemption/cancellation/retirement in whole or in part of any securities issued by thecompany; (g)

Information regarding opening, closing of status of ADR. GDR or any other class of securities 1o be issued abroad;h) Cancellation of dividend/rights/bonus, etc;Price sensitive information is required to be disseminated to the stock exchange on animmediate and continuous basis. How does Insider Trading Work? In an insider trading case in 1989, a former stockbroker was convicted of trading based oninsider information. He received the insider information about a company after its presidenttold his sister, who told her daughter, who told her husband, who in turn told the defendantwho traded on the information. This is an example of just how far removed insider information can get. It is very difficult to express opinion on the extent and magnitude of insider trading inIndia. During the last five years or so, this practice has almost been perfected so well by the regular players that today it is accepted as part and parcel of the day to day stock exchange operations. Promoters of several new ventures admit, albeit off-1he-record,that they are forced to play into the hands of big brokers by participating in modifiedforms of insider trading to brighten the market prospects for their issues. Advanceknowledge "of an imminent take-over bid. Knowledge of a forthcoming placement of new shares in combination with the implementation of financial recovery programmes,and knowledge of a significant change in the investment policy of a unit trust are someof the examples of insider trading. There are many types of ways of insider trading. Let us take a simple case of bonus issue vis--vis insider trading. Suppose A Ltd. is coming out with a bonus issue.The share price of A Ltd. will definitely be affected by such an action of the company.The management personnel who are privy to this information may contract to buy large quantity of the company's shares directly in their own names or indirectly in the namesof their main family members or friends. After this, the information is 'leaked out' sothat the general public enters into the market, which will ensure the price to rise.Moreover, advise of brokers, saying to their customers that one must buy the shares of A Ltd., because management of the company is also buying. Such practices bring moreand more buy orders and thus lead to substantial increase in prices, and that is what theoriginal 'tip makers' wait for. When this happens, the insiders unload and depart withthe cream of appreciation safely. The early investors who had taken the plunge alsomake some money but, most of the investors have entered the market rather late, theyare left in the lunch holding large chunks of shares purchased at high prices. Thus, themajority of the new investors do not gain at all. Motivated reports strategically published in newspapers and magazines are also oneform of insider trading. Several investors act on the motivated reports and suffer their own fate, by the time they realise their mistake the insider has got away with the benefits. Insider trading also takes the form of manipulation. Under the listing agreementsentered into by the companies with the stock exchange concerned, the publication of half yearly working results are mandatory. Now the normal practice of dressing the half yearly results in such a manner so as to show a result contrary to the general trend is very common feature of companies. Suppose, A Ltd. is expected to do reasonably wellat the year end, the management of A Ltd. shows almost a break picture

for the half year. The individuals close to the management will unload all their holdings a few days before the publication of the results. The common investor of A Ltd. will be watchingthe share prices coming down. Then the poor half yearly results will be published whichwill further bring down the prices. After a few months, the insiders will slowly buy back the holdings and spread the news that the company has started doing well and the prospects of (he company are bright.Yet another form of insider trading takes the form of market support provided by themanagement by resorting to very heavy purchases of its company's shares throughvarious intermediaries. Such practice is particularly used when the company is comingout with a big right issue and the management cannot afford the price to fall below aspecified minimum. Generally, after the issue is over subscribed the price comes downand the investor who has subscribed for the new issue realise that the issue was notworth the price paid by him. This aspect of insider trading has almost become a permanent feature of the share market operations of today's corporate world.Such unfair practices are more common and frequent during or near the time of declaration of annual or half yearly profits, bonus or rights issue or issue of convertibledebentures, new profits schemes of amalgamations or takeovers etc. Sometimes, insider trading is resorted to by connected persons through speculators or brokers under the benami transactions. Whatever form insider trading may assume, it is obvious that thecommon investors are the ones who always lose. Who Does Insider Trading Affect? For understanding the effects of insider trading, it is helpful to categorize the agentsinvolved or affected into several groups. Economic analysis of insider trading typicallyconsiders the following parties: insiders, market professionals, liquidity traders, and Investors, who are defined as follows. Insiders, as defined earlier, are the officers,directors, and other key employees of a firm who, by the nature of their employment,obtain or possess confidential information regarding the firms prospects. An exampleof an insider is the chief executive officer or the chief engineer of the firm. Market professionals are informed non-insiders, including securities analysts, brokers, or arbitrageurs, who have acquired private information regarding the firms prospects byspending their own resources and who do not have any fiduciary relationship with thefirm. For example, a security analyst may have called the firms major customers andlearned that they are not interested in buying its new product line. Liquidity traders,sometimes referred to as noise traders, are short-term stock market participants whohave some, usually negligible, holdings of the firms shares and trade in order to hedgerisk or balance their portfolios without consideration of a firms prospects. An exampleof a liquidity trader is a large pension fund that buys and sells the firms shares fromtime to time in order to meet the investment and redemption needs of its clients.Investors may be small or large shareholders who have a long-term investmentobjective such that they buy and hold. While not privy to managements privateinformation, investors have a significant beneficial interest in the firms actual performance. For instance, the heir to a substantial holding of the firms stock who doesnot take an active role in its daily management is an investor. Insider trading involvesand affects each of the above classes of agents. If insiders were allowed to trade on their privileged information, they would of

course reap trading profits. At the same time,insiders who are professional managers may receive reduced compensation frominvestors to reflect the profits managers can earn from trading. Insider trading alsoaffects liquidity traders, who face the prospects of incurring losses when trading withagents possessing superior information. On the other hand, if they avoid trading, they will lose the diversification/hedging benefits that prompt them to trade in the first place. In addition, insider trading impliesthat informed non insiders or market professionals face informed competitors in the financial marketplace. The rivalry between informed insiders and informed noninsiders