ARTICLE ON

An Insight into Insider

Trading
VIKASH KUMAR SINGH

LLM 3YEARS
ROLL NO 51024

Key Words Securities and Exchange Board of India, Insider Trading Regulations,

Unpublished Price Sensitive Information.

 I. A PRIMER OF INSIDER TRADING

You can never succeed in getting at the truth if you think you know, ahead of time, what the

truth ought to be. ~ Marchette Chute

Recently insider trading has become an object of fascination throughout the world, although

as a form of social and economic conduct it is hardly a new activity.1 It is the most

recognizable and publicly known form of securities fraud. It was only about three decades

back that insider trading was recognized in many developed countries as what it was - an

injustice; in fact, a crime against shareholders and markets in general. At one time, inside

information and its use for personal profits was regarded as a perk of office and a benefit of

having reached a high stage in life. The term insider trading refers to trading with the

knowledge of price sensitive information obtained from a source connected with a

corporation and likely to materially affect the price of the securities at the time they are being

traded. While insider trading may be seen merely as a reflection of greed and opportunity, a

more sophisticated explanation would recognize that it has become institutionalized in the

practices of actors in the securities market.2 There is no need for the insider trader to make a

profit: indeed it is still considered insider trading when no profit has been made by the trader,

although the aim of insider trading is always likely to be to make a profit or to avoid a loss.

II. GLIMPSE INTO THE PAST OF INSIDER TRADING

In October 2009, when Raj Rajaratnam was arrested on charges of insider trading and

prosecuted with an 11 year prison term the world was astounded at the severity of punishment

for a crime unfamiliar to them. Though unfamiliar, insider trading had its root way back in

the ages.

1
Roman Tomasic & Brendan Penrony, Insider Trading and Business Ethics, 13 LEGAL STUD . F. (Jan. 1, 2015),
http://www.heinonline.org.
2
Id.

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According to Bergmans, the first insider trading case allegedly arose when the Rothschilds

benefited from insider trading when they learnt of Wellingtons victory in Waterloo earlier

than rest of London.3 During the great takeover battles in the 1980s, several insider scandals

shocked the corporate world in the United States. The cases of Ivan Boesky and Dennis

Levine, Michael Milken and Martin Siegel provide poignant examples of the significance and

dimension of insider trading. The most infamous of those scandals, known as Wall Streets

Watergate involved a financial district arbitrageur, Ivan Boesky.4 The Securities Exchange

Commission charged Boesky for amassing close to $200 million by trading on insider

information just days in advance of major take over announcements and as a result of which

he had to pay a $100 million penalty and also face a criminal charge.5

In 1993, a former Goldman Sachs executive agreed to disgorge $1.1 million that he had

received from profits deriving from insider transaction.6

However, insider trading did not end in the 1980s and remains an issue even today.

III. WHY INSIDER TRADING IS NOT ILLEGAL?

Though insider trading is heavily regulated and severely sanctioned, a consensus remains to

be achieved among legal and economic experts with regard to the desirability to prohibit

insider trading.

The hostility towards insider trading is based not on any legal consideration but on a vicious

perversion of morality.7 Government restrictions on insider trading violate the right to

3
Bernhard Bergmans, Inside Information And Securities Trading: A Legal And Economic Analysis of the
Foundations of Liability in the USA and the European Community 3 (1991).
4
Steve Broady, Criminal Insider Trading: Prosecution, Legislation and Justification, 12 J. APPLIED ECON. 85-88
(Oct., 2009) available at http://works.bepress.com/steven_broady/1.
5
Jeanne M. Hauch, Insider Trading by Intermediaries: A Contract remedy for Acquirers Increased Cost of
Takeovers, 97 YALE L.J. 115 (1987).
6
John C. Coffee Jr., Hush , The Criminal Status of Confidential Information after Mcnally and Carpenter and
the Enduring Problem of Overcriminalisation, 26 AM. CRIM. L. REV. 121 (1988).
7
Harry Binswanger, Insider Trading Is A Right: Dont Shackle The Knowledge- Seekers, FORBES, May 8, 2013.

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freedom of contract. The owners of a corporation, its shareholders have the inalienable right

to make whatever contracts they think best concerning how the insiders of the firm deals with

confidential information. It is by contract that the firm should specify the duties owed or not

owed by everyone who chooses to deal with them - its own officers , directors, executives and

employees, and any outside consultants, suppliers etc. If a firm's contracts allow them to trade

on information they legitimately acquire, by what right does the government overrule that

contract?

So according to the proponents of this school of thought who supports insider trading, it is not

an offence but merely a contract within the company where the government does not have

any say.

IV. THEORIES PERTAINING TO INSIDER TRADING

Theories are the basis of every law and the law regulating insider trading is no different. So,

basically there are two types of theories dealing with insider trading and the United States

Supreme Court played a formidable role in their development. One of these is the Classical

Theory.

The classical theory targets a corporate insider's breach of duty to shareholders with whom

the insider transacts. Under the United States Supreme Courts Classical theory of insider

trading, a corporate insider must disclose, or abstain from trading on, material non- public

information, obtained from a unique position within a corporation. A relationship with a

company gives rise to such a duty because of a perceived necessity to prevent corporate

insiders from obtaining unfair benefits at the expense of the less informed.

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In Chiarella v. United States8, the court held that the printer who took steps to find out the

names of the target companies in a takeover bid and then purchased stock in them was not

liable for insider trading because he did not owe any fiduciary duty to the target company.

The court reasoned that liability is based on the existence of a relationship of trust and

confidence between the parties to a transaction and that Chiarella, as a non- insider did not

have any obligation to reveal material facts. This theory was ultimately sidelined when the

Supreme Court developed a misappropriation theory which outlaws trading on the basis of

nonpublic information by a corporate outsider in breach of a duty owed not to a trading

party, but to the source of the information. In the case of United States v. O Hagan9, a lawyer

representing a corporation in a confidential tender offer plan used his access material non-

public information to purchase stock in the target company. Even though O Hagan did not

owe a fiduciary duty to the target company or its shareholders, the court held him liable for

insider trading because a fiduciary who pretends loyalty to the principal while secretly

converting the principals information for personal gain defrauds the principal.10

These theories have paved the way for the growth of a comprehensive legislation for

regulating insider trading.

V. ANALYSIS OF LAWS RELATING TO INSIDER TRADING

India was not late in recognizing that a menace in the form of insider trading was rapidly

penetrating the securities market. The first concrete attempt to curb this menace was

constitution of the Thomas Committee in 1948. Pursuant to the recommendations of the

Thomas Committee11 sections 307 and 308 in the Companies Act 1956 were introduced. This

change paved way for certain compulsory disclosures by directors and mangers of all

8
445 U.S. 222, 228-29 (1980).
9
521 U.S. 642, 652 (1997).
10
Id. at 647-648.
11
Report on the Regulation of the Stock Exchanges in India- 1948
http://www.sebi.gov.in/History/HistoryReport1948.pdf.

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corporate bodies. Subsequently the Sachar Committee and the Patel Committee were

constituted in the year 1978 and 1986 respectively to recommend measures for curbing

insider trading in India. The Abid Hussain Committee constituted in 1989 had recommended

that a person guilty of insider trading should be punished both in the form of civil and

criminal proceeding. On the basis of the recommendation of this committee a comprehensive

legislation called SEBI (Insider Trading) Regulations, 1992 was enacted.

The SEBI ([Prohibition of]12 Insider Trading) Regulations, 1992 were one of the initial few

regulations that were prescribed by SEBI upon its establishment.

2(e) insider means any person who,

(i) is or was connected with the company or is deemed to have been connected with the

company and 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 ;

SEBI has clarified in the matter of KLG Capital Services Limited13 that a person would

qualify as an insider under the insider trading regulations, if such person fulfills all or any of

the conditions specified:

the person should, have or have had connection or had deemed connection with the

company and by virtue of such connection should reasonably be expected to have

access to UPSI; or

the person has received or has had access to UPSI.

12
Inserted by the SEBI (Insider Trading) (Amendment) Regulations, 2002,w.e.f. 20-02-2002.
13
Adjudication Order No. PB/AO-15/2011 (Jan 12, 2015), www.sebi.gov.in/cmorder/klgorder.pdf.

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So it can be inferred that there are two kinds of insiders. Firstly, who are connected or

deemed to be connected with the company, and secondly, outsiders who are not connected to

the company but have access to UPSI.

The law stipulates that insiders of corporate organizations should not indulge in insider

trading by taking undue advantage of their position within the company. Regulation 3 of the

Insider Trading Regulations contains provision in this regard.

3. No insider shall

(i) either on his own behalf or on behalf of any other person, deal in securities of a company

listed on any stock exchange when in possession of any unpublished price sensitive

information; or

(ii) communicate or counsel or procure directly or indirectly any unpublished price sensitive

information to any person who while in possession of such unpublished price sensitive

information shall not deal in securities :

Provided that nothing contained above shall be applicable to any communication required in

the ordinary course of business or profession or employment or under any law.

3A. No company shall deal in the securities of another company or associate of that other

company while in possession of any unpublished price sensitive information.

As it can be clearly inferred from the above provision that the offence is committed only

when the information is unpublished and price sensitive. Information pertaining to the normal

course of business undertaken by the company cannot be price sensitive as the company is

entitled to trade such information.

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For a clear understanding SEBI has defined Unpublished Price Sensitive Information (UPSI)

as:

2(ha) 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.

Explanation.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) and significant changes in policies, plans or operations of the company;

There have been a lot of discussions on whether insiders should deal in securities in the very

first place on the basis of UPSI to commit insider trading .Two major views which have

emerged out of this discussion are that an insider is guilty of insider trading only if he has

dealt in securities based on UPSI.14 On the contrary the second view suggests that mere

possession of UPSI at the time of dealing in securities will trigger the offence of insider

trading. This second view is endorsed by a literal interpretation of Regulation 3.

14
Mrs. Chandrakala v. SEBI, Appeal No. 209 of 2011.

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However, the experience regarding the implementation of the legal regime on insider trading

has been fraught with considerable difficulties. Although several actions were initiated by

SEBI, including a few high profile ones, its track record of success has been far from clear. A

substantial part of it had been attributed to the lack of robustness in the SEBI Regulations.

Taking that into account, several incremental amendments were made to the Regulations in

2002 largely as a result of the lessons learnt from the experience until then. While these

efforts were helpful in plugging some of the more obvious loopholes in the Regulations,

SEBI more recently made Regulations so as to provide an efficient means to curb undesirable

insider trading and to enhance fairness and information symmetry in the capital market.

The new rules make it tougher for people with price-sensitive information to trade in the

market for quick gains. In addition to promoters, directors and some top officials, SEBI's new

rules15 on insider trading now also include all people who are in possession of information

which are generally not available to public and which may impact the price of a stock, called

unpublished price sensitive information.16

The regulator also settled for easier delisting rules for buying out minority shareholders,

approved listing agreements to become regulations and restricted mutual fund companies

with less than Rs 50 crore capital to launch only two schemes a year till they meet the capital

requirement.

Under the new insider trading rules, SEBI has defined a connected person as someone who is

or has during the past six months prior to the concerned act has been associated with a

company, directly or indirectly. It says immediate relatives of connected persons will also be

15
Securitirs and Exchange Board of India (Prohibition of Insider Trading) (Amendment) Regulations, 2014.
16
SEBI tightens insider trading regulations, The Hindu, November 19, 2014,
http://www.thehindu.com/business/markets/sebi-tightens-insider-trading-norms/article6615373.ece.

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treated as insiders unless they can prove that they were not in possession of UPSI. The onus

to prove that they were not in possession of UPSI, however, is on the connected persons.17

A provision of Trading Plans on the lines of the U.S. has been introduced for insiders with

necessary safeguards. Such a plan is for bonafide transactions and has to be disclosed on

stock exchange platform in advance.18

Apart from SEBI Regulations section 195 of the Companies Act 2013 also deals with insider

trading, albeit, in a generalized manner as it covers unlisted public companies and private

companies unlike the Insider Regulations which deals only with public listed companies.

Guidelines define insider19, connected person20 and deemed to be connected person21 in

a company or with it and declares trading by any of them or by another person on being

counseled by them on the basis of unpublished price sensitive information in the companys

security listed on the market as an offence under the SEBI Act.

VI. STATUTORY COMPLIANCES TO PREVENT INSIDER TRADING

SEBI has put in place a very comprehensive mechanism to prevent offences like insider

trading which affect the functioning of the company. (1) Regulation 12 of the Insider Trading

Regulations obligates all listed companies and organizations associated with the securities

market to frame and adopt a code of internal procedures and conduct. SEBI authorizes the

listed companies to either draft a Code of Conduct without diluting the requirements of the

Model Code of Conduct as specified in Schedule 1 of the Regulations or they can also adopt

the Model Code of Conduct given in Schedule 1 itself. (2) Model Code of Conduct prescribes

17
SEBI tightens insider trading norms, TIMES OF INDIA, November 20, 2014,
http://timesofindia.indiatimes.com/business/india-business/Sebi-tightens-insider-trading
norms/articleshow/45211837.cms..
18
supra note 16.
19
Section 2(e) of Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992.
20
Section 2(c) of Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992.
21
Section 2(h) of Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992.

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for the appointment of a Compliance Officer who shall be responsible for prescribing and

implementing the internal policies and rules for the preservation of Price Sensitive

Information (PSI)22. (3) SEBI has introduced a new feature called the Trading Window

which specifies the period when the Directors and employees are authorized to deal in the

securities of the company. The moot point behind the introduction of this feature is to direct

the designated employees, directors and officers to trade in the securities of the company

when the trading window is open. The company shall also have the freedom to determine

when the trading window should be open and when it should be closed. (4) The Regulation

also specifies that all the directors, officers, designated employees of the company who deals

or intends to deal in the securities of the company shall obtain prior approval of the

transaction. (5) The Regulation authorizes the company to impose penalties like wage

freezing, suspension on the employees whose trading in the securities contravene the code of

conduct. (6) The Code also provides for a Chinese Wall Policy which separates the areas of

the company which have day to day access to confidential information from those areas

which provide support services. It introduces a concept of Grey Listing by which company

shall restrict trading in certain securities. (7) The Regulations stipulate that all directors,

officers and substantial shareholders in a listed company shall make certain disclosures

regarding their shareholding in the company. These disclosures can be classified as one time

disclosures and continual disclosures.23

SEBI may conduct an inquiry into the Books of Account if it suspects any violation. Further,

it may also examine the books and records of the stock exchanges, mutual funds,

intermediaries organization and other associated person24. SEBI may also appoint an auditor

22
Part A Schedule 1 of Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations,
1992.
23
Regulation 13 of Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992.
24
Regulation 4A of the Insider Trading Regulations read with Section 11(2) (i) of the SEBI Act, 1992.

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for the investigation of Books of Account and other activities of the insider.25 Depending

upon the outcome of the investigation, SEBI may also impose a penalty of INR 250,000,000

or 3 times the profit made out of insider trading, whichever is higher.26

For the purposes of regulation of the market, SEBI has the same powers as a civil court. It can

ask companies, intermediaries, brokers, trustees and any other person associated with the

securities market to furnish any documents, accounts, information that it requires. It can

conduct enquiry and investigation, on a complaint or suo moto. It can issue directions, cease

and desist orders and impose fines.

VII. WALL STREETS SCANDAL

At the times pertinent to this prosecution, Gupta was a member of the board of directors of

The Goldman Sachs Group, Inc. the global financial services firm headquartered in New

York. Rajat Gupta was once a respected high-achiever who, after striving through an

orphaned childhood and excelling in the famously competitive Indian educational structure,

made it big on the global corporate scene. During his reign at the top, he rubbed shoulders

with the high and mighty of global capitalism and was in control of some of the key engines

of financial (McKinsey, Goldman Sachs) and humanitarian (Gates Foundation) worlds.27

Gupta has served on several high-profile corporate boards as a director during his career. He

became a member of the board of Procter & Gamble in 2007, and held that post until March

2011.28 He was also a member of the board of investment bank Goldman Sachs from 2006

until the expiration of his term in 2010.29

25
Regulation 10 of the Insider Trading Regulation, 1992.
26
Section 15G of SEBI Act, 1992.
27
Prabhir Vishnu Poruthiyil, Using Religious Epics for Enhancing Morality, XLVIII No. 45 ECONOMIC &
POLITICAL WEEKLY (Nov. 10, 2012).
28
Gupta resigns from Procter & Gamble board, BUSINESS COURIER, August 23, 2012.
29
Goldman Names Wal-Mart Chairman as Board Candidate, NEW YORK TIMES, March 22, 2012.

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Coverage of the event noted that Anil Kumar who, like Gupta, had graduated from IIT, was a

highly regarded senior partner at McKinsey, and had also co-founded the Indian School of

Business and had already pleaded guilty to charges in the same case. 30 Gupta, Kumar, and

Rajaratnam were all close friends and business partners.

In 2005, five years after Raj Rajaratnam gave generously to two of Guptas favorite Indian

causes, Gupta, Rajaratnam and Ravi Trehan, an investor via BroadStreet Group and another

friend of Gupta, co-founded Voyager Capital, 80% of which was owned by Rajaratnam and

capitalized at $50 million.

Rajat Gupta is the most prominent corporate executive convicted in the United States

governments sweeping investigation into insider trading. He was found guilty of conspiracy

and securities fraud for leaking boardroom secrets to a billionaire hedge fund manager. It also

demonstrated that prosecutors could win an insider trading case largely built on

circumstantial evidence like phone records and trading logs. Previous convictions, as in the

trial of Raj Rajaratnam, the hedge fund manager on the receiving end of Mr. Guptas assumed

tips, have relied more heavily on the use of incriminating wiretaps.

The Federal District Court in Manhattan found Mr. Gupta guilty of leaking confidential

information about Goldman to his former friend and business associate, Mr. Rajaratnam, on

three different occasions in 2008. He was also convicted on a conspiracy charge. On March 1,

2011, the SEC filed an administrative civil complaint against Gupta for insider trading with

Rajaratnam. On October 26, 2010 the United States Attorney's Office filed criminal charges

against Gupta. He was arrested in New York City by the FBI and pleaded not guilty.

30
ISB aiming to be world No.1: Gupta, THE FINANCIAL EXPRESS, August 6, 2010.

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The current case is focusing on the relationship between Raj Rajaratnam, Anil Kumar and

Gupta.31 Gupta, Rajaratnam, and Kumar were all involved to varying degrees as founding

partners of private-equity firms Taj Capital and New Silk Route, though Rajaratnam and

Kumar left before they began operation. Gupta remained as chairman of New Silk Route, and

Rajaratnam eventually invested $50 million in the fund. By engaging in this conduct, Gupta

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.

Rajat Gupta's trial began on May 22, 2012. On June 15, 2012, Gupta was found guilty on

three counts of securities fraud and one count of conspiracy. He was found not guilty on two

other securities fraud charges. At the time, his lawyer told reporters, We will be moving to

set aside the verdict and will, if necessary, appeal the conviction. The maximum sentence for

securities fraud is 20 years and the maximum sentence for conspiracy is five years.32

On October 24, 2012, Gupta was sentenced to two years in prison by Judge Jed Rakoff of

the United States District Court in Manhattan for leaking boardroom secrets to former hedge

fund manager Raj Rajaratnam. His conviction was upheld by a Federal Appeals Court on

March 25, 2014. His prison sentence will begin from June 17. On June 11, 2014 US Supreme

Court rejected Gupta's bail plea, a week before his prison term began.33

On 12th January 2015, the US Supreme Court denied an appeal by Rajat Gupta, who had

challenged a ruling by a lower court permanently banning him from serving as an officer or

director of a public company. Mr. Guptas certiorari was denied, in effect keeping intact the

ruling made by the U.S. Court of Appeals for the 2nd Circuit last year which had imposed a

permanent injunction prohibiting the former McKinsey head from serving as an officer or

director of a public company, associating with brokers, dealers, or investment advisors, and

31
Yoshita Singh, Rajat Gupta trial: Prosecutors want email about Mukesh Profile, May 30, 2012.
32
McCool, Grant & Basil Katz, Rajat Gupta guilty of insider trading, REUTERS, June 15, 2012.
33
US Supreme Court rejects Rajat Guptas Plea to avoid jail term, IANS (June 12, 2014), news.biharprabha.com.

14 | P a g e
further violating securities law. Mr. Gupta has also been ordered to pay a $five million fine in

the criminal case and $6.2 million restitution to Goldman Sachs.34

So, the case shook the very morality of the securities market and the world woke up to a new

offence called insider trading.

VIII. JUDICIAL INTERPRETATION OF INSIDER TRADING

Rakesh Agarwal v. SEBI35

Facts

Rakesh Agarwal was the managing director of ABS Industries Ltd. for more than 25 years.

ABS Industries Ltd. was a listed company incorporated under Companies Act 1956 in 1973.

Bayer a German company approached ABS in February, 1996 as to the possibility of

synergizing the technical expertise of both the companies.

The officials of the two companies had been in continuous discussions since on this aspect.

Finally, Bayer AG acquired the control of ABS in October, 1996, and a public announcement

was made in BSE and NSE on the same date. Mr. Agarwal had discussions with Bayer

between September 6, 1996 and September 8, 1996 at Germany. During that meeting, the

decision to proceed with the transaction was arrived at but Bayer management had stipulated

a condition that the acquisition would be subject to Bayer being able to acquire a minimum of

51% in ABS. Subsequently, the proposal with Bayer was discussed by the Board of directors

of the Company at its meeting held on September 20, 1996. During the period between

September 9, 1996 and October 8, 1996, Mr. I.P. Kedia, Mr. Agarwals brother-in-law had

acquired 1,82,500 shares of ABS using the funds provided by Mr. Agarwal.

34
U.S. apex court denies Rajat Guptas appeal against lifetime ban, THE HINDU, January 13, 2015,
http://www.thehindu.com/news/international/world/us-apex-court-denies-rajat-guptas-appeal-against-lifetime-
ban/article6784063.ece.
35
(2004) 1 Comp LJ 193 SAT.

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On September 29, 1996, Mr. Agarwal visited Germany again, with a view to obtain a definite

commitment from Bayer to enter into the said merger and to agree on the terms and

conditions on the basis of which the parties would do so. Bayer was proposed to be given a

preferential issue by ABS and on the other hand, Bayer proposed to a public offer to the other

shareholders of ABS under the SEBI (Substantial Acquisition and Takeover) Regulations,

1994.

Between October 2, 1996 and October 3, 1996 the legal consultants of both parties prepared a

share subscription agreement and shareholders agreement detailing the terms and conditions

of the parties to the transaction. The subscription agreement was entered into on October 5,

1996. The said agreement contained a covenant on the Board of Directors of ABS as well as

the Indian Promoters (being the Appellant) to co-operate with Bayer in enabling it to acquire

20% additional shares in the public offer. Further, the acquisition of 51% shares by Bayer

(with 31% being through preferential allotment and 20% being through public offer) was a

condition precedent to the successful completion of the merger, including the execution of the

shareholders agreement.

SEBI ruled that Mr. Rakesh had indulged in insider trading through Mr. I.P.Kedia during the

period between September 9, 1996 and October 1, 1996, when the information about the deal

with Bayer was a UPSI. SEBI also directed Mr. Rakesh to deposit INR 34,00,000 in the

investor protection funds of the various stock exchanges involved to compensate for the

losses that may be suffered by the shareholders of ABS at a later point of time. SEBI also

ordered the initiation of adjudication proceedings against Mr. Rakesh under Section 15I read

with Section 15G of SEBI Act.

Mr. Agarwal in his defence said that the information of a merger with Bayer was not UPSI as

it was extensively covered by the media.

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Questions Raised

1. Whether Mr. Rakesh Agarwal is liable for insider trading?

2. Whether SEBI can compel Mr. Rakesh Agarwal to pay INR 34,00,000?

Judgement

1. Securities and Appellate Tribunal (SAT) observed that ABS was trying to ally with

strategic market players since 1995. It also observed that reports by the media were

merely speculative and incomplete and so could not be relied upon in this regard. SAT

ruled that the information of Bayer having a 51% stake was a UPSI till it became

public on 1st October 1996 (when disclosures were filed in Bombay Stock Exchange

and National Stock Exchange).

2. SAT observed that SEBI did not possess such wide powers under Regulation 11; the

power under this regulation was restricted to pass necessary interim directions for the

purpose of preserving the status quo during or immediately after the investigation.

Regulation 11 read as follows:

a) directing the insider not to deal in securities in any particular manner;

b) prohibiting the insider from disposing of any of the securities acquired in violation

of these regulations;

Taking a cue from it, Securities and Exchange Board of India broadened its ambit by the

amendment in 2002.

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Gujarat NRE Mineral Resources Ltd. v. SEBI36

Facts

FCGL Industries Ltd. is a public limited company whose shares are listed on Bombay Stock

Exchange Ltd., Mumbai (for short BSE) and Calcutta Stock Exchange, Kolkata. It is a core

investment company having more than ninety per cent of its assets as investment in

associated or group companies. It held 17.7% of the total paid up equity capital of the Gujarat

NRE Coke Ltd. The board of directors of FCGL in their meeting held on July 4, 2005 decided

to acquire coal mining leases in Australia through a special purpose vehicle which was

registered as a company in Australia under the name and style of Gujarat NRE FCGL Pty

Ltd (joint venture). In order to meet the cost of acquisition, FCGL decided to dispose a part

of its investment in the Coke company.

The meeting was attended by Shri G.L.Jagatramka and Shri A.K.Jagatramka who were the

chairman and director, respectively of FCGL. Soon after the meeting, the BSE was informed

of FCGLs decision to acquire mining leases in Australia and of the high costs involved,

however, the decision to dispose of its investments in the Coke Company was not disclosed.

This non-disclosure has been taken by SEBI as a serious violation of the regulations and also

of clause 2.1 of the Code of Corporate Disclosure Practices specified in Schedule II to the

regulations.

SEBI carried out investigations in the scrip of FCGL during the period from September 5,

2005 to September 24, 2005 and found that Matangi Traders and Investors Limited (Matangi)

and Marley Foods Private Limited (Marley) had bought the shares of FCGL during the

investigation period on the basis of unpublished price sensitive information. Sebi further

found that Shri G. L. Jagatramka and Shri A. K. Jagatramka who attended the board meeting

36
SAT decision dated November 18, 2011.

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of FCGL on July 4, 2005 were also the directors of Matangi and Marley which were persons

acting in concert with the promoters and directors of FCGL.

Questions Raised

Whether disposing of a part of the investment to acquire mining leases in Australia amount to

PSI?

Judgment

Court held that the answer to this question depends on the interpretation of the term Price

Sensitive Information The definition of PSI under the Insider Trading Regulations clarify that

the information on disposal of the whole or substantial part of the undertaking is PSI. It had to

be determined if part sale of investment would amount to disposal of the whole or substantial

part of the undertaking.

FGCL being an investment company, its day to day affairs include buying and selling of

securities and reporting to the stock exchange every time it trades in securities would not be

possible. Therefore, the decision of FGCL to dispose of a part of its investment would not

constitute a UPSI. Hence, the Appeal was allowed and the impugned order of SEBI was set

aside.

Chandrakala v. SEBI37

Facts

M/s Rasi Electrodes Ltd., a company whose scrips are listed on the Bombay Stock Exchange.

The Board conducted investigations between the period of June 8, 2007 to July 20, 2007 for

the rise in price and volume of the scrip of the company. It was noted that certain promoter

entities had traded in the scrip during the investigation period. It was further noticed by the
37
Decision dated January 31, 2012.

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Board that the agenda for the board meeting to be held on June 30, 2007 was discussed

internally between Mr. B Popatlal Kothari, chairman and managing director and Mr. G

Mahavirchand Kochar, whole time director of the company.

The agenda was finalized between June 19 to 21, 2007. The rate of dividend was finalized in

the meeting held on June 30, 2007. The period of June 19 to 30, 2007 was considered as a

period when the information about the financial results and dividend was UPSI. It was further

noted by the Board that the agenda for the board meeting regarding bonus issue to be held on

July 25, 2007 was discussed internally during the period July 15 to 17, 2007 and the agenda

papers were circulated on July 17, 2007. The period July 15 to 17, 2007 was considered to be

the period when information about the issue of bonus shares was UPSI.

Mrs. Chandrakala is the wife of Uttam Kumar Kothari who is the promoter of the company

and is brother of B Popatlal Kothari, chairman and managing director and Ranjit Kumar

Kothari, director of the company. Therefore, according to the Board, Mrs. Chandrakala was

deemed to be a connected person with the company and its directors who had access to UPSI

and hence an insider. It was alleged that Mrs. Chandrakala had dealt in the scrips of the

company based on the UPSI she possessed. She was said to have violated Regulation 3(i), (ii)

and 4 of the Insider Regulations, 1992. Accordingly, a show cause notice dated 11th March

2011 was issued to her. Mrs. Chandrakala was held guilty and as a result of which penalty

was imposed. Hence, she filed an appeal against this order.

Questions Raised

1. Whether Mrs. Chandrakala was liable for insider trading?

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Judgment

The court upheld the order of the Tribunal as regards the point that Mrs. Chandrakala was

deemed to be a connected person but acknowledged the fact that though she possessed the

UPSI, she did not trade on that basis. Mrs. Chandrakala traded on the basis of her corporate

wisdom. On the contrary, if she had other ulterior motives, she would not have sold the

securities knowing the fact that there was an impending bonus issue.

The court held that though Mrs. Chandrakala was an insider, but the allegation against her

of using UPSI does not hold good and hence the court allowed the appeal.

IX. A GLOBAL COMPARATIVE ANALYSIS

United Kingdom and India

In the United Kingdom, the two statutes governing the offence of insider trading are Financial

Services and Markets Act (FSMA), 2000 and Criminal Justice Act (CJA), 1993.

Under CJA, insider dealing will be committed where an insider, while in possession of inside

information, deals in securities which are price-affected in relation to that information, or

where he either acquires or relies on a professional intermediary or is himself acting as a

professional intermediary and disposes of such securities on a regulated market, or where an

insider in possession of inside information encourages another person, including a company,

to deal in price-affected securities, even if that other person does not know that the securities

are price-affected and where an insider discloses inside information to another person,

including a company, otherwise that in the proper performance of the functions of his

employment, office or profession.38

38
Section 52 of Criminal Justice Act, 1993.

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Under Section 56 of the Criminal Justice Act, 1993, an important requirement of inside

information is that it should be such that if disclosed, it would have an effect on price of such

securities.

Under Section 57 of the Criminal Justice Act, 1993 which defines insider, a person has

information as an insider, if and only if:

a. it is, and he knows that it is, inside information, and

b. he has it, and knows that he has it, from an inside source.

Further, a person is said to have information from an inside source, if and only if:

a. he has it through:

i. being a director, employee or shareholder of an issuer of securities; or

ii. having access to the information by virtue of his employment, office or profession; or

b. the direct or indirect source of his information is a person within paragraph (a).

However inspite of the initial similarities between the laws of the two countries, there exists

stark dissimilarities between the two laws. In some circumstances the Indian law appears to

be lagging behind the English law but in certain cases it is far ahead.

Indian Law defines an insider as a person who has received or had access to UPSI on the

other hand English law defines insider as any person who receives or has access to UPSI from

any source whatsoever.

Both the Indian and the UK laws have similar definition of price sensitive information. The

information should be such that it would have substantial effect on the price of the security.

Insider trading is both civil and criminal offence. In India civil and criminal offence are dealt

by same statue but not so is the case with English law.

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Indian Law defines UPSI in Section 2(k) of Insider Trading Regulations, 1992 whereas U.K.

Law being less stringent does not define public information.

Under Section 62 of the CJA, territorial connection to the UK is required for commission of

insider dealing. No such requirement has been spelt out under the Indian regulation.

The penalty prescribed under Section 15G of the SEBI Act, 1992 specifies a penalty of INR

250,000,000 or three times the profit earned from the insider trading, whichever is higher.

Also Section 24 of the SEBI Act prescribe the punishment of 10 years or a fine of INR

25,00,00,000 or both. The maximum sentence for insider trading in UK is 7 years.39 Under

Section 123, FSA has the authority to impose a fine of such amount as it thinks appropriate.

United States of America and India

Statutory insider trading laws were first passed in United States in 1933. Congress passed the

Securities Act of 1933 and the Securities and Exchange Act of 1934. Both Acts were intended

to increase transparency for investors while placing the obligation of due diligence on the

preparers of documents containing detailed information about the security. The Securities and

Exchange Act, 1934 created the Securities and Exchange Commission (SEC) to regulate the

secondary trading of securities.

The SEC makes the rules that govern the securities market and also enforces them along with

the Department of Justice. The SEC is the most active of all the worlds financial regulatory

institutions at prosecuting insider trading and the laws. Much of the law in the U.S. has been

developed in the courts because of United States tradition of common law.

The SEC in their definition of insider trading has bestowed ample discretionary powers in

their hands; this requires frequent interference by the court. The penalties for insider trading

39
Section 61, Criminal Justice Act, 1993.

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are a maximum of 20 years in prison and a fine of $5 million. These fines were increased in

the Sarbanes-Oxley Act of 2002.

Indian law gives a comprehensive description of who would be an insider, unlike US where

the majority law is subject to the interpretation of the courts.

There is a difference between the penal measures adopted in both the countries.

China and India

China has two major stock exchanges: Shanghai and Shenzhen Stock Exchanges. China ranks

second in the world for market capitalization. The securities market in China is regulated by

the China Securities Regulatory Commission (CSRC). China first made insider trading illegal

in 1993 with the introduction of the Establishment of Securities Companies with Foreign

Equity Participation Rules.40 Inside information in China is defined as, information that is

not made public because, in the course of securities trading, it concerns the companys

business or financial affairs or may have a major effect on the market price of the companys

securities. Punishment for insider trading is a maximum fine of five times the illegal

proceeds from illegally purchased or sold securities. If the case is serious enough, those

convicted could also face criminal charges and a maximum prison sentence of 10 years.41

Being a more developed economy than India, Chinas insider trading laws is still growing. As

a result for which conviction rate for the offence of insider trading in China is abominably

low as compared to India.

The laws of India have much to learn from the laws of other countries and also impart certain

inputs to their laws as well.

40
James H Thompson, A Global Comparison of Insider Trading Regulations, 3 No. 1 INTERNATIONAL JOURNAL
OF ACCOUNTING AND FINANCIAL REPORTING 5 (2013).
41
Id.

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 X. IMPACT OF INSIDER TRADING

Insider trading is a term subject to many definitions and connotations and it encompasses

both legal and prohibited activity. Insider trading takes place legally every day, when

corporate insiders officers, directors or employees buy or sell stock in their own

companies within the confines of company policy and the regulations governing this

trading.42

Insider trading amounts to theft of information and a breach of fiduciary duty. It would be

very difficult to regulate and monitor due to the intangible nature of the good used:

information.

(1) Insider trading is based on informational disparity between investors and insiders. It

discourages investment and, thus, decreases market liquidity. (2) It is economically inefficient

and generates agency problems within the corporation, meaning that insider trading gives

incentives to insiders, particularly managers, to make decisions not necessarily in the best

interest of the shareholders in order to profit from short-term stock price swings.43

(3) Even proponents of insider trading acknowledge that it causes greater disparities between

bid and ask prices. 44Further, the SEC has said that economic studies have provided support

for the view that insider trading reduces liquidity, increases volatility, and increases the cost

of capital.45

42
Mr. Thomas C. Newkirk, Associate Director, Division of Enforcement, SEC.
43
Alexander Padilla, How Do We Think About Insider Trading? An Economist's Perspective On The Insider
Trading Debate And Its Impact, 4 J.L. ECON & POLICY 239 (2007-8), www.heinonline.org.
44
Stanislav Dolgopolov, Insider Trading and the Bid-Ask Spread: A Critical Evaluation of Adverse Selection in
Market Making, 33 CAP. U. L. REV. 83 (2004).
45
Exchange Act Release No. 43154, 73 SEC Docket 3, [2000 Transfer Binder] Fed. Sec. L. Rep. (CCH) M 86,
319 (Aug. 15, 2000).

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Thus, insider trading impairs more than it enhances the efficient functioning of stock markets,

even when it is illegal, and therefore not very common.46 Some academics argue that insider

trading acts as a price escalator and helps bring the price of securities to their proper level

more quickly than would happen without it.47

XI. SUGGESTIONS

Attitudes to insider trading are closely related to prevailing patterns of business ethics

in the securities industry. This relationship is not just a matter of greed, although

greed is obviously a key underlying motivation for many in the industry. The real

issues concerns such factors as the culture of tolerance of insider trading, peer group

support for insider traders, the low stigma attaching to insider traders, and the largely

symbolic role of law and regulation in this area. Some professionals such as lawyers,

accountants and many older and more established brokers clearly espouse and practice

very high ethical standards, although we found that even they were very reluctant to

come forward and complain about insider traders or be prepared to give evidence

against them. Many others are relaxed towards their commitment to ethical standards

of the industry. For this reason, every business organization should organize seminars

and workshops for their employees, directors and officials to make them aware about

their obligation towards the industry.

The Compliance officer has been deputed by the company to examine the reports of

every director and official of the company which are filed with them. This is a good

initiative but materiality and exception reporting has not been followed. So much

responsibility and requirements have been placed on the compliance department as

well as the compliance officer, apart from too many procedures, that it is likely that

this department and the compliance officer may be drowned in paperwork. There

46
Id.
47
supra note 1.

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 should definitely be a cut-off point or threshold limit exceeding which organizations

are required to file reports, but organizations which do not exceed the limits can file

shorter reports. Since the requirements are quite detailed not all such entities can

afford or even require such detailed procedure and infrastructure such as an elaborate

compliance department headed by a compliance officer.

The language of Regulation 348 requires an overhaul as it is ambiguous. Judicial

decisions differ on the point whether mere possession of UPSI would constitute

insider trading. A literal interpretation of Regulation 3 supports this point. However,

some judicial decisions support the view that mere possession is no offence, but using

the information for the purpose of trading would constitute the offence of insider

trading. So, SEBI should come up with clear provisions so as to remove the ambiguity

in this regard.

The Securities and Exchange Act, 1934 of United States authorizes the Securities and

Exchange Commission to award a bounty to whoever provides information about

insider traders. This could be introduced by Securities and Exchange Board to crack

new cases of insider trading.

XII. CONCLUSION

The core of securities regulations is the implementation of the purpose that all investors

should have equal access to the rewards of participation in securities transactions In other

words, all members of the investing public should be subject to identical market risks. India

being on the verge of becoming the third largest economy by 2050 is a nascent superpower

and hence, cannot afford to have instances where the confidence of the investors about the

prospects of the Indian markets is dampened. Like other developed countries, India is also

trying to have a comprehensive legislation that would control insider trading.

48
Regulation 3 of Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992.

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