Examination Number:

MN 996

Prohibition on Insider
Trading: A toothless Law

Professor P.W. Alldridge

Electronic copy available at: http://ssrn.com/abstract=1400824

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Abstract

The principle objective of this paper is to demonstrate and analyse various

aspects of Insider trading, and to evaluate the effect of this practice on the

fidelity of a company towards the securities market and the common investor.

The main focus of this dissertation will be on insider trading in the securities

market of United States, United Kingdom and India. Indian securities market is

studied in this dissertation because despite there being regulation against insider

trading, the enforcement rate is equivalent to nil. So as to attract foreign

investment and to retain the confidence of the domestic investor, India needs to

bring it securities market at par with the securities market of these two developed

economies.

In this work the particular emphasis will be on the legal and economic

consequences of such practice, with a comparative aspect of rules and regulation

that are being made in the above mentioned jurisdictions. And also to see as to

why there is lack of enforcement of these regulations against this practice.

Finally, this dissertation will pave a way for further research question, focusing

upon the harmonisation of regulations against insider trading globally, by

providing a unified regulation against this practice.

Electronic copy available at: http://ssrn.com/abstract=1400824

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Contents

1. Introduction

1.1 Background and introduction to Insider Trading 5

1.2 Aim of the Dissertation 8
1.3 Scope of the Dissertation 9
1.4 Structure of the Dissertation 10

2. Inside of Insider Trading

2.1Introduction 11

2.2 Why regulate insider trading 12

(i) Rule of Equity
(ii) Fairness
(iii) Public Confidence
(iv) Breach of Fiduciary duty
(v) Harmful to the portfolio of the issuer

2.3 Insider trading is fair 19

(i) Compensation for entrepreneurs
(ii) Efficient pricing of securities
(iii) Public Choice

2.4 Conclusion 23

3.Studies of jurisdictions

3.1 Introduction 24

3.2 Evolution and regulation of practice of Insider Trading

in US 25
(i) Disclose or Abstain Theory
(ii) Misappropriation Theory

3.3 Evolution and regulation of practice of Insider Trading

in UK 29
(i) European Union
(ii) United Kingdom

3.4 Evolution and regulation of practice of Insider Trading in

India 34

3.5 Conclusion. 38

4. Nabbing the insider – Easier said than done

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4.1 Introduction 39

4.2 Gap between the enactment and enforcement of law 40

(i) United States of America
(ii) United Kingdom
(iii) India

4.3 Corporate Governance in India, is it at par with U.S

and U.K? 46

4.4 Conclusion 47

5. Conclusion

5.1 Summary of dissertation 49

5.2 Harmonisation of law against Insider Trading. 51

Appendices 53

Bibliography 55
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Chapter One: Introduction

1.1 Background and introduction to Insider Trading

Before defining what is insider trading, it will be good to understand first who is

an “insider”. But it is not easy to define this term, as no clear definition has been

provided by the securities regulation authorities of the major financial economies.

Insider (in context of insider trading in stocks) is anyone who has privileged

access to material price sensitive non-public information of the company due to

some special relationship who could be the director, corporate executive, lawyer,

banker, accountant or a major shareholder.

The dilemma of the securities regulatory agencies around the world, especially of

the SEC, regarding insider trading has been highlighted in this quote:

The transformation of the insider trader from legitimate corporate officer to swindler is
unique in American legal history. While Congress regularly identifies problems and
responds with (hopefully) corrective legislation, such was not the case with insider
trading.1

Now to build upon this topic it is essential to define what is insider trading, the

most simplified explanation of this practice is provided by Larry Harris, who

asserts that insider trading is the trading of a corporation's stock or other

securities (e.g. bonds or stock options) by corporate insiders such as officers, key

employees, directors, or holders of more than ten percent of the firm's shares.2

Further, it is argued that Insider trading may be perfectly legal, but the term is

frequently used to refer to a practice, illegal in many jurisdictions, in which an

insider or a related party trades based on material non-public information

1 R.G Small, path dependence and the law; A law and economic analysis of the development of insider trading laws of the US,
UK and Japan, PhD thesis, Vol 2001, “14”. Hereinafter cited as Small. Further cited from Razzano, Frank C., ‘ William K.S.
Wang and Marc I. Steinberg’s Insider Trading (1997) 52 Bus. Law, “1431”

2 L. Harris, Trading & Exchanges, (Oxford : Oxford press, 2003). “584”. Hereinafter cited as Harris
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obtained during the performance of the insider's duties at the corporation, or

otherwise misappropriated.3

Also, not all insider trading is illegal. As stock options and grants are popular

ways to compensate senior officers in a company. Because it is believed that due

credit in the form of stocks should be given to the people who are responsible for

the prosperity of the firm. But as long as they report their trades to regulators

within Ten days of the trade (and they're not acting on information that has not

been publicly disclosed), there's no problem. It's when they act on non-public

information that the trade can become illegal.

Finally, view of A.M. Louis on insider trading is worth mentioning, who in his book

‘The Unwinnable War on Insider Trading,’ asserted that:

Of all the issues that have confronted regulators of the securities markets, the regulation
of insider dealing has proved among the most intractable. Experience of such regulation,
which has attracted the unflattering label of ‘the unwinnable war’, prompts
reconsideration of the issue.4

A detailed analysis of the conflicting views on this practice has been provided in

the next chapter, which will help us to balance both sides of this issue that

whether prohibition of insider trading is just or unjust. But to create the back

ground scene for the next chapter it is necessary to see how the attitude towards

this practice changed from toleration to condemnation and why the regulation of

insider trading became an important issue in securities regulation.5

This practice was brought in legal scrutiny first by United States, as it has been

the leading country in prohibiting insider trading. Thomas Newkirk and Melissa

Robertson of the SEC, summarize the development of U.S. insider trading laws:

U.S. insider trading prohibitions are based on English and American common law
prohibitions against fraud. In 1909, well before the Securities Exchange Act was passed,
the United States Supreme Court ruled that a corporate director who bought that
company’s stock when he knew it was about to jump up in price committed fraud by
buying while not disclosing his inside information.6

3 Laws that Govern the Securities Industry U.S. Securities and Exchange Commission, accessed March 30, 2007
4 A.M. Louis The Unwinnable war on insider trading. (1981)
5 J. Suter, The regulation of insider dealing in Britain (London: Butterworth, 1989). P6. Hereinafter
cited as Suter.
6 Insider Trading- ‘A U.S. Perspective’
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Section 17 of the Securities Act 1933 was the first legislation that brought this

practice under the categories of other fraudulent practices. This was further

strengthened by Securities and Exchange Act 1934. Section 16(b) of the

Securities Exchange Act of 1934 prohibits short-swing profits (from any

purchases and sales within any six month period) made by corporate directors,

officers, or stockholders owning more than ten percent of a firm’s shares. While

SEC Rule 10b-5, prohibits fraud related to securities trading. The continuous

development of legislation and case laws since this practice was first prohibited is

ensuring to create an effective regulation against insider trading. And with the

continuous efforts of SEC, which is entering into Memorandum of Understanding

with foreign jurisdictions, with a aim to not only develop its law further but also

to establish the American model of regulation as the global standard.7

The lead provided by America is followed by various economies around the world,

though U.K. vary from U.S. in regard to the interpretation and the application of

the rule against insider trading but the aim is the same to provide a safer playing

grounds to the investors. Statutory regulation against insider trading in United

Kingdom was first touched upon in 1970s. Bur this practice was first criminalised

by part V of the Companies Act 1980,8 the law against insider trading has been

strengthen further by Financial Services and Markets Act 2000, which introduces

a new offence of market abuse. On the lines of U.S. SEC, U.K. has its Financial

Services Authority, which sees insider trading as its main target from the early

days of its inception.

Another major financial economy of the world that has promulgated a law against

insider trading on the pattern of Section 10(b) and Rule 10(b)-5 of the US

7 ‘See n 1 above’, “16”. For further reading see Kehoe, James A., ‘Exporting insider trading Laws: The enforcement of U.S.
Insider Trading Laws Internationally’ (1995) 9 Emory Int’l L. Rev. 345. Hereinafter cited as: Kehoe.
8 Companies Act 1980, Part V, s68 (1), (2), (3), (4), (5), (6), (7), s 69(3).
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Securities Exchange Act 1934 is Japan. But “Even today many Japanese do not

understand why this is illegal. Indeed, previously it was regarded as common

sense to make a profit from your knowledge".9

Finally, a country like India, which is in its restructuring phase since the abolition

of “Licence Raj” has to deal with various offences related to the financial market,

the outcome of that was the Securities and Exchange Board of India Act 1992,

which outlawed insider trading in 1992 and gave Securities and Exchange Board

of India the power to investigate the instances of alleged insider trading. The

truth of the wide prevalence of this practice in Indian securities market was

provided by the former president of the Bombay Stock Exchange, who stated

that: There is no other kind of trading in India, but the insider variety.10 But

despite this fact there is a huge gap between the enactment of law against insider

trading and in its enforcement. So, to ensure the confidence of investors in the

securities markets of India a strong and unbiased enforcement mechanism is

required.

1.2 Aims of this Dissertation

The aim of this dissertation is to investigate the development of insider trading

regulation on a comparative basis by examining the legal regimes of United

States, European Union and India.

Further, This Dissertation particularly seeks to accomplish three tasks: Firstly, to

see why there are divergent views on this practice, as to why regulation of insider

9 See Japanlaw.info (Last visited on 07.06.2008)

10 S. Dalal, ‘ Nabbing Insider Traders: Easier said than done,’ http://www.suchetadalal.com/articles/display/1/362.article
(Last visited on 12.07.2008)
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trading is favoured by some and opposed by other’s. Secondly, it will study the

evolution of legislation and regulation against this practice and will try to see that

whether there is a link between the globalisation of businesses and the

amendments of laws prohibiting this practice.

Finally, it aims to enquire why there is a gap between the formation of legislation

against this practice and in its enforcement. And to see to what extent India can

follow the footsteps of America in curbing this practice, while taking into

consideration the difference in their corporate culture.

1.3 Scope of this Dissertation

This particular dissertation will primarily focus upon the legal regimes of United

Kingdom (with a brief overview of European Union), United States of America and

India. These particular regimes have been selected for this work because United

States of America and United Kingdom being the two largest financial markets of

the world can act as a guide to the emerging market of India.

India is considered in this dissertation because India being one of the fastest

growing economies of Asia (with around Eight percent GDP growth) need to have

an effective check on its financial markets so as to provide a fair and equal play

field for domestic and international investor, if it wants to be in the ranks of

major economies of the world.

This dissertation will examine this practice from the time of first regulation

against this practice in United States in 1933 up till the present time. To have a

good understanding of various aspects of this practice, references from various

secondary sources such as articles published in academic journals and books

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along with primary source inclusive of case law and legislation will be taken.

While there being considerable debate on most of the references mentioned, they

will be accepted on their credentials due to space constraints of this dissertation.

1.4 Structure of this Dissertation

This dissertation is divided into five chapters inclusive of introduction and a

conclusion. Chapter two will be focusing upon the insider trading debate, which

has been in existence since long and is believed, to continue in the times to

come. The main focus of this chapter will be the literary review on this practice

arguing for and against the regulation of insider trading. Chapter three will focus

and evaluate the evolution of insider trading in the major financial markets of the

world, with the main focus upon United States of America, United Kingdom and

India. Chapter four will focus upon the shortcomings of the regulations against

this practice and will try to evaluate why there is a gap between the adoption of

law and in its enforcement. Finally in chapter five, the conclusion will summarise

the finding of the paper and will draw a conclusion based on them. Also the

conclusion of this dissertation will provide a thought for further research, that on

the lines of harmonisation of commercial law, there is a need for unified

international regulation against insider trading in this present scenario of

converging markets.
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Chapter Two: ‘Inside of Insider Trading’

2.1 Introduction

This particular chapter will introduce and describe the insider trading debate,

since the time this particular practice came to the forefront of academic

discussion.

My research in this particular area of corporate law will also have a glimpse of

divergent views on insider trading and will evaluate the arguments for and

against the prohibition. This is to serve as the background frame for the reference

of this dissertation. Because some view this practice as an incentive to an

executive, principle among them being Henry Manne and Milton Friedman, while

others view it as a fraud, particularly the investor and the securities regulatory

authorities around the world.

Further, this chapter shows that there is no firm conclusion one way or the other

over the regulation of Insider trading. As there is a vast body of literature

present, which focuses upon this practice. Thus it is acknowledged that in each of

the area considered all of the relevant literature is not referred to, rather a small

representative sample is made. This chapter is not meant as an exhaustive

review of the debate thus far, but rather as a brief overview of the major

arguments for and against the regulation of insider trading.

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2.2 Why regulate Insider Trading

(i) Rule of Equity

The most primary and common justification given in favour of regulation of

insider trading is that it is unequal to a common investor. This trading takes place

when those privileged people who have confidential information about some

important events use that information to reap profits or avoid losses on the stock

market, without considering it’s after effect on the typical investors who buy or

sell their stock without the advantage of that “inside” information.

The concern on degradation of ethical standards in this practice was highlighted

by both the council for securities industry11 and the justice report12 when they

argued ‘it is contrary to good business ethics that a man holding a position of

trust in a company should use confidential information for his personal benefit’.

On this basis, the CSI termed insider dealing a ‘reprehensible’ practice.13 This

view was echoed in description of insiders by the panel as ‘dishonourable men’

and by its former chairmen as having ‘betrayed ethical principles which forbid

“insider” dealings’.14

Another view focussing upon this aspect of insider trading is that “ Inequality of

access to information, however, may enable informed investors to increase their

wealth at the expense of the less informed”.15

(ii) Fairness

Another argument that complements the rule of equity is the issue of fairness,

but this is the particular issue on which the law and economic community have

different stands.

11 Council for the securities industry, ‘Statement on Insider dealing’ (June, 1981) , para4, published as an appendix to its
report on the year to 31st March, 1981.
12 Justice, ‘Insider Trading’ (1972), para3.
13 CSI, ‘Department of Trade Inspections and Prosecutions’ (1979), para40.
14 Statement by lord Shawcross, chairman of the city panel on take-over and mergers, 26th October 1972.
15 See Suter ‘n 4 above’
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Justifying the stand of SEC on enforcement of a law against insider trading during

a Sixteenth International Symposium on Economic Crime, SEC staff stated that:

More Americans are investing in the stock market than ever before and
Americans now have almost twice as much money invested in the stock market
as in commercial banks. We believe this reflects Americans' trust and confidence
in the American stock markets and that trust stems from a belief that our
government relentlessly pursues its mandate to maintain the fairness and
integrity of the stock markets.16

Support for prohibition on insider trading based on the principle of fairness was

highlighted " In 1961, in the case of In re Cady Roberts & Co.,17 the Securities

and Exchange Commission, applying a broad construction of the provisions,

stated that:

Analytically, the obligation [not to engage in insider trading] rests on two principal
elements: first, the existence of a relationship giving access, directly or indirectly, to
information intended to be available only for a corporate purpose and not for the
personal benefit of anyone, and second, the inherent unfairness involved where a
party takes advantage of such information knowing it is unavailable to those with
whom he is dealing.18

Also in SEC v Texas Gulf Sulphur Co., a landmark case, which endorsed the

concept of fairness from Cady Roberts case,19 stated that:

[t]he core of Rule 10b-5 is the implementation of the congressional purpose that all
investors should have equal access to the rewards of participation in securities
transactions…. [I]nequalities based upon unequal access to knowledge should be
shrugged off as inevitable in our ways of life, or in view of the congressional concern in
the area, remain uncorrected.20

As stated earlier that this aspect of unfairness related to insider trading has been

the bone of contention between the law and economic community, but Professor

Manne has made a special contribution against this aspect that he successfully

altered the direction of the debate by changing the focus of this debate from legal

to economic point of view.21

Also a counter argument to the notion of unfairness is that when no one

complains that the salary, bonus or other incentive that the managers of a firm

16 16th International Symposium on Economic Crime, Jesus College, Cambridge, England

17 40 SEC 907 (1961).
18 Id., at 912
19 40 SEC 907 at 912 (1961)
20 SEC v Texas Gulf Sulphur Co., 401 F.2d 833, 851-52 (2d cir. 1968), cert. denied, 394 U.S.976 (1969).
21 H.G. Manne, Insider Trading and the Stock Market (Toronto: The free press (Mac Millan), 1996),”122”. Hereinafter cited as
Manne
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receive are unfair and should be returned to the shareholders than on what basis

it is said that “insider” trades at the expense of the outsider.22

(iii) Public Confidence

Another important factor, which contributes towards creating a conducive

atmosphere in favour of regulation of insider trading is that, prevalent of insider

trading results in diminishing of the confidence of a common investor in the

securities market.

This notion of upholding the confidence of common investor in securities market

was put forward by Chairman Levitt of the United States Securities and Exchange

Commission in his address to the legal and investment community:

Our markets are a success precisely because they enjoy the world's highest
level of confidence. Investors put their capital to work – and put their fortunes
at risk – because they trust that the marketplace is honest. They know that our
securities laws require free, fair, and open transactions. 23

This view is further supported by Professor Schotland, who argues that insider

trading regulation enhances public confidence and results in increased investor

participation.24

The main factor due to which confidence of public is required in the securities

market is that the suspicion created by the existence of fraud and insider dealing

discouraged the entry of investor into the market, hence resulting in increased

cost of capital.

Similar to US, in Britain also, the regulatory agencies have emphasised the

importance of public confidence. Strengthening the view on public confidence in

the securities, the panel has stated:

22 D.W. Carlton, D.R. Fischel;’The regulation of Insider Trading’ (1983) 35 Stan. L. Rev. 857. 869- 871. Hereinafter referred
as Carlton & Fischel.
23 Arthur Levitt, A Question of Investor Integrity: Promoting Investor Confidence by Fighting Insider Trading, Address Before
the "SEC Speaks" Conference, February 27, 1998.
24 R.A. Schotland, ‘Unsafe at any price: A Reply to Manne, Insider Trading and the Stock Market’ (1976) 53 Virginia Law
Review, 1425.
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One of the principle objectives of any regulatory authority must be to maintain a

securities market in which shareholders and potential shareholders have
confidence that when they deal with their investments they will receive fair
treatment. If this confidence is not maintained people will cease to invest through
the market.25

The CSI also considered that insider dealing ‘damages public and indeed

international confidence in the securities market’.26 Similarly, whilst regarding

much of the disquiet about the alleged extent of insider dealing as ‘emotive and

unjustified’, the panel commented: ‘its very existence is damaging to the

27
confidence upon which a securities market must be founded’.

Further, contradicting the views of Professor Manne’s that insider trading should

be legalized professor Schotland stated that as the financial markets are an

important part of any country’s economy, so to keep the confidence of the public

in this institution firm, the regulatory authorities should ensure an effective

compliance and enforcement of the law against insider trading and should ensure

that a common investor gets a “safe place for investment” rather than a

“jungle”.28

The notion of public confidence has been highlighted in various case laws dealing

with insider dealing, one of them being Chiarella v. United States where the court

held that ‘the purpose of the disclose or abstain rule is to equalize access to

material information, and that if this is achieved it would encourage investor

confidence that the financial markets are fair’.29

On the contrary, Mark Miller, in reference to Stock Exchange Board of India

(SEBI), noted:

Indian stock market has many problems related to efficiency, such as the lack
of transparency and the existence of market manipulation, but he argues that
whether it is just to equate insider trading with market manipulation because most
varieties of insider trading do not, as is often claimed, result in loss of confidence
in the market.30

25 The Panel on Take-overs and Mergers, Supervision of the Securities Market (1975), “1”.
26 Council for the securities industry, ‘statement on insider dealing ‘ (june1981), para4, published as an appendix to the
report on the year to 31st March, 1981
27 The panel on Take-Overs and Mergers, Report on the year ended 31st March 1973, “9”.
28 See Schotland, ‘n 23 above’, “1440”
29 Chiarella v. United States, 445 U.S. 222 (1980)
30 M. Miller, ‘The Insider: Parasite or Legitimate Profit-Maker?’. State, Market & Economy.
www.ccsindia.org/policy/money/studies/wp0029.pdf (Last visited on 27 June 2008)
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(iv) Breach of fiduciary duty

One of the important pillars of the theory that supports the regulation of

insider trading is the Misappropriation or fiduciary theory, which provides that the

insider in any form whether it being the director or on any executive post in the

company or any person dealing in the capacity of the agent of the company are

bound by their special relationship with the company and hence owes a fiduciary

duty towards the company not to misuse such inside or non-public information for

their personal gains. Most of the securities regulation authorities around the world

have based their prohibition of insider trading on this notion of breach of fiduciary

duty.

Further, in words of Suter, The fiduciary principle applies to companies as well.

Hence, when a company sells its securities, neither management nor existing

shareholders are permitted to benefit from non-disclosure of material information

to purchasers. Likewise, when it buys its own securities, it has no right to

overreach some shareholders so that other benefit from non-disclosure. The

fiduciary duty is based on the principle that all shareholders are entitled to equal

access to information from the company when it deals with them.31

The misappropriation theory found its roots in the case of Chiarella v. United

States.32 In that case Supreme Court reversing the criminal conviction of a

printer, who during his work decoded certain confidential information and traded

on those information, court held that it would have upheld the conviction on the

grounds that the defendant had "misappropriated" confidential information

obtained from his employer and wrongfully used it for personal gain. This ruling

was subsequently developed in a number of cases until the Supreme Court

31 See Sutter, ‘n 4 above’, “40”

32 United States v Vincent F. Chiarella, 445 U.S. 222(1980)
 17

affirmed the Misappropriation theory in United States v. O'Hagan,33 a landmark

case where the scope of Rule 10b-5 was defined. In this case, court

acknowledges "information as a property" rationale underlying insider trading

prohibitions:

A company's confidential information . . .qualifies as property to which the

company has a right of exclusive use. The undisclosed misappropriation of
such information in violation of a fiduciary duty . . . constitutes fraud akin to
embezzlement – the fraudulent appropriation to one's own use of the money
or goods entrusted to one's care by another.34

The theory that Non-public confidential information is property of the corporation

is linked with Professor Manne’s assertion that insider trading is compensation to

the innovators of the information.35

Finally, Professor Bainbridge holds that instead of allowing the insider to use the

Information, as it is against the reputation of the corporation and as claimed, it is

not an effective way of compensating the insider. Hence, the property right in the

information should remain with the corporation.36

(iv) Harmful to the portfolio of the issuer

Another strong reason, providing a support for the prohibition of insider

trading is that insider trading is not only a fraud against the investor but it also

works against the goodwill of the company whose stocks are listed on the stock

exchange.

But it is being argued that when insider dealing harms the reputation of the

company than why does not the corporation ban the dealings of the insider, the

most reasonable response to it is the high cost of enforcing of such regulations,

so it’s easier to leave enforcement against insider trading in the hands of the

government.37

33 117 S. Ct. 2199 (1997).

34 117 S. Ct. at 2208.
35 See Manne, ‘n 20 above’
36 Bainbridge Securities Law: Insider Trading, 164-169. Hereinafter cited as Bainbridge
37 See Carlton & Fischel, ‘ n 21 above’
 18

A prominent case law dealing with this effect of insider trading is Diamond v

Oreamuno where holding the director accountable for misusing confidential

information, court held that, ‘The company has a better claim to insider profits

than insiders, when the effect of insider dealing could be to cast a cloud on the

company’s name, injure relations with shareholders and undermine public regard

for its securities’.38

Another argument put forward by professor Mendelson is that insider trading

raises the cost of capital of the firm, as the news of insider of the corporation

dealing in corporation stock’s goes public, this creates a doubt in the mind of the

investor as to go for the stocks of that corporation or not, hence resulting in the

lowering of the number of subscribers and forcing the corporation to look out for

other mode of expensive sources of raising capital.39

Professor Bainbridge while commenting on effect of insider on the issuer states

that:

While insider trading will not always harm the employer, it may do so in
some circumstances. Specifically, there are four significant potential harms
connected with insider trading that are worth considering: First, insider trading may
delay the transmission of information or the taking of corporate action. Second, it
may impede corporate plans. Third, it gives managers an incentive to manipulate
stock prices. Finally, it may injure the firm’s reputation.40

Finally, Judge Easterbrook asserts that in order to create incentive for them

managers may elect to follow policies that increase fluctuations in the price of the

firm’s stock. “They may select riskier projects than the shareholders would prefer,

because if the risks pay off they can capture a portion of the gains in insider

tradings and, if the project flops, the shareholders bear the loss”.41

But this was contradicted by Carlton and Fischel who holds that the incentive to

choose high-risk projects, will not be beneficial to one of the managers as

38 Diamond v Oreamuno, 248 N.E. 2d 910, 912 (N.Y.C.A) [1969].

39 M. Mendelson, ‘The Economics of Insider Trading Reconsidered’ (1969) 117 U.Pa.L.Rev.470.
40 See Bainbridge, 'n 38 above’
41 F.H. Easterbrook, ‘Insider Trading, Secret Agents, Evidentary Privilages, and the production of Information’ (1981) Sup.
Ct. Rev. 309. Hereinafter cited as Easterbrook.
 19

managers work in teams, the ability of one or a few managers to select high-risk

projects is severely constrained through monitoring by colleagues.42

2.3 Insider trading is fair

Like the two sides of a coin this practice of insider trading also has two

contradicting views attached to it. Having discussed the arguments in favour of

regulation of this practice, now we focus on the views that have been put forward

by various Scholars for the deregulation of this practice.

There have been many strong arguments against the prohibition of insider trading

from various economics and legal scholars like Henry Manne, Milton Friedman,

Thomas Sowell, Daniel Fischel and Frank H. Easterbrook.

Milton Friedman in support of insider trading said: ‘you want more insider trading,

not less. You want to give the people most likely to have knowledge about

deficiencies of the company an incentive to make the public aware of that’.

In Friedman’s view an insider trader should not be required to make his inside

information known to public, because his buying and selling tendency is in itself

information for the market.43

Further in support of this practice, some critics have stated that insider trading is

a victimless act: Where a willing buyer and a seller agrees to trade property

which the seller rightfully owns, without any condition to refrain from trading if

there is asymmetric information.

(i) Compensation to Entrepreneur

Henry Manne propounded this notion that inside trading is an effective way to

compensate corporate agents for innovations.44

42 See Carlton & Fischel, ‘n 21 above’,871-872

43 See Harris, ‘n 2 above’. 591-597
44 See Manne, ‘n 20 above’ 116-119
 20

Manne further provided that ‘ a rule allowing insiders to trade freely may be

fundamental to the survival of our corporate system’.45 He added that the

entrepreneur can recover the value of his discovery through buying the firm’s

securities prior to disclosure and selling them after the price rises. Support for

Manne’s assertion came from Carlton and Fischel, as they believed that the salary

that the agents gets, fails to compensate them for their innovations. Carlton and

Fischel suggested that:

One of the advantages of insider trading is that an agent revises his compensation
package without renegotiating his contract. By trading on the new information,
the agent self-tailors his compensation to account for the information he produces,
increasing his incentive to develop valuable innovations.46

But these compensation theories used as a support to insider trading is

debatable, because as a compensation device, it operates in an arbitrary manner,

as there is no relation between the compensation received by the entrepreneur

and the services rendered by him and further it allows the insider to avoid bad

loss through bad news and so to gain from failure also.47

Further, J.Suter holds that, Manne’s proposition that insider dealing provide

appropriate compensation for entrepreneurs is incorrect. Rather, inefficiencies in

the pricing mechanism are compounded by the inefficiency of insider dealing as a

device for compensating entrepreneurs. The inappropriateness of insider dealing

as entrepreneurial compensation is further underlined by equity considerations.48

Finally, as professor Bainbridge noted that as it is difficult to calculate the reward

that insider trading would generate, hence it makes choosing the most cost-

effective compensation package difficult.49

45 Ibid, “110”
46 See Carlton & Fischel, ‘n 21 above’, 869-871
47 See Suter ‘n 4 above’, “33”
48 ibid, at 35
49 See Bainbridge, ‘n 38 above’, 138-139.
 21

(ii) Efficient pricing of securities

The second notion of defence put forward for the deregulation of insider

trading is that insider trading is beneficial to the securities market as it helps in

providing the correct price for the securities and therefore results in accurate

pricing of the securities. And the resultant benefit of which is enjoyed by the

economy along with the corporations.

Professor Manne, taking the reference of SEC v Texas Gulf Sulphur Co., stated

that insider trading is an effective tool to maintain an effective balance between

the need for preserving incentives to produce information and the need for

maintaining accurate securities prices.50

He further held that insider trading acts as a replacement for public disclosure of

the information, preserving market gains of correct pricing while permitting the

corporation to retain the benefits of nondisclosure.51

The stand taken by Professor Manne in favour of deregulation of insider trading,

on the basis of its merits towards effective pricing of securities was supported by

Professor Bainbridge who stated that:

Accurate pricing benefits society by improving the economy’s allocation of capital

investment and by decreasing the volatility of security prices. This dampening of
price fluctuations decreases the likelihood of individual windfall gains and
increases the attractiveness of investing in securities for risk-averse investors.52

Despite these theories in support of deregulation of insider trading, empirical

studies on this particular aspect of insider trading has been of little help. As early

market studies indicate that insider trading has an insignificant effect on the price

of the securities.53 Further studies reflected that market responded quickly when

insider buys securities but the effect is not the same when he sells his

securities.54 But an important limitation factor in the above stated empirical

research and other theories is the lack of empirical evidence to support it and also

50 See Manne, ‘n 20 above’, 138-141

51 Ibid, at 80-90
52 See Bainbridge, ‘n 38 above’
53 See Schotland, ‘n 23 above’ 1425-1478
54 Finnerty, Joseph E., ‘Insiders and Market Efficiency’, 31 Journal of Finance 1141-48 (1976).
 22

most of these theories relied upon the transactions reports of corporate officers,

directors, and Ten percent shareholders that they are required to file under

S16(a). Because insiders are unlikely to report transactions that violate rule 10b-

5.55

(iii) Public choice

Finally, another notion favouring the deregulation of insider trading is the

model based on public choice, as some critic of the insider trading prohibition

contends that the prohibition can be explained by a public choice-based model of

regulation in which rules are sold by regulators and bought by the beneficiaries of

the regulation.56

Emphasising on this theory, Sutter asserted that:

Initially, the public choice theory asserted that regulation was introduced for the
protection and benefit of the public or large subsections thereof. But disillusion with
regulatory systems led to development of the capture theory, which views regulation as an
attempt by competing interest groups to acquire economic privileges: ‘as a rule, regulation
is acquired by the industry and is designed and operated primarily for its benefit’.57

But According to professor Bainbridge, we cannot opt for deregulation of insider

trading simply on the basis that prohibition of this practice is beneficial to some

specific group.

55 See Bainbridge ‘n 38 above’ 138-139

56 ibid, 139-146
57 See Suter, ’n 4 above’, 44-45, for further reading see G.j. Stigler, ‘ The Theory of Economic Regulation’ (1971) 2 Bell j.
Econ. and Management Sci. 316
 23

2.4 Conclusion

The theories and views for and against the regulation of insider trading presented

above shows that this debate is ongoing. As on one hand strong arguments are

provided in favour of regulation of insider trading, while on other hand convincing

arguments are provided against the regulation that prohibition of insider trading

does not rests on a firm ground as it fails to provide an effective justification for

treating insider trading as an evil.

Hence there is no final conclusion to the debate. But insider trading continues to

be prohibited in almost every securities market around the world.58 Although

some, who are in favour of legalising this practice questions that why activity that

is similar to insider trading is legal in other markets, such as real estate.

A pure justification of prevalence of prohibition on insider trading around the

world is that insider-trading laws exist for notion of greater fairness and market

efficiency, which is accepted as a foundation of securities market by most

countries. As nobody wants to stand for unfairness or appear to be favoring rich

investment bankers over investors of more modest means.59

58 Bhattacharya, Utpal and Hazem Daouk, “The World Price of Insider Trading.” www.e.u-
tokyo.ac.jp/cirje/research/workshops/macro/macropaper04/utpal1.pdf (Last visited on 20 July 2008)
59 See Miller,’ n 31 above’
 24

Chapter Three: Studies of Jurisdictions

3.1 Introduction

The particular purpose of this chapter is to provide a overview of the regulatory

regimes of the various jurisdictions like United States of America, United Kingdom

and India.

The focus of this chapter will be on the progression of regulatory regime

governing insider trading in the above said jurisdictions. So this chapter will set

the base for the next chapter where the particular consideration will be given to

find, as to why there is a gap between the adoptions of the legislations and their

enforcement.

In this particular chapter we will follow the progression of regulation and case law

of United States of America first, as this particular jurisdiction set the example for

other financial economies to follow, also America being the first nation to view the

trading by an insider on a confidential non- public information to be a fraud

against the common investor. Further, America and United Kingdom will be taken

as starting point against which India will be compared.

3.2 The United States of America

As vast amount of work on both economic and legal perspective of insider

trading focuses upon United States as the centre point of their reference, so it will

be justifiable to follow the progression of regulation against insider trading of this

jurisdiction first.
 25

Thomas Newkirk and Melissa Robertson of the SEC summarize the development

of U.S. insider trading laws during the International Symposium on Economic

Crime in the best possible words that:

Rooted in the common law tradition of England, on which our legal system is based, we
have relied largely on our courts to develop the law prohibiting insider trading. While
Congress gave us the mandate to protect investors and keep our markets free from
fraud, it has been our jurists, albeit at the urging of the Commission and the United
States Department of Justice, who have played the largest role in defining the law of
insider trading.60

Prior to the great depression of the 1929, there was no particular checks placed

upon the securities market by the regulatory authorities of United States, but this

particular event where the stock exchange crashed forced the law making bodies

to make the securities market more transparent in order to win back the

confidence of the common investor.

Before the adoption of Securities Exchange Act of 1934, there was no codified

rule in United States that regulated insider trading, but there was significant body

of common law dealing with the fraud provisions of financial market, one of a

good example highlighting the lack of legislation on this practice at that time is

the case of Goodwin v Agassiz,61 where the court held that as there was no face

to face contact between the plaintiff and the dependant, because the transaction

took place on the securities exchange, so according to the common law there

arise no liability from the defendant to the plaintiff.

The above stated two factors along with the need to provide an effective

regulation of the securities market forced the congress to pass the Securities Act

of 1933, in which Section 17 contained prohibitions of fraud in the sale of

securities, which were greatly strengthened by the Securities Exchange Act of

1934. But the important factor of this later act was that it dealt with insider

trading directly through section 16(b) and indirectly through section 10(b). Where

Section 16(b) prohibits short swing profits (from any purchases and sales within

any six month period) made by corporate directors, officers, or stockholders

60 Insider Trading- A U.S. Perspective

61 Goodwin v Agassiz, 283 Mass. 338, 186 N.E. 659 (1933)
 26

owning more than Ten percent of a firm’s shares. The main provision of this

section is to prohibit those “insiders” from getting rich at the expense of other

with the help of the confidential information, which is the property of the

corporation.

Also Section 10(b) makes it unlawful for any person "to use or employ, in

connection with the purchase or sale of any security registered on a national

securities exchange or any security not so registered, any manipulative or

deceptive device or contrivance in contravention of such rules and regulations as

the [SEC] may prescribe." To implement Section 10(b), the SEC adopted Rule

10b-5, which was drafted by the simple device of copying most of the language

from section 17(a) of the Securities Act 1933 and adding the phrase ‘in

connection with the purchase or sale of any security’, taken from section 10(b). It

was not until some years after its adoption that private litigants began to find the

rule 10(b)-5 was a flexible weapon in the courts against general company

misconduct, including insider trading.62

With the mark of early and mid 1980s by some interesting cases on insider

trading, Congress in order to curb this practice of insider trading promulgated

Insider Trading Sanction Act 1984. This particular act as compared to its

predecessors had a more deterrent effect on the insider, as it allowed the SEC to

pursue the insider for triple damages plus a disgorgement of the amount of profit

that the insider made or the amount of loss that the insider avoided. The major

change that this act brought was to allow the SEC to bring a civil suit directly

rather than first having the Department of justice bring a criminal suit and than a

civil suit. So this helped the SEC to save itself from proving that the insider was

guilty of criminal misconduct, which required the SEC to overcome various

62 Philip LR Mitchell Insider Dealings and Director’s duties, (London: Butterworths, 2nd ed; 1989) “261”
 27

safeguard that an insider can rely upon in a criminal case, rather now the

standard of proof is simply on the preponderance of the evidence, which is easier

for SEC to prove.

Then in 1988 Congress enacted another legislation to combat insider trading with

much deterrent effect, which was the Insider Trader and Securities Fraud

Enforcement Act 1988 that had following provisions:

Firstly, it increased the penalty for insider trading to a maximum sentence of 10 years in
prison. Secondly, it allowed a 10 percent of the total amount of profit that the insider
earned or of the loss that he avoided, for anyone who supplies information to the SEC
regarding an insider deal. Finally, it provided the provision of self regulation to the
corporation for ensuring compliance with this regulation and if the corporation fails to keep
an effective check on its insider than that corporation could be liable for the a maximum
fine of up to one million dollars.

From the 1980s onward the SEC began to negotiate Memoranda of Understanding

with a number of jurisdictions. This was done with aim of facilitating and

championing the SEC model of combating insider trading and to ensure that

cooperation is made among the jurisdictions in those cases of insider trading

where there is a foreign element present.63

To support the legislation there has been various theories developed by the court,

so as to ensure effective regulation against insider trading, important among

them being misappropriation theory and the disclose or abstain theory. These two

theories find their origin under section 10(b) of the securities act and rule 10b-5

there under.

(a) Disclose or Abstain Theory

Disclose or abstain theory, finds its origin in the case of Cady Roberts & Co,64

where rule 10b-5 was applied and the theory of disclose or abstain was

developed, which held that insiders and those who would come to be known as

63 See Kehoe, ‘n6 above’.

64 40 SEC 907 (1961).
 28

"temporary" or "constructive" insiders, who possess material non-public

information, must disclose it before trading or abstain from trading until the

information is publicly disseminated.

Several year’s later in a landmark case dealing with insider trading, SEC v Texas

Gulf Sulphur Co65, court upheld the ruling of Cady, Roberts & co. And further built

upon the, disclose or abstain rule, by including the tipper as being liable under

rule 10b-5.

But ironically instead of making its regulation more strict, the ruling of Supreme

Court in United States V Chiarella66 limited the scope of this theory. Where the

court held that trading on material non-public information in itself was not

enough to trigger liability under the anti-fraud provisions and because the

accused in this case a printer owed target shareholders no duty, he did not

defraud them.

This forced SEC to promulgate Rule 14e-3 under Section 14(e) of the Exchange

Act, and made it illegal for anyone to trade on the basis of material non-public

information regarding tender offers if they knew the information emanated from

an insider.

(b) Misappropriation Theory

The Misappropriation theory has been the centre of controversy since the first

time this theory was suggested in United States v Chiarella.

Professor Bainbridge provides a clear definition of the misappropriation theory:

65 401 F.2d 833 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969).
66 United States v Vincent F. Chiarella, 445 U.S. 222 (1980)
 29

‘Like the traditional disclose or abstain rule, the misappropriation theory requires

a breach of fiduciary duty before trading on inside information becomes

unlawful’.67

The concept of misappropriation theory does not require the insider to owe any

fiduciary duty toward the investor or the issuer of the securities, instead the

misappropriation theory applies when the inside trader violates a fiduciary duty

owed to the source of the information.

Misappropriation theory has been mentioned by the court in later cases like in

United States v Carpenter,68 SEC v Cherif69 and SEC v Clark.70 But then in the

United States v Bryan71 the government lost when the fourth circuit rejected the

misappropriation theory. Court held, that for an action under the violation of rule

10(b) there must have been a fraud in the securities transaction itself.

The land mark case which further developed the misappropriation theory further

was United States v o’ Hogan.72 Where the court held that:

Misappropriation theory is designed “to ‘protect the integrity of the securities markets
against abuses by ‘outsiders’ to a corporation who have access to confidential
information that will affect the corporation’s security price when revealed, but who
owe no fiduciary or other duty to that corporation’s shareholders.’”

Finally, as the regulation against the insider trading is on the continuous evolution

in United States, it is being hoped that the yardstick developed by SEC against

which the performance of insider is to be evaluated would act as a guiding factor

for other developing economies around the world.

67 See Bainbridge, ‘n 38 above’.

68 791 F.2d 1024 (2d Cir. 1986), aff'd 484 U.S. 19 (1987).
69 993 F.2d 403,410 (7th cir. 1991)
70 915 F.2d 439, 449 (9th Cir. 1990)
71 58 F.3d 933,944(4th Cir. 1995)
72 92 F.3d 612, 662 ( 8th Cir. 1996) and 117 S. Ct.2199 (1997)
 30

3.3(i) European Union

The next jurisdiction that we will be focusing upon is European Union with a prime

focus upon United Kingdom. European Community Directive Coordinating

Regulations on Insider Trading, adopted on November 13, 1989,73 which arose

out of the 1957 Treaty of Rome, establishing the European Economic Community,

which mandated creating a single internal European financial market.74 This

directive was followed by the Insider dealing and market manipulation (Market

abuse) directive, adopted by the European parliament and Council in 2003 and

implemented in 2004.

These particular directives were adopted with the aim of harmonisation of

prohibition of insider trading throughout the European Union. As lack of such

harmonisation would have resulted in great number of difficulties for the member

states, as different set of regulation dealing with insider trading in each state

would have resulted in the lack of transparent securities market to the investor,

which would have further resulted in difficulties in raising and movement of

capital among the member state. While there was a regulation already in place in

United Kingdom dealing with insider trading at the time of Council Directive

89/592, but in number of other member states this directive came as a first

prohibition on insider trading.75

As before the adoption of this directive, insider trading was an offence only in

United Kingdom, France and Denmark. While other member had a voluntary code

of compliance, including Germany, while two member states, Italy and Ireland

had no regulation at all. So this directive came as an effective measure to curb

the menace of insider trading.

73 Council Directive 89/592 Coordinating Regulations on Insider Trading, 1 Common Mkt. Rep. (CCH) ¶ 1761 ("EC
Directive").
74 See Insider trading- A US perspective, further cited from Warren, The Regulation of Insider Trading in the European
Community, 48 Wash. & Lee L. Rev. 1037 (1991).
75 See Small, ‘n 1 above’, 158-159, for further readings see Summe, Philip, McCoy, Kimberley A., Insider trading regulation:
A developing State’s Perspective (1998), “320”.
 31

The basic difference between these directives and the United States regulation on

insider trading is that the directive does not require the insider to breach a

fiduciary duty to the source of the information for liability to attach.

Reason for low enforcement of these directives is the difference in corporate and

the social culture of the European countries. Particularly Germany and Italy,

which had trouble in application of this prohibition on insider trading as they

traditionally viewed insider trading as an acceptable practice. One commentator

recently observed in regard to Italy that: ‘In spite of the passage of laws on

takeovers and insider trading since 1992, the bourse has not shaken its

reputation as a fiefdom of an inward-looking financial community that treats

small shareholders shabbily’.76

While Chairman Levitt recently in relation to U.S. markets observed that:

‘Individual investors think – and I passionately believe – that the proverbial little

guy' on Main Street should have the same fair chance as the big guys’.77 Due to

the limitation of the scope of this Dissertation we will not go in much detail of

each member of EC, but rather will focus upon the main financial capital of EU;

United Kingdom, without which a background scene for the next chapter will not

be created.

3.3(ii) The United Kingdom

The main purpose of this section is to overview the evolution and the

development of the regulations against insider dealing78in United Kingdom. U.K.

76 Robert Graham, ‘New Broom for Bourse: The Head of Italy's Stock Market Watchdog Outlines His Plans’, Financial Times
(London Edition), March 24, 1997, at 22.
77 See ‘n 5 above’
78 In United Kingdom Insider Trading is referred as Insider dealing
 32

has developed strict regulation against insider trading recently but has a very low

enforcement rate as compared to United States.

United Kingdom did not had a direct legislation governing insider trading until the

companies Act 1980. Reason for not having any such regulation was provided in

the Times of UK that described insider trading in one of its article in 1973 as a

"the crime of being something in the city", which showed that insider trading was

believed to be a legitimate practice in those time and the laws and regulation

against it was treated as a punishment for high achievement.

Case of Percival v Wright, acted as the cornerstone for the development of insider

trading regulation in United Kingdom, where the court held that ‘the directors of

the company are not trustees for individual shareholders, and may purchase their

shares without disclosing pending negotiations for the sale of the company’s

undertaking.79

The ruling in the Percival case was criticised by the Cohen Committee report,80

which stated that directors should not use their non- public confidential

information, for making profit while keeping the interest of a common investor at

stake. This particular committee report led to the promulgation of the Companies

Act 1948.

Until recently Insider trading came under the ambit of Company Law, which

recognised that the concept of fraud that is provided in the common law covers

the manipulation in the markets as well. Which is evident from the case of R v

Berenger, in which the court held that:

… an indictable offence to conspire on a particular day by false rumour to raise the

Price of the public government funds, with the intent to injure the subjects who
should purchase on that day, and that the indictment was well enough without
specifying the particular persons who purchased, as the person intended to be
injured,…81

After learning from the American experience in 1970’s, United Kingdom’s resolve

to deal with this practice got more strengthened and that finally led to the

79 Id [1902] 2 Ch 421.
80 Report of the Committee on Company Law Amendment ( The Cohen Committee), Cmnd 6659 (1945).
81 R v Berenger(1814) 3 Maule & S. 67, at 67
 33

criminal sanctions against insider trading in the Companies Act of 1980. But it

was without the civil sanctions, reasons for strict regulation against insider

trading was highlighted by Professor Barry Rider ‘that the press is to be blamed

for the pressure that led to the regulation of insider trading’.82

In March 1985 the Companies Securities (Insider Dealing) Act was promulgated,

Which created the base for the Financial Services Act 1986, in which section 173,

widened the liability for insider trading present in section 2 of the 1985 Act.

Next Act that further showed the resolve of United Kingdom to curb this menace

of insider trading was the Criminal Justice Act 1993, in which part V completely

replaced the Companies Securities (Insider Dealing) Act 1985. This particular Act

was promulgated to bring English law in compliance with the EC Directive 89/592.

Where Section 52, 56, 57, defines the offence of insider trading, inside

information and defines an insider respectively.

Finally, The Financial Services and Markets Act 2000, is the latest Act dealing with

this practice of insider trading. The FSMA 2000 radically changes the system of

regulation for the financial services, which came up with a new regulatory

authority, the Financial Services Authority (FSA). This particular act, along with

retaining part V of the CJA 1993, provided for a new section 15, dealing with a

new offence of market abuse.83

Section 188 of the FSMA 2000 creates three categories of offence: the misuse of

information; creating a fake or misleading impression, and distortion.

Though FSMA 2000 provides core rules that FSA must follow, but under section

119 of the FSMA 2000, FSA is required to publish a code of conduct to determine

which behaviour can be considered to be market abuse.

There have been number of cases that have came up after the promulgation of

the FSMA 2000, dealing with the enforcement action by the FSA, prominent

82 Rider, Barry A.K., ‘ The Control of Insider Trading- Smoke and Mirrors!’ (2000) 7 J. Fin. Crime 227, “229”.

83 A. Haynes, ‘Market abuse: an analysis of its nature and regulation’.(www,westlaw.com). Last visited on 15 July 2008
 34

among them being Hutchings and Smith (2004)84 case which was a fairly

straight- forward insider dealing case. Hutchings and Smith were fined £18,000

and £15,000 respectively for illegal trading in the shares of Feel Good (Holdings)

plc. Smith provided inside information to Hutchings who traded on the basis of it.

A recent case of Jabre v FSA (2006)85 Mr Jabre was a senior trader at GLG

Partners, a hedge fund manager. He was provided with inside information by a

salesman at Goldman Sachs on a restricted basis, meaning that he could not

trade on the basis of that information. Mr Jabre then proceeded to short sell $16

million worth of shares in SMFG on the Tokyo Exchange ahead of an

announcement of a new issue of convertible preference shares by them. The FSA

held that as the shares were also sold on the London Stock Exchange, they were

being sold on a “prescribed market” and hence liable under s.118 FSMA. He was

fined £750,000.

Having seen the evolution and the development of insider trading regulation in

United Kingdom, it is evident that it is regulating insider trading on the basis of

regulatory competition, having accepted the norm that insider trading need to be

prohibited. And thus competing with other regimes to demonstrate that they have

a satisfactory implementation of the norm so as to attract a greater share of the

global financial markets, which has led to increased legislation.86

3.4 India

Study of this particular jurisdiction is important to this dissertation because India

is among the fastest growing economies of the world, so along with the growth of

84 FSA Enforcement action, February 28, 2005

85FSA Tribunal decisions on jurisdiction and market abuse, both July 10, 2006.
86 See Small, ‘n 1 above’, “175”
 35

its financial market, there has been a rapid increase in the financial crimes

associated with the market. And so as to bring this particular jurisdiction at par

with many developed jurisdiction, it is necessary to retain the confidence of the

common investor in its securities market. But the prohibition on insider trading in

India is not a self developed prohibition and nor it is widely adopted by the

corporate culture of India, which is evident from the lip service that the

regulatory authority pays that insider trading should be prevented, but does very

little in its enforcement.

In the history of over hundred years old stock market of India, Insider trading

was outlawed in 1992, when the stock market was liberalised following the end of

“Licence Raj” in India. Though insider trading was first recognised as unfair in late

1970’s, when this practice was highlighted in the Sachar Committee report in

1979, which cautioned that the confidential non- public information could be

misused by the officers of the corporation like directors, auditors, secretaries, etc

in manipulating stock price, hence resulting in financial loss to the general

investing public. The final report of the committee recommended amendments to

the Companies Act 1956, so as to restrict or prohibit the dealings of employees /

insiders. Penalties were also suggested to prevent the insider trading.

Sachar committee report, was followed by the Patel Committee in 1986, the main

recommendations of this committee was to amend the Securities Contract

(Regulation) Act, 1956, so as to empower the securities exchange to curb insider

trading and unfair stock deals. Apart from the heavy fines suggested by the

previous committee report, Patel committee report suggested for imprisonment to

the defaulting insider along with the refunding of the profit made or the loss

averted by the insider to the stock exchange.87

87 S.Vadielu, ‘Insider trading in Indian stock markets’,

http://www.theindiastreet.com/2007/06/insider-trading-in-indian-stock-markets.html, (last visited on 16th July 2008)
 36

The final report forming the base of the Securities and Exchange Board of India

(Insider Trading) Regulations 1992, was the Abid Hussain Committee report in

1989, which was different from the suggestion provided by previous committee,

because following the guidelines set by SEC (Securities Exchange Commission) of

United States of America regarding insider trading, it recommended that the

insider trading activities may be penalized by civil and criminal proceedings and

also suggested that the SEBI formulate the regulations and governing codes to

prevent unfair dealings.

Following the recommendations by the above mentioned committees, India

through Securities and Exchange Board of India (Insider Trading) Regulations

1992, prohibited this fraudulent practice and a person convicted of this offence is

punishable under Section 24 and Section 15G of the SEBI Act 1992. But following

the promulgation of this regulation, having not succeeded in obtaining much

prosecution, Indian regulatory authorities came with a drastically amended and

renamed SEBI (Prohibition of Insider Trading) Regulations 1992 Act in 2002. Both

of these above mentioned Insider Trading Regulations are basically punitive in

nature and have to be complied with by all listed companies; all market

intermediaries (such as brokers) and all advisers (such as merchant bankers,

professional firms, etc.).

But according to some India amended its insider trading laws so that the new law

is ten times as long as the original and Insider trading has been defined much

more broadly so that more transactions in the stock market will be considered

illegal.88

In order to make SEBI as powerful as the SEC, it has been authorized to conduct

investigation on its own or on receipt of a complaint. It can set up an

Investigating Authority and commence investigation proceedings. Apart from the

orders, which are general in nature like restraints/ restrictions/ prohibition from

dealing in securities in any manner, SEBI may also declare the transaction in

88 P. Shah, ‘A Victimless Crime?’, April 18, 2002, http://economictimes.indiatimes.com/ (Last visited on 16th July 2008)
 37

securities as null and void. Furthermore, SEBI may also transfer the proceeds

equivalent to the cost price or market price of shares whichever is higher to the

Investor Protection Fund of a recognized stock exchange.89

Due to lack of any landmark decision on this practice in India, we will briefly

overlook over the most publicised instances of insider trading in India.

One significant case, which is worth mentioning, is the Hindustan Level Limited

(HLL) case. Shortly before HLL announced that it was merging with Brooke Bond

Lipton Limited, HLL purchased eight hundred thousand shares of that company

from Unit Trust of India (UTI). So after this dealing it was alleged that this is the

case of insider trading. But HLL defended itself by claiming that the stock was

purchased at three hundred and fifty rupees per share, a ten percent premium

over the market price.90 After this case SEBI amended the regulations and

defined "insider" as a person who is reasonably expected to have access to such

unpublished price sensitive information and also changed the definition of “ price

sensitive information”. The important point to note here is that insider trading

laws were used, in this case, to prosecute a questionable case while more clear

forms of insider trading occur almost daily in India. The fact that the government

pursued a criminal investigation against HLL in this case shows that the use of

insider trading laws is less efficient than the use of traditional torts in civil law.91

The wide prevalence of insider trading and market abuse in Indian securities

market can be highlighted by the quote of one author that: “Price-rigging and

insider trading have become a way of life in the Indian stock market.92

There have been various instances of insider trading since than, but without any

stringent action taken against any of them. The most prominent among them

being Lakme sell-out to Unilever and the Tata’s sell- out of their stock in Merind

to Wockhardt, where in the later case the Merind scrip had shot up by 9.94per

89 C. Bhui, ‘Insider Trading In India– An Overview’

90 J.Ghosh, ‘Surprise Move,’ http://www.the-week.com/97Aug31/biz3.htm.
91 See Miller,’n 31 above’
92 Sivakumar, S, ‘insider Trading–-Following the SEC’sLead’
http://www.hinduonnet.com/businessline/2001/04/26/stories/042662ss.htm (last visited on 27th May 2008)
 38

cent to Rs191.30 from Rs174 on the Bombay Stock Exchange on 24 February, a

day before the public announcement of this deal. Along with these above

mentioned cases there have been numerous cases of insider dealing, but due to

lack of corporate governance in India, this kind of practice is widely prevalent in

the corporate culture of India.

3.5 Conclusion

This chapter summarises that regulation against insider trading is present in

almost every economy of the world, lead to which has been provided by United

States of America. An important issue that arises from this is that almost all the

developing countries have adopted this prohibition against its face value, without

considering its relevance to their particular jurisdictions.

Further, it shows that the emerging economies in the global markets are no

longer really free to choose their legislation and that they must regulate their

markets according to the norms that prevail in the dominant markets.

 39

Chapter Four: “Nabbing the insider – Easier said than done”

4.1 Introduction

Having discussed the opposing views on this practice of insider trading and after

considering the evolution of legislations against this practice, now the focus of

this chapter will be on, to find the reason for low enforcement rate against this

practice, despite there being stringent regulation in place and news of insider

trading being in the press media every now and then.

A quantitative study on the effect of insider trading, showed that till 1990, out of

the one hundred and three countries that have stock markets reveals that insider

trading laws exist in eighty seven of them, but enforcement, as evidenced by

prosecutions has taken place in only thirty eight of them. This study also focused

upon the relation between market efficiency and insider trading, and further

argued that of all the one hundred and three countries that have stock

exchanges, the enforcement of insider trading laws increases market liquidity and

decreases the cost of equity.93

Reason for low enforcement of prohibition against insider trading, has been

provided by Stamp and Welsh:

"...In a number of common law jurisdictions.....the burden of proof on the

prosecution is onerous, making it difficult to secure a conviction. In other
jurisdictions, this problem is exacerbated by the legislatures’ attempt to provide an
exhaustive list...which can be exploited by the experienced insider dealer. On the
other hand, in a number of other countries, ...there is no political will to enforce the
legislation.”94

Finally, after discussing the reason for low enforcement rate of prohibition against

insider trading, the chapter will be concluded by briefly over viewing that whether

the corporate governance in India is at par with its developed western

93 Bhattacharya, ‘n 78 above’
94 Stamp M. and C. Welsh (eds), 1996, ‘International Insider Dealing’, FT Law and Tax, Biddles Limited,viGuildford, UK.
 40

counterparts (U.K and U.S), so as to ensure effective compliance of insider

trading regulation.

4.2 Gap between the enactment and enforcement of law.

(i) United States of America

The difference between the prohibitions against insider trading on legislative

papers and in its enforcement is provided by the investigation of the legislative

history, which reveled that at the time of the promulgation of these legislations it

was expected that no more than a few percent of insider traders at the most

would be caught. The main idea behind these laws was to provide a deterrent

effect in the society that this kind of practice is unacceptable.

One of the main reason for lack of enforcement of insider trading law is that

insider trading has become a norm, which followed in the minds of general public

from legislature, administrative agencies and the judiciary. Which has resulted in

every economy to have the prohibition against insider trading along with other

market abuse law on their law books, as investors are generally unwilling to

invest in the markets, which do not offer adequate legal protection against fraud

and other unfair activities, which are against the interest of a common investor.

Also as this issue has become an option for the political parties to gain political

leverage against their political rivals, hence creating a toothless law.95

Failure of the effective enforcement of insider trading regulation has been

cautioned by Arturo Bris, who asserts that the prevalence of insider trading

regulation but its non-enforcement is more in favor of the insider trader than the

non existent of insider trading law in an economy, as market reacts more strongly

to public announcements when insider trading is illegal since there are less people

willing to act on inside information prior to public disclosure. This means that the

95 See Small, ‘n 1 above’, “119”

 41

few people who are willing to take the risk to trade based on inside information

can earn larger profits and the net result is that the profitability of insider trading

is increased rather than decreased.96

An important critique on the enforcement capabilities of SEC, in regard to the

practice of insider trading is provided by R. Foster Winans, who states that:

Definition of insider trading provided by SEC, will make insider trading so common that
the only way the Securities and Exchange Commission can enforce laws against it is by
being selective, much as a patrolman tickets only the red sports car when everyone on
the road is speeding. It may make for sexy headlines when a brazen conspiracy is
uncovered, or a Martha Stewart is accused. But stopping the sports car slows traffic
only for a mile or two. It gives the false impression that the policeman is on the beat,
making the financial markets safe for the rest of us.97

Alan D. Jagolinzer, an accounting professor at Stanford University, referring the

law against insider trading as impotent, in his published research paper showed

that officers and directors of publicly held companies systematically sell company

stock after positive news and ahead of bad news, generating abnormal returns

compared with the market at large.

A study published in 2004 by Alan J. Ziobrowski of Georgia State University found

that United States senators on average beat the market by twelve percent a year.

“The results clearly support the notion that members of the Senate trade with a

substantial informational advantage over ordinary investors,” Mr. Ziobrowski told

The Financial Times, noting that the law does not prohibit senators from trading

stock on the basis of information acquired in the course of their work. This

research clearly shows that the creators of the law are mocking the law by

themselves and hence limiting the scope of enforcement of the insider trading law

against the big fish in the financial market, that also in limited cases, so as to

create an illusionary image in the eyes of the investor, that the securities market

are fair and transparent.

96 Bris, Arturo, ‘Do Insider Trading Laws Work?’ www.stern.nyu.edu/fin/pdfs/seminars/013w-bris.pdf, (last visited on 07 May
2008)
97 R. Foster Winans ‘Let Everyone Use What Wall Street Knows’, www.iht.com/articles/2007/03/13/opinion/edwinans.php,
(last visited on 12 may 2008)
 42

(ii) The United Kingdom

Though it has been referred in the previous chapter that United Kingdom, is

following the footsteps of United States of America, so as to show the common

investor that its regulation against insider trading is of global level, but as regard

to difference in what is said and what is done, FSA lags far behind its American

counterpart (SEC), in curbing the menace of insider trading. Till recent years

enforcement of prohibition of insider trading law was quiet low because treating

the insider as a criminal, has a limited effect, as the heavy burden of proof in

relation to an offence which, by its nature is difficult to prove, renders

enforcement of such prohibition by criminal penalties particularly costly. Hence

few regulatory agencies will be willing to waste resources on efforts to enforce

measures that it is impracticable to enforce.

According to J. Suter, for the effective enforcement of prohibition of insider

trading law, there should be involvement of both regulatory agency and of the

private plaintiffs. But as seen from the US experience, agency enforcement is

inadequate due to high cost of enforcement, in comparison to its benefit to the

general public. Also private plaintiffs are also dependant upon the availability of

incentives to bring proceedings.98

In reference of the enforcement of the prohibition of insider dealing regulation,

Professor Barry A.K. Rider asserts, “Whilst jurist and philosophers may argue that

the validity of law is a matter wholly independent from the ability to enforce it, in

the real world a law which is not enforceable is of doubtful value”.99

He further states that, low level of enforcement of legislation can be due to

various factors like the legislation may be drafted in such a way, so as to make

the enforcement well nigh impossible or the burden of proof may be

98 See Suter, ‘n 4 above’, “379”

99 Rider, Barry A.K, insider trading (Bristol: Jordan & sons ltd, 1983), “283”
 43

inappropriately placed, or the standard of proof too high. Also the agencies (FSA)

charged with administrating the law might lack the desire, enthusiasm, resources

or expertise or perhaps the enforcement of other law assumes a higher place on

the list of priorities for the allocation of effort.100

Till the formation of the Financial service Authority, there was a constant

demand, that by gaining from the experience of certain Commonwealth

jurisdictions, a cadre of investigators should be created who have the expertise

required to investigate and prosecute cases of insider trading. So as to provide an

effective enforcement regime against this practice of insider trading.

Further, the provision of self regulation by the corporations against the practice of

insider trading, will not help FSA to track the insider as the corporation has little

to gain and more to loose by drawing attention to the suspected insider trading.

Also due to the relation between the high level executives and in the interest of

industrial relations the suspected case of insider trading may go unreported.

Finally, the overview of the Financial Service and Market Act (2000), done by

Andrew Haynes, shows that the recent developments in this area of law raise the

issue of how widespread market abuse is. The FSA itself has published an

analysis,101 which measured the extent to which the share prices fluctuate ahead

of any significant public disclosure. The key part of the analysis focused on

takeover bids involving FTSE 350 companies. The research did not prove how

much market abuse was taking place but it did suggest that approximately

twenty three percent of takeover announcements were preceded by transactions

that were probably based on inside information. It is clear therefore that however

much the recent market abuse regime may be an improvement on the old insider

dealing laws, they achieve little beyond scratching the surface of the problem.102

100 ibid 290

101 N. Monteiro, Q. Zaman and S. Leittertorf, “ Updated measurement of market cleanliness” , FSA Occasional Paper 25,
March 2007. See also B. Dubow and N. Monteiro, “ FSA publishes measure of scale of market abuse” , FSA Occasional Paper
23, March 2006.
102 Andrew Haynes ‘Market abuse: an analysis of its nature and regulation’ (2004)
 44

(iii) India

This particular emerging economy has to strengthen its enforcement of recently

amended insider trading act, so as to prove to both the domestic and foreign

investor that they are investing in fair and transparent securities market, where

strict compliance of the prohibition is ensured by the enforcement agencies.

Loopholes in the enforcement prohibition against insider trading are evident from

the movement of stock prices of the company, prior to some important news

becoming public. One of the recent cases that can illustrate this trend is

allegation against Reliance Petroleum, that it has indulge in insider trading

activity on large scale, which is evident from the fluctuation in its share price in

the past fifty two weeks, the share has fluctuated in a wide range of between

sixty seven rupees and two hundred ninety five rupees, as per information

available with the stock exchange. But according to company sources 'the sale of

Reliance Petroleum shares was conducted by transactions through the Stock

Exchanges and has helped to further broad base the shareholding pattern of

Reliance Petroleum'. So it will be interesting to see that whether SEBI, will be

able to prosecute the insider’s in this, case or will they be let off due to the poor

drafting of its insider trading regulation, which place emphasis on motive rather

than action.103

Finally, The poor enforcement of insider trading regulation in India should be

viewed with the glasses of cost-benefit aspect of enforcement on. Even if

restriction on insider trading is considered desirable, its sound implementation is

extremely expensive. As virtually every one comes under the definition of

“insider”, by virtue of possessing information material to securities prices. As a

result the Enforcement of restrictions upon insider trading runs the risk of either

being ineffective or being a witch hunt.104

103 Online edition of Economics times.

104 A. Shah, “Why Forbid Insider Trading?” http://www.mayin.org/ajayshah//MEDIA/1998/insider.html.
 45

Enforcement of prohibition against insider trading in country like India is very

difficult, as this practice is widely rampant. Also in the United States of America,

where significant resources have been utilised on deterring insider trading, there

is anecdotal evidence that a great deal of successful speculation continues based

on insider trading. Hence, in order to ensure effective enforcement of insider

trading regulation, India needs to strengthen its enforcement regime, by

strengthening its insider trading regulation and to ensure that every insider,

trading on non- public information is booked. So as to be at par with other

developed economies, in order to provide equal level field, to all the investors.

Insider trading regulation for most inside insiders is of little relevance as they

often trade under disguised entities, easily allowed by our ill-designed

shareholding disclosure format.

Enforcement of insider trading can be made more efficient in India, if the time

limit for disclosure of holding to the company by any person having a holding of

more than five percent (four days) and further the disclosure by the company to

the stock exchange of information received about the above transaction (five

days), should be reduced to one day in total. Also like other developed countries

the above stated disclosure should be made to both exchanges and the regulator,

instead of exchange alone.105

Further, there should be a provision of civil penalties, like in US, where the

penalties are based on the profit made or loss avoided, also SEC let’s off the

offender, if he pays without admitting to offence, but merely publishes the

settlement, which act’s as a deterrent to the society and prevents cases from

being locked up in the court.

Additionally, the maximum penalty limit of five lakh106 rupees should be

increased, as the profit reaped by the insider runs into a huge amount.

105105 P. Haldea ‘Insider Trading A critique of regulations and practices’, FICCI’s National Conference on Securities Market
Regulations
106 In India 1 million is equal to 10 lakh
 46

Finally, preventing insider trading is not about a set of rules or filling alleged

loopholes. It is about a determination to go after illicit trades and the power to

punish offenders. Until SEBI shows it is serious about checking insider trading,

the activity will continue to thrive unchecked. For that the regulatory authority

has to ensure that the SEBI Regulations on Insider trading is a separate code by

itself. Preferably, it must be made into a separate Act as a part of general law

relating to frauds, as is the case in the US. This will ensure that SEBI does not

have to draw concepts and principles from the UK and US laws to strengthen its

case. At the same time it must also avoid the impression that there is ambiguity

or weakness in the Indian Insider Trading Regulations.107

4.3 Corporate Governance in India, is it at par with U.S and U.K?

While discussing in the previous section that Indian securities regulatory

authorities, should ensure that there enforcement mechanism governing insider

trading activities should be equal to United States of America and United

Kingdom, but it is easy to adopt than to enforce, because in U.S. and U.K there is

effective compliance of the insider trading regulation by the company’s due to

high level of corporate governance, but in a country like India where this

prohibition is in its nascent stage and where the practice of insider trading is so

widely practiced that every trader in the securities market think that he is acting

on a non- public confidential information,108 so in order to bring effective

enforcement of insider trading regulation, there is a need of cooperation from the

corporations as well, as the news of insider trading hampers the portfolio of that

company also. But this can be done when the standard of corporate governance

107K. Thiagarajan www.thehindubusinessline.com/iw/2003/11/09/stories/2003110900270700.htm - 22k (Last visited on

23rd May 2008)
108 See ‘n 10 above’
 47

is raised in India. As in this present era of commingling of financial markets and

to be a participant in the benefits of Globalisation, India needs to uplift its

securities markets standards, so as to attract foreign investments and that can be

done when its financial markets are fair and transparent towards all its investors.

Which can be ensured by good corporate governance, because this is one of the

pillars on which effective enforcement against insider trading stands.

With the efforts of SEBI, in this regard is appreciable, as it has issued new

guidelines, which are aimed at tightening existing Insider trading rules and

plugging loopholes. SEBI also has shifted the onus for monitoring insider trading

on to compliance officers, which each company is expected to appoint. These

officers are to report directly to the managing director. It is indeed true that

making an insider responsible for preventing insider trading will have a deterrent

effect on the employees. But despite these efforts, the broker-promoter—

politician-fund manager nexus that accounts for the biggest chunk of insider

trading cannot be caught.109

4.4 Conclusion

So the crux of this chapter is that, despite there being presence of stringent

insider trading regulations along with autonomous enforcing agencies (SCE, FSA,

SEBI) complemented by the ever growing support of corporate governance, it is

still not been possible to curb this menace of insider trading to the fullest.

The demand of the time is to have Laws, in a free society that should not seek to

force people to change the way they conduct their everyday affairs but, instead,

should “seek to enable [the people] to continue doing what they do within the

framework of a set of rules that promote the common good without altering the

basic rhythms of society.110

109 See ‘n 10 above’

110 Chakraverti, Sauvik, 2000, Antidote: Essays against the Socialist Indian State, Macmillan India Limited, New Delhi.
 48

Chapter Five: Conclusion

As the last chapter of this dissertation, the particular emphasis will be to

summarise the findings of this dissertation and to focus upon the ways in which it

can provide a base for the future research on this topic, as the financial markets

of the world are converging in this era of globalisation, so there is a need to

ensure cooperation among the economies around the world, for harmonising their

law against this practice of insider trading, so as to provide the investor all over

the world an equal level field to play in securities.

The aim of this dissertation, as defined in the introduction was to compare

divergent views on the regulation of insider trading along with to enquire, as to

why there is a gap between enactment and the enforcement of the regulations

against insider trading and finally to see on which grounds India lags behind other

developed economies of the world, so as to suggest various measures it can

incorporate to curb this widely prevalent practice in the Indian securities market.

This dissertation did not seek to make any normative statement as to whether or

not insider trading ought to be regulated, but the current situation creates a

doubt whether prohibition is a viable option as there is a lack of clear foundation

for the prohibition, the low rate of enforcement and the high cost of policing the

securities market. Also some analyses of the law from an economic perspective

have suggested that there is little or no economic justification for the prohibition

of insider trading.111 The debate of whether to regulate or de-regulate insider

trading is inconclusive, but actual practice suggests that, despite spending large

amount of money and time on enforcement of these regulations, the vast

majority of abusers are never caught.112 But regardless of this, support for

111 See Manne ‘n 20 above’

112 Hearing before the House Committee on interstate Banking and Foreign Commerce, H.R. 7852 and H.R. 8720, 73rd
Cong., 2d Sess. (1934)
 49

prohibition against insider trading has grown in almost every country, whether it

is developed or developing.

5.1 Summary of the Dissertation.

This dissertation summaries its findings by providing a sign of caution that

significant threat and fraud toward the investor and the company is not only from

outside but from inside as well. Since illegal insider trader takes advantage not of

skill but of chance, it threatens investor confidence in the capital market. It is

important to understand that insider trading is illegal because it may affect you as

an investor and the company in which you are investing.

Despite all this said about the practice of insider trading and the presence of

regulations against this practice, one recent comprehensive survey of insider

trading regulations in every country that had a stock market at the end of 2002,

showed that one hundred percent of the twenty three developed countries, and

about eighty percent of the eighty emerging markets, had insider trading laws in

their books. But the enforcement of these laws, however, has been spotty. And

further it showed that there has been a prosecution in only one out of three

countries. Developed countries have a better record than emerging markets

(approximately seventy eight percent of developed countries, and twenty three

percent of emerging markets have had prosecutions).113 Though the findings of

this survey are not updated, but it shows that there is a wide gap between the

presence of law on the book and in its enforcement.

113 See Bhattacharya, ‘n 78 above’

 50

An important drawback in the insider trading regulation in India, which is worth

mentioning, is that the regulation of insider trading should incorporate a mens

rea requirement for liability for the offence of insider trading. Mere possession of

unpublished price-sensitive information should not be enough to constitute insider

trading. Along with these suggestions in the imposition of criminal liability,

statutory civil liability for insider trading should also be introduced. As the

standards of proof would be easier in the case of civil liability, this would

safeguard against abuse caused by liberalising criminal liability standards.114

To fill the gaps in the present regulation against insider trading and in its

enforcement, Professor Macey suggests that the enforcement agencies like the

SEC, FSA and SEBI, has a comparative advantage in prosecuting insider trading.

He further contends that these agencies should monitor insider trading, but refer

detected cases to the affected corporation for private prosecution.115

While other’s asserts that the present regulations are not justified, as they

believe that for creating respect for such regulations, they should be supported

by studies that isolate the individuals or groups who are fraudulently harmed by

insider trading, if any such groups exist, then the legislators should pass a clearly

worded legislation that prevents any fraud from being committed against these

individuals and groups, while allowing non fraudulent transactions to be

completed without fear of prosecution, as such fear violate individual rights and

will likely have a negative market reaction.116

114 N. Jain ‘Significance of mens rea in insider trading’ (2004)

115 Macey, Jonathan R., ‘Insider Trading: Economics, Politics, Policy’ (American Enterprise Institute Press 1991), “40”
116 Robert W. McGee ‘Ethical issues in insider trading: Case studies’
 51

5.2 Harmonisation of law against Insider Trading.

Having discussed the practice of insider trading and the regulations prohibiting it

in different jurisdictions, a firm support is provided to the furtherance of the

regulation against this practice on international level, by harmonising the conflict

of laws dealing with insider trading. As in this era of globalisation many initiatives

have been taken by the countries around the world to harmonise their

commercial law, similarly the need of the hour is to harmonise the law against

insider trading, as an investor in this present scenario is not limited to any

particular jurisdiction, rather with the liberalisation of markets especially of the

emerging economies, there has been an increase in foreign investments, so it is

must for these economies in particular to bring their securities market at par with

the developed economies, by making their markets more fair and transparent.

At present, as discussed above that all the developed countries and almost all the

developing countries have a regulation against insider trading, but the scope of

the law governing insider trading, is different in different country, for example

country like India lacked civil liability and imposes criminal liability upon the

insider accused of trading on non- public information which is difficult to prove,

hence reducing the enforcement rate. So in order to provide a safer and equal

level field to investors all over the world, there should be an harmonised law all

over the world dealing with insider trading on the lines of EC Directive 89/592,

which act as guideline for the securities regulatory authorities all over the Europe,

as to how to tackle the menace of insider trading.

Further, International Organization of Securities Commissions (IOSCO) can play a

leading role in this initiative, as its membership covers near about ninety percent

of the securities markets around the world. And one of its main aim as mentioned

in its preamble is to unite the efforts of the securities regulatory authority around
 52

the world, so as to ensure effective surveillance of international securities

transactions.

This section can be summarised in the lines of Thomas Newkirk and Melissa

Robertson of the SEC that:

The importance of policing insider trading has assumed international significance

as overseas regulators attempt to boost the confidence of domestic investors
and attract the international investment community. Reports from the
international press confirm a proliferation of law-making and regulatory actions
within just the last several months in countries across the globe aimed at
curbing insider trading.117

Finally, these recent developments herald a new era of universal recognition that

insider trading, in the words of the SEC's Chairman Levitt, "has utterly no place in

any fair-minded law-abiding economy.118

117 See ‘n 6 above’

118 See A. Levitt ‘n 22 above’
 53

Appendices

Proportion of zero returns around the enforcement of insider trading

Laws

Fig 1.This figure plots the average proportion of zero returns in the period before and after the
enforcement in developed and emerging markets. The event window includes the three-year
period before and after the enforcement year, excluding the year of the enforcement.

This Particular finding has been derived from Fernandes and Ferreira research

paper titled ‘Insider Trading Laws and Stock Price Informativeness’ (2008), which

concludes with a caution that enforcement of insider trading regulation has

positive effect in developed economies, whereas in developing economies where

there is not so strong infrastructure in terms of efficiency of judicial system,

investor protection, financial reporting and where insider trading plays an

important role in deciding the price of stock, so regulation against such practice

provides no improvement in the overall stock price informativeness.

Also, in one of its findings the author states that simply transporting laws against

insider trading from developed to developing economies, without any changes in

the countries above discussed infrastructure may give negative results. Finally,

author’s recommends that ‘To achieve an improved overall information

environment and most effectively to lower the cost of capital, regulators must
 54

complement insider trading restrictions with other policy initiatives to encourage

investment in the production of information and minimize crowding-out effects’.

 55

Bibliography

Primary Source

(i) US.
(ii) UK (reference of EU).
(iii) India.
(iv) Other Documents.
(v) Internet Resources.

Secondary Resources

(i) Books.
(ii) Articles.
(iii) News Updates.

USA

Legislations:

1. Securities Act 1933.

2. Securities exchange Act 1934.
3. Organized crime control Act 1920.
4. Insider Trading sanctions Act 1984.
5. Insider trading and Securities fraud enforcement Act 1988.

House Reports:

1. Insider Trading and Securities fraud enforcement Act of 1988,

House Insider Trading (Energy and Commerce Committee).
2. Memorandum of the Securities And Exchange Commission in
support of the Insider Trading sanction Act of 1982.
3. Reports of the special committee on securities laws and
regulations.

Cases:

1. Carpenter v Danforth, 52 Barb. CH. 581 (N.Y 1868)

2. Cady, Roberts & Co., 40 S.E.C. 907 (1961)
3. Diamond v Oreamuno, 248 N.E. 2d 910 (N.Y.C.A) (1969)
4. SEC v Texas Gulf Sulphur Co., 401 F.2d 833 ( 2d cir. 1968),
cert. denied sub. Nom. Coates v SEC, 394 U.S. 976 (1969)
5. Dirks v SEC, 463 US 646 (1983)
6. Goodwin v Agassiz, 283 Mass. 338, 186 N.E. 659 (1933)
7. SEC V Clark, 915 F2d 439 (9th cir 1996)
8. United States V Microsoft, C.A 98-1232 (1999) Finding of
facts, Thomas Penfield Jackson
9. U.S V O’ Hagon (1997) 117 S Ct 2199
 56

UK

Legislation:

1. Prevention of fraud (investment) Act 1958

2. Companies Act 1967
3. Companies Act 1976
4. Companies Act 1980
5. Financial services and market Act 2000
6. Model code for securities transactions by Directors of listed companies,
Stock exchange listing rules.
7. Resolution of the international organisation of Securities Commissions,
International Conduct of Business Principles (1991) 12 IOSCO News 1

Parliamentary papers:

1. Insider Trading, a report by Justice (chair: William Goodhare) (1972)

2. Companies Bill 1978
3. Review of Investor protection, Report: Part 1 (L.C.B Gower) (1984)
4. Financial services in the UK: A new framework for investor protection, the
department of Trade and Industry (Jan 1985), cmnd 9432
5. Council of Europe convention on Insider Trading, cm 1803 (1992)
6. The Law on Insider Dealing: A consultative Document, Department of
Trade and Industry (December 1989)
7. Financial Services and Markets Bill 1999

Cases:

1. Boardman v Phipps (1967) 2 A.C. 161

2. Percival v Wright [1902] 2 Ch. 421
3. R v Berenger [1814] 3 Mavles S. 67
4. Hutchings and Smith v FSA (2004)
5. Jabre v FSA (2006)

EU

1. Commission recommendation of 25th July 1977 concerning a European

code of conduct relating to transaction in transferable securities
(77/534/EEC) official journal of the European communities No. L 212/37
2. Council Directive 89/592 of November 13, 1989 coordinating regulations
on insider dealing (O.J 1984, L 334/30)
3. Insider dealing and market manipulation (Market abuse) directive,
directive of the European parliament and council on 2003/6/EC,
implemented by directive of the European parliament and council
2004/72/EC
 57

India

Legislations:

1. Companies Act 1956

2. Securities and exchange board of India (Prohibition of Insider
Trading) Regulation1992
3. SEBI (Insider Trading) (Amendment) Regulations, 2002, w.e.f.
20.02.2002.
4. SEBI (Prohibition of Insider Trading) (Second Amendment)
Regulations, 2002, w.e.f. 29.11.2002.
5. Securities and Exchange Board of India (Substantial Acquisition of
Shares and Takeovers) Regulations, 1997.

Committee Reports:

1. Sachar Committee Report 1979.

2. Patel Committee Report 1986.
3. Abid Hussain Committee Report 1989

Cases:

1. Hindustan Lever Ltd. v SEBI (1998)

2. Samir C. Arora v SEBI (2004)
3. Videocon International Ltd. V. SEBI [(2002) 38 SCL 422 (SAT-
MUM)]
4. Anand Rathi v SEBI (2001)
5. Rakesh Agrawal v SEBI (2003)

Internet Resources

1. Financial service authority (2008) < http://www.fsa.gov.uk/>

2. International organization of securities commission (2008)
http://www.iosco.org
3. Securities and exchange commission (2008) http://www.sec.gov/
4. Securities and exchange board of India (2008) http://www.sebi.gov.in/
5. The times internet edition (2008) http://www.thetimes.co.uk
6. Lexis Nexis
7. West law
 58

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press, 1999)
3. Brazier, Gil, insider dealing: law and regulation (Cavendish publishing ltd,
1996)
4. Gaillard Emmanuel, Insider Trading; The laws of Europe, US and Japan
(Boston: Kluwer law and taxation publishers, 1992)
5. Hannigan, Brenda, Insider dealing (London: longman, 2nd ed, 1994)
6. Hopt, Klaus, Wymeersch, Eddy, European insider dealing (Butterworths,
1991)
7. R.G small, ‘path dependence and the law; A law and economic analysis of
the development of insider trading laws of the US, UK and Japan, Phd
thesis, Vol 2001’
8. Macey, Jonathan R, insider trading: Economics, politics and policy
(Washington DC: American enterprise institute press, 1991)
9. Manne, Henry G, Insider trading and the stock market (Toronto: The free
press (Mac Millan), 1996)
10. Mitchell, Philip L.R., Insider dealing and directors duties (London:
Butterworths, 2nd ed; 1989)
11. Reams, Bernard D, Insider trading and securities fraud: A legislative
history of insider trading and securities fraud enforcement Act of 1988
(Buffalo, New York: William S. Hein & co. inc., 1989)
12. Rider, Barry A.K, insider trading (Bristol: Jordan & sons ltd, 1983)
13. Stamp, Mark, welsh, corsen, international insider dealing (London:
Pearson professional ltd, 1996)
14. J. Suter, The regulation of insider dealing in Britain (London: Butterworth,
1989)
15. L. Harris, Trading & Exchanges, (Oxford : Oxford press, 2003)
16. Tennekoon, Ravi, The Law and Regulation of International Finance
(London: Butterworths, 1991)

Articles

1. Alcock, Allistair, ‘In defense of insider trading’ (1990) 140 New L.J 1470
2. Aldave, Barbara. Bader, Misappropriation: A general theory of liability for
trading of non public information (1984) 13 Hofstra L Rev.Col
3. Bainbridge, Stephen M, ‘The insider trading prohibition: A legal and
economic enigma’ (1986) 38 U. Fla. L. Rev. 35
4. Barry, John F, ‘The Economics of outside information and rule 10b-5’
(1981) 129 U. Pa. L. Rev. 1307
5. Bech-Dudley, Caryn L, Stephen, Alan A, ‘The Efficient market theory and
insider trading’: are we heading in the right direction (1989) 27 AM. BUS.
(.) .441
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6. Brandon, Rhett D, Reiter, Glenn M, ‘Regulators have to harmonize capital

market rules’ (1996) XV int’l Fin. L. Rev 53
7. Brudney, Victor, ‘Insiders, Outsiders and Informational Advantages under
the federal Securities Laws’ (1979) 93 Harv. L. Rev. 322
8. Carlton, Dennis W., Fischel, Daniel R., ‘ The Regulation of Insider Trading’
(1983) 35 Stan. L. Rev. 857
9. Easterbrook, Frank H., ‘ insider Trading, Secret Agents, Evidentiary
Privileges, and the production of Information’ (1981) 1981 Sup. Ct. Rev.
309
10. Carey, Patrick, ‘Inside insider trading’ (1986) 136 New L. J 1155
11. Davies, Paul L, ‘The European communities directive on insider dealing’
(1991) 11 OX. J. Legal stud. 92
12. Ferber, David, ‘The case against insider trading’: A response to professor
Manne (1970) 23 Vand. L. Rev. 621
13. De graaf, H.J, ‘Insider Abuse’: A plea for criminalisation (1999) 7 J. Fin.
Crime 171
14. Herzel and Katz, ‘Insider trading’: who loses? (1987) 165 110y & bank Rev
15
15. Horiguchi, watarv, ‘Difference in culture, society, economics and politics
and their effect on enforcement of securities law’ (1991) 14 Hastings int’l
comp. L. Rev 303
16. Kehoe, James A, ‘Exporting insider trading laws: The enforcement of US
insider trading laws internationally’ (1995) 9 Emarg int’l Rev 345
17. Moh, Pearlve MC, ‘Securities regulation in ASIAN – Is it time for a
harmonious tune to be sung?’ (1995) 1995 Singapore J. legal studies 146
18. Mc Grath, T.A, ‘The rise and fall (and rise) of information – based insider
trading enforcement’ (1993) 61 Fordham L. Rev. 127
19. Naylar, J., ‘The use of criminal sanction in the UK and US Authorities for
insider trading’ (1996) 11 co. law 53
20. Pitt, Harvey L, Hardison, David B, ‘Games without frontiers: Trends in the
international response to insider trading’ (1992) 55 law & contemp. Probs
199
21. Prakash, Saikrishna, ‘our dysfunctional insider trading regime’ (1999) 99
colom. C. Rev 1491
22. Prentice, Robert A, ‘The Internet and its challenges for the future of insider
trading regulation’ (1999) 12 Harv. J. L. & tech. 263
23. B.A.K Rider, ‘The control of insider dealing-smoke and mirror’ (2000) 19
Dickinson Journal of international law1.
24. Langevoort, Donald C., ‘Insider Trading and the Fiduciary Principle: A
Post- Chiarella Restatement’ (1982) 70 Cal. L. Rev
25. Manne, Henry G., ‘In Defense of Insider Trading’ (Nov/ Dec 1966) Harv.
Bus. Rev. 113
26. R.A Schotland, ‘Unsafe at any price: A Replt to Manne, Insider Trading and
the Stock Market’ (1967) 53 Va. L. Rev. 1425.
27. M. Miller, The insider: Parasite or Legitimate Profit- Maker? State, Market
& Economy.
28. M. Mendelson, ‘The Economics of Insider Trading Reconsidered’ (1969)
117 U. Pa. L. Rev. 470
29. Bhattacharya, Utpal and Hazem Daouk, ‘The World Price of Insider
Trading’ (2004)
30. A. Haynes, ‘Market abuse: an analysis of its nature and regulation’ (2004).
31. C. Bhui, Insider Trading in India- An Overview.
32. J. Ghosh, “ Surprise Move,” http:// www.the-week.com/97Aug31/biz3.htm
33. Sivakumar. S, Insider Trading- Following the SEC’s Lead.
34. Bris, Arturo, ‘Do Insider Trading Laws Work?’
35. Shah, Ajay, ‘Why Forbid Insider Trading?’ http://
www.mayin.org/ajayshah/Meida/1998/insider.html
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36. S. Dalal, “Nabbing the Insider Traders: Easier Said than Done,”
http://www.rediff.com/money/2000/aug/16dalal.htm
37. Chakraverti, sauvik, 2000, Antidote: Essays against the Socialist Indian
State, Macmillan India Limited, New Delhi.
38. N. Jain, ‘ Significance of mens rea in insider trading’ (2004).
39. R.W. Mc Gee ‘Ethical Issues in Insider Trading: Case studies’
40. N. Fernandes, M.A. Ferreira ‘Insider Trading Laws and Stock Price
Informativeness’ (2008)

Newspapers

1. P. Shah, A Victimless Crime?, April 18, 2002, The Economic Times.

2. R. Foster Winans ‘ Let Everyone use What Wall Street Knows’. The
Financial Times (online edition)