Comparative Analysis of Insider Trading in India and Abroad
April 11, 2022 • Nikita Saha
AUTHOR'S PROFILE: I am Rajshree Shekhar, a 4th-year student pursuing BBA LLB from Amity University, Kolkata. I am interested in Business and commercial laws
In many industrialized countries, the occurrence of insider trading has become rampant. The expansion of the business world in the global market has led to an acceleration of various instruments such as trading shares, bonds, and derivatives. Insider trading is one such form that has received considerable interest in recent years. When an individual has implicit access to confidential information about the Company buying or selling shares or stocks, insider trading arises. When trading is done so that confidential information is used for the advantage, it is permissible. In other words, when the companies listed in a recognized stock exchange get affected by the fraudulent malpractices, it is said to be insider trading. Insider trading is a global phenomenon that can create several problems, especially economic problems, as in this stock market collapse and economic growth turns down. By the end of the 20th century, around 87 countries had adopted the insider trading law. Developing an effective and efficient stock market for investment and economic growth is necessary. Breach of fiduciary takes place in the case of insider trading. The breach of fiduciary duty has to be discharged by the officers of a company or by connected persons, including merchant bankers, share transfer agents, trustees, brokers, investment advisors, bankers, brokers, sub-brokers, etc.
The United States was the first country that effectively addressed insider trading. Under the Insider Trading Sanctions Act, 1984, the Securities and Exchange Commission in the US has been empowered to impose civil penalties in extension criminal proceedings. To curb the threat of insider trading, most countries have incorporated suitable legislation. In India, to prevent and curb insider Trading in the security market, SEBI (Insider Trading) Regulations 1992 have been framed under Section 11 of the SEBI Act, 1992. The rules and regulations are amended and rechristened as SEBI Prohibition of Insider Trading Regulation, 1992.
Insider trading means dealing in a company's securities subject to confidential information that is not published in any public domain or 'unpublished price sensitive information. To make an illegal profit and dodge some loss, insider trading is carried out. Confidential or material information refers to any information that substantially impacts investors' decisions regarding whether they will buy or sell the securities. The information possessed by the handful of people who are straightforwardly related to it and such information is not legally out in the public domain. Deliberate exploitation of unpublished material information, which is price-sensitive information acquired through good relationships to make a profit or to dodge loss by dealing in a company's securities, as the information can alter the price of securities disclosed. The explanation behind the prohibition of insider trading is the need and concern of the Company regarding the damage that can be caused to its public confidence and to prevent the cheating by using the inside knowledge to make a profit while dealing with others. Several reasons for the misuse of confidential information are as follows:
- Involve taking unfair advantage
- A company's best interest may take second place because of insider wrongful interest, resulting in conflict between the interests.
- The market can be disesteem and be result in a disincentive to investment.
- Insider trading amounts to a breach of fiduciary duty as it is ethical and trust and confidence are at stake.
Insider information cannot be used for anyone's interests as the directors and others are closely associated with companies. Public confidence is at stake. They will be responsible for the breach of their obligation and would be held responsible for taking undue and unfair advantage of the people they are dealing with.
Rationale Behind Prohibition of Insider Trading
Quality and integrity of the market play an important role in smooth functioning, healthy growth, and development of the security market. Marketing having such features can itself attack the confidence of investors. Insider trading can change the security market because in such trading; investors can lose their confidence as they would feel that the market is rigged and can give benefits or help make a profit to the people who have Company's inside information. Therefore, the practice of insider trading corrupts the ‘level playing field’ in the Company. In order to sustain the investor's confidence in the integrity of the security market, the practice of insider trading should be prohibited.
In the case Samir C Arora Vs. SEBI (83 /2004), It was observed that the interest of ordinary investors is injured due to activities like insider trading, fraudulent trade practices, and professional misconduct, which are entirely detrimental to the interests of ordinary investors and is vehemently opposed under the SEBI Act, 1992 and the Regulations made thereunder. Nevertheless, there are no severe punishments for indulging in such activities.
Insiders are defined as officers, directors, or any beneficial who had owned more than 10% of a class of the Company's equity securities. When this type of Insider trades with the Company's stock because the materials, which are non-public information, are fraudulent because they violate the fiduciary duty they own to the shareholders. E.g., Corporate officers -, directors, and employees of the Company who traded the Company's securities after learning of significant, confidentiality corporate developments; Employees of law, banking, brokerage, and printing firms- who were given such information to provide services to the corporation whose securities they traded; Government employees – who learned of such information because of their employment by the government.
If the Company's chief executive officer has prior knowledge regarding some public announcement that which Company is going to make regarding the price company's shares and, based on such information, bought those shares, then it would be said that the illegal insider trading had occurred. Any capital market regulatory system needs to prevent such transactions.
Protection Under General Law
The general laws of India are not effective in controlling insider trading. Following are the protection available for protection under general laws:
- Under the standard rule, the trader can be held liable for misrepresentation if he makes an affirmative misrepresentation regarding the Company's security to his counterpart.
- A trader can be held liable for non-disclosure if he omits to disclose any material factor about the Company's security. Nevertheless, for non-disclosure, there is no liability.
Insider trading law in India
To curb insider trading, the first attempt made by India was in the shape of a disclosure requirement in respect of the Company's director's shareholding. Presently, the governing law which regulates insider trading is the Securities and Exchange Board of India (Insider Trading) Regulations of 1992. Under section 2(e) of the regulation, the term insider has been defined, and the definition has two limbs who are deemed to have been connected with the Company and who are reasonably expected to have access, under such connection, to unpublished price sensitive information in respect of securities of the Company. Section 11 (2) (e) of the companies act, 1956 prohibits insider trading, but no one has insider trading been defined in the Companies Act. Section 11(2) (e) of the Act states that it is necessary to prohibit insider trading attain the security market is fair and transparent; all the participants in the market must have a level playing field to dodge information asymmetry and also for free flow of information. Price sensitive information is generally deemed to be:
- Periodical financial results
- deliberate declaration of the dividends
- Issue of securities or buy-back of securities
- Any major expansion plans or execution of new projects
- Amalgamation and mergers or takeovers
- Any significant changes in policies, plans, or operations of the Company
The case of Rakesh Agrawal v. SEBI was one of the important case laws that helped develop the legislation regulating inside trading in India. Rakesh Agrawal, the then Managing Director of ABS Industries Ltd, was allegedly involved in an insider trading transaction. He was fully aware that ABS Industries Ltd. and Bayer AG would merge. SAT held that Rakesh was not guilty of insider trading as he did not gain unfair personal gains, and the gains held by him were only incidental and certainly not to cheat. SEBI appealed to Supreme Court, and it was held that Mr. Rakesh Agrawal had to pay Rs. 48,00,000 for the settlement.
Insider Trading in the US and other countries
In the United States and several other countries, within a few business hours of trade, the corporate officers, key employees, directors, or significant shareholders who are beneficial owners of 10% or more of the Company's equity securities recite such information to the regulator or can be publicly disclosed. The insiders can use open market repurchase, and such transactions are also legal and are encouraged by regulators amid safe harbours against insider trading liability. In the US, the Insider's legal trades are common because stock or stock options are available to the employees of publicly-traded companies. Form 4 of Securities and Exchange Commission filings made such trade public in the US. In the United States, the Security Exchange and Commission Rue 10(b) 5 states that the possession of information related to insider trading is sufficient to violate the provision. Evidence claiming that such material non-public information was used for conducting the trade is not required. Suppose the Insider can demonstrate that the trade was conducted on behalf of the Insider because of a pre-existing contract or some written binding plan for trading in the future. In that case, he can use it as his defence mentioned in Security Exchange and Commission Rue 10(b) 5-1. Section 16(b) and 10(b) of the Securities Exchange Act of 1934 address insider trading directly and indirectly.
The liability for violation of insider trading bypassing the information in a quid pro quo arrangement cannot be avoided because it is the Company's property known to the person receiving such information. All the parties involved in such an illicit Act would be found guilty. The misappropriation theory is one of the parts of US laws. The theory states that information misappropriated or stolen by anyone from their employer and such information used to trade any stock, including both the employer's stock and the Company's competitor stocks, would amount to insider trading.
Supreme Court of the US, in the case of Dirks v. SEC (1984), held that tippees who receive the second-hand information are guilty if the court has reasonable ground to believe that the fiduciary duty was breached, which results in disclosing the tipper received confidential information and any personal benefit from such discloser. In order to expose the fraud, Dirks disclosed all the information, but he did not disclose such information for personal gains. Hence no one was liable for insider trading. The concept of constructive insiders was defined in this case. It includes all those who receive confidential information from a company while rending their service to the Company, such as lawyers, investment bankers, and others. Constructive insiders are also liable for insider trading if the reasonable ground can provide evidence that the Company expects the information to remain confidential, as they have fiduciary duties.
In India, the 2002 regulation bill have further enriched the 1992 regulations and elongated the list of person who will be considered the insiders. Insider trading by directors, employees, partners, etc., has to be precluded by specific guidelines and policies that all the listed companies and other entities have to frame. It was tough to enforce the legislation related to insider trading because of ineffective legislation that has impacted the security market. The low enforcement rates and few convictions against insiders can be described as ineffectiveness. When the task related to administrating the law, it is evident that the SEBI, which has bestowed wide-ranging power, failed. International importance was provided for policing insider trading as overseas regulators endeavours to heft the confidence of domestic investors and draw the interest of the international investment community. Special courts can be constituted for the effective and efficient disposal of cases.