Decoding The Concept and Law of Insider Trading in India
It is interesting to know that the Market regulator investigated 70 companies in 2019 accused of insider trading. This number is far much higher than in 2018. Securities Exchange Board of India (hereafter referred to as SEBI), revealed that the term ‘insider trading’, is being increasingly in use now.
Table of Contents:
- Introduction
- Insider Trading
- Who is an Insider?
- Insider Trading can be Legal or Illegal
- Why Illegal Insider Trading is considered as Unethical?
- Laws for Insider Trading in India
- Exceptions to Insider Trading Prohibition in India
- Recent cases of Insider Trading settled by SEBI
- Case Laws
- Samir Arora v. SEBI
- Chandrakala v. SEBI
- Conclusion
Insider Trading
The name suggests it all. ‘Insider’ is a person in connection with the company. ‘Trading’ means to trade. When a person in connection with the company, uses the company’s information to indulge in a trade to benefit himself, is called insider trading. The information should be unpublished price sensitive information of the company hereafter referred as UPSI).
Unpublished Price sensitive information is defined in Regulation 2(n) of the SEBI (Prohibition of Insider Trading Regulations), 1992 (hereafter referred to insider regulation), as information which directly or indirectly is related to the company and is of such a nature that if published, will affect the price of the company’s securities.
Being an insider, a person can have access to the company’s unpublished internal secret information, according to which he can eventually trade in securities, which will help him in gaining profits. The information should be necessary to make an investment decision in the company. Thus, trading in securities by company insiders who have access to secret information due to their advantageous position in a company is called insider trading.
In simple words, it can be called theft of information.
However, it is to be noted that the information should be unpublished. If the information used for insider trading is already available in the media etc. then it will not be called insider trading.
Thus, the important elements of insider trading are: –
- i) The information should be material non-public information;
- ii) It should be used by some insider;
iii) They should later deal in the securities.
Who is an Insider?
Regulation 2 (g) of insider regulations define an insider as-
- The person should be connected with the company;
- Or person should be in possession UPSI;
- The person having access to UPSI.
Insider-trading can be Legal or Illegal
Insider trading lawfully takes place in companies every day. It happens when the company’s directors or employees trade in securities of their company. They are not prohibited from dealing in it.
The Insider Regulations detail the circumstances in which insider trading is permitted. So, for such situations, insider trading will not be prohibited, nor will be considered illegal.
But, if an insider takes undue advantage of his position and does insider trading, at the expense of others interests, to make undue gains to himself or to any person related to him, then in such a scenario, it would be completely illegal.
Why Illegal Insider Trading is considered Unethical?
There are reasons why Illegal Insider trading is considered to be unethical. They are as follows: –
- Causes Damage to market
For functioning of a smooth market, it is necessary to maintain integrity. It will help the market to gain the confidence of the investors. But the cases of insider trading loosen the trust of the investors on the market. Thus, they hesitate to invest in the company. This will cause damage to the market of the country.
- Unfair to non-insiders
Markets should be fair for all their participants. But insider trading takes the insider a level up in taking decisions of investing.
By taking advantage of their position, the insiders use the information gained to benefit themselves. Thus, they will not have any fear of making losses. But this becomes unfair for those investors who did not have the access to such information. They can lose or gain in future, but the informant having insider information will only gain himself.
Thus, insider trading creates a situation that becomes unfair to the outside investors.
Laws for Insider Trading in India
The evolution of insider trading regulation took place in India when The Sachar Committee stated that the directors, employees etc. may have certain price-sensitive information with them. They can use the same to influence the security prices in the stock market, therefore, the Companies Act, 1956 must be amended to prevent the investors and the market from such practices.
SEBI (Prohibition of Insider Trading) Regulations, 2015
In India, insider trading is generally regulated by the SEBI (Prohibition of Insider Trading) Regulations, 2015.
Regulation 3 prohibits an insider to give or allow access to any UPSI, related to a company or its securities that are listed or going to be listed to any person or any other insider, except where the same is done for any legitimate purpose or for discharging any legal obligations.
Further Regulation 4 does not allow the insiders to trade in listed or proposed to be listed securities when they have UPSI.
Regulation 5 requires the insider to make a ‘Trading Plan’, following which, he can carry trade on his behalf after taking approval of the compliance officer and public disclosure.
Regulation 6 requires public disclosure of trading in securities from any people including disclosure by immediate relatives of the person or any other person for whom he takes decisions.
Regulation 7 requires initial disclosures to be made by every person on becoming Director or Key Managerial Personnel or promoter of the company. It states that on becoming so, the person will have to within seven days of such appointment disclose his securities in the company within the date of his appointment.
The Regulation further requires the informant to submit Original Information by way of a form, called the Voluntary Information Disclosure Form (hereafter referred as Disclosure Form) to the office of Informant Protection of the Board.
An informant is a person who voluntarily submits the Disclosure Form to the board about a violation or reasonable belief of a violation of the insider trading laws.
The Regulation further provides for a reward for such informants. Earlier the reward amount was INR 1 crore, but recently SEBI increased it to INR 10 crore. This is done to restrict all the chances of future possible insider trading’s.
Regulation 8 provides for a Code of practices and procedures for fair disclosure of the UPSI which would be followed by the listed companies.
Regulation 9A provides for an effective system of internal controls to ensure that the requirements given in these regulations have complied.
Regulation 10 provides that any violation of the regulation will be dealt with by the Board under the Act.
The Companies Act, 2013
The Companies Act, 2013 (hereafter referred to as 2013 Act) provides for insider trading in Section 195. Section 195 of the 2013 Act prohibits directors, key managerial personnel from entering into any insider trading.
But this will not be applied to any communication required in any ordinary course of business or under any law.
It further provides that any person contravening the said section will be punishable with a penalty which can extend to 25 crore rupees or three times the amount of the profit made through insider trading, whichever is higher, or it can be both too.
SEBI Act, 1992
Section 12 A and section 15G of the SEBI Act, also provide for insider trading.
Exceptions to Insider Trading Prohibition in India
In certain circumstances, the Insider regulations allow doing Insider trading. The circumstances are as follows-
- Regulation 3of Insider regulations prohibit the communication of insider trading, but it also carves out certain exceptional circumstances where insider it will not be considered as illegal and thus can be done.
The circumstances are as follows: –
- Where the communication is in the furtherance of legitimate purposes;
- Where the communication is in furtherance of the performance of duties;
- Where the communication is made to discharge a legal obligation.
- Further exceptions to insider trading regulations are laid in Sub-Regulation 3 of Regulation 3. It states that a price sensitive information can be communicated or can be allowed to be procured when-
- Where due to takeover regulation, the responsibility to make an open offer arises and the Board is satisfied that it is in the best interest of the company.
- No obligation arises, but the company considers disclosing information to be in the best interest of the company. However, here the company needs to disclose the UPSI to the public, before two days of the transaction taking place.
In both of these points’ disclosure has to be made to the public, so that the general public also gets a chance to benefit themselves from the information.
In the case of Samir Arora v. SEBI, Arora was accused of disclosing UPSI of a merger. But later, the information was found to be false and no such merger took place. It was held by the Securities Appellate tribunal that, to attract a charge of insider trading, the UPSI ought to be true.
- Regulation 4of the insider Regulations provide for another set of important exceptions. It states that a person holding a UPSI shall not trade in securities, that are listed or about to be listed on the stock exchange. But the Regulation further provides circumstances where the insider can prove himself to be innocent.
In the case of Chandrakala v. SEBI, it was held by the Securities Appellate Tribunal, that, if a person while possessing UPSI, enters into deals into securities, it will be presumed that he is trading based on UPSI.
- Under Regulation 5(4), the Trading plans are irrevocable and the insider has to mandatorily implement the plan.
But if the UPSI has not been made public till the execution date, then execution will be delayed.
Recent cases of Insider Trading settled by SEBI
- Recently, SEBI has bar Allergo Capital and its senior executive from the securities market for one year for allegedly indulging in insider trading activities in Biocon.
- The alleged insider trading case of Rakesh Jhunjhunwala and his family in shares of Aptech Limited has been settled after 5 years by paying 37 crores to SEBI.
- The promoters of NDTV, Prannoy Roy and Radhika Roy were restrained from accessing the securities market for two years for indulging in insider trading as they violated Regulation 3(i) and 4 of Insider Regulations. They were asked to pay INR 16,97,38,335 with 6% of interest per annum.
Conclusion
SEBI is making more and more stringent laws to curb the malpractice of insider trading. But the revelations made by SEBI, about the increasing number of insider trading cases, is signaling a need to make more stringent laws to punish insider trading, one of the most important financial crimes of the country.