INSIDER TRADING: COMPARATIVE ANALYSIS OF

INDIA AND USA

By

Arun Kumar Singh

Associate Professor
Noida International University
Noida, INDIA

And

Anil Kumar
Scholar Noida International University
Noida, INDIA

Electronic copy available at: http://ssrn.com/abstract=2552418

ABSTRACT

Insider trading, the occurrence of which has become rampant in many

industrialized countries, the research seeks to examine the legal mechanism
prevalent in India and assess the extent to which it has been implemented by
interpreting cases taken up by the Courts. The research shall further draw a
comparison between the legal frameworks of India and USA pertaining to
insider trading and shall highlight the merits and demerits of each by analysing
cases which have taken place at an international level which have led to the
breach of fiduciary duties by connected persons and mis-appropriation of large
amount of funds involving Raj Rajaratnam, the billionaire founder of the Galleon
hedge fund, which is one of the most controversial and widely deliberated
issues in the field of securities regulation followed by Rajat Gupta’s scam. The
research shall also analyse whether India would benefit from assimilating
certain features from the legal system of the United States, and if so which
features would help India strengthen its regulatory mechanism. The study shall
be limited to the laws of these two jurisdictions only. Further, the research will
not be delving into the question of whether insider trading should be legalized
or not since that a question more of economics and less of law.

Electronic copy available at: http://ssrn.com/abstract=2552418

I. INTRODUCTION

Insider trading means dealing in the securities of a company on the basis of

certain confidential information relating to the company which is not published
or not in the public domain, i.e. ‘unpublished price sensitive information.’ Such
information, had it been published, would have materially affected the price and
worth of the securities of that company and includes information relating to the
periodical financial results of the company, any major expansion plans, new
projects, mergers, takeovers, amalgamations, issue or buyback of securities,
significant changes in policy, etc. An ‘insider’ is a person who has received or
had access to such information or is so connected with the company that it is
reasonable to expect that he would have had access to such information. For
instance, if the director of a company, has information that the company has
discovered oil on lands owned by it, before such information is released to the
public, and thereafter, in anticipation of the increase in the market value of the
securities of the company once such information is made public, purchases a
large number of shares of the company, he would be guilty of and liable for
insider trading.

Insider trading, classically involves the breach of a fiduciary duty 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. Once an insider receives unpublished price sensitive information
by virtue of his position in the company or his connection with the company, he
owes a fiduciary duty to the company not to abuse his position and misuse such
information. Moreover, insider trading also requires an element of manipulation
or deception by the insider i.e. he should have used such information to make
secret profits or unlawful personal gain. Insider trading is considered lawful
when the insiders (i.e. directors, employees, officers,) of the Company who are
in possession of price sensitive information, buy or sell securities of their own

3
Company within the confines of Company’s policy and regulations governing
this trade 1 .

The Modus operandi initiates when insiders act as initiators of price change by
receiving the information much earlier than others. An insider, first of all, buys
the stock of the Company at the existing market price. He then spreads some
price sensitive information relating to the Company to select group of people,
who on the basis of such information will buy such stocks and would further
spread the information. When this information reaches a large number of
persons, it pushes up the sales volume and price of the stock. After a certain
price of the stock is reached, insider sells his stock, as do the ones close to him
before others do the same. As now everyone tries to sell his or her stock, its
price will fall down. When information is available to everyone, the stock
reaches back to its realistic price level, which results in huge loss to common
investors 2 . The rationale behind the prohibition of Insider Trading is “the
obvious need and understandable concern about the damage to public
confidence which insider dealing is likely to cause and the clear intention to
prevent, so far as possible, what amounts to cheating when those with inside
knowledge use that knowledge to make a profit in their dealings with others 3 ”.

SEBI, the market regulator, has to deal sternly with companies and their
Directors indulging in manipulative and deceptive devices, insider trading etc.
or else they will be failing in their duty to promote orderly and healthy growth
of the Securities market. Economic offence, people of this country should know,
is a serious crime which, if not properly dealt with, as it should be, will affect
not only country's economic growth, but also slow the inflow of foreign
investment by genuine investors.

1
Thummuluri Siddaiah, Financial Services, Pearson Education India, 2011, pg 226
2
Ibid. pg 226.
3
Attorney General’s Reference No.1 of 1988 (1988) BCC 765 cited in Dr. K.R. Chandratre et al.,
Compendium on SEBI, capital issues and listing, Bharat Publishing House, 1996, pg 663.

4
II. THE LEGAL REGIME TO CONTROL INSIDER TRADING IN INDIA

Insider trading is extremely detrimental to the growth of a healthy market.

Even a small quantity of securities traded on the basis of inside information
may also affect the integrity of the market 4 . The security market in India was
developed through the establishment of the Bombay Stock Exchange way back
in 1875. The concept of Insider Trading can also be traced with its
establishment. It was realized that such a system is detrimental to the interest
of the Indian stock exchange 5 . Before the establishment of Securities Exchange
Board of India (SEBI), Insider Trading was mainly tackled by the provisions
under the Companies Act, 1956 that required disclosure by directors etc. of the
Company.

The first governmental effort to regulate Insider Trading was the formation of
Thomas Committee in 1947, which gave its recommendation in 1948 on the
basis of which the provisions relating to Insider Trading were incorporated in
the Companies Act, 1956 6 in the shape of a disclosure requirement. Sections
307 and 308 were incorporated under the Companies Act as a solution to
reduce the problem of Insider Trading. These provisions were modelled on the
basis of Section 195 and 198 of the English Companies Act, 19487 . In 1977, the
Sachar Committee was constituted to review the Companies Act, 1956 and the
Monopolies and Restrictive Trade Practices Act, 1969. In its report submitted in
1979, it stated that unfair profits, can, on occasion, be made in share dealings
by the use of confidential information, not generally available to the investing
public, by certain insiders having access to such price sensitive information. It
recommended that amendments be made to Sections 307 and 308 of the

4
Supra no. 2, pg 226
5
Byomakesh Nayak, “An Overview of Insider Trading Regulations in India”, available at
www.airwebworld.com.
6
Anand Kumar Tripathi, “The Concept of Insider Trading in India”, CLC/VI/2011, pg.174.
7
Anand Kumar, “Insider Trading and Regulatory Framework in India”, (2011) 3 Comp LJ, pg 118.

5
Companies Act, 1956 to prohibit and restrict dealings by insiders and their
relatives.

Thereafter, the High Powered Committee on Stock Exchange Reforms, the Patel
Committee, was constituted in 1984 and in its report submitted in 1986
recommended that the Securities Contracts (Regulation) Act, 1956 be amended
to make stock exchange manipulations including insider trading punishable.
Thereafter in 1989, the Working Group on the Development of the Capital
Market, the Abid Hussain Committee, recommended inter alia, a ban on insider
trading and penalty for the same and that the SEBI, be asked to formulate the
necessary legislation which should give it authority to enforce the same. In
1991, a consultative paper was issued by SEBI, which made provisions for the
curbing of insider trading.

In 1992, the SEBI brought out certain regulations, which are referred to as The
Securities and Exchange Board of India (Prohibition of Insider Trading)
Regulations, 1992 [‘SEBI Regulations’]. There were certain drawbacks in the
Insider Trading Regulations as they were short with only 12 Regulations and
were not sufficient to deal with the problem of Insider Trading, these
Regulations suffered from the following major drawbacks, such as the definition
of ‘insider’ given in the Regulations is not happily framed it appears to be an
ambiguous one 8 , the regulations did not contain any provision prescribing
penalty for contravention of the provisions of the regulations thereof and the
power to seize the documents and to detain suspected offenders/violators
under these Regulations 9 .

Thus these regulations have been amended on a number of occasions, the

latest being the amendments made in the year 2011, wherein, Regulation 13

8
Dr. K.R. Chandratre et al., Compendium on SEBI, capital issues and listing, Bharat Publishing
House, 1996, pg 671-672.
9
ibid.

6
has been amended to include Sub- Regulation (2A) and (4A). Under Sub-
Regulation (2A) any person who is a promoter or part of promoter group of a
Listed Company is also required to disclose to the Company the number of
shares or voting rights held by such person, within two working days of
becoming such promoter or person belonging to promoter group. Further, Sub-
regulation (4A) requires a promoter or part of promoter group of a listed
company to disclose to the company and the stock exchange where the
securities are listed, the total number of shares or voting rights held and
change in shareholding or voting rights, if there has been a change in such
holdings of such person from the last disclosure made and the change exceeds
Rs. 5 lakh in value or 25,000 shares or 1% of total shareholding or voting
rights, whichever is lower. This disclosure also has to be made within a period
of two days. In the amendments made in 2008 provisions were made to
prohibit the practice of insider trading and empower SEBI to investigate the
same including the power to make enquiries and inspections, appoint an
investigating authority which shall submit a report to it, appoint auditors and
give directions.

7
III. THE SCOPE AND APPLICABILITY OF THE SEBI REGULATIONS

As aforementioned, first it is essential to examine who would qualify as an

‘insider’ under the Indian law. Regulation 2(e) provides for the definition of an
‘insider’ which has been defined in two clauses: firstly, a person who is or was
connected with the company or is deemed to have been connected with the
company and who is reasonably expected to have access to unpublished price
sensitive information in respect of securities of a company, and secondly, a
person who has received or has had access to such unpublished price sensitive
information.

To qualify within the first clause of the definition, it appears that one must be
(a) either a ‘connected person’ within the scope of Regulation 2(c) or a ‘person
deemed to be a connected person’ within the scope of Regulation 2(h) and (b)
must be reasonably expected to have access to unpublished price sensitive
information. Regulation 2(c) has defined a ‘connected person’ to include firstly,
a director or a person deemed to be a director or secondly, any person who (a)
occupies the position of an officer of the company, (b) occupies the position of
an employee of the company (c) any person who holds a position involving a
professional or business relationship between himself and the company,
whether temporary or permanent and who may reasonably be expected to have
access to unpublished price sensitive information in relation to that company. It
has been further clarified that aconnected person means a person who is a
‘connected person’ within the scope of the definition for a period of six months
prior to an act of insider trading.

The parameters of the definition of a person ‘deemed to be a connected person’

have been even more widely defined and have brought within its ambit a whole
range of individuals. Secondly, the definition has as previously mentioned, by

8
virtue of the 2002 amendment, brought within its ambit intermediaries 10 ,
investment companies, trustee companies, asset management companies or
their employees or directors, or an official of a stock exchange, clearing house
or corporation. Thirdly, the definition specifically brings within its ambit the
following intermediaries: merchant banker, share transfer agent, registrar to an
issue, debenture trustee, broker, portfolio manager, investment advisor, sub-
broker, investment company or an employee thereof, a member of the Board of
Trustees of a mutual fund, a member of the Board of Directors of the Asset
Management Company of a mutual fund and any employee thereof who has a
fiduciary relationship with the company. Fourthly, a Member of the Board of
Directors, or an employee, of a public financial institution has been brought
within the ambit of the definition. Fifthly, an official or an employee of a self-
regulatory organization recognized or authorized by the Board of a regulatory
body is also deemed to be a connected person within the ambit of Regulation
2(h). Sixthly, a relative of all the aforementioned persons and by virtue of the
2002 amendment all relatives of connected persons have also been deemed to
be connected persons. Seventhly, the banker of the company has been included
within the ambit of the definition. Lastly, by virtue of the Second Amendment of
2002, Regulation 2(h) has also been stretched to include a concern, firm, trust,
Hindu undivided family, company or association of persons wherein any
‘connected person’, relative of a connected person or aforementioned
categories of persons (one to five), or the banker of the company have more
than 10 per cent of the holding or interest.

It is essential to point out that to qualify as an ‘insider’ within the first clause of
Regulation 2(e), in addition to being a ‘connected person’ or a person ‘deemed
to be a connected person’, a person must also fulfil the requisite of being
reasonably expected to have access to unpublished price sensitive information.

10
As per Section 12 of the SEBI Act an intermediary includes a stock broker, sub broker, share
transfer agent, banker to an issue, trustee of trust deed, registrar to an issue, merchant banker,
underwriter, portfolio manager and investment advisor.

9
It has been observed that the segregation of the first clause of Regulation 2(e)
from the second clause has had the effect of bringing even ‘outsiders’ of the
company within the ambit of the ‘insider’ and hence has broadened the
definition beyond its desirable limits. 11

11
Parekh, Sandeep, “Insider trading laws should not become a booby trap”, Economic Times, as
available on <http://economictimes.indiatimes.com/markets/analysis/Insider-trading-laws-should-
not-become-a-boobytrap/articleshow/3806148.cms> (last visited on 06/09/2014).

10
IV. WHAT IS ‘UNPUBLISHED PRICE SENSITIVE INFORMATION’?

Before, analyzing the provisions of law which determine what exactly would
constitute ‘insider trading’, it is important to first establish what exactly
constituted ‘unpublished price sensitive information’. The SEBI regulations as
they stand today do not define ‘unpublished price sensitive information’, as was
the case prior to the 2002 amendment regulations, but define the terms ‘price
sensitive information’ and ‘unpublished’ separately. Regulation 2(ha) defines
‘price sensitive information’ to mean any information which relates directly or
indirectly to a company and which if published is likely to materially affect the
price of securities of company. Further, certain information has been deemed to
be price sensitive information firstly, periodical financial results of the company;
secondly, intended declaration of dividends (both interim and final); thirdly,
issue of securities or buy-back of securities; fourthly, any major expansion
plans or execution of new projects; fifthly, amalgamation, mergers or
takeovers; sixthly, disposal of the whole or substantial part of the undertaking;
and lastly, significant changes in policies, plans or operations of the company.
Further, Regulation 2(k) has defined ‘unpublished’ information to mean
information, which is not published by the company or its agents and is not
specific in nature. Further, the Explanation to the Regulation has specifically
clarified that speculative reports in the print or electronic media would not be
considered ‘published information’. Thus, the 2002 amendment sought to take
away the defense, which was provided by the un-amended definition i.e. that
any information, which was generally known in the media or otherwise could
not have qualified as unpublished price sensitive information. 12

12
Vyas, Amit K, ‘SEBI (Prohibition of Insider Trading) Regulations, 1992: concept of unpublished
price sensitive information radically amended’, Chartered Secretary, The Institute of Company
Secretaries of India, Vol. 32, 2002 (May) 597-9 p, 598.

11
V. WHICH ACTIONS CONSTITUTE THE OFFENCE OF INSIDER TRADING?

In order to highlight the functioning of the regulatory mechanism in India and

its various advantages and shortcomings, it is essential to examine the
various instances of insider trading in India and the extent to which the laws
which existed at the relevant time were able to keep pace with the growing
manipulation in the stock market. In the following paragraphs an attempt has
been made to analyse some of the major insider trading scams which the
country has seen in the last couple of decades.

Since the various concepts that would circumscribe and sculpt the ambit of
insider trading have been elucidated above, the next inevitable question that
arises is which acts exactly, would constitute the offence of insider trading. The
answer to this question lies in Chapter II of the SEBI Regulations on the
conjoint reading of Regulations 3, 3A, 3B and 4. Regulation 4 provides that any
insider who deals in securities 13 in violation of Regulations 3 or 3A shall be
guilty of insider trading. Regulation 3 prohibits certain actions: it provides that
no insider shall, firstly, either on his own behalf or on behalf of any other
person, deal in securities of a company listed on any stock exchange when in
possession of any unpublished price sensitive information; or secondly,
communicate or counsel or procure directly or indirectly any unpublished price
sensitive information to any person who while in possession of such
unpublished price sensitive information shall not deal in securities. Apart from
the prohibitions in Regulation 3, Regulation 3A specifically provides that no
company shall deal in the securities of another company or associate of that
other company while in possession of any unpublished price sensitive
information. However, Regulation 3B provides certain defenses which a
company against which proceedings have been instituted on the basis of
Regulation 3A, may avail of. It provides that if the company that entered into a

13
Regulation 2(d) defines ‘dealing in securities’ to mean an act of subscribing, buying, selling or
agreeing to subscribe, buy, sell or deal in any securities by any person either as principal or agent.

12
transaction in the securities of a listed company when the unpublished price
sensitive information was in the possession of an officer or employee of the
company, it may plead exception if it can establish: firstly, that the decision to
enter into the transaction or agreement was taken on its behalf by person(s)
other than that officer or employee; secondly, that the company had put in
place such systems and procedures which demarcated the activities of the
company in such a way that the person who entered into transaction in
securities on behalf of the company could not have had access to information
which was in the possession of any other officer or employee; thirdly, that the
company had in operation at that time, arrangements that could reasonably be
expected to ensure that the information was not communicated to the
person(s) who made the decision and that no advice with respect to the
transactions or agreement was given to those person(s) by that officer or
employee; or lastly, that the information was not so communicated and no such
advice was given. Moreover, it provides that a company which is in possession
of unpublished price sensitive information may, in a Regulation 3A proceeding,
take the defence that acquisition of shares of a listed company was as per the
SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 if the
same can be substantiated with proof.

13
VI. THE HINDUSTAN LEVER LTD. CASE

The case of Hindustan Lever Ltd. v. SEBI 14 was one of the first ever case of
Insider Trading in India where SEBIscrutinized the involvement of a big
Company (HLL) on Insider Trading. This case relates to Hindustan Lever Ltd
who was alleged to be involved in Insider Trading transactions when it
purchased 8 lac shares of Brooke Bond Lipton India Ltd (BBLIL) from Unit Trust
of India (UTI) on the basis of unpublished price sensitive information regarding
the impending merger of HLL and BBLIL. However, SAT reversed the order of
SEBI on the ground that proposed merger was generally known and that and
cited press reports which revealed the prior market knowledge of the proposed
merger. The most significant fall out of this case was the subsequent
amendment introduced in the SEBI Regulations, which was aimed at removing
the loophole in the law that any information, which was generally known in the
media, could not constitute unpublished price sensitive information. The
amendment to Regulation 2(k) introduced in 2002, clearly provided that
speculative reports in the print or electronic media would not be
considered ‘published’ information.

14
[1998] 18 SCL 311 (SAT).

14
VII. THE RAKESH AGRAWAL CASE

The case of Rakesh Agrawal v. SEBI 15 has been a major milestone in

developing the insider trading laws prevalent in India. This case relates to the
alleged involvement of Mr. Rakesh Agrawal, who was the then Managing
Director of ABS Industries Ltd., in Insider Trading transactions while he had
access to the price sensitive information regarding the merger of ABS
Industries Ltd. to Bayer AG. After a detailed consideration of issues and
evidence the SAT found that his intention in acquiring the share was to facilitate
the entry of Bayer and not to gain unfair personal gain. SAT held that although
it was true that in the process the shares purchased at a lower price fetched a
higher price when offered in the public offer, this gain was only incidental, and
certainly not to cheat. Thus, SAT held that Rakesh Agrawal was not guilty of
insider trading. SEBI appealed from the decision of SAT to the Hon’ble Supreme
Court which has settled the matter by its consent order whereby Mr. Rakesh
Agrawal has agreed to pay Rs. 48,00,000 towards the settlement 16 . Also with
respect to the prosecution initiated by SEBI in 2001, the offence was
compounded by payment of Rs. 4,90,000 by the accused to SEBI.

15
[2004] 49 SCL 351 (SAT).
16
Consent Order dated 23.01.2008

15
VIII. THE SAMIR ARORA CASE

The case of Samir Arora v. SEBI 17 was another important case in the evolution
of insider trading laws in India. The case relates back to 2003 wherein Samir C.
Arora, the fund manager of Alliance Capital Mutual Fund was alleged to be
involved in Insider Trading transactions when he disposed off the entire scrip of
Digital Global Soft (DGL) held by him on the basis of the alleged unpublished
price sensitive information of the merger ratio of DGL with HPI (Hewlett
Packard)25. It was alleged that based on inside information, Samir Arora had
first moved up the price of the scrip from Rs. 537.55 on 2nd May, 2003 to Rs.
597.25 on May 7, 2003 with certain statements made by him to the Business
Standard on April 30, 2003 which was published on May 5, 2003 and then sold
all the holdings of the funds managed by him over the next four trading days
thereby averting a loss of about Rs. 23 crore to the Funds managed by him.
The SEBI found that he was prima facie guilt of the offence of insider trading.
SEBI passed orders debarring him from accessing the securities market for a
period of five years.

On an appeal to the SAT, after carefully analysing the contentions of both

parties concluded that the price sensitive information which Samir Arora was
alleged to have accessed was not correct information because the merger was
not infact announced on May 12, 2003. It held that information which finally
turns out to be false or at least uncertain cannot be labelled as information.
Thus, it was concluded by the SAT that the sale of securities prior to the board
meeting could only be considered to be based on Samir Arora’s analysis and
18
assessment of the information available in the public domain.

17
[2005] 59 SCL 96 (SAT)
18
Lalu John Philip, “Insider Trading law – A critical Analysis”, (2011) 103 CLA (Mag.) 41.

16
IX. A COMPARISON BETWEEN THE LEGAL SYSTEMS IN INDIA AND THE
UNITED STATES

It is essential to keep in mind that the two regimes are in such different stages
of their growth, the regime of the United States having evolved considerable
over the eight decades, whereas in India, the regulatory regime is only about
two decades old. Firstly, the regulatory mechanism to curb insider trading in
India is under the supervision of the SEBI. The counterpart of SEBI in the
United States of America is the Securities and Exchange Commission [‘SEC’].
The SEBI and the SEC both have supervisory and regulatory roles in the
mechanisms of both legal systems. In India, there is no separate legislation to
govern insider trading, which is governed by the SEBI (Prohibition of Insider
Trading) Regulations, 1992 and certain provisions of the SEBI Act, 1992,
whereas in the United States of America, the law governing insider trading is
predominantly governed by the provisions of the Securities Exchange Act, 1934
which provides the substantive provisions the violation of
which would give rise to penalty.

The next important aspect of both jurisdictions which must be compared would
be whether or not it is essential for there to be a breach of fiduciary duty for
there to arise a liability for insider trading. In the United States of America,
there has been a gradual, yet consistent demise of fiduciary principles as far as
affixing liability for insider trading has been concerned. The most significant
case which emphasized the need for there to be a fiduciary breach was the
decision of the United States Supreme Court in Chiarella v. United States, 19
wherein the Supreme Court, clearly held that there was no policy of equal
access to information underlying the securities laws that creates a general duty
to disclose material, non-public information or refrain from trading, and this
duty had to stem from a special relationship between the trader and the

19
445 U.S. 222 (1980).

17
shareholders of the issuer corporation. The Supreme Court’s decision in the
Chiarella Case came to be coined the ‘classical theory’ of insider trading.

In the Indian regime, a similar movement away from the breach of a fiduciary
duty requirement to affix liability has been observed especially after the 2008
amendment. Prior to the 2008 amendment in Regulation 2(e), the SAT made
some interesting observations with respect to the fiduciary duty requirement in
case of Rakesh Agrawal v. SEBI. 20 It observed that:

“The requirement for establishing a breach of fiduciary duty to

successfully make out a violation of insider trading under Regulation 4 is
implicit in the provisions of Regulation 3, and necessarily needs to be
read into the same.

The next essential aspect of both regimes which needs to be compared is the
liability of a person who has traded on the basis of misappropriated
information. In the United States of America, the ‘misappropriation theory’ of
insider trading has now come to be widely accepted i.e. if a person
misappropriates material non-public information for the purpose of trading in
breach of a duty of confidence or loyalty, there is a violation of Section 10(b)
and Rule 10b-5.

In India, it would appear that the SEBI has infact even gone beyond the
parameters of the insider trading theories laid down in the United States of
America, especially in view of the 2008 amendments. By creating Regulation
2(e)(ii), the SEBI has expanded the liability under Regulation 3 to any person
who may have been in receipt of unpublished price sensitive information. Thus,
in India, it appears to not merely a person who is alleged to have
misappropriated information in violation of any duty or confidence, business or
personal, may be liable, but any person who has ‘received’ unpublished price
sensitive information. Thus, on a conjoint reading of Regulations 2(e)(ii),

20
[2004] 49 SCL 351 (SAT).

18
Regulation 3 and Regulation 4, it appears that any person in receipt of
unpublished price sensitive information who deals in securities would be liable
for insider trading, despite the fact that he may not have breached any duty
either to the company, or to any person who was the source of the information.

Another significant area of controversy in both the legal regimes of India and
the United States is the ‘possession v. use’ i.e. whether liability for insider
trading may be affixed if there is a trade while the insider was in possession of
the relevant information or whether it is essential to prove that the relevant
information was actually used in the trade. In the United States, it was held
that it was not necessary to prove a causal relationship between the
misappropriated information and the dealing in securities. The dealing in
securities ‘on the basis of’ material non-public information has been interpreted
to mean trading while being ‘aware’.

In the Indian regime, Regulation 3 adopts the ‘possession’ standard and

prohibits an insider from dealing in securities ‘while in possession of’
unpublished price sensitive information. The exact position in the Indian regime
remains unclear.

The liability regime in both jurisdictions is similar in the sense that both
jurisdictions provide for a criminal liability. However, the law of the United
States of America contains various different provisions with respect to liability
which are not found under the Indian law. Under the Indian regime, Section
15G of the SEBI Regulations provides a civil penalty of twenty five crore rupees
or three times the amount of profits made out of insider trading whichever is
higher. 21 The criminal prosecution for insider trading is envisaged in Section

21
Under Section 15G, SEBI Act, 1992 liability is incurred by an insider who: (1), either on his own
behalf or on the behalf of any other person, deals in securities of a body corporate listed on any stock
exchange on the basis of unpublished price sensitive information or (2) communicates any
unpublished price sensitive information to any person, with or without his request for such
information, except as required in the ordinary course of business or under any law, or (3) counsels,

19
24(1) which provides for a punishment of a maximum of ten years
imprisonment, or a maximum fine of 25 crores or both. Section 24(2) also
provides that if the person concerned does not pay the civil penalty imposed by
the adjudicating officer, he may be punished with imprisonment which may
extend to ten years, but which shall not be less than one month, and a fine that
may extend to twenty five crores or both.

In the United States of America, the criminal liability is envisaged in Section

32(a) of the Securities Exchange Act, 1934 .Under Section 32(a) it is provided
that if a person is convicted of a ‘wilful’ violation he shall be fined upto
$5,000,000, or imprisoned not more than 20 years, or both, except that if not a
natural person, a fine upto $25,000,000 may be imposed. Which now brings us
to the landmark case of Raj Rajaratnam, a New York hedge fund manager, In
October 2009, the Justice Department charged him with fourteen counts of
securities fraud and conspiracy. Rajaratnam, who was found guilty on all
fourteen counts on May 11, 2011, had allegedly cultivated a network of
executives at, Intel, McKinsey, IBM, and Goldman Sachs.

These insiders provided him with material non-public information. Preet

Bharara, the government’s attorney, argued in the case that Raj Rajaratnam
had made approximately $60 million in illicit profits from inside information.
There were many players i.e Raj Rajaratnam was the manager of the hedge
fund Galleon Group, which managed $6.5 billion at its height. Rajat Gupta is a
former director at Goldman Sachs and head of McKinsey consulting. On
September 23, 2008, Warren Buffet agreed to pay $5 billion for preferred
shares of Goldman Sachs. This information was not announced until 6 p.m.,
after the NYSE closed on that day. Before the announcement, Raj Rajaratnam
bought 175,000 shares of Goldman Sachs. The next day, by which time the

or procures for any other person to deal in any securities of anybody corporate on the basis of
unpublished price sensitive information. [The apparent disconnect between Regulation 3 and Section
15G has been previously discussed].

20
infusion was public knowledge, Rajaratnam sold his shares, for a profit of
$900,000. In the same period of time financial stocks as a whole fell. Rajat
Gupta had called Rajaratnam immediately after the board meeting at which
Warren Buffet’s infusion had been announced, and told him of the money
Goldman expected to receive. This information was material to the price of
Goldman stock, thus inciting Rajaratnam to make the trade, something he
would otherwise not have done. By buying 175,000 shares of Goldman stock
immediately before the market closed on September 23, 2008, Rajaratnam
inflated its price, making this reflect the then-unknown fact that Berkshire
Hathaway would invest $5 billion in the bank. It is clear that Rajaratnam’s
actions caused Goldman Sachs stock to more accurately reflect its true value. 22

On a comparison of the regulatory regime in India and in the United States of

America, it is apparent that the regulatory regime in the United States is not
only more aggressive, but it has also evolved significantly over the last eighty
years. In comparison, the Indian regulatory regime is at a nascent stage in its
growth.

22
http://sevenpillarsinstitute.org/case-studies/raj-rajaratnam-and-insider-trading-2 (last visited on
12/09/2014)

21
X. THE LACUNAE IN THE FRAMEWORK AND IMPLEMENTATION OF THE
REGULATORY MECHANISM

The implementation of the regulatory mechanism highlights some significant

glitches that need to be plugged. These have broadly been enumerated
hereunder:

Firstly, the definition of ‘insider’ under Regulation 2(e), is conspicuously

ambiguous. It appears from a plain reading of the provision that to prove that
one is an insider either of the two must be established: firstly, to qualify as an
‘insider’ within the ambit of Regulation 2(e) (i) two elements need to be
established: (a) proof of a connection with the entity concerned (b) a
reasonable belief of his having had access to unpublished price sensitive
information.

Secondly, to qualify as an insider within the ambit of Regulation 2(e)(ii),

although a relationship with the company is not essential, it is essential to
actually prove receipt of the information. From a prima facie reading, it
appears, as though, ‘outsiders’ would also be within the definition of ‘insider’
under the SEBI Regulations.

Thirdly, there seems to be a disconnect in Section 15G of the SEBI Act, 1992
which provides the penalty for insider trading. There is a grey areas which
appear to emerge on a reading of this provision, in clauses (i) and (iii) of
Section 15G, liability arises when an insider or a person to whom he has
communicated unpublished price sensitive information to deals in securities, ‘on
the basis of’ such information. The phrase ‘on the basis of’ was used in
Regulation 3 prior to the 2002 amendment, after which the phrase ‘on the basis
of’ was substituted with the phrase ‘when in possession of’. However, a similar
amendment has not been made in Section 15G which has given rise to an

22
anomalous situation. Thus, it is unclear whether mere possession is sufficient to
affix liability of insider trading under the Indian law.

Fourthly, another area of concern, which has the potential to raise controversy,
is the scope and ambit of what constitutes ‘unpublished price sensitive
information’. This is evidenced by the Hindustan Lever Limited Case wherein it
was successfully argued that since certain information was being speculated by
the media, it did not qualify as unpublished price sensitive information. The
amendment of 2002 in Regulation 2(k) has to some extent reduced this
controversy. However, there seems to be a contradiction between the
Regulation 2(k) and the decision of the SAT in the Samir Arora Case. In the
case of Samir Arora, it was held that information which ultimately turns out to
be incorrect or uncertain cannot be held to qualify as ‘unpublished price
sensitive information’. However, Regulation 2(k) provides that ‘unpublished’
information means information which is not published by the company, or its
agents, and is not specific in nature. Thus, there seems to be a fundamental
contradiction in this regard between the decision of the SAT and the SEBI
Regulations.

Fifthly, the most significant predicament which arises is the degree of ‘mens
rea’ necessary to establish a charge of insider trading. The failure to establish
the requisite mens rea is a major dilemma for the enforcing agencies, especially
given the covert nature of the offence of insider trading. A clear example is the
Rakesh Agrawal Case wherein it was held to establish a violation of Regulation
3 it was necessary to prove an element of ‘deceit’ or ‘manipulation’, which the
SEBI was unable to prove in the facts of that case. The SAT specifically rejected
the contention of SEBI that it was not necessary to establish a ‘profit motive’ to
establish a charge of insider trading. Thus, it was clear that the element of
mental intent, although not specifically contemplated by Regulation 3, cannot
be ignored for the purpose of establishing a charge of insider trading.

23
Lastly, it is not merely the proof of the existence of a negative mental intent
that creates difficulty in implementation but also the ambiguity in the degree of
proof necessary to prove the facts necessary to establish the offence of insider
trading.

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XI. CONLUSION

Thus, the problems in establishing charges of insider trading are largely related
to the unavailability of sufficient proof to establish mental intent and whether or
not access to unpublished price sensitive material was possible in the facts and
circumstances of a particular case. On an analysis of the regulatory mechanism
in India, the only conclusion that can be reached is that the laws prevalent in
India are ill-equipped to combat insider trading and are not conducive to the
needs of a rapidly changing economy and corporate structure.

On analysis of the laws prevalent in both countries, it is concluded that the laws
in force in the United States are better equipped than the laws prevalent in
India to prevent and penalize the practice of insider trading. Further elucidated
are certain suggestions as to reform the Indian regime such as:

I. The ambit of Regulation 2(e)(ii) of the SEBI Regulations, post the 2008
amendments have widened the definition of an ‘insider’ beyond its
desirable limits and this needs to be limited.

II. Disconnect between Regulation 3 of the SEBI Regulations, and Section

15G of the SEBI Act, 1992 must be resolved.

III. The element of Mental Intent has to statutorily incorporated.

IV. Affirmative defences for pre-planned trades envisaged in Rule 10b5-1

should be incorporated into the SEBI Regulations.

V. Indian regulatory mechanism would be able to substantially bolster its

enforcement mechanism if it incorporated a provision along the lines of
Section 21A (e) of Securities Exchange Act, 1934 whereby the SEC has
the powers to award bounties to the extent of 10% of the civil penalties

25
 imposed on the insider under Section 21A (a)(2) to informants who
played a significant role in providing information which led to the
conviction of the insider.

Though the legal regime in India would have to develop and evolve
significantly. Moreover, the regulatory mechanism in India must be vigilant to
evolve itself to keep pace with the fast growing securities market so as to
prevent unfair practices like insider trading from hampering its balanced growth
and shaking the confidence of the common investor.

26
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