INSIDER TRADING IN INDIA IN COMPARISON WITH USA

-Kamshad1

“Markets are never wrong – opinions often are.”2

Insider trading, the most conspicuous misbehaviour of the stock market, is additionally one of the
most troublesome & difficult one to crack by regulators around the globe. Insider trading is a term
dependent upon numerous definitions and meanings and it envelops both lawful and disallowed
action. Insider trading happens legitimately every day when corporate insiders – officials, directors
or employees – purchase or sell stock in their own companies inside the bounds of company policy
and the guidelines administering this trading. In basic terms 'insider trading' is purchasing or
selling of a security, in breach of a trustee obligation or other relationship of trust, and confidence,
while possessing material, non-public information about the security.

Insider Trading essentially denotes dealing in a company’s securities on the basis of confidential
information relating to the company which is not published or not known to the public (known as
unpublished price sensitive information), used to make profits or avoid loss. It is fairly a breach of
fiduciary duties of officers of a company or connected persons as defined under the Securities
Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992, towards the
shareholders.

An ‘unpublished price sensitive information’ means information relating to the present or

probable future state of the company, that can potentially affect the value of the securities of the
company in the market, that has not been available to the public. By the use of such material non-
public information, the insider himself, or the person to whom the information is made available
to, can trade in the securities of the company for his own benefit, thus causing a loss to those who
do not possess such information.

1
LLM, Galgotias University.
2
Jesse Livermore (American stock trader of the 1920s).

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An insider deals in shares of a company to make unwarranted gains by virtue of his employment
or such other connection, thereby rendering the underlying principle of fair and free transferability
of shares unaccomplished in the capital market. This is the primary reason for the formation of
these regulations viz. to promote free and fair transferability of stocks in the capital market wherein
the investors can deal in the securities in an unperturbed manner.3

INSIDER TRADING IN INDIA

Insider Trading means trading in the shares of a company by the persons who are in the
management of the company or are close to them on the basis of undisclosed price sensitive
information regarding the workings of a company, listed on a recognised Stock Exchange(s),
which they possess but which is not available to others. Insider trading in India is regulated by the
Securities and Exchange Board of India (“SEBI”).4

History of Insider trading in India

1948 – The Thomas Committee Report cited instances of directors, agents, officers, auditors
possessing strategic information regarding economic conditions of the company regarding the size
of the dividends to be declared, issue of bonus shares or awaiting conclusion of favourable contract
prior to public disclosure.

1979 – The Sachar Committee in 1979, the Patel Committee in 1986 and Abid Hussain Committee
in 1989 proposed recommendations for separate statute regulating Insider Trading. Sachar
Committee, in its report stated that directors, auditors, company secretaries etc. may have some
price sensitive information that could be used to manipulate stock prices which may cause financial
misfortunes to the investing public. The Committee recommended amendments to Companies Act

3
legal Service India (2017). Insider Trading in India. [online] Legalserviceindia.com. Available at:
http://www.legalserviceindia.com/article/l199-Insider-Trading.html [Accessed 15 Jul. 2020].
4
Vivro.net. (2015). Overview of the SEBI (Prohibition of Insider Trading) Regulations, 2015. [online] Available at:
http://www.vivro.net/blog/Overview-of-the-SEBI-(Prohibition-of-Insider-Trading)-Regulations,-
2015#:~:text=Insider%20trading%20in%20India%20is,Applicability%20of%20Insider%20Trading%20Regulations
%3A&text=%E2%80%9CInsider%E2%80%9D%20means%20any%20person%20who,or%20having%20access%2
0to%20UPSI [Accessed 15 Jul. 2020].

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1956 to restrict or prohibit the dealings of the employees. The Committee opined that Sections 307
& 308 of the Companies Act were insufficient to curb insider trading.

1992 – SEBI (Insider Trading) Regulations, 1992 came into existence.

2002 – The regulation was amended and renamed as SEBI (Prohibition of Insider Trading),
Regulations 1992.

2008 – Regulations amended to widen the definition of an insider.

2015 – SEBI in its Board Meeting held on November, 2014 approved SEBI (Prohibition of Insider
Trading Regulations). 2015 which were notified on Jan 15, 2015, effective from May 15, 2015.

Insider Trading and the Securities Exchange Board of India

Insider trading in India is basically determined by SEBI laws which govern the whole trading in
national stock exchange or Bombay stock exchange. The main aim of this law is that to ensure
traders that no one is gained by trading on ‘insider’ or ‘unpublished’ information- information that
is not made public. Another aim of this law is to make the information available to all the
participants. The enforcement of insider trading laws increases the market liquidity and decreases
the cost of equity. Insider trading laws are found in developed countries where strong trading
regulations are adopted. The main aim of government in the enactment of insider trading laws is
that all the participants in the market have the same information. When the Indian economy was
liberalized and security market was open to foreign institutional investors, common investors aim
to get quick returns in short period of time.

In India, SEBI (Insider Trading) Regulation, 1992 framed under the Section 11 of the SEBI Act,
1992 intends to curb and prevent the menace of insider trading in securities. An insider is a person
who is an accepted member of a group or organization who has special knowledge regarding his
firm.

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 Evolution

Bombay stock exchange was established in 1875 and since then Indian securities markets started
functioning. Before the enactment of SEBI Act 1992, there were two acts namely Capital Issues
Control Act,1947 and Securities Contract Regulation Act,1956. After independence, there was no
such as act which governed the insider trading practices in India.5

An ‘insider’, as defined by the Securities and Exchange Board of India (Prohibition of Insider
Trading) Regulations, 1992 is:

any 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, by virtue of
such connection, to unpublished price sensitive information in respect of securities of the
company, or who has received or has had access to such unpublished price sensitive
information.6

The Amendment Regulations in the year 2002 were formulated to eradicate the loopholes in the
Regulations of the year 1992. The changes in the definition of ‘insider’ in the Regulations of 2002
fundamentally include the substitution of ‘the’7 by ‘a’ in the group of words ‘securities of the
company’ and also the omission of the words ‘by virtue of such connection’3 from the SEBI
Regulations, 1992. The Regulations of 2002 were termed as the SEBI ([Prohibition of] Insider
Trading) Regulations, 1992, which is also known as the SEBI (Prohibition of Insider Trading)
(Amendment) Regulations, 2002. The reasons for this abovementioned amendment have been
discussed elaborately later.

Penalties for committing insider trading

5
Kumar Gourav (2018). Role of SEBI in curbing Insider Trading in India - An Analysis - iPleaders. [online] iPleaders.
Available at: https://blog.ipleaders.in/sebi-insider-trading-
offences/#:~:text=Insider%20trading%20in%20India%20is,that%20is%20not%20made%20public. [Accessed 15 Jul.
2020].
6
Clause 2(e), SEBI (Insider Trading) Regulations, 1992.
7
Subs. for ‘the’ by amendment regulations, 2002 vide Notfn. No. S.O.221 (E), dt.20/02/02.

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The penalties and punishments for committing insider trading have been defined under Chapter
IV-A of the SEBI Act. The penalties have been discussed below according to the SEBI
(Amendment) Act, 2002.

• Section 15(G)(i)– if an insider either on its own or on behalf of any person has dealt on
behalf of his company any unpublished information then he may be fined with RS. 25
crores or 3 times the profit made, whichever is higher.
• Section 15G(ii)– if an insider has given any price sensitive information then he may be
fined up to RS. 25 crores or 3 times the profit made.
• Section 15G(iii)– if an insider has procured any other person to deal in securities of
anybody corporate on basis of published information then he may be fined up to RS. 25
crores or 3 times the profit made which is higher.

Role and Power of SEBI in curbing Insider Trading

SEBI is established as a statutory body which works under the framework of Securities and
Exchange Board of India, 1992. The various roles and power of SEBI have been discussed under
Section 11 of the SEBI Act,1992.
• The main duty of SEBI is to protect the safeguard of investors and ensure proper trading.
• The main power of SEBI is that if any person has violated the provisions of this Act then
SEBI set up an enquiry committee.
• In order to investigate SEBI may appoint officers who look after the books and records of
insider and other connected persons.
• It is the duty of SEBI to give a reasonable notice to the insider before starting the
investigation.
• The board can also appoint an auditor who may inspect the books of accounts and affairs
of an insider.
• It is the duty of insider to provide necessary documents to the investigating authority.
However, it has neither any power to examine on oath, nor does it have the same power as
are vested in a civil court under the Code of Civil Procedure,1908 while trying a suit.

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 • After all the investigations, the officer has to submit the report within 1 month as per SEBI
1992 regulations. It also depends on the investigating officer to take longer time if he funds
that the work could not be completed within the stipulated time.
• After the final report submission, SEBI has to communicate the findings to the insider and
issue a show cause to the insider or other person within 21 days of the receipt of the
communication.
• The person to whom the finding has been communicated has to give the reply to the notice
within 21 days of receiving the notice. The Expert Group (headed by Justice M.H. Kania)
constituted by the SEBI in August, 2004, recommended in its Report that, Section ll(2)(i)
of SEBI Act be amended to empower SEBI to call for information from professionals,
subject to the professional’s rights (for not parting with the privileged information in their
possession).
• Any person who feels aggrieved by the directions of the SEBI can appeal to the Securities
Appellate Tribunal (Regulation 15).
• An appeal can be filed within 45 days of the receipt of the copy of the order from the date
on which appeal had been filed. SEBI (insider trading) regulations, 1992 consists of three
chapters and twelve regulations.

An insider is a connected person who is connected to the company directly or indirectly with the
company. The term ‘connected person’ is an important concept for defining the charge of insider
trading. It represents a person who is a director of a listed company or is an officer or an employee
of a listed company. Connected persons have access to the unpublished price sensitive information
of the company. It also includes a person who has been connected to the company prior to 6 months
to the implementation of insider trading regulations.

There are various regulations under SEBI Regulations, 1992 that defines the term ‘connected
persons’. They are as follows:

• Regulation 2(h)(i)- an officer or employee of the same company under subsection(1b) of

Section 370(1b) or subsection (11) of Section 372 of the Companies Act, 1956 or
subsection (g) of Section 2 of the MRTP Act,1969.

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 • Regulation 2(h)(ii)
• Regulation 2(h)(iii)
• Regulation 2(h)(iv)- a member of the board of directors
• Regulation 2(h)(v)- an official or an employee of a self-regulatory organisation
• Regulation 2(h)(vi)- any relative of any of the aforementioned persons
• Regulation 2(h)(viii)- a relative of the connected person
• Regulation 2(h)(ix)- a concern, firm, trust, Hindu undivided family

Shortcomings of The Sebi Regulations for Insider Trading

There have been many lacunae in the SEBI Insider Trading Regulations that have been observed
over the years, eventually making it tough for the investors to repose their confidence in the laws
designed to safeguard their rights and interests against the practice of insider trading. SEBI has
time and again encountered difficulties in establishing and proving a case (beyond reasonable
doubts in case of criminal proceedings) to convict the person/s accused of insider trading,
substantially owing to the lack of evidence.

One of the most famous cases highlighting the vulnerability of the SEBI’s 1992 regulations in this
regard is Rakesh Agarwal vs. SEBI. In this famous case, Rakesh Agarwal, the Managing Director
of ABS Industries Ltd. (ABS), was involved in negotiations with Bayer A.G (a company registered
in Germany), regarding their intentions to takeover ABS. Therefore, he had access to this
unpublished price sensitive information. It was alleged by SEBI that prior to the announcement of
the acquisition, Rakesh Agarwal, through his brother in law, Mr. I.P. Kedia had purchased shares
of ABS from the market and tendered the said shares in the open offer made by Bayer thereby
making a substantial profit. The investigations of SEBI affirmed these allegations. Bayer AG
subsequently acquired ABS. Further he was also an insider as far as ABS is concerned. By dealing
in the shares of ABS through his brother-in-law while the information regarding the acquisition of
51% stake by Bayer was not public, the appellant had acted in violation of Regulation 3 and 4 of
the Insider Trading Regulations. Rakesh Agarwal contended that he did this in the interests of the
company. He desperately wanted this deal to click and pursuant to Bayer’s condition to acquire at
least 51% shares of ABS, he tried his best at his personal level to supply them with the requisite

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number of shares, thus, resulting in him asking his brother-in-law to buy the aforesaid shares and
later sell them to Bayer.

The SEBI directed Rakesh Agarwal to deposit Rs. 34,00,000 with Investor Education & Protection
Funds of Stock Exchange, Mumbai and NSE (in equal proportion i.e. Rs. 17,00,000 in each
exchange) to compensate any investor which may make any claim subsequently. along with a
direction to (i) initiate prosecution under section 24 of the SEBI Act and (ii) adjudication
proceedings under section 15I read with section 15 G of the SEBI Act against the Appellant.
On an appeal to the Securities Appellate Tribunal (SAT), Mumbai, the Tribunal held that the part
of the order of the SEBI directing Rakesh Agarwal to pay Rs. 34,00,000 couldn’t be sustained, on
the grounds that Rakesh Agarwal did that in the interests of the company (ABS), as is mentioned
in the facts above.
Similarly, in the case of Samir.C.Arora vs. SEBI,8 Mr. Arora was prohibited by the SEBI in its
order not to buy, sell or deal in securities, in any manner, directly or indirectly, for a period of five
years. Also, if Mr. Arora desired to sell the securities held by him, he required a prior permission
of SEBI.
Mr. Arora in the Securities Appellate Tribunal contested this order of SEBI. SAT set aside the
order of SEBI on grounds of insufficient evidence to prove the charges of insider trading and
professional misconduct against Mr. Arora.

The abovementioned cases throw light on the inability of SEBI in proving its cases so as to prove
the allegations of Insider Trading. Most of this can be accounted to the lack of evidence in cases
relating to Insider Trading in India which make it difficult for the prosecution to prove the criminal
liabilities that may be imposed on the person accused of Insider trading. Unlike the balance of
probabilities that is required in proving a civil liability, a case involving criminal liability requires
the allegations to be proved beyond reasonable doubts.

8
[2005] 59 SCL 96 (SAT-Mum).

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 AMERICAN INSIDER TRADING LAW

The United States has been the leading country in prohibiting insider trading and the first country
to tackle insider trading effectively.
The market crash in 1929 due to prolonged lack of investors confidence in the securities market
followed by Great Depression of US Economy , led to the enactment of Securities Act of 1933 in
which Section 17 of the contained prohibitions of fraud in the sale of securities which were greatly
strengthened by the Securities Exchange Act of 1934The 1934 Act addressed insider trading
directly through Section 16(b) and indirectly through Section 10(b).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 10% of a
firm’s shares. Under Section 10(b) of the 1934 Act, SEC Rule 10b-5, prohibits fraud related to
securities trading. Further the Insider Trading Sanctions Act of 1984 and the Insider Trading and
Securities Fraud Enforcement Act of 1988 provide for penalties for illegal insider trading to be as
high as three times the profit gained or the loss avoided from the illegal trading..[ Much of the
development of insider trading law has resulted from court decisions. In SEC v. Texas Gulf
Sulphur Co.9, a federal circuit court stated that anyone in possession of inside information must
either disclose the information or refrain from trading. (1966)

In 1984, the Supreme Court of the United States ruled in the case of Dirks v. SEC that tippees
(receivers of second-hand information) are liable if they had reason to believe that the tipper had
breached a fiduciary duty in disclosing confidential information and the tipper received any
personal benefit from the disclosure. (Since Dirks disclosed the information in order to expose a
fraud, rather than for personal gain, nobody was liable for insider trading violations in his case.)

The Dirks case also defined the concept of "constructive insiders," who are lawyers, investment
bankers and others who receive confidential information from a corporation while providing
services to the corporation. Constructive insiders are also liable for insider trading violations if the

9
(1966)

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corporation expects the information to remain confidential, since they acquire the fiduciary duties
of the true insider.

In United States v. Carpenter (1986) the U.S. Supreme Court cited an earlier ruling while
unanimously upholding mail and wire fraud convictions for a defendant who received his
information from a journalist rather than from the company itself. The journalist R. Foster Winans
was also convicted.10
"It is well established, as a general proposition, that a person who acquires special
knowledge or information by virtue of a confidential or fiduciary relationship with
another is not free to exploit that knowledge or information for his own personal benefit
but must account to his principle for any profits derived therefrom."
However, in upholding the securities fraud (insider trading) convictions, the justices were evenly
split.

In 1997 the U.S. Supreme Court adopted the misappropriation theory of insider trading in United
States v. O'Hagan, 521 U.S. 642, 655 (1997),. O'Hagan was a partner in a law firm representing
Grand Met, while it was considering a tender offer for Pillsbury Co. O'Hagan used this inside
information by buying call options on Pillsbury stock, resulting in profits of over $4 million.
O'Hagan claimed that neither he nor his firm owed a fiduciary duty to Pillsbury, so that he did not
commit fraud by purchasing Pillsbury options.

The Court rejected O'Hagan's arguments and upheld his conviction

The "misappropriation theory" holds that a person commits fraud "in connection with" a
securities transaction, and thereby violates 10(b) and Rule 10b-5, when he misappropriates
confidential information for securities trading purposes, in breach of a duty owed to the source of
the information. Under this theory, a fiduciary's undisclosed, self-serving use of a principal's
information to purchase or sell securities, in breach of a duty of loyalty and confidentiality,
defrauds the principal of the exclusive use of the information. In lieu of premising liability on a

10
Christopher Cox, U.S. Securities and Exchange Commission Speech by SEC Chairman:Remarks at the Annual
Meeting of the Society of American Business Editors and Writers

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fiduciary relationship between company insider and purchaser or seller of the company's stock, the
misappropriation theory premises liability on a fiduciary-turned-trader's deception of those who
entrusted him with access to confidential information.

The Court specifically recognized that a corporation’s information is its property: "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."

In 2000, the SEC enacted Rule 10b5-1, which defined trading "on the basis of" inside information
as any time a person trades while aware of material non-public information — so that it is no
Defense for one to say that she would have made the trade anyway. This rule also created an
affirmative Defense for pre-planned trades.

In May of 2007, representatives Brian Baird and Louise Slaughter introduced a bill entitled the
"Stop Trading on Congressional Knowledge Act, or STOCK Act." that would hold congressional
and federal employees liable for stock trades they made using information they gained through
their jobs. The bill would also seek to regulate so called "Political Intelligence" firms that research
government activities and sell the information to financial managers.

CONCLUSION

The SEBI has strengthened the anti-insider trading laws by the amendment introduced in the year
2002. This amendment has simplified the task of curbing and tracking down the practice of insider
trading in more than one ways. With the expansion of the domain of the persons coming under the
category of ‘Insiders’, a different trend is observed in the cases that followed the amendment. The
persons who were earlier precluded from the purview of insiders have now been added to the list
and attempts have been made to prove their liability too in cases of insider trading.
Then again, the disclosures required to be made by the directors, officers and substantial
shareholders of a company and the appointment of a compliance officer in every listed company

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has proved to be effective in managing the accounts and noticing any abnormalities in the trading
patterns.
Despite the desirous changes that the amendment brought in, SEBI has not been able to utilize this
to its best. It has failed many times in proving its cases owing to lack of evidence. There should be
a strong and more efficient investigative mechanism to aid the SEBI in its investigations for insider
trading.
SEBI should welcome any kind of information that leads to the discovery of the practice of insider
trading being indulged in and it should also encourage people to share with it, any kind of
information relating to insider trading activities in progress. Though it is a bit too much to expect
out of people without any reward therefore SEBI should throw some light on its US counterpart,
the SEC, as far as this issue is concerned. The SEC gives away rewards, or what it terms as Bounty,
to the individuals who provide them with any kind of information leading to the discovery of an
insider trading scam. This bounty, as fixed by the SEC, is 10% of the amount of money recovered
of that made in profits by the insider until the discovery of his deeds.
Similarly the SEBI should also introduce the concept of giving away bounties or rewards so as to
lead to a decline in this practice by inducing fear in the minds of insiders of being exposed. If not
10%, then whatever amount that SEBI deems just, can be given as rewards to any person on the
basis of whose information, an act of insider trading can be uncovered or even better, prohibited.
Insider Trading is a practice that has been prevalent since the very inception of stock markets and
can never possibly be ended completely. But an endeavour can be made to curb this practice at all
the levels of the society and not just by the SEBI but also by the people aware of any kind of insider
trading practices being indulged in. Practically speaking, the practice of insider trading cannot be
eradicated completely, but an effort can be made to limit it to a great extent. This can be only
possible if there are deterrents to set examples for all the offenders and also the people likely to
involve in this evil practice.

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