Professional Documents
Culture Documents
The effective functioning and governance of a corporate organisation are attributed to ensuring
transparency, openness, and disclosure. To achieve these attributes, it is essential to maintain a
positive relationship among the managers and the stakeholders, and embrace the faith of the
investors. Investors are attracted by good corporate governance and this increases their
reliance on the companies. The Directors of the companies constituting the Board of Directors
play a major role in deciding the future of the company. The decisions of the board can affect
the stock market reaction towards investors. Hence, the meetings and decisions of the board
amount to confidential information. Confidential information is only shared when it is required
for the benefit of the company. Hence, it is important to maintain the confidentiality of the
information, until disclosed in public. It has been observed over the years that to gain an unfair
advantage over others, the people working in the organisation manage to get their hands on
confidential information and often engage in unfair trade. This is an unfair practice and morally
wrong, which can have bad consequences. Hence, it is essential to curb these practices globally.
There are steps taken by different governments to prohibit such practices via regulations
globally.
The problem of insider trading emerged with the introduction of the concept of trading of
securities in the global market. In India, SEBI regulates the functioning of the capital market. It
was established in 1992 under the SEBI Act, 1992. It was necessary for the protection of
investors to enact legislation and establish an authority that can regulate the securities market
effectively. In 1952, it was recommended by the Bhabha committee to make it obligatory for
the directors to disclose the information of sale/purchase of shares in a different register
managed by the company. Consequently, Section 307 (provides for maintenance of a register
by the companies to record the directors’ shareholdings in the company) and Section 308
(prescribed the duty of the directors and persons deemed to be the directors to make
disclosure of their shareholdings in the company) were introduced in the Companies Act, 1956.
By the Companies Amendment Act, 1960, Managers of the company were added to the scope
of section 308. In 1978, it was recommended by the Sachar Committee to make stringent laws
to acknowledge transaction details of traders so that it can be identified that no unfair gain has
taken place by using price-sensitive Information. In 1986, a committee headed by G. S. Patel
described the term ‘Insider Trading’ in their report recommending to amend the Securities
Contract (Regulation) Act (“SCRA”), 1956 to allow the exchanges to implement strict policies to
prohibit insider trading of information. In 1989, it was recommended by the Abid Hussain
Committee to include the act of insider trading under civil and criminal offences and it was also
suggested for stricter regulation by SEBI to restrain the unfair practice of Insider Trading. To
regulate the unfair trade practices in the securities market, SEBI (Insider Trading) Regulations,
1992 was enacted. The regulations were amended in the year 2002.
Insider trading refers to the trading of unpublished price-sensitive information behind the
corporations in order to gain unfairly or avoid loss. The Securities Exchange Board of India
(Prohibition of Insider Trading) Regulations, 1992 defines it as a breach of fiduciary duty by the
officers of the company towards the shareholders. The regulations on restriction of Insider
Trading were formed with the view of ensuring fair transfer and trade of securities in the
market. However, it is still difficult to say that countries have successfully overcome the
problem of insider trading.
“Insider trading is an act of buying, selling, subscribing or agreeing to subscribe in the securities
of a company, directly or indirectly, by the key management personnel or the director of the
company who is anticipated to have access to Unpublished Price Sensitive Information with
reference to securities of the company and it is deemed to be insider trading.”
When the trading is done by keeping in mind all the regulations and rules of fair trading, it is
termed as fair trading whereas when trading is done by violating such rules and regulations for
unfair gain, it is termed as unfair trading. Similarly, unfair trading is termed insider trading when
such trading takes place by involving the use of unpublished price-sensitive information. It is
ethically and morally wrong to share such information in the market as this provides an unfair
advantage to the person possessing the information whereas the traders not having the
information are left at a disadvantageous position.
In India, members of a company can trade in their company’s stocks subject to disclosure of
transaction records to maintain transparency and restrict the use of confidential information.
SEBI has framed several regulations on disclosure by insiders to bring the investors into
confidence and ensure transparency in trading. To ensure fair market trade, the practice of
insider trading is made a punishable offence in the country.
Who is an insider?
“Insiders” can be referred to as persons who are in a position to access confidential price-
sensitive information, connected with the company. They use such information against
uninformed investors in making huge profits before it comes to the knowledge of the public.
The term “insider” has wide interpretation and includes partners, directors, officers and
employees of a company and related companies, persons holding some kind of official
relationship with a company, professional or business (e.g., auditors, consultants, bankers, and
brokers), stockholders, government officials, and stock exchange employees, etc. It can be
noted that the board of directors and employees have direct access to price-sensitive
information and therefore are in a position to use such information in the manner they want.
There can be instances where the insider can supply the information to an outsider and hence,
deal with the outsider without letting the blame fall on him. The insider can engage in many
other such malpractices and remain unnoticed. Hence, it becomes important to point out such
deficiencies in the system.
The basis of insider trading is the exchange of securities willingly on receipt of some piece of
confidential information that is not publicly available and which has the potential to affect the
price of these securities drastically. For instance, a director of a company is aware that the
company is in a bad financial state and sells his shares in the company knowing that there will
be an announcement made to the public about the cut in a dividend. Similarly, the director
would be engaged in insider trading if he buys more stocks in a company on receiving
information about the discovery of diamond or gold on the company’s land, before public
announcement expecting the price of stocks to rise on such announcement. Thus, an insider
who knows that the company is in a financial mess may sell his shares in the company knowing
that shortly there will be a public announcement of the news.
Any person having any kind of professional or business relationship may become a connected
person and thereby an insider, if he may reasonably be expected to have access to unpublished
price-sensitive information. The relationship and accessibility to unpublished price-sensitive
information facilitated by such a relationship are necessary.
The conditional buying or selling of securities by the advantageous person only when in
possession of confidential information affects the determination of the value of those
securities. Also, the possession of confidential information in question implies that the
advantageous person has some connection in the corporation who is yielding the essential
information to that person. He may be a director, employee, or professional adviser of that
company. This is disadvantageous for the corporation as well.
It is essential for a fair trade that insider information must not be utilised by the directors or
employees to further their own interests. Doing such an act would amount to a breach of their
obligation towards the company. People will lose interest in such companies. There should be a
continuous check on such practices to ensure the integrity of the market is not degraded by the
loss of confidence of investors. These practices are immoral, unethical and can cause damage to
a large number of innocent investors.
Over time, countries have expressed their objections to such practices. The USA was the first
country to tackle the problem of insider trading effectively. The United Kingdom has imposed a
lot of obligations and duties on the Directors to control the transfer of confidential information.
India has also developed various regulations in this regard. The Companies Act and SEBI
Regulations 1992, are examples of such regulations. However, the country has not been
effective in fighting such practices.
The committee was formed in June 1977 for reviewing the Companies Act, 1956
and Monopolies and Restrictive Trade Practices Act (MRTP), 1969. The committee submitted its
report recommending: Insider shall notify his intention of trading; prohibition on trade by
Insiders, of the securities before and after two months of the closing of the accounting year, it
shall be applicable for right’s issue also; the insider’s dealings of shares is required to be
maintained in a register by the company; provision for compensation and civil remedy.
The committee was formed in May 1984 with the aim of conducting a thorough review of the
dealings of stock exchanges and making recommendations in that regard. The committee
identified the essential need for the legislation on insider trading in the country, the absence of
which was the primary cause of these activities.
It was created in 1989. The committee recommended the declaration of insider trading as a civil
as well as a criminal offence. It advised SEBI to form regulations in this regard. In furtherance of
the recommendations by the committees, SEBI enacted regulations to curb the practice of
insider trading: –
Regulatory authority
In India, SEBI is the regulating authority for insider trading. SEBI derives its power to form the
regulations for insider trading under the SEBI Act, 1992. It is the responsibility of SEBI to
regulate and safeguard the securities market in India. Also, SEBI keeps a check on the insider
trading of securities.
The Indian market has no depth because of which it is considered to be highly volatile.
However, there has been significant growth in the capital market due to the increasing number
of investors, more participation of different companies, capitalisation, stock exchanges, foreign
direct investment, turnover, mutual funds, brokers, etc. The growing economic reforms in the
country are a big reason behind the development of the capital market. The market has also
improved its volume, transparent operations, and investment holding methods by way of a
depository.
The Harshad Mehta scam of 1992 and other fraudulent practices in the Indian capital market
have negatively impacted the image of the market that many investors fear the credibility of
investment in the security market, nowadays. Some of the common reasons for these
apprehensions are:
There have been various regulations issued by SEBI to control insider trading and other mal-
practices of market manipulations. However, for the first time with respect to insider trading,
SEBI issued the SEBI (Insider Trading) Regulation, 1992 which was last amended in 2018.
SEBI Regulations
Insider trading in India is prohibited by the Companies Act, 2013 and the SEBI Act, 1992. SEBI
has formed the SEBI (Prohibition of Insider Trading) Regulations, 2015 which prescribe the rules
of prohibition and restriction of Insider Trading in India.
The Regulations passed by the Securities Exchange Board of India i.e., SEBI (Prohibition of
Insider Trading) (Amendments) Regulations, 2018, are applicable mainly to “dealing in
securities” which involves “buying, selling or agreeing to buy, sell or deal in any securities by
any person either as principal or agent, by insiders on the basis of any private confidential
information.” The Regulations are only applicable to the exchange of listed securities.
Loopholes
The regulation of the practice of Insider Trading has been quite a task for the Indian Authorities.
The Annual Report of SEBI for the year 2016-2017 revealed that of all the investigations taken
up by SEBI, the Insider Trading cases covered 14% cases (34 in number) in the year 2016-2017
as opposed to 12 cases in the year 2015-2016. With each passing year, the offence of Insider
trading is significantly increasing and so is the demand for stricter regulations. The pendency of
cases is also a major concern as of 34 cases investigated, only 15 were finished. The allegations
of insider trading are raised on the basis of circumstantial evidence and lack of concrete
evidence makes it difficult to detect and prove the offence. Though the regulatory system is
very robust, the rate of successful cases is quite less. This is because SEBI does not hold the
required technological expertise to effectively perform investigations. The acute shortage of
resources and manpower is also one reason for the failure of SEBI. Further, the Indian law does
not cover the cases where the offence of Insider Trading has been committed by a foreign
national. There is no provision of penalty or investigation in such cases. The Acts lack the
application on the extra-territorial applicability of the regulations.
The Directors of a company plays a major role in the preservation of the unpublished price
sensitive information and hence, to eliminate the offence of insider trading and for the
preservation of interest of investors in the market, it is essential to make the people who are
considered as ‘Insider’ in the company, accountable for their unlawful dissemination of price-
sensitive information. It is not possible to fully control the actions of the Insiders and hence, the
people holding the top managerial positions i.e The directors, officers, and other members of
the company should set high standards of ethical behaviour in their organisations to ensure
that the company’s goodwill is not damaged. This behaviour cannot be imposed compulsorily
on anyone. The Indian authorities can also focus on adapting such techniques or technologies
that can help in the faster redressal of pending cases.