Professional Documents
Culture Documents
and India
Dr. Rajesh Kumar
Background
Capitalism and information asymmetry in the corporations
Development and growth of the securities market and
establishment of SEC as Market regulator with the aim of
creating trust of the investors
Insider trading Law is mostly developed not by the
legislature but by the SEC and defined by the courts.
Legal insider trading v illegal insider trading
Problems in prevention, detection and prosecution
Problems in implementation
Rationale
Inherent unfairness in use of information by someone where
others are not having the access. ( Uneven level Playing field)
Certain positions provides access to some information . Such
positions should not be used for personal benefit.
Information as a corporate property should not be used in an
unauthorised manner
Individual Selfishness and greed v Collective Selfishness
Public confidence and trust being the main element of
securities market should not be breached by a few people.
Idea of insider trading
• Difficulty in
• Classical theory (Connected person- establishing
disclosure by employee)
• Extended idea of Insiders link
• Others having access and possession
Trading on
• Trading after
Insider the basis of having the
(Fiduciary) informatio possession but
n without
knowledge
Legal
Material
Insider
Information
• Problem of definition Trading
• Effect is known only after
being put in public
• Trading by Insider
domain
disclosing trading
plan in advance
Contd.
Insider trading refers generally to buying or selling a security, in breach
of a fiduciary duty or other relationship of trust and confidence, on the
basis of material, nonpublic information about the security.
Insider trading violations may also include "tipping" such information,
securities trading by the person "tipped," and securities trading by those
who misappropriate such information.
Examples of insider trading cases :Corporate officers, directors, and
employees who traded the corporation's securities after learning of
significant, confidential corporate developments;
Friends, business associates, family members, and other "tippees" of
such officers, directors, and employees, who traded the securities after
receiving such information;
Contd.
Employees of Company, banking, brokerage and printing firms who traded
based on information they obtained in connection with providing services to
the corporation whose securities they traded;
Government employees who traded based on confidential information they
learned because of their employment with the government;
Political intelligence consultants who may tip or trade based on material,
nonpublic information they obtain from government employees; and
Other persons who misappropriated, and took advantage of, confidential
information from their employers, family, friends, and others.
Because insider trading undermines investor confidence in the fairness and
integrity of the securities markets, the regulator has to treat the detection
and prosecution of insider trading violations as one of its enforcement
priorities
Law of Insider Trading in U.S.
https://www.ecfr.gov/current/title-17/chapter-II/part-240/subpart-A#240.10b5-1
Securities Exchange Act of 1934 Rule 10b5-1 prohibits Trading "on the Basis
of" Material Nonpublic Information
The "manipulative and deceptive devices" prohibited by Section 10(b) of the
Act and Rule 10b-5 thereunder include, among other things, the purchase or
sale of a security of any issuer, on the basis of material nonpublic information
about that security or issuer, in breach of a duty of trust or confidence that is
owed directly, indirectly, or derivatively, to the issuer of that security or the
shareholders of that issuer, or to any other person who is the source of the
material nonpublic information.
Definition of "on the basis of." Subject to the affirmative defenses in paragraph
(c) of this section, a purchase or sale of a security of an issuer is "on the basis
of" material nonpublic information about that security or issuer if the person
making the purchase or sale was aware of the material nonpublic information
when the person made the purchase or sale
Defences available in Insider trading cases in U.S.
Before becoming aware of the information, the person had:
Entered into a binding contract to purchase or sell the security,
Instructed another person to purchase or sell the security for the instructing
person's account, or
Adopted a written plan for trading securities. However, The contract,
instruction, or plan described must state the specified amount of securities to
be purchased or sold and the price at which and the date on which the
securities were to be purchased or sold
Included a written formula or algorithm, or computer program, for determining
the amount of securities to be purchased or sold and the price at which and the
date on which the securities were to be purchased or sold.
Contd.
Did not permit the person to exercise any subsequent
influence over how, when, or whether to effect purchases or
sales; provided, in addition, that any other person who,
pursuant to the contract, instruction, or plan, did exercise
such influence must not have been aware of the material
nonpublic information when doing so; and
The purchase or sale that occurred was pursuant to the
contract, instruction, or plan. . . .
Duties of trust or confidence in misappropriation insider
trading cases
Punishment and Penalty
Up to 20 years imprisonment
Fines up to $5 million or twice the gain
Criminal forfeiture of profits
Example: assume a single trade with profits of $500,000
Under Sentencing Guidelines, even for a first time
offender, and assuming a prompt guilty plea:
Prison for up to 37 to 46 months on the low end
Could be up to 70 to 87 months (depending on various
factors)
Civil Action
Disgorge “ill-gotten gains”
Paymonetary penalties up to three times the amount
of those gains
Defendants lost their jobs and their hedge funds are
out of business
SECbars against future employment in the securities
industry
Under pending legislation, bar will include the hedge
fund industry
Interpretation of law
The Texas Gulf Sulphur Co (TGS) was on a mining exploration throughout Canada
based on a geological survey. TGS began mining in a particular area that the survey
stated was promising for mineral deposits. After finding quite a bit of minerals and
then verifying their existence, TGS was quite confident they had found a rich
mineral deposit. This information was not released to the public. Officers,
employees, and others closely connected to TGS began buying shares in the
company.
The purchase of shares by these insiders led to speculation and rumoring throughout
the industry that TGS had found a promising area. TGS issued a false statements to
quell the rumors, which actually incorrectly stated the results of the findings. Three
days later company announced the real findings, although the news did not reach
the public until four days later. Between the initial misleading statement and the
eventual correct announcement Ds continued to trade TGS stock .
Contd.
The SEC brought this action for insider trading. Defendant argued the
information was not “material” and didn’t rise to the level required for
public disclosure. Persons are held guilty of insider trading on the basis
of following reasoning.
A reasonable person would believe the information was relevant to the
share price. In this case, the uncertainty regarding the information was
not substantial enough to justify withholding the information.
The information was material to all shareholders and Ds explicitly
traded on that basis, thus their actions constitute insider trading.
When reviewing whether their actions constituted insider trading, the
court looked to the conduct as evidence that information was material.
Contd.
O’Hagan, a partner of a law firm that was providing legal services to a company called
Grand Metropolitan PLC that was interested in acquiring a company called Pillsbury
Company. O’Hagan did not work on the case himself, but using the information about
the planned acquisition he acquired a significant number of shares of the target
company, without disclosing that fact to the law firm in which he worked.
The court held him liable of breaching Rule 10b-5 and made the misappropriation
theory the law of the land.
The scope of the liability under the misappropriation theory is therefore as follows:
1) Duty of confidence and trust between the source of the material non-public
information and the trader;
2) Trader uses the information without disclosing it to the source of the information;
3) Trader uses the information for personal gain.
SEC v. Dorozhko
Thecourt found Dorozhko liable for insider trading, even though
there was no fiduciary duty applicable to him.
Hewas a Ukrainian citizen who hacked the computer of an
employee of the IMS Health Inc. and stole the financial report of
the company that was supposed to be disclosed the next day.
Based on the information that he obtained ‘put options’ and
inquired significant profits after the report was disclosed.
Thecourt found Dorozhko liable for insider trading based on
fraudulent access to inside information, not the breach of
fiduciary duties.
Salman v. United States
Unpublished
1. Not Published By Company/Its Agents &
2. Not Specific In Nature
SEBI Powers
Right To Initiate Criminal Proceedings Under Section
Insider Not To Deal In Securities
Prohibiting Disposal Of Securities Acquired In Violation
No Communication To Deal/Counsel
Disgorgement
Deliver Back Securities to Seller
Pay To Seller Market Price At Time Of Issuing Directions Or At
Transactions Time
Transfer To Investor Protection Fund Higher Of Cost/Market
Price Of Securities
Cases