Insider Trading
What is insider trading?
History and Development of Insider Trading Laws in India
The history of Insider Trading in India goes back to the 1940s with the formulation of government committees such as the Thomas Committee of 1948, which evaluated inter alia, the regulations in the US on short swing profits under Section 16 of the Securities Exchange Act, 1934. Thereafter, provisions relating to Insider Trading were incorporated in the Companies Act, 1956 under Sections 307 and 308, which required shareholding disclosures by the directors and managers of a company.
Due to inadequate provisions of enforcement in the companies Act, 1956, the Sachar Committee in 1979, the Patel Committee in 1986 and the Abid Hussain Committee in 1989 proposed recommendations for a separate statute regulating Insider Trading.
International Overview of Insider Trading Regulations
Different countries have diverse enactments and codes of conduct to curb the ill practice of Insider Trading. While the US and the UK have comprehensive legislation and monitoring bodies in this regard, countries like Germany rely on a voluntary code of conduct.
United States:
The United States has been the most successful in prohibiting insider trading and the first country to tackle insider trading effectively. The market crash due to protracted lack of investor’s confidence in the securities market and then the great depression in the US economy led to the enactment of the Securities Act, 1933 in which the provisions relating to prohibition of fraud in the sale of securities were included, which were greatly braced by the subsequent Act viz. Securities Exchange Act, 1934.
United Kingdom:
Insider trading was first exposed in the UK in Para 22 of the White Paper on the Conduct of Company Directors 19776. However, the United Kingdom first legislated against this practice in the year 1980 and broadcasted its first enforcement in the year 1981 which preceded the enactment of the Company Securities (Insider Trading) Act, 1985 or the English Act which principally regulates the practice of Insider Trading today. The Act prohibits an individual from dealing on a recognized stock exchange in the securities of the companies which are listed, with which he is or has been, in the past six months, connected and by virtue of his connection, has acquired unpublished price sensitive information. The contravention of the provisions of the Act involves both civil and criminal liabilities.
One interesting aspect of the Act in the UK is that the prohibition extends to dealing in the securities of a company, apart from that with which the individual is connected, if the information relates to another company or any other transaction involving both companies. Furthermore, the recipient of such an unpublished price sensitive information is also prohibited from dealing, with the exception of certain circumstances.
It is seen by practical examples that the success of Insider Trading laws in the UK has been pretty low. Most of the defendants have been acquitted on technicalities owing mainly to the rigidity in the definition of Insider Trading and partly because of the inadequate powers granted to the Securities and Investments Board (SIB). Another aspect that emphasis should be laid on is the undesirable degree of burden of proof required to prove any case of Insider Trading.
Germany:
In Germany, a voluntary code of conduct is emphasized upon, which is to be strictly followed by the Companies, Stock Exchange dealers and banks so as to preclude the wrong use of confidential inside information by the persons concerned. This code has astonishingly been very successful as there has been no major Insider Trading scandal notwithstanding the flourishing market and the ever-increasing take-over bids.
Insubstantial Investigative Infrastructure
Proving Insider Trading is a bizarrely difficult task owing to the lack of material proof in a majority of cases. Insider Trading cannot be proved beyond reasonable doubts unless there is substantial material proof supporting it or when the insider himself confesses in an admissible form, to have indulged in the dealing of confidential information for personal gains, which is very rare a possibility and is not expected to happen in the practical world. Indulging in buying and selling of Securities is a legal practice. It is only what’s in the mind of the dealer that constitutes the basis of its legality.
Lowering down the degree of proof required to prove a case of Insider Trading would be unaccounted for, as Indian Judiciary has always believed in acquitting 100 guilty offenders in an attempt not to convict one innocent person. Even though the removal of the words, by virtue of such connection came as a relief to SEBI and simplified its task of proving an insider trading case to a great extent, it is still recommended that the SEBI should be granted slightly extended powers for more exhaustive and efficacious investigation of cases involving Insider Trading, which would definitely help impart justice and convict every such violator of the Insider Trading regulations by providing greater degrees of positive evidence supporting every such conviction thus proving every case beyond reasonable doubts. Because despite of not having to prove the connection of the accused with the company, most of the cases are not established owing to the lack of evidence gathered against the accused.
Furthermore, it is advised that the SEBI should be provided downright assistance of the official government investigative agencies like Central Economic Intelligence Bureau (CEIB) to investigate into the matters relating to Insider Trading so as to improve the standards of investigation and hasten up the process of gathering proof against the insider. SEBI already has access to the CBI (Central Bureau of Investigation) whenever it seeks help in investigation and collection of evidence. But any additional help would prove to be useful and very much welcome by SEBI. Such a practice of official governmental assistance in an investigation into Insider Trading matters has also proved to be extremely successful and efficient in the United States, where The Federal Bureau of Investigation (FBI) aids the Securities and Exchange Commission (SEC) in inspecting the cases of Insider Trading in a more comprehensive and yet expeditious way. It has, therefore, shown a higher rate of indictments in the recent past.
Remedy for Investors
Talking about the SEBI regulations in India, another glaring loophole is of the absence of an adequate remedy available to the investors at large. The insider is more often than not, acquitted scot-free. Even in the cases where they are convicted, they are required to pay a sum of money much less than the number of profits that they might have actually made or they have to undergo a prohibition of dealing in securities for a time period stipulated in the order. The end result is that the insider walks away satisfied with the profits he eventually is left with. If this trend continues, then the investors would be apprehensive about investing in the securities market. Although it sounds practically impossible to provide a remedy for the investors, owing to the difficulty in calculating the comparative losses suffered by each and every investor, SEBI should work out a way in which such aggrieved investors may be refunded the losses that they might have suffered due to any act of insider trading.
In order to provide compensation to the investors, the first step would be to ascertain the number of aggrieved investors and also to calculate how much losses they might have suffered comparatively, due to an act of insider trading. It is thus suggested that after convicting a person of insider trading and ordering him to pay the penalty in consequence of his indictment, a public notice to be issued for a certain period of time, asking the aggrieved investors to demand compensation for the losses that they might have suffered due to a biased trading activity by the insider. The compensation would be paid out of the amount recovered from the person indicted. The investors not acknowledging such a notice would simply lose their right to ask for repayment.
After the number of investors has been ascertained, SEBI would have to calculate and decide how much money does each investor individually deserves to get. Calculating this amount can prove to be a tedious task but very useful howsoever. SEBI has the records of the scrip at the time the insider trading activity happened and also the present scrip for the same securities. It can thus calculate the difference in the two and further determine the investors’ individual holdings in the securities both at the time of dispute and presently and thus award them compensation accordingly.
Another question that arises is that if the price of the securities had fallen after the insider trading activity happened, then how and what to pay the investors? The answer is simple. In case the price of the securities on the present date is lesser than on the date in dispute, then it is almost impossible to provide the investors with any kind of remedy. Therefore, there won't be any need of issuing a public notice or even calculating the amount.
These suggestions, however, are very crude, and SEBI can effectively introduce new regulations providing a remedy for the innocent investors aggrieved of the acts of insider trading.
Famous Cases of Insider Trading
Dilip Pendse:
Dilip Pendse served as the Managing director of Nishkalpa, a subsidiary of TATA Finance Ltd. As of March 2001, Dilip made a loss of 79.37 crores. This information was to be made public only a month later on April 30th. This information was price sensitive as it would lead to a fall in prices if leaked. Dilip Pendse was in access to this information due to the role he played within the company.
During this period Dilip leaked this price-sensitive information to his wife. In between this period, 90,000 shares which were held by his wife and a company jointly run by his wife and her father in law in Nishkalpa were sold to avoid losses. Dilip Pendse, his wife, and the company jointly owned by his wife and her father in law were found guilty of insider trading.
A penalty of Rs 500,000 was imposed on each of them and Dilip Pendse was banned from capital markets for three years
Rajesh Jhunjhunwala:
Rakesh Jhunjhunwala was investigated by the SEBI in January 2020 on account of alleged insider trading. These allegations were based on the trades made by him and his family in the IT education firm Aptech. Aptech is the only firm in Jhunjhunwala’s portfolio in which he owns managerial control. SEBI also questioned Jhunjhunwalas wife, brother, and mother in law. This, however, is not the first time that Rakesh Jhunjhunwala has been embroiled in insider trading controversy.
In 2018 too he was questioned over suspicion of insider trading in the shares of the Geometric. Rakesh Jhunjhunwala settled the case through a Consent order mechanism. In a consent order, SEBI and the accused negotiate a settlement to avoid a long-drawn litigation process.
Martha Stewart:
Martha Stewart is a prominent TV personality who has also won an Emmy for her work on the ‘Martha and Snoops Dinner Party’. In 2001 Martha Stewart owned up to 4000 shares of the BioPharma Company ‘ImClone Systems’. Her broker received a tipoff that the CEO of ImClone Systems sold all his holdings held in ImClone. The CEO did this as he received information that the FDA was about to reject one of ImClone’s cancer treatment drugs. Shortly after this news became public the shares of ImClone dropped 16% in one day.
Martha Stewart was able to save herself from losses amounting to $45,676. In 2004, Martha Stewart was convicted as the trade was made on the information that the CEO sold his stake, which was non-public info. Martha Stewart and her broker were announced guilty. She received 5 months in a federal correction facility and fined $30,000. The CEO of ImClone Systems was also convicted and sentenced for 7 years with a fine of $ 4.3 million.
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