Insider Trading

Besides the prohibition against unauthorised communication of inside information or insider trading, it is also sought by PIT Regulations to prevent the same and the model codes have been prescribed for prevention of insider trading for the listed companies as well as other organisations, which are associated with the securities market.

Introduction

Insider Trading is prohibited activity by virtue of sub-section (d) of section 12, which is further included in the wide ambit of sub-section (e). Even though it cannot be interpreted as criminal activity under the instance of fraudulent and unfair trading such as back running/ front running, it interferes with the trading in the best interest of the company, thereby opposing the object of corporate laws in India.

To ensure the fulfilment of that particular object and prohibit the transfer of price-sensitive information, India regulates the securities market with the help of Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992. The principal Insider Trading Regulations were published in the Gazette of India on 19.11.1992 vide S. O. LE/ 6308/ 92 (E).

Since the Act does not specifically define the meaning of ‘insider trading’ we interpret the prohibition [prescribed in sub-section (e)] as a deal involving securities and communications in such a manner which is not in consonance with the provisions of this Act or regulations or rules made thereunder. To make the interpretations further specific we refer to the world wide control of Insider Trading.

The United States, insider trading prohibition laws fall under a part of general laws made on fraud and according to SAT, it provides help only in appreciating the circumstances in a better way wherein a specific type of trading can result into insider trading otherwise, whereas “the cases that arise in India [have] to be considered within the framework laid down by the Insider Trading regulation of SEBI which are very specific in nature.”[1] That makes the scrutiny of trade in India, much more regulated as than the US laws.

“The prohibition imposed by Regulation 3 of PIT Regulations is as follows:

On insiders from dealing in securities while they possess unpublished price sensitive information;
On insiders from counselling or communicating such unpublished price sensitive information to any other individual except in the ordinary course of employment, business or profession or under any other law.”[2]

Prohibition is also imposed on procuring the unpublished and price-sensitive information in circumstances other than ordinary course of employment, business or profession or under any other law.[3]

Further, there are various regulations against insider trading under Regulation 3B of PIT Regulations and sec 15G of the SEBI Act, 1992. To safeguard the interest of other stakeholders in the company, in context of the ‘prohibition on a company possessing unpublished price sensitive information to deal in securities of another company’, there are two defences available viz., the defence of takeover complaint acquisition and Chinese wall. However, the burden of proof of the availability of defences is on the entities.

INSIDER

PIT Regulations throws light on the definition of insider such as the person who is in possession of unpublished price sensitive information. Under Regulation 3A of PIT Regulations, a company, which is in possession of any unpublished price sensitive information, is restricted to deal with the associate of some other company or to deal in the securities of some other company.[4]

Further, a connected person is also defined by this Regulation as a person who is deemed to be a director of the company or a director of the company.[5] The ambit of the ‘connected persons’ include not only employees and officers of the company but also those people who have any kind of business or professional relationship with the company if there is a suspicion that they can be in possession of any such information which is price sensitive in nature. PIT Regulations provide a list of people who are deemed to be connected with a company.[6]

According to the constructive interpretation done by SEBI in the matter of KLG Capital Services Ltd.,[7] insider includes all those persons who are, or were in connection with the company or was deemed to have been connected with the company; and

is reasonably expected that any unpublished price sensitive information in the context of securities of a company is accessible to them, or
have had access to or have received such information that is price sensitive in nature.

PRICE SENSITIVE INFORMATION

As per PIT Regulation, price-sensitive information includes that information which is a connection with a company either directly or indirectly and if such information is published, it is likely that such publication will affect the prices of the securities of the company materially.[8] A list of information that can be considered as price-sensitive is also provided by PIT Regulations.

The context of unpublished price sensitive information is explained by SAT as that information, which is not in knowledge of the people but if it is known, it is capable to affect the price of the scrip of a company, is known as unpublished price sensitive information. This is inclusive of mergers, amalgamations, takeovers, financial results of the company and intended declaration of dividends- both final as well as interim.[9] The ambit of price-sensitive information also includes that price, which is agreed to be paid to the shareholder of the target company by the acquirer for the substantial acquisition of shares and takeovers.[10]

UNPUBLISHED

Before the amendment brought by SEBI (Insider Trading) (Amendment) Regulations, 2002, both the expressions ‘price sensitive information’ as well as ‘unpublished’ were defined together.

It was observed in the matter of Hindustan Lever Ltd. v SEBI,[11] in light of the market speculation on merger as indicated by a large number of press releases during that period, there exist very strong reasons to believe that the impending merger, though not published or formally acknowledged, was in one sense known generally and denial of knowledge by UTI cannot be understood as indicative of market, in general, had no information in this context.

As per the amendment which came in 2002, speculative reports specifically fall under the purview of publication while the concept of ‘generally known’ is excluded from its domain. Typically, when the public has access to any information, it is known as published information and this publication can be done through various modes. SEBI prefers when a publication is done with the help of stock exchanges as it is more meaningful and reliable.[12]

MOTIVE IRRELEVANT FOR INSIDER TRADING

It was argued in Hindustan Lever Limited v SEBI[13] that in order to prove insider trading, it is a requirement to establish beyond a reasonable doubt that the transaction was undertaken with the motive of making a profit, gain in order to avoid any loss or to get an advantage. This argument finds its root on Sec 15J that speaks about the factors which are relevant for quantifying the penalty is the amount of unfair advantage or disproportionate gain. However, the Appellate Authority rejected this contention and agreed with the views of SEBI that there is no bearing of Section 15J on the breach of Regulation 3(1) of PIT Regulations and there is no necessity of avoiding the loss or making a profit for proving the charges of insider trading.

On the other hand, in the matter of Rakesh Agarwal v SEBI[14], it was observed by SAT that it is essential to prove the motive for the charges of insider trading. The above observation was set aside by the Supreme Court in the matter of SEBI v Shriram Mutual Funds.[15] It was stated that no question arises on the men’s rea or the proof of intention by the appellants and it is not an important element to impose a penalty under the SEBI Act or any of its regulations.

PREVENTION OF INSIDER TRADING

These model codes are comprised of various provisions such as the appointment of a compliance officer, pre-clearance of trades above a threshold limit, notification of grey/ restricted list and prevention and preservation of misuse of information being price sensitive in nature. For regulation of trade in the securities of the market by the employees and officers, a trading period is known as the trading window has to be made available for, during which the employees and officers of the company indulge in trade in the securities of the market.

The penalty is imposed on those who fail to comply with or implement the modal code of conduct.[16] On the other hand, a concept of the grey/restricted list is introduced in the model code that is prescribed for entities other than listed companies.[17] According to this provision, if any entity or intermediary is handling an assignment in connection with a listed company and is privy to some price-sensitive information, the trading in the securities of such a company is restricted. It is prescribed that any security that is either being purchased or being sold or even if it is under consideration for sale or purchase by the entity on behalf of the scheme of mutual funds/ its clients, has to be a part of the grey list.

Any organisation is restricted to trade in the securities of the company that is included in the grey list. It was observed that the ambit of the words ‘being considered for purchase or sale’ is so wide that it is inclusive of all those cases where advice is given for their purchase.[18] The provisions of PIT Regulations are violated if there is a breach of the code of conduct. SAT has observed that model codes are an inalienable part of PIT Regulations. The code cannot be understood as unenforceable or something separate. If the arguments presented by the notice have to be accepted then it would amount to ordaining the status of a lame duck to the board that is vested with the powers only for the stipulation of the code of conduct but is deprived of any means to get it enforced on the people.[19]

[1] Sameer C Arora v SEBI, Appeal No. 83/ 2004, SAT Order dated 15.10.2004

[2] AO Order No. PB/AO- 15/ 2011. In respect of Mr. Naval Choudhary, dated 28.02.2011 where a husband (insider) was penalized for communicating the information to his wife.

[3] Technically, Regulation 3 of PIT Regulation is drafted in a manner that ‘procuring’ unpublished price sensitive information may be argued that no person should be prohibited other than the one who is procuring the information is an insider. But such inconsistency may be ignored with the help of purposive construction. For instance, SEBI Order No. WTM/ KMA/ ISD/ 167/ 11/ 2009, In the matter of soliciting insider information, dated 18.11.2009, where a person used to solicit unpublished price sensitive information on his blog in return for a share in the profits between Rs. 10k and Rs. 1 Lakhs.

[4] The requirement of this separate provision was questioned as a company is a ‘person’, which is covered within the ambit of Regulation 3 of SEBI (Prohibition of Insider Trading) Regulation, 1992.

[5] Regulation 2(c) of SEBI (Prohibition of Insider Trading) Regulation, 1992.

[6] Regulation 2(h) of SEBI (Prohibition of Insider Trading) Regulation, 1992. See also, DSQ Holdings Ltd. v SEBI, Appeal No. PB/ AO- 16/ 2011, In respect of Mr. Neeraj Jain, dated 28.02.2011

[7] SEBI Order No. WTM/ MMS/ ISD/ 18/ 2009, In the matter of KLG Capital Services Limited, dated 22.09.2009. SAT, in appeal, has remanded the matter in Praveen Mohnot v SEBI, Appeal No. 191/ 2009, SAT Order dated 21.20.2010

[8] Regulation 2(ha) of SEBI (Prohibition of Insider Trading) Regulation, 1992.

[9] Rajiv B Gandhi & Ors. v SEBI, Appeal No. 50/ 2007, SAT Order dated 09.05.2008; Supreme court dismissed the appeal in CA No. 5302/ 2008 vides order dated 11. 09.2008.

[10] S Ramesh and S Padmalat Asis Bhaumik v SEBI, [2005] 59 SCL 521 (SAT).

[11] [1998] 18 SCL 311 (AA)

[12] AO Order No. PKB/ AO- 77/2010, Against Manmohan Shetty, dated 09.06.2010

[13] [1998] 18 SCL 311 (AA)

[14] Appeal No. 33/ 2001, SAT Order dated 03.11.2003

[15] AIR 2006 SC 2287

[16] AO Order No. PKK/ AO/ 126/ 2011, Against Shri Raj Kumar Shekhani, dated 20.06.2011. The penalty was also imposed on account of violation of Regulation 3(i) of the SEBI (Prohibition of Insider Trading) Regulation, 1992.

[17] AO Order No. PKB/ AO- 77/ 2010, Against Manmohan Shetty, dated 09.06.2010. See also, AO Order, in the matter of IQ Infotech Ltd., dated 30. 12. 2010.

[18] Informal guidance No. IVD/ ID1/ PKN/ JJ/ 06 dated 08.08. 2006 issued to M/s Prodigy Investment Management.

[19] AO Order No. PKB/ AO- 77/ 2010, Against Manmohan Shetty, dated 09.06.2010 which got upheld in Manmohan Shetty v SEBI, Appeal No. 132/ 2010, SAT Order dated 27.05.2011.