Insider trading is perhaps one of those subtle but consequential crimes which has evaded legal sanctions for a long time. In India, it was recognized as a crime itself just a few decades ago.
By definition, insider trading occurs when a person, equipped with information that is not available to everyone, uses that information to buy or sell stocks of a company (in most cases a company he is associated with). It is seen as a crime is because it puts the said person at an advantage; the person can reap profits on the basis of confidential information. Evidently, this goes against the basic principle of fair trade on which all kinds of markets ought to function. If left unchecked, such an act can cause investors to lose confidence in the market which can in turn come crashing down.
There are two schools of thought with regard to insider trading. One seems to believe that a complete ban on trading of shares of a company by an insider would put an end to this corporate crime. Some, on the other hand, argue that when employees of a company are allowed totrade in in its shares, it promotes a feeling of participation in company. Therefore, those who indulge in insider trading breach the trust or confidence which is in violation of law. In tandem with this belief, there exist the Employee Stock Ownership Plans (ESOPs). These are regulated by the SEBI (ESOS and ESPS Guidelines) 1999 as well as the Companies Act.
What is of prime importance, however, is the efficiency of the capital markets as efficiency directly correlates to profitability. It is for the basic reason that capital markets are now at the synapses of all other markets and financial transactions. Eugene Fama’s hypothesis demonstrates the gravity behind the smallest of transactions in the capital market. His theory states that when there is any monopolistic information in the market, that is information which is not available to all the players, then there would be no profits and the market would suffer a net loss. This entails that evensmall nuggets’ unpublished and sensitive price information are convertible into undue profits for one person but results in net inefficiency (more losses) for the whole market.
Therefore, it is pertinent to understand that an investment is made by an investor on the belief that all the information that is available to him shows him the true value of the stock. But, if someone trades on the basis of information that is not available to everyone, then again a crime has been perpetuated, albeit there is no breach of trust in the conventional sense.
It is the SEBI (Prohibition of Insider Trading) Regulations 1992 which regulate insider trading in India. For a violation of insider trading to occur, the regulations require that an insider who is in possession of “material unpublished information” deals in securities on the basis of this information.
The law, as it stands today, does not make any person aware of UPSI an Insider. He needs to have had the information or be expected to have the information on the basis of duty owed to the company. Therefore, currently, a person who merely overhears an UPSI would not fall under the purview of the said regulations.
Under the SEBI Act, Section 24 prescribes a jail sentence to the offender. Unfortunately, the conviction rate in India in such cases is as low as 3 %. One however wonders if a jail sentence is enough for such cases or economically paralyzing the insiders is a more effective punitive measure in order to curb such crimes. The amendments in 2002 to the 1992 Regulations had ushered in several positive changes. These focused on bringing better regulation rather than merely making stricter laws. The most significant are the good governance requirements that sought to bring transparency within a company by requirements such as — disclosures by officers and appointment of compliance officers. It also regulated trades by allowing trading within specific time-windows and protecting sensitive information by augmenting software security.
Further changes in the laws were being argued for long and in response to the same there have been relevant committee recommendations. These are discussed below:
The NK Sodhi Committee has recommended many changes to the SEBI (Prohibition of Insider Trading) Regulations 1992 in order to streamline the law with realities.
The first and the most primary change that the committee recommends is the definition of a ‘company’. The guidelines define a company notionally and not specifically. It states that a company is any entity that has issued securities which are listed on the stock exchange or which are intended to be so listed. The regulations in their present state do not define a company; instead they derive the definition of a ‘body corporate’ from Section 2 of the Companies Act 1956. The guidelines expand the scope of the regulations to any and all entities that are listed on the stock exchange and do not limit themselves to only companies or body corporates.
Even a mutual fund set up as a trust which can issue units of close-ended schemes that are traded in the market would also be a company for purposes of the Proposed Regulations. This definition will also update the provision and bring them in tune with The Companies Act, 2013 which delegates powers to SEBI to prosecute insider trading in securities of listed companies and companies which intend to get their securities listed.
Another element of the Regulations that the committee recommends is redefining an ‘Insider’. The committee argues it is not so much the principle on which an Insider is based, than the way it is defined that needs revisiting. The SEBI Regulations of 1992 defined an insider definitively. It stated than an Insider is a person who is or was connected to the company or is deemed to have been connected with the company and is in possession of unpublished pricesensitive information; or is any person who has received such information. Therefore, in order to decide whether a person is an insider within the meaning of the present law, a court would need to fit the concerned persons in one of categories enlisted in the said definitions and determine whether or not that person was in possession of unpublished price-sensitive information.
The committee, on the other hand, has proposed a definition which leaves more room for the courts to determine the same question on a case-to-case basis. The committee defines an insider, quite simply, as a ‘connected person’ or ‘a person in possession of the UPSI’.
Therefore, the definition of “connected person” is important for defining an insider. The committee has recommended that it is important to have a framework that has an enhanced set of responsibilities for a ‘connected person’. The proposed definition expands the scope of a connected person by not limiting it to a person who holds an official position with regards to the company or a relative of such a person (which is the current ambit of the law), but a person who is involved with the operations of a company.
The proposed definition, if made law, would encompass any person who has been in constant contact with an officer of a company including public servants and persons holding statutory positions that can reasonably be expected to have access to UPSI. This communication would, however, need to be substantially evidenced.
Moreover, the proposed provisions state that an immediate relative of a connected person is presumed to be a connected person unless an absence of such a communication is established. It should be noted that the aforementioned communication is not in itself incriminating. There needs to be a possession of UPSI and an act on the basisof the same. Therefore, where the law earlier set liability on only those who held the sensitive information by virtue of duty to the company, the recommendations have now diluted this concept. The element of duty is not longer required and one would fall within the ambit of the law even as a person who happens to be in possession of UPSI even by virtue of a relation with the insider.
Clearly, a connected person is a person who holds any unpublished price-sensitive information. In the present set of regulations, it includes any information that can materially affect the price of securities of a company. The explanation under Section 2 (ha) of the 1992 Regulations, illustrates that and directly corelates to the finances, securities, plans and operations of the company. Furthermore, this information is deemed to be unpublished only when it has not been published by the company or its agents.
However, this expansion in the definition may lead to compliance issues as the number of people required to make disclosures under the earlier mentioned good governance guidelines would multiply.
The committee has expanded the definition of unpublished price-sensitive information. It opines that UPSI is essentially information that is not generally available. On becoming available, it would materially affect the price of securities to which it relates. Information that is accessible to the public on a non-discriminatory basis would be considered ‘generally available information’. Analysis and research based on ‘generally available information’ would also be ‘generally available information’. The reference to “public availability” of any information is not whether it has been published by a company or its agents but whether it is available on a nondiscriminatory basis.
In a situation where price-sensitiveinformation has become common knowledge, it would still be deemed to be UPSI on the sole criterion that it was not published by the company or its agents. This would not happen in case of the draft regulations. For example, if a person only observes the amount of materials being produced from a factory and guesses the company’s productivity, such information would be deemed to be ‘generally available information’ and that person would not fall under the category of a ‘connected person’.
The use of the words “non-discriminatory”, however, opens doors for a wide variety of interpretations. If a court chooses to interpret the same narrowly, then any information that is available on an expensive internet resource could be deemed to unpublished information as it would be available only to those select few who can afford that resource.
It is beyond doubt that the recommendations are a positive step towards a more stringent check on insider trading. The principle of insider trading was based in the concept of breach of duty and not parity of information. This concept will be diluted if the recommendations are accepted. That is, in the present law if a person chances upon information and uses it for his benefit, it would not fall under the purview of the law. It is only in case he is entrusted with the information by virtue of his duty and uses that information to his benefit. This limitation on the ambit of the law should be done away with.
The proposed regulations also leave a lot upon facts and circumstances of a case. Therefore, the courts would need to be careful in interpreting the law and applying it to each case. Without caution the law could expand uncontrollably to engulf situations which would not be the intention of the regulations to cover.
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