Vyshnavi Praveen, Ananya Soni
ABSTRACT
India is home to one of the most active and largest financial markets in the world. With millions of investors and amounts exceeding crores, it is safe to say that the market is extremely volatile. With the number of investors increasing by the day and the growing instances of securities fraud, people have become weary of investment, and it is for this reason that SEBI has been established. Amongst some of the malpractices that exist, insider trading is one of the biggest and most pressing concerns of them all.
Insider trading is the buying or selling of a publicly-traded company's stock by someone who has non-public, material information about that stock. By its very nature, insider trading hampers the true aim of the stock market. Insider trading not only shakes the confidence of investors but also acts as an unfair advantage to individuals in positions of power. The Securities and Exchange Board of India was specifically introduced to regulate and look into malpractices such as insider trading and draws its power from the Securities and Exchange Board of India Act, 1992. Insider trading is governed under the provisions of the SEBI (Prohibition of Insider Trading) Regulations, 1992.
Although SEBI has made great strides when it comes to curbing several malpractices in listed companies, there appear to be pressing issues and major drawbacks concerning the existing legislative framework, making complete prohibition nothing but a far-fetched dream.
This paper attempts to understand the role that SEBI plays with regard to the prohibition of insider trading by undertaking an analysis of the provisions in place to prohibit it and the potential roadblocks. The paper also takes a look at a comparison between the United States of America and India with regards to the role and function of the SEC versus the SEBI. Further, the paper will provide suggestions and solutions which might be incorporated with regard to formulating rules and regulations on insider trading for a more comprehensive framework.
Key Words: Insider Trading, Price sensitive information, SEBI, Shareholders, Financial Markets
1. INTRODUCTION
Insider trading is a commonly known practice, even among individuals who do not participate in the stock markets. It is a practice by which a company insider has access to certain price-sensitive information that is not public and uses such an advantage to benefit himself by either buying or selling that particular stock. The reason this practice is looked down on is due to the fact that it goes against the free market nature of the share market. It is notable that most countries did not term insider trading illegal until the 20th century. It was the United States that first termed insider trading an illegal practice[1]. Insider trading has been a long-standing issue in India with most instances being reported during the period of 1940 to 1990. The first popularly known and reported case was that of the Garware Nylon insider trading case[2]. In this case, a rumour that the company was going to issue bonus shares spread like wildfire through the company. This led to mass buying amongst the staff, which drove up the price. The rumour was, however, denied a few days later, causing a massive price fall. The management of the company ended up purchasing large amounts of shares and following the same, bonus shares were announced. This resulted in heavy losses to the general public who had put their faith in the hands of the company. Another similar case was the Great Eastern shipping company, where it was detected that the share price of the company unexpectedly rose 200% and all of a sudden collapsed. This resulted in the complete collapse of the company[3]. When investigations were carried out, it was revealed that the company had provided price-sensitive information regarding the issue of bonus shares to a brokerage company and this created mass buying and eventually the shares were sold at extremely high prices.
2. THE EVOLUTION OF INSIDER TRADING LEGISLATION IN INDIA
India has a long history relating to insider trading dating back to the Bombay Securities Contract Act 1925. This Act was used to regulate the sale of certain securities, back in the day[4]. The Capital Issue Control Act was passed just a few months before the Indian independence and it laid out the rules relating to the issue of capital and price-fixing[5]. Insider trading was expressly discussed for the very first time in the Thomas Committee Report[6] The Report highlighted the fallacies of the Indian securities market which were being used by top-level management for personal gains. This report also highlighted the need for urgent regulations to be placed to regulate insider trading and other unethical trade practices. The Patel Committee Report in 1986 was constituted by the government of India specifically to deal with insider trading and also made suggestions regarding contract regulations[7]. The Abid Hussain Committee Report in 1989 suggested that there ought to be criminal liability for insider trading and also called for the creation of a separate statute to deal with insider trading[8]. The establishment of the Securities and Exchange Board in India (SEBI) was a huge milestone and a stepping stone toward more regulated financial markets[9]. The SEBI was established in 1988 under the resolution of the Government of India to regulate the activities of the securities market. It was the increase in fraud and malpractices that finally pushed for the creation of the SEBI. Section 11 of the SEBI Act 1992 prescribes the power and functions of the board. Under Section 11(2)(g), the prevention of insider trading is one of the main duties of the SEBI. Section 12 A - which was amended in 2002 - explicitly prohibits insider trading in securities of companies that are listed on stock exchanges. The SEBI (Insider Trading Regulations) 1992 came to be due to the increased instances of fraud in the financial markets[10]. Under the powers conferred by Section 30, the Board made certain provisions to prevent insider trading, with the approval of the Central Government. Section 3 and Section 4 deal with the prevention of insider trading and the powers to investigate the same. Based on the recommendations of the Kumar Mangalam Birla committee, efforts were made to make the provisions more comprehensive and inclusive, by defining terms like “price-sensitive information” and so on[11]. By way of the Companies Act, the definition of “price-sensitive information” was divulged. Section 195 of the Act prohibits insider trading of securities by any internal individual, including but not limited to directors and connected persons[12]. The SEBI Prohibition of Insider Trading Regulations 2015 was based upon the Sodhi committee recommendations and replaced the SEBI (Prevention of Insider Trading) Regulations of 1992 and continues to remain in effect.
3. AN ANALYSIS OF LANDMARK CASES SURROUNDING INSIDER TRADING
India has had a long history of insider trading and over the years, there have been some major landmark cases that have shaped the course of legislation that governs trading. Harshad Mehta vs CBI dealt with one of the most infamous scams of the stock markets[13].Harshad Mehta, infamous stock broker, and advisor was found to be guilty of price rigging the Bombay Stock exchange in 1992. He did so by taking advantage of loopholes in the banking system and draining several funds from interbank transactions. Subsequently, he bought a large quantum of shares at a premium rate, which drastically shot up the Sensex Index. When the intricacies of the scam came to light, the banks began to demand their money back from Mehta, and this resulted in a drastic plunge of the Sensex overnight. The scam resulted in losses of over Rupees 5000 crores and he was charged with 76 criminal cases and 600 civil suits. The Hindustan Unilever Limited vs SEBI[14] case is also one of the most prominent cases of insider trading. Hindustan Unilever Limited (HUL) had purchased 8 lakh shares of Brooke Bond Lipton India Limited (BBLIL) from the Unit Trust of India. This purchase was made about 2 weeks before a proposed merger was supposed to go through between Hindustan Lever Limited (HLL) and BBLIL. HLL and BBLIL were both subsidiaries of the Unilever company. The shares were purchased at Rs 320 per share and soon after the merger, they were valued at Rs 410 per share. This resulted in enormous gains to the Company. The SEBI noticed these irregularities and issued a show-cause notice. Prosecution proceedings were ordered against the chairman and a fine was also levied. A similar situation of insider trading between the parent company and the subsidiary company was in the case of Dilip Pendse vs SEBI[15]. This case pertains to Nishkalpa, which is a subsidiary of Tata Finance. Dilip Pendse, former managing director of Tata Finance was found to have taken advantage of price-sensitive information and engaged in insider trading. The SEBI intervened and sentenced him accordingly. Upon further investigation, it was revealed that this was not the first time that Pendse had been engaging in insider trading. Another landmark case dealing with insider trading is Reliance Industries Ltd. vs SEBI[16]. Reliance Industries sold about 4% shares of the petroleum division in 2007. To prevent a drastic fall in the price, the shares were first sold in the futures market and then were later sold in the spot market. This came to the SEBI’s notice due to the volume of transactions. The Board noticed the malpractice since the Company’s sales in the two markets were with the intent of manipulating the share price, and therefore, the Board deemed the Company’s actions to be an evident case of insider trading. The case of Satyam Ramalinga Raju vs SEBI [17] is also extremely infamous. This case dates back to 2009 when an ex-insider of Sathyam Enterprises unveiled the scam while also adding that the Chairman had confessed to committing the fraud. The Company was found to have created fake invoices to show inflated sales and use fabricated invoices to artificially jack up sales to show as receivables in the books of accounts, thereby inflating the Company’s revenues. Investigations revealed insider trading within the company. Financial irregularities concerning Rs 4 crores in shares were recorded and owing to the quantum of money involved and the dexterity in execution, the Sathyam scam has proven itself to be one of the biggest scams in Indian history.
4. THE POWERS AND ROLE OF THE SEBI WITH REGARD TO INSIDER TRADING The SEBI was established as a statutory body with its roles and duties being highlighted in Section 11 of the SEBI Act 1992[18]. Some of the powers of the SEBI include the following: ● The power to work towards the promotion of investors' interests and work towards safeguarding them; ● The power to set up an inquiry committee if there is a violation of any provision; (Insider trading see: Chapter VA, VIA, IV) ● The power to appoint officers to look into the books of accounts of insider persons; ● The power to provide reasonable notice to the insider before initiating an investigation; ● The power to appoint a special auditor to inspect the books and accounts of an insider. It is crucial to note that after conducting the investigations, the officer is required to submit a report within 1 month, as per the Regulations of 2015. Following the final report submission, the SEBI will be required to communicate the findings to the insider and issue a show cause within 21 days of such communication. The SEBI is empowered to take action concerning insider trading and has actively increased the ambit of its role over the years. The SEBI took up 70 cases for an investigation related to insider trading in the fiscal year 2019 - which was over a fourfold increase from the number reported the previous year[19]. Although this is a step in the right direction, there are still a lot of issues concerning the extent of the role that the SEBI can play. For starters, the SEBI does not possess even basic investigative powers. One of the most commonly faced issues is the lack of evidence. Unless evidence is published in the form of written information or electronic mail, it can rarely be established that there was any insider trading at all and this is more so the case when the quantum is on a smaller scale. This was highlighted in several cases including Tata Iron and Steel Co. Ltd. Etc vs Union of India and Anr [20] and the L&T case[21]. This is also reflected by the fact that the SEBI was granted powers to call for phone data records only in 2014 and to date, it does not have the power to tap phone records, which was recommended by the Vishwanathan panel.[22] Without being granted the right to tap phone calls, the scope of evidence to establish insider trading is minimum. Several cases go unnoticed and insider trading activities on smaller scales can rarely be followed. Another crucial drawback with regards to the enforcement of anti-insider trading laws is the severe lack of manpower. Practices such as insider trading take a great deal of scrutiny which requires a great amount of follow-up. It is evident that the SEBI lacks the manpower to keep up[23]. The SEBI needs to be granted more manpower to effectively use its powers to crack insider trading. There is also limited scope with regards to individuals carrying out investigations. In India, under Section 11B (3) of the SEBI Act, 1992, engaging the SEBI to complete an examination, the exploring specialist may require an intermediary or any person associated with the securities market in any manner to outfit data and perform the necessary tasks. Upon comparing this with the Financial Services Act, 1986 the secretary of state is required to designate a qualified and capable investigator to carry out the deeds. This results in more specific and targeted investigations and overall improves the investigation strategy. Another important fallacy of the powers regulating insider trading is the lack of territorial jurisdiction outside of India. Unfortunately, under the Indian laws regulating insider trading, there is no provision to penalise or even conduct investigative activities outside Indian territory. Further, there is no specific mention in the regulations about the performance of criminal action against any executive of a remote organization recorded in residential trade, which has enjoyed benefits stemming from insider trading. This is because the SEBI Act will not be relevant to regions outside India, which renders it to be just another regional Act, limited by geography[24]. Additionally, the Indian government has made little to no effort to seek effective transnational assistance[25]. The Indian government’s one-sided endeavours are not sufficient to tackle an issue as pressing as insider trading. Another issue with the powers of the SEBI is the lack of any anticipatory action on their part. The SEBI has the power to dispatch an examination just when any mediator or any individual related to the securities advertise has disregarded any of the arrangements of the Act, the Rules or the Regulations made, or headings issued by the Board[26]. Owing to its expertise and knowledge in the area, it is likely that the SEBI may be able to anticipate certain instances of insider trading. However, the lack of any legal provisions - which could enable the SEBI to take anticipatory action - is a major drawback as it prevents timely action. Another aspect that has proven to be detrimental when it comes to making progress with regard to insider trading is the unreasonable time frame. The regulation does not prescribe an appropriate time at which the investigations ought to be completed within. The delays that come about as a result of this destroy the purpose of the provisions and prevent timely action from being taken. Excessive deferral of time can result in the concealment of crucial evidence and information that can be the key to the case. This is a major flaw of the investigative mechanism of the SEBI[27]. The lack of manpower in addition to the already existing issue of the lack of anticipatory powers highlights that the SEBI fails to act timely on several occasions and is not able to prevent any other happenings. By extension of not paying heed to the time aspect of these wrongdoings, the SEBI is failing to execute its obligations as prescribed under the Act. In addition to these obvious regulatory and jurisdictional issues, there exist the same problems that most statutory bodies in this country face that is basic bureaucratic issues and delays with regard to decision making. The lack of manpower in addition to the red-tapism adds to the already existing issues regarding insider trading. The lack of adequate resources and initiative is another problem that plagues the functioning and effectiveness of the SEBI. The regulations might seem to be adequate on paper, but on the large scale, the battle is far from won. With the lack of adequate vigilance, small-scale insider trading - in a country with financial markets as active as India - appears to be impossible to detect and address. Another issue is with regards to reporting instances of insider trading: The board has the power to appoint an independent office of informant protection to whom such instances may be reported however there is extremely high scope for bias and lack of independence of such body owing to the sheer levels of powers in the hands of the board which may prevent efficient reporting[28]. It also appears that the Board possesses a very high level of discretion regarding informant confidentiality which might take away from the very intent[29]. Under the prescribed regulations, the Chief Executive Officer, the Managing Director and other such persons of power shall work to ensure that mechanisms are in place to tackle insider trading: this is another conundrum seeing as to how we discussed in several cases that it is often these individuals found guilty of insider trading. Such high levels of discretion and powers granted to insiders only seem to be redundant and provide ample scope for malpractice which might severely shake shareholders’ confidence[30]. The board is also given the powers to deal with any contravention of the prescribed rules which provides ample scope for misuse and coverups. A detailed study of the provisions seems to in many ways hint that the inherent imbalance in power coupled with the ever-so-many loopholes provide room for insider trading and other such malpractices. The lack of adequate measures to safely secure the interest of witnesses and the vast powers granted to the board in this regard is concerning and it is about time that these provisions were looked over and revised.
5. INSIDER TRADING LAWS IN INDIA AND THE UNITED STATES OF AMERICA: A COMPARISON
It is anticipated that insider trading is rather widely practiced and is an issue that plagues most countries. Like the SEBI, other countries too have regulatory bodies empowered to look into matters concerning securities and investors’ protection. The regulatory body in the United States of America is the Securities and Exchange Commission (SEC). Both the SEBI and SEC have regulatory and supervisory roles and are vested with the task of protecting the interests of the investors. Just as the SEBI (Prohibition of Insider Trading) Regulations 1992 applies to India, it is the Securities Exchange Act that governs insider trading in the United States of America[31]. Moving to compare the provisions between the regulations in India and the United States of America, there are a few notable comparisons. The first is based on whether there needs to be a breach of fiduciary duty for there to arise a liability for insider trading. In the United States, the trends indicate that there has been a gradual demise of fiduciary principles where affixing responsibility for insider trading is concerned. One of the most prominent cases that established that there needs to be a fiduciary breach was Chiarella v. the United States[32], where, the Court held that there was no policy of equal access to information underlying the securities laws that creates a duty to disclose material, non-public information or abstain from trading. Further, it was held that this obligation had to stem from a special relationship between the trader and shareholders of the company issuing the shares. The decision of this case also came to be coined the General Theory of Insider Trading. Comparing this with the Indian scenario, there was a similar move - away from the fiduciary duty requirement to establish liability - that was observed, especially after the Amendment of 2008. The Securities Appellate tribunal made an interesting observation in the case of Rakesh Agrawal v. SEBI[33] that “The requirement for establishing a breach of fiduciary duty to successfully make out a violation of insider trading under Regulation 4 is implicit in the provisions of Regulation 3, and necessarily needs to be read into the same.” Another important aspect that differs in the American and Indian legislations is the liability of the individuals involved. In the United States of America, the misappropriation theory is what is widely accepted. By virtue of this theory, the liability extends to a person misappropriating material non-public information to carry out trades as a breach of duty and loyalty, which leads to a violation of Section 10b. In India, the extent of liability seems to be more far-reaching. By creating Regulation 2(e)(ii), the SEBI has expanded the liability under Regulation 3 to any person who may have been in receipt of unpublished price-sensitive information. Therefore, it is concluded that as opposed to the United States of America - where it is just the person caught disclosing the information is held guilty - in India any person who is found to be the recipient of the information is held guilty under the law. Despite the recipient of the information not breaching their duty of loyalty to the company, they are still held guilty under Indian law. This highlights that the American provisions regulating insider trading are fixated on the breach of duty. Both the Indian and American legislations call for criminal jurisdiction against individuals found engaging in insider trading. While there are similarities with respect to the legislation, the law of the United States of America contains various different provisions with respect to liability which are not found under Indian law. Under Indian law, Section 15G of the SEBI Regulations provides a civil penalty of Rs 24 Crores or 3 times the number of profits made out of insider trading, whichever is higher. The criminal prosecution for insider trading is found in Section 24(2) provides that if the person concerned does not pay the civil penalty imposed by the adjudicating officer, he may be punished with imprisonment which may extend to ten years, but which shall not be less than one month, and a fine that may extend to twenty-five crores or both. Upon comparing this with the American legislation, it is evidenced that criminal liability is envisaged in Section 32(a) of the Securities Exchange Act, 1934, which calls for a fine extending up to $5 million or a jail time of not more than 20 years. Further, the SEC is better staffed than the SEBI, making the carrying out of investigations and follow-ups a lot more efficient. Based on the Annual Report (CY 2016) of the US SEC, they have almost one employee for each listed company whereas the SEBI has one per every six companies[34]. In key divisions of importance such as corporate finance, it is reported that the SEC has 15 times more employees as opposed to the SEBI[35]. Despite the United States of America hosting a smaller population, the staffing proportion is a lot higher, which makes implementation and investigative actions possible with efficiency. The SEBI however continues to face understaffing as a severe issue. Despite India being home to a larger population and an extremely active financial market scene, the SEBI remains to be inadequate. The SEC employs over 3958 staff[36] meanwhile the SEBI employs a mere 643 persons all over the country at its various offices[37]. A simple comparison between the two countries shows that the SEC is more proactive and acts timely, and the consequences for insider trading are stricter and well-executed, as opposed to the comparatively lackadaisical situation in India. Suggestions and Conclusion Although the SEBI has taken several steps in the right direction, there are several measures that can be taken to ensure speedy and effective redressal to the issue of insider trading. The steps that the SEBI can take and some changes that can be implemented include: 1. Effective investigation mechanism: In order for the SEBI to discharge its duty more efficiently, it is essential for there to be more power granted to it. This can help strengthen processes and make the investigative process easier. Additionally, the SEBI ought to be granted more powers such as the ability to tap phones, as this will make tracking insider trading movements a lot easier. 2. Restructuring: There is a need to restructure the Board. Increasing the number of officers and regulators will also allow the SEBI to increase its efficiency regarding investigative authority. 3. Minimal Government intervention: The reason several bodies such as the SEBI cannot efficiently perform is due to the massive number of restrictions in place and the huge government control. By comparing SEBI with the SCC, it is noticeable that minimal intervention will allow for a more efficient discharge of duties. 4. Permanent and continuous surveillance mechanisms: With regard to insider trading, surveillance is key. With a concrete surveillance system, the SEBI will be in a better spot to take action and this can prevent losses. 5. Fast-tracking of courts for quicker trials: With regards to offenders, there is a need to speed up the trial process to penalize offenders at the earliest. This will prevent them from becoming fugitives on the run and eliminates unnecessary delay. 6. Rewarding whistle-blowers and increasing whistle-blower protection schemes: Whistle-blowers are crucial in disclosing vital information and can be the key to cracking down on cases. Hence, there need to be more schemes that encourage and protect whistle-blowers after exposing such cases. India has a long way to go to fix the various loopholes in the system and most of them are related to increasing resources and the flow of power. In good time, with constant efforts and discussion, it is estimated that the Indian scenario regarding insider trading will become a lot more stable.
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