RESEARCH DISSERTATION ON

CRITICAL STUDY
A CRITICAL ANALYSIS WITH RESPECT TO CORPORATE GOVERNANCE NORMS IN INDIA

Area of Research
CORPORATE GOVERNANCE
ON

INSIDER TRADING LAW

SUBMITTED TO: Prof. (Dr.) Mamta Biswal

(FACULTY OF LAW)

SUBMITTED BY: Mohit Gupta (11B084)

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TABLE OF CONTENTS
SYNOPSIS.4
TITLE OF THE PAPER..4
RESEARCH PROBLEM.....4
RESEARCH QUESTION....5
HYPOTHESIS.5
RESEARCH SCOPE...5
RESEARCH METHODOLOGY....................................................................................................6
CHAPTERISATION.........6

ACKNOWLEDGEMENT.8
LIST OF ABBREVIATION..9
ABSTRACT.10
INTRODUCTION11
HISTORYOF INSIDER TRADING13
INDIA....13
UNITED STATES OF AMERICA...17

RATIONALE BEHIND INSIDER TRADING LAW.20

CLASSIC THEORY..20
ECONOMIC
THEORY.20
EQUALITY AND FAIRNESS THEORY20
MISAPPROPRIATION THEORY...21

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COMPARATIVE ANALYSIS22
CORPORATE GOVERNANCE MEASURES...37
CONCLUSIONS..45
BIBLIOGRAPHY46

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SYNOPSIS
TITLE OF THE PAPER
Insider Trading Law: A comparative and critical analysis with respect to
corporate governance norms in India.
RESEARCH PROBLEM
The area of research chosen for this dissertation is the role of Corporate
Governance to curb insider trading in India. It is a much known fact that as
financial markets are developing, the white collar crimes are also becoming
more and more sophisticated and so do the laws to deal with them. In recent
years, because of massive frauds in financial markets and also to bolster the
confidence of investors, the legislators and regulators have turned towards
making corporate governance standards mandatory and also attaching
penalties if there is any violation of these standards. The act of insider
trading can be held as one of the most violent crimes as it destroys the
confidence of investors. The two decade old insider trading law proved to be
inept in curbing insider trading in India and as a result of this SEBI recently
overhauled the 1992 regulations and passed Securities and Exchange Board
of India (Prohibition of Insider Trading) Regulations, 2015. In this globalized
world regulations and policies need to be highly dynamic and change
according to the international environment and the changing domestic
economic condition, so it becomes imperative to study the adequacy of
present laws. The dissertation addresses the problem of why there are no
convictions on insider trading in India and whether the corporate governance
measures are adequate to deal with problem of insider trading and the
changes brought by 2015 regulations and its effect.

RESEARCH OBJECTIVE

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Through the dissertation the author aspires to achieve the following

objectives:

To trace the history of insider trading law in India and rationale of

having a law against insider trading.

To study the changes brought by the recent amendment and its

subsequent effect on financial markets.

To study the law of insider trading in the United States of America
which has always been at the forefront of implementing the law against

insider trading and its comparison with Indian Law.

The study also focuses on the objective why it is difficult to prosecute
the offenders and the concepts of corporate governance which deal with
insider trading.

RESEARCH QUESTION
Certain questions dealt with in this research are as follows:
1.
2.
3.
4.

What is the history of Insider Trading Law?

What is the rationale behind implementation of insider trading law?
What are the changes brought by 2015 amendment and its effect?
Whether the substantial laws regarding insider trading in India are

sufficient?
5. Whether the corporate governance standards in India are in tune with the
standards provided in other countries?
6. What are reasons because of which the conviction against traders is
difficult to obtain? Are the laws which empower SEBI to investigate
inadequate?
HYPOTHESIS
The Hypothesis in this research is as follows:
1. That the corporate governance standards which have mandated by SEBI to
deal with insider trading in India which have been mandated by SEBI are at
par and incorporate all significant concepts. The reason for not obtaining
convictions in India on insider trading is the lack of investigative powers of
SEBI.

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RESEARCH SCOPE
The area selected for research is very vast and thus there are various aspects
which fall within the ambit of the study. However, it is not possible to
encompass all of them. Hence the scope of this dissertation is to trace the
history of insider trading law, relevant legislations, changes brought by the
2015 amendment and its effect. The dissertation will also make a comparative
analysis between United States and India and to analyze reasons as to why
convictions for insider trading are difficult. The study will deal with different
case laws of India and the United States of America.

RESEARCH METHODOLOGY
The methodology adopted for research, is doctrinal in nature. Also the
very sub-methods of Doctrinal study i.e. descriptive and analytical
methods have been used individually as well as in a combined form as
and when required, to do justice to the topic of study. From the collected
material and information, researcher proposes to analyze the topic of the
study and tries to reach the core aspects of the study.

TENTATIVE CHAPTERIZATION
.
I.

INTRODUCTION

II.

HISTORY OF INSIDER TRADING

II.1

INDIA

II.2. UNITED STATES

III.

RATIONALE FOR THE LAW OF INSIDER TRADING

III.1 Economic Rationale
III.2 Misappropriation Theory

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III.3 Classical Theory

III.4 Efficient Market Hypothesis
IV.
V.

COMPARATIVE ANALYSIS OF LAW OF INSIDER TRADING IN

INDIA & UNITED STATES OF AMERICA
CORPORATE GOVERNANCE AND INSIDER TRADING IN
INDIA:
V.1

Different Concepts of Corporate Governance in Schedule I &

II
V.1.1 Compliance Officer
V.1.2 Preservation of Price Sensitive information
V.1.3. Trading Window
V.1.4. Pre-clearance of Trade
V.1.5. Short Swing Profits
V.1.6. Reporting Requirements:
V.1.7. Penalty
V.1.8 Chinese Wall

V.2

VI

CORPORATE DISCLOSURES
VI.3.1

Responses to Market Rumors

VI.3.2

Disclosure to Analysts

CONCLUSION

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ACKNOWLEDGEMENT
First of all I would like to offer my hearty devotion to the Almighty
without

whose

blessings

this

dissertation

would

not

have

been

accomplished. There after I express my regards to give this very useful

dissertation to our university. I would like to take this opportunity to
express my gratitude to Prof. (Dr.) Mamta Biswal for giving us an
opportunity to undertake this project and for his advice, support and
guidance.
I would also like to express my appreciation for the co-operation, help
and support of other members of GNLU who helped and technically
supported me in this project. I would also like to thank all the support
staff of the library and the computer lab for the assistance they have
provided me in researching on the present project. Thanks to all the
authors of the websites and the books I have referred is also a must. I
have put in my whole and sole into this work in order to come up with a
laudable performance. Even after this if there are any discrepancies on
my part, I request you to kindly consider them.

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LIST OF ABBREVIATIONS
1. &...............................................................................................................................And
2. AIR .....................................................................................................All India Reporter
3. Bom....................................................................................................................Bombay
4. BOD...Board of Directors
5. Cal......................................................................................................................Calcutta
6. Del.......................................................................................................................... Delhi
7. Edn........................................................................................................................Edition
8. HC..................................................................................................................High Court
9. LJ..................................................................................................................Law Journal
10. LR................................................................................................................Law Reports
11. Ltd....................................................................................................................... Limited
12. Ors........................................................................................................................ Others
13. p................................................................................................................................Page
14. para...................................................................................................................Paragraph
15. S........................................................................................................................... Section
16. SC.............................................................................................................Supreme Court
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17. SCC................................................................................................Supreme Court Cases

18. SCJ..............................................................................................Supreme Court Journal
19. SEBI..Securities and Exchange Board of India
20. SEC.Securities Exchange Commission
21. US.............................................................................................................United States
22. UPSIUnpublished Price Sensitive Information
23. V..........................................................................................................................Versus

ABSTRACT

Over the years Indian financial markets have become more and
more lucrative for the investors and thus the regulators have to
be on their toes to keep the markets well-structured and
regulated. The regulators and legislatures have increasingly
leaned on corporate governance standards to keep the markets
safe. The laws on insider trading represent one such attempt by
the legislatures to curb the white collar crime and make markets
more investor friendly. Insider trading can be curbed by
imposing civil and criminal liability and preventing its
occurrence by corporate governance standards.

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The paper attempts to study the history of insider trading law,

rationale behind the insider trading laws, laws on insider
trading under the SEBI (Prohibition of Insider Trading)
Regulations, 1992 and the circumstances leading to the
comprehensive changes brought in 2015. The paper shall
compare the insider trading laws in India with that of the USA
and the difference between the investigating powers of SEBI and
Securities Exchange Commission of USA. The paper will also
study the corporate governance measures on insider trading
such as closure of trading windows, short swing profits and
Chinese Walls and implementation of these measures in the
financial markets.

I.

INTRODUCTION

This paper will study the corporate governance measures on insider

trading implemented by SEBI and its effect on financial markets and the
paper will also make a comparative analysis of Indian Law on insider
trading and USA law on insider trading.
Chapter 2 will trace the history of insider trading law in India and in USA
and the changes brought by 2015 amendment. The insider trading law
originated in USA back in 18th century and thus it is very imperative to
trace their history on insider trading law in order to comprehend the
development of insider trading law. This chapter will also discuss the
recommendations given by the various committees on insider trading law.

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Chapter 3 will discuss the rationale behind the insider trading law and
what it exactly seeks to outlaw because insider trading per se is not
illegal. This chapter will also discuss the various doctrines on insider
trading law like misappropriation theory and classical theory. The study
of rationale and doctrine is important in order to understand the
objectives of the insider trading law.
In Chapter 4 the author will make a comparison of insider trading law in
India and in USA. This comparison would be in two parts. The first part
would compare the substantive law of both the countries in order to
dispel the notion that insider trading law in India are not sufficient and
would prove the hypothesis that Indian laws are in fact more stringent
than the laws of USA. Also the author would enter into a comparative
analysis of requirement of motive and intention under the laws of USA
and India to prove the offence of insider trading. The second part would
compare the investigative powers of SEBI and SEC and would discuss
how difficult it is for the regulator to prove the offence of insider trading
and whether any reforms is required.
Chapter 5 focusses on the corporate governance provisions provided by
SEBI in order to pre-empt the offence of insider trading. Corporate
governance is a means of self-governance whereby a company discloses
its accounts and financial statement. Corporate governance standards
provide for a proactive approach as it tries to prevent the commission of
offence itself. This chapter will also discuss the several important
provisions which help in tackling insider trading to test the hypothesis
that the corporate governance laws regarding insider trading are
adequate in India. It will also discuss important measures such as trading
window, chinese wall, compliance officer, short swing profits, corporate
disclosure to analysts, addressing market rumours and reporting
requirements.

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Chapter 6 is the concluding chapter in which the author would record its
finding that whether the hypothesis is proved or disproved and would
make recommendations on insider trading law if any.

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II.

HISTORY OF INSIDER TRADING

II.1 INDIA

The first thing we should know that not all insider trading is illegal.
Insider trading can be said to be illegal when a person trades in
securities of a publicly listed company based on information not available
to the public at large and which can influence the market price of the
securities of such a company.
The securities market in India came into existence in 1875 with the
establishment of Bombay Stock Exchange (BSE). History of Insider
trading in India can be traced back to 1948 with the formation of Thomas
committee by the government of India. Though the issue of insider
trading in India came into light in 1940s, it was prevalent even before
that but it did not receive the necessary public indignation. The
committee observed and analysed that insider trading occurred due to
possession of information by some people before everybody else and
misuse of such information. Thus, the committee recommended a special
legislation to deal with insider trading and setting up of a body which
should be very much similar to U.S. Securities Exchange Commission
(SEC). The government of India failed to take any step based on these
recommendations.
In 1952, the Bhaba committee was constituted to revamp the then
existing Companies Act, 1913. In its report the committee observed the
fraudulent dealing in securities by the directors of the companies. It is
also interesting to note that the committee never used the word insider
trading anywhere in its report. Thus section 307 and 308 were
incorporated in the Companies Act, 1956 which dealt with insider
trading. Section 307 mandated the companies to maintain a registry to
record the shareholding of directors in the company and section 308
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imposed a duty on the director to make disclosure of its shareholding in

the

company.

Through

Companies

Amendment

Act,

1960

this

requirement of disclosure was also imposed on companys managers as

well.
In 1977 Sachar Committee was constituted by the government to analyse
the provisions of Companies Act, 1956 and MRTP Act, 1969. The
committee pointed out that section 307 and section 308 is inadequate to
curb the menace of insider trading. The committee also identified certain
category of persons as insider; a broader category of the same was
provided by Thomas Committee.
In 1986, Patel Committee was constituted by the government which
defined insider trading as, Insider trading generally means trading in
the shares of a company by the person who are in the management of the
company or are close to them on the basis of undisclosed price sensitive
information regarding the working of the company, which they possess
but which is not available to others. 1 The Committee recommended the
government to amend Securities Contract (Regulation) Act (SCRA), 1956
to enable the exchanges to prevent insider trading. This committee
heavily relied on USA and UK regulations to make recommendations.
The next committee constituted by the government was Abid Hussain
Committee in 1989, which recommended that insider traders must be
convicted under civil as well as criminal laws and SEBI should formulate
a separate regulation to prevent the offence of insider trading.
Finally on November 19, 1992 after setting up of so many committees the
government of India implemented SEBI (Insider Trading) Regulation,
1992.
In 2002, SEBI amended the SEBI (Prohibition of Insider Trading)
Regulations, 1992 which was prompted by the failure to prosecute the
1 Para 7.25 of the Patel Committee Report
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perpetrators in Rakesh Agarwal vs SEBI2 and Hindustan Lever v. SEBI3

which will be discussed in detail later. The 2002 amendment regulations
were preventive in nature. It introduced Chapter IV including two
schedules regarding disclosures and corporate governance in the
regulations. Schedule A provides for a model code of conduct for the
prevention of insider trading for listed companies and Schedule B
provides for a model code of corporate disclosure practices.
Further this act was amended in 2003, 2007, 2008 and 2015 respectively.
The 2003 amendment provided changes in multiple forms which are used
for disclosing information under the said regulations. The 2007
amendment introduced regulation 11A which lays down the manner of
service of summons and notices to be followed. The 2008 and 2015
amendment brought comprehensive changes in the act. Through 2008
amendment provision for e-filing of disclosures was made. Regulation
13(7) was introduced to enable electronic filing of disclosures in
accordance with the system devised.
On January 15, 2015 SEBI notified the SEBI (Prohibition of Insider
Trading) Regulations, 1992 which was effective from May 15th, 2015. The
key changes brought in by this amendment are as follows:

Compliance Officer: The 2015 amendment provides for the

appointment of a compliance officer. Regulation 2(1)(c) defines
compliance officer as, any senior officer, designated so and
reporting to the board of directors or head of the organisation in
case board is not there, who is financially literate and is capable of
appreciating requirements for legal and regulatory compliance
under these regulations and who shall be responsible for
compliance of policies, procedures, maintenance of records,
monitoring adherence to the rules for the preservation of

2 2004 49 SCL 351 SAT

3 (1998) 18 S.C.L 311 AA, Hereinafter referred to as HLL v SEBI
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unpublished price sensitive information, monitoring of trades and

the implementation of the codes specified in these regulations
under the overall supervision of the board of directors of the listed
company or the head of an organization, as the case may be. 4
From above definition it is clear that compliance officer must be a
senior officer who reports to the Board of Directors (BOD) of the
company. So, generally speaking a CEO or managing director of a
company can be regarded as the compliance officer for the
purpose of this regulation. A company secretary cannot be
regarded as a compliance officer even though it fulfils the
qualifications prescribed and is fully competent to discharge the
duties because it doesnt report to the BOD.

Connected Person: Through 2015 amendment the scope of the

term

connected

person

has

been

enlarged.

Through

this

amendment immediate relatives will be presumed to be connected

persons but this presumption is rebuttable. It was done as SEBI in
past has faced difficulties in prosecuting an immediate relative.
This new definition is also intended to bring within its ambit the
persons who do not occupy any position in a company but are in
regular touch with the company or its officers as the might have
access to unpublished price sensitive information (UPSI).

Insider: Any person who is a connected person or is in possession

or has access to UPSI is an insider. The importance has been laid
on the possession or having access to UPSI and not on the source
through which a person is in possession or has access to UPSI.
Onus is on the regulator to prove that person is in possession or
has access to UPSI after which the onus shifts on the person to
prove that he was not in possession of UPSI or he has not traded
by relying on UPSI.

4 Regulation 2(1)(c) of Securities and Exchange Board of India (Prohibition on Insider Trading)
Regulations 2015.
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Trading: The term trading is provided a wide construction in

order to curb activities which are not strictly related to buying,
selling or subscribing, like pledging for example when in
possession of UPSI. Agreement to buy or sell has also been
brought within the ambit of these regulatory provisions.

Generally Available Information: The 2015 regulation define

generally available information as an information which is
accessible to the public on a non-discriminatory platform, like
stock exchange website.

Unpublished Price Sensitive Information (UPSI): The New

Regulations strengthens the definition of UPSI by providing a test
to identify price sensitive information, aligning it with listing
agreement and providing platform of disclosure. Earlier, the
definition of price sensitive information had reference to company
only; now it has reference to both a company and securities.5
Regulation 3 prohibits an insider from providing or allowing
access to any UPSI to any person including other insiders except
where such communication is in furtherance of legal obligations or
legitimate purposes. It also prohibits a person from procuring or
securing such UPSI.

Disclosure Requirement: A person who is in possession of UPSI

is mandated to disclose such UPSI two days prior to trading in
securities.

Trading Plan: Regulation 5 permits trading by persons who may

continuously be in possession of UPSI so that they are able to
lawfully trade in securities in accordance with a pre-determined
trading plan for a period of at least one year. Trading plans have

5
http://www.mondaq.com/india/x/360874/Securities/SEBI+Reforms+New+Insider+Trading+Regulatio
ns
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to comply with the 2015 Regulations and are required to be

approved

by

the

designated

compliance

officer.

The

2015

Regulations further restrict the trading plan from including trades

that are to be made twenty days prior to the end of a financial
period for which results are to be declared by the concerned
company.6

II.2.UNITED STATES:
Discussion of history of insider trading in U.S. is imperative as the first
instance of insider trading is seen in this country and also it is a
forerunner in preventing the offence of insider trading.
In 1790, U.S. Department of Treasury had incurred massive debts due to
the American War of Independence. In order to finance this debt, the
government issued public bonds worth US $80 million for the first time.
The then Assistant Secretary of U.S. Department of Treasury, Mr. William
Duer (and in this sense an insider), bought the bonds in huge amounts
which led to shooting up of price of the bonds and to finance such a huge
amount of purchase, Duer borrowed the money from other people. When
it became clear in 1792 that Duer will not be able to pay this debt, the
market bubble burst and the price of bonds crashed 7. This event is known
to be the first recorded instance of insider trading.
6 http://www.gibsondunn.com/publications/Documents/SEBI-Announces-New-Insider-TradingRegulations.pdf
7 Franklin, Kylie, U.S. V. U.K. INSIDER TRADING LAWS: WHO IS THE TOP DOG?, Available at
SSRN: http://ssrn.com/abstract=2308356 or http://dx.doi.org/10.2139/ssrn.2308356
19 | P a g e

Influence by this incident, 24 brokers thought self-regulation was the

best answer to preclude such incident and gathered to sign the
Buttonwood Agreement in 1792 which stipulated that the assembled
brokers would only trade with other mutually recognised brokers. In
1817, the buttonwood group became the New York Stock & Exchange
Board which was later incorporated into the New York Stock Exchange
(NYSE) in 1863.8 A lot of scandals surfaced over the next few years like
manipulation of railroad stocks but U.S. legislators failed to take any
action.
Finally in 1909, the United States Supreme Court acted in the case of
Strong v. Repide9, and made the first judicial propounded rule against
insider trading which said the company officials are under an obligation
to disclose their identity and non-public information when they trade in
the stocks of the company. Before this ruling, there was no duty on an
insider trader to disclose the information, only in cases of fraud they had
to disclose the information.
In the landmark case of Goodwin v. Agassiz10 the defendant bought a
sizable amount of company stocks by relying on the report of one
geologist. Homer Goodwin the plaintiff sued Mr. Agassiz contending that
he would never have sold the shares had he known the geologists report.
The Massachussets Supreme Court held that only in instances where an
insider trader trades in shares in a private transaction he has to disclose
the material information. By buying shares in an open market, Mr.
Agassiz was merely exercising the perk of being an insider.
U.S. Congress passed the Securities Act, 1933 as a result of market crash
in 1929. The two main objective of the Act was to ensure that to ensure
8 http://insidertrading.procon.org/view.resource.php?resourceID=002391
9 213 U.S. 419, 420 (1909)
10 186 N.E. 659 (1933)
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more transparency in financial statements so investors can make

informed decisions about investments, and (2) to establish laws against
misrepresentation and fraudulent activities in the securities markets 11.
U.S. Congress also passed the Securities Exchange Act, 1934.

The

Securities Exchange Act defined insider trading as when a person sells

a security while in possession of material non-public information in
violation of a duty to withhold the information or refrain from trading.
In 1942, the Commission was in a predicament when a president of the
company was buying shares at a low price by misrepresenting the
financial statements. The act only dealt with fraud in sale of securities.
Thus, the SEC created the Securities Exchange Act Rule 10b-5, which
extended the application of section 17(a) (1) i.e. prohibition of fraudulent
behaviour in sale of securities also to purchase of securities.
In 1961, the Securities Exchange Commission held tipping as a violation
of the rule 10b-5 In The Matter of Cady, Roberts & Co12. The board of
directors of Curtiss Wright Corporation decided to reduce the companys
quarterly dividend. One of the directors of this company was also a
partner of the stock brokering firm Cady, Roberts & Co. He provided the
necessary information to the firm and therefore the firm sold all the
shares of the company. Thus its customers avoided the losses. This act by
the director was held to be tipping by SEC. An insider who knows
confidential information does not himself trade, but rather informstips
someone else, who does trade. It also involved trading on an
impersonal stock exchange, instead of a face-to-face transaction... The
SEC held that Gintel had violated Rule 10b-5.13
In 1968, U.S. Federal Court held in SEC vs Texas Gulf Sulphur14, held that
anyone who possessed material non-public information was required
11 See supra note 8
12 (1961) 40 SEC 907
13 See supra note 8
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either to disclose it or abstain himself from trading on the basis of such

non-public information.
In 1980, the United States Supreme Court in Chiarella vs United States15
held that trading on material non-public information in itself was not
illegal under anti-fraud provisions as the financial printer owed no duty
to shareholders. Thus in order to deal with similar situations popping up
in future, the SEC promulgated Rule 14e-3 which made it illegal for
anyone to trade on the basis of material non-public information if they
knew the information came from an insider.
In Dirks vs SEC16, the US Supreme Court decided the liability of tipper on
the basis of motive. The court held that tippee is under a duty to disclose
information or abstain from trading when the tipper sought an improper
benefit for his information. But when tipper acts for non-personal
benefits there could be no liability.
In 1984, Insider Trading Sanctions Act was passed which increased civil
and criminal penalties for trading while in possession of material nonpublic information. In 1988 Insider Trading and Securities Fraud
Enforcement Act was passed to rope in persons who fail to take adequate
steps to prevent insider trading.
In 2012, Stock Act was passed which mandated the president, the vice
president,, cabinet members, lawmakers and their staffs, must publicly
report all trades valued at $1,000 or above within 30 days of the
transaction and in no case later than 45 days after the transaction
occurred.

14 401 F.2d 833 (2d Cir. 1968)

15 445 U.S. 222, 248 (1980)
16 463 U.S. 646 (1983)
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III. RATIONALE FOR THE LAW OF INSIDER TRADING

The debate whether to ban insider trading or not is going on for decades
with some thinkers believing that insider trading should not be
considered as a crime at all17. The insider is allowed to trade in securities
on the basis of information generally available to public. Thus insider
trading is not illegal per se. It is illegal when a person trades on the basis
of UPSI. Now the question that stems up in our mind is why insider
trading is illegal. One of the reason being that the insider has an upper
hand or undue advantage over the other investors, thus they are capable
of manipulating the market. This can destroy the investors confidence.
Some of the reasons for the implementing the law of insider trading is as
follows
III.1Economic Rationale
As it has been previously stated insider trading is not illegal per se. When
an insider trades in the securities of the company aligning his interest
with the interest of various shareholders of the company is legal and fair
trading. But trading on the basis of UPSI by an insider is illegal. The
economic effect of insider trading is that investors will lose the
17 Henry Manne, INSIDER TRADING AND THE STOCK MARKET, 1966, 1st edition, The Free
Press, New York,
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confidence in securities market because of the very fact that there is no

fairness, equality and in long run they would lose their money. This would
make it problematic for the companies to raise funds in capital markets.
All this will lead to slow growth rate of economy and increase in
unemployment.
III.2 Equality and fairness
The insider trading law seeks to level the playing field for the insiders
and other investors. The insider has access to UPSI which can affect the
price of securities, thus they have an upper hand over the other
investors. This could dissuade other investors from investing in the
securities market.
III.3 Classical Theory
According to classical theory a corporate insider violates a duty to
corporate shareholders to either disclose his intent to trade or to abstain
from trading, on the basis of material non-public information. The tippee
of a corporate insider assumes the tipper's duty to shareholders if the
tippee knows or should know that the tip constitutes a breach of the
tipper's duty. This breach of duty to shareholders constitutes the
deception necessary for liability under our general anti-fraud statute in a
classical insider trading case.18 According to classical theory there exists
a fiduciary relationship between the insider and other investors and thus
the insider owes a duty to not break that trust reposed in him. In 1980s
the U.S. Supreme Court in Chiarella vs United States19 held that the
printer owed no duty towards investors as there exist no fiduciary
relationship between them, thus over-turning his conviction. The classical
theory applies not only to officers, directors, and other permanent

18 https://www.sec.gov/news/speech/2008/spch021908lct.htm
19 See Supra note 15
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insiders of a corporation, but also to attorneys, accountants, consultants,

and others who temporarily become fiduciaries of a corporation.
III.4Misappropriation Theory
This theory relies on the principles that all information generated by or
through the company belongs to the company. Consequently, persons
who come into possession of such information in circumstances that
warrant

confidentiality

are

not

permitted

to

misappropriate

the

information for their personal gain or benefit. 20 Misappropriation theory

is comparatively a modern theory on insider trading. It was endorsed by
U.S. Supreme Court in the case of United States vs OHagan21. OHagan
was an attorney and thus claimed that he was not an insider and outside
the purview of classical theory approach. The Court held that by using
the law firms confidential information to trade in securities he has
misappropriated the information. The Court held that a corporate
outsider

violates

Section

10(b)

and

Rule

10b-5

when

he

misappropriates confidential information for securities trading purposes,

in breach of a fiduciary duty owed to the source of the information,
rather than to the persons with whom he trades. 22 The misappropriation
theory premises liability on a fiduciary-turned-traders deception of those
who entrusted him with access to confidential information. 23 Also it is
premised on the argument that companies own a proprietary right to
information and, in particular, the exclusive right to the use of the
information.24 The misappropriation theory is designed to protect the
integrity of the securities markets against abuses by outsiders to a
20 [2004] 59 CLA (Mag.) 43
21 521 U.S. 642 (1997)
22 O'Hagan, 521 U.S. at 652
23 ibid
24 See supra note 20
25 | P a g e

corporation who have access to confidential information that will affect

the corporations security price when revealed, but who owe no fiduciary
or other duty to that corporations shareholders.25

IV.COMPARATIVE ANALYSIS OF LAW OF INSIDER TRADING IN INDIA

& UNITED STATES OF AMERICA
The comparison between Indian insider trading law and U.S. insider
trading law is imperative as well as inevitable as U.S. has always been
the forerunner in the field of insider trading law and Indian expert
committees has always analysed the position of law in U.S. while
recommending modifications. In this part, the author attempts to
highlight the difference between the laws on insider trading which
prevail in the United States of America and in India and would test the
hypothesis whether Indian laws are adequate.

IV.1 Who is an insider?

IV.1.1

India

Insider was defined under the SEBI (Insider Trading) Regulations, 1992
as:Any person who is or was connected with the company or is
deemed to have been connected with the company and who is
reasonably expected to have access by virtue of such connection, to
unpublished price sensitive information in respect of securities of a

25 http://www.americanbar.org/content/dam/aba/administrative/litigation/materials/sac_2012/292_the_law_of_insider_trading.authcheckdam.pdf
26 | P a g e

company, or who has received or has had access to such

unpublished price sensitive information.
The following essentials can be deduced from the above definition for a
person to be an insider:
1)

The person must be connected with the company. The word

person referred in this definition can be either a natural person or
a legal person.

2)

That by the virtue of the persons position in company it is

reasonably expected of him to have access to price sensitive
information.

3)

Such price sensitive information must not be published.

The second element of definition which states that person can be

reasonably expected to have acquired information by virtue of such
connection has serious lacunae because the words by virtue of such
connection could be interpreted to mean that the person should have
acquired information by virtue of such connection to the company.
Therefore, it can be argued that if a person who has acquired a tip but
not by virtue of his connection to the company, then such a person cannot
be held to be under the ambit of insider as defined by the regulations.
But in Hindustan lever case26, the court had upheld the argument of SEBI
that procurement of UPSI by an insider could be independent of the
insiders connection with the company. To remove any doubt and any
other interpretation SEBI amended the definition in 2002.
The amended regulation defined insider as any person who:
(i) is or was connected with the company or is deemed to have been
connected with the company and
26 1998 SCL 311
27 | P a g e

(ii) is reasonably expected to have access to unpublished price sensitive

information in respect of securities of company, or has received or has
had access to such unpublished price sensitive information
The definition of insider had undergone an amendment in 2008 which
neither deleted nor added any words; it just rephrased it by making a
minute change in the position of comma. The effect of this change was
huge. The scope of the term insider was increased. After the 2008
amendment, the definition of insider is a person who
(i) is or was connected with the company or is deemed to have been
connected with the company and is reasonably expected to have access
to unpublished price sensitive information in respect of securities of
company
(ii) or has received or has had access to such unpublished price sensitive
information
Therefore, if a person is in possession of unpublished price sensitive
information then he is an insider according to the definition even though
he is not connected to the company at all27.
Recently on May 15, 2015 comprehensive amendments were notified in
insider trading regulations. A noteworthy feature of new regulations is
that a note is appended below every regulation which provides a very
clear explanation of the regulation.
Regulation 2(g) now defines insider as any person who is
i)
ii)

a connected person; or
in possession of or having access to unpublished price sensitive
information;

27 http://indiacorplaw.blogspot.in/2008/12/amendments-to-insider-trading.html Accessed on 18th

September, 2013
28 | P a g e

Now a person would be treated as an insider if he is in possession of

UPSI or has access to UPSI irrespective of the fact that how he came into
possession of or access to information. The onus of proof is on SEBI to
prove that the person is an insider after which the onus shifts on the
accused to prove that he was not in possession of or has access to
information or he has not traded or that his trading when in possession of
UPSI was covered by exculpating circumstances.

IV.1.2

United States

In U.S. no specific definition of the term insider is provided. The Rule

10b-5 of Securities Exchange Act of 1934 which prohibits insider trading
in the United States reads as follows It shall be unlawful for any person,
directly or indirectly, to employ any device in connection with the
purchase or sale of securities.
The definition uses the words any person which widens the scope of
term insider. However, the definition of who is an insider and the scope
of the words any person has been laid down judicially by the courts in
the United States. It has been laid down that a person will be an insider if
he has knowledge of or access to material unpublished price sensitive
information because of his fiduciary relationship to the company and its
shareholders28. A fiduciary relationship exists when one person acts in
the best interest of another person. Their relationship exists on trust. The
definition of insider has been expanded to also include tippee and tipper.
In Securities Exchange Commission v. Obus29, the 2nd Circuit reconciled
the liability of the tippee with the liability of the tipper. The court said the
Hochfelder decision of the Supreme Court applies to tipper liability and
the tipper should have actual knowledge that the information was non28 In Re Cady Roberts (1961) 40 SEC 907
29 693 F.3d. 276 (2nd Cir. 2012)
29 | P a g e

public and would affect the price of the shares in the market and he
should actually know that he would violate his fiduciary duty. The court
cannot infer liability of a tipper on the basis that he should have known
but on the basis that he actually knew30.
However, in the case of tippee liability, the Supreme Court of U.S. in
Dirks case31 held that the tippee should know or should have known that
the tipper breached his fiduciary by giving the information to him.
The definition of insider can be said to be broader in India than in the
United States. In India, a person will be considered to be an insider if he
is in possession of UPSI or has access to UPSI even though he is not
connected with the company. While in U.S. mere possession of material
non-public information is not enough for a person to be considered as an
insider. The extra element of fiduciary duty towards the shareholders or
company is also to be proved. A simple example to further clear the
difference is that of a person who overhears a conversation and trades on
the basis of that conversation wouldnt be held liable in U.S. as he owes
no fiduciary duty towards the company or shareholders but will be liable
in India.
In cases of tipper, there must be a personal benefit which accrues to the
tipper. In case of tippee, the tippee in addition to possession of such
unpublished price sensitive information, must also know or should have
known that the information has come due to breach of duty by the
tipper32. In U.S. a different standard has been provided for tipper and
30 Tannenbaum Helpern Syracuse & Hirschtritt LLP, INSIDER TRADING AND TIPPEE
LIABILITY: THE SECOND CIRCUIT RECONCILES TWO INCONSISTENT SCIENTER
REQUIREMENTS, http://www.thsh.com/documents/Insider-Trading-and-Tippee-Liability--Nov2012.pdf
31 See supra note 16
32 Greg Kramer, INSIDER TRADING: EXAMINING TIPPER AND TIPPEE LIABILITY, New
York Law Journal,
http://www.kkwc.com/library_cat/uf_Insider_Trading_Examining_Tipper_and_Tippee_Liability.pdf
30 | P a g e

tippee while in India a same standard is provided in the definition of

insider which will apply to tipper and tippee.

IV.2KNOWLEDGE AND MOTIVE:

IV.2.1

INDIA

The knowledge and motive requirement for conviction in India for insider
trading offence is very ambiguous. The author would examine that
whether knowledge and motive is required for conviction under section
24 of SEBI Act, 1992 by relying on legislations and case-laws. The
ambiguity was created because of the SAT ruling in Rakesh Agarwal
case.33
The facts of this case are as follows Rakesh Agarwal was MD of ABS
Industries Ltd. and for survival of his company he entered into
negotiations with Bayer AG for takeover. Rakesh Agarwal asked his
brother-in-law, to purchase shares of ABS in order to facilitate the
takeover of shares in the open offer made by Bayer.
The SAT held that even though Rakesh Agarwal had access to UPSI he
had no intention to make profits for himself and whatever he had done
was in the best interest of his company. The SAT held that Rakesh had
made those purchase in order to ensure that Bayer gets 51% of shares of
ABS.
Therefore, it is apparent from the judgment that the SAT was of the
opinion that profit element is implicit in the concept of insider trading
33 2004 49 SCL 351 SAT
31 | P a g e

and therefore, a person will be held liable only when the profit element
is satisfied. The court went further and said that if a penal provision of
law is silent on requirement of mens rea than the presumption would
be that it is present and therefore the legislator has to specifically
exclude the presumption of mens rea.

"Mens rea - There is a presumption that in any statutory crime

the common law, mental element, mens rea, is an essential
ingredient. A crime may or may not contain an express definition
of the necessary state of mind. A statute may require a specific
intention, malice, knowledge, willfulness or recklessness. On the
other hand it may be silent as to any requirement of mens rea
and in such a case in order to determine whether or not mens rea
is an essential element of the offence, it is necessary to look at
the objects and terms of the statute. It has always been a
principle of the common law that means rea is an essential
element in the commission of any criminal offence against the
common law. In the case of statutory offences it depends on the
effect of the statute..... There is a presumption that mens rea is
an

essential

ingredient

in

statutory

offence,

but

this

presumption is liable to be displaced either by the words of the

statute creating the offence or by the subject matter with which it
deals34"
Regulation 4 states that any insider who deals in securities in
contravention of the provisions of Regulation 3 or 3A of the Insider
Trading Regulations shall be guilty of insider trading. Thus, a person
may be convicted if there is a breach of regulations and in absence of
mens rea, thereby making it strict liability crime.

34 State of Maharashtra v Mayer Hans George AIR 1956 SC 722

32 | P a g e

In SEBI vs DSQ Biotech Ltd.35, the court rejected the genuine

corporate policy intention and held that in India intention or mens rea
to make profit is irrelevant for conviction under SEBI Act, 1992. Also in
SEBI vs Cabot International Capital Corporation 36, it was held by the
Bombay High Court that the scheme of penalty under SEBI regulations
and SEBI Act is penalty for failure of statutory obligation or breach of
civil obligation. There is no element of any criminal offence as
contemplated under criminal proceedings and hence mens rea is not an
essential element for imposing penalty under the SEBI Act and SEBI
Regulations. This view was upheld by the Supreme Court which stated
that Section 15G of the SEBI Act deals with defaults or failure of
statutory civil obligations under the SEBI Act and SEBI Regulations,
while Section 24 of the SEBI Act deals with criminal offences under the
said Act and its punishment. Since the proceedings pertaining to
Section 15G are neither criminal nor quasi-criminal, there is no
question of proof of mens rea as an essential element for imposition of
penalty and that the penalty is attracted once the contravention of
statutory obligations under the SEBI Act and Regulations is established
regardless of the intention of the parties, and the 'no mens rea, no
penalty' principle is erroneous.37 The SAT was also of the view that
making mens rea an essential requirement for the charge of insider
trading under the SEBI Act sets the stage for various market players to
violate statutory regulations with impunity and subsequently plead
ignorance of law or lack of mens rea, which frustrates the object of
Section 15G, that is to give teeth to SEBI to ensure strict compliance of
the SEBI Act and SEBI Regulations.38 These judgments have been

35 MANU/SB/0033/2003
36 (2004) 51 SCL 307 (Bom)
37 SEBI v. Shriram Mutual Fund, AIR 2006 SC 2287
38 Rajiv B. Gandhi and Others v. SEBI, Appeal No. 50/2007, SAT Order dated May 9, 2008
33 | P a g e

subsequently approved by a three-judge bench of the Supreme Court.39

Section 195 of the Companies act, 2013 which prohibits insider trading
by directors and other key-managerial personnel does not make mens
rea criteria and the acts applicability is extended on unlisted
companies and private companies.

IV.2.2

Motive in the United States:

Dirks vs SEC40 and Chiarella vs United States41 are two basic cases for
understanding the concept of mens rea in insider trading. Rule 10b-5
states that
It shall be unlawful for any person, directly or indirectly, by the
use of any means or instrumentality of interstate commerce, or of
the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to
state a material fact necessary in order to make the statements
made, in the light of the circumstances under which they were
made, not misleading, or
(c) To engage in any act, practice, or course of business which
operates or would operate as a fraud or deceit upon any person, in
connection with the purchase or sale of any security."

39 Union of India v. Dharmendra Textiles Processors and others (2008) 2008 SCC (13) 369. See also,
Kanbay Software India Pvt. Ltd. v. Dy. CIT (2009) 122 TTJ (Pune) 721.
40 Supra Note 16
41 Supra Note 15
34 | P a g e

The Supreme Court in Dirks case held that for the tipper to breach his
fiduciary duty, it was necessary for the tipper to communicate insider
information to a tippee for monetary or personal benefit and not for
reasons such as a genuine desire to fraud 42. The court stated that
presence of some personal gain was a pre-requisite for the commission of
the offence of insider trading. Because the tippee's duty was derivative of
the tipper's duty, there could be no liability for the tippee absent a breach
of duty by the insider43.
The Supreme Court in Chiaralla case44 held that it is absolutely necessary
to prove breach of fiduciary duty fraudulently by insider which was
reposed on him by the shareholders and the company.
In United States vs OHogan45 held that the insiders action must
constitute a wilful violation of the securities crimes to qualify for criminal
penalty.
Thus in India for a criminal penalty under section 24 to be attracted
there must be violation of regulations and in U.S. over and above proving
violation of regulations SEC also has to prove mens rea which is very
difficult and cumbersome to do. Thus Indian position in relation to this
aspect is far stricter in comparison to U.S.

42 Ibid, at p 663
43 Ibid, at p. 667
44 Supra Note 15
45 521 U.S. 642
35 | P a g e

IV.3USE V. POSSESSION IN THE UNITED STATES AND

IN INDIA:

IV.3.1

The Use v. Possession in United States:

The debate whether to have insider trading law based on the

jurisprudence of knowing possession or use has been going on for
decades and the position of U.S. seems to be unclear on this point. In
Cady, Roberts & Co.46, in ruling that insider trading constitutes fraud
and deceit reliance was placed on the theory of disclose or abstain rule.
According to this rule an insider in possession of material non-public
information should either disclose the information before trading or
abstain from trading. This rule was also accepted in Texas Gulf Sulphur

46 40 S.E.C. 907, 913 (1961)

36 | P a g e

Co. case47. Even SEC has been inconsistent in its interpretation of the
above mention rule as it is evident from the example of Investors
Management Co. case48 and Sterling Drug Inc. case49. In investors
Management Co. the SEC effectively endorsed a "use" requirement,
asserting that a requisite element for insider trading liability is "that the
information be a factor in decision to effect the transaction. 50 While in the
other case the theory of use was rejected and the rule of knowing
possession was adopted by SEC.
In United States v Teicher51, the court adopted the knowing possession
by placing their arguments on three factors. The first being that section
10(b) and Rule 10b-5 require only that a deceptive practice be conducted
in connection with the purchase or sale of a security. 52 The court noted
that the phrase "in connection with" has been construed quite flexibly,
suggesting that such an interpretation supports the more flexible and
less restrictive "knowing possession" standard. 53 The second reason for
placing reliance on possession theory was because of disclose or
abstain rule. The court held that either the person should disclose the
material information before trading or if he doesnt want to disclose then
he should abstain from trading. Finally the court said that the "knowing
possession" standard because it is simple to apply, requiring only a
determination of whether the trader possessed material, non-public
47 401 F.2d 833 (2d Cir. 1968)
48 44 S.E.C. Docket 633, 646 (1971)
49 14 S.E.C. Docket 824 (1978)
50 http://scholarship.law.upenn.edu/cgi/viewcontent.cgi?article=3347&context=penn_law_review
51 987 F.2d 112 (2d Cir.)
52 Teicher, 987 F.2d at 120 (quoting section 10(b) and Rule 101-5)
53 Ibid
37 | P a g e

information.54 The "use" standard, on the other hand, requires factual

inquiries into the state of mind and motivations of the trader. 55 The court
also argued that use standard would make it difficult for SEC to prove
the offence of insider trading. The court also stated that if any person is
in

possession

of

material

non-public

information

than

strong

presumption or inference could be raised against the person that he

traded on the basis of that information however this presumption is
rebuttable.
However in the case of SEC vs Alder,56 the 11th Circuit Court advocated
the standard of use by relying on Supreme Courts various previous
observations. The court held that though SEC had expressly adopted the
knowing possession test in Rule 14e-3, the SEC has not amended Rule
10b-5 or promulgated other rules to adopt knowing possession
standard.
Shortly after this case, the Ninth Circuit Court had addressed the same
issue in affirmative in United States vs Smith.57 The court argued that the
rationale behind the law is that the insider shouldnt have an unfair
advantage over the other investors and there must be fairness and
equality in financial market. Therefore, the court held that if the insider
doesnt trade on the basis of the material non-public information then the
same person does not obtain an unfair advantage over the other
investors. According to the court, it was the insider's use, not his
possession, which gave rise to an informational advantage and the
requisite intent to defraud.

54 Ibid
55 Ibid

56 137 F.3d 1325 (11th Cir. 1998).

57 1998 U.S. App. LEXIS 20750
38 | P a g e

Thus because of the wavering decisions and ambiguity the SEC

implemented Rule 10b5-1 in 2000 which states that rule 10b-5s
prohibition of insider trading is violated whenever someone trades on
the basis of material non-public information. SEC further provided
definition of trading on the basis of material non-public information as
Purchase or sale of a security of an issuer is on the basis of
material

non-public

informationif

the

person

making

the

purchase or sale was aware of the material non-public information

when the person made the purchase or sale.58
Therefore Rule 10b5-1 formally rejects the Alder position.

IV.3.2.

India

In HLL v. SEBI59case, there was a debate going on whether the words on

the basis of mentioned in regulation 3 mean that the person trading has
to trade on the basis of the insider information. There was an ambiguity
as to whether the legislators intended for the rule of use to apply by
using the words on the basis of. In HLL v. SEBI case the allegation
levelled against HLL was that being an insider it had purchased the
securities of Brook Bond Lipton India Ltd (BBIL) on the basis of
unpublished price-sensitive information. HLL argued that the transaction
was not motivated by the news of the impending merger but for the
purpose of enhancing the share of Unilever in BBIL to 51 per cent
independent of the merger. Thus it was not on the basis of insider
information as they had no motive. Though the Appellate Authority
rejected this contention and stated that there was enough circumstantial
58 17 C.F.R. 240.10b5-1(b
59 Supra Note 3
39 | P a g e

evidence to show that the transaction was motivated by the knowledge of

the impending merger but it was very difficult and cumbersome for SEBI
to prove that the transaction was done on the basis of insider
information.
This prompted the 2002 amendment in which the words on the basis of
were replaced by the words when in possession of. Thus SEBI expressly
removed the requirement of motive.
Regulation 4 of SEBI (Prohibition of Insider Trading) Regulations 2015
states that when a person who trades in securities has been in possession
of UPSI, it would be presumed that his trades were motivated by UPSI.
Thus, the onus shifts on the insider who has to prove that he was
innocent according to the defences mentioned in the regulation 4. The
Indian law is based on the rule of possession.
The Indian position is much clearer because the regulation 4 raises the
presumption against the insider once it is proved that the person is an
insider and he was in possession of UPSI by the Board. The act goes one
step forward in cases of a connected person. In connected person the
onus is on the person to prove that he was not in possession of UPSI once
it is established that he is a connected person. The Indian Law is much
more stringent compared to USA in this regard.

IV.4Investigative Powers in India & United States;

IV.4.1

United States

The conviction of widely popular case of Rajat Gupta and Raj

Rajarantham was possible because of the use of recorded telephonic
conversations. In this case Rajat Gupta CEO of Goldman Sachs was
convicted for disclosing corporate secrets to his friend Raj Rajarantham.
40 | P a g e

Rajat Gupta was ordered to pay fine of $13.9 million and a two year
imprisonment was imposed which was upheld by Supreme Court. It is
also interesting to note that Mr. Gupta had made no profit or gain from
this transaction. Raj Rajarantham was imposed a fine of $92.8 million
penalty and an 11 year prison time. This case is extraordinary not just
because of the amount of fine imposed and prison time but also because
exclusive focus was placed on the telephonic conversations recorded
between Mr. Rajarantham and his sources. There were around 40
wiretapped recording which was placed before the court.
In the United States, the federal and state agencies have the power to
tap phones. However, prior permission has to be taken from a court of
law in order to tap phones. Use of wiretaps has increased considerably in
U.S.

in

last

decade

in

order

to

obtain

direct

evidence.

The

Communications Act, 1934 in the United States had made wire-tapping

inadmissible evidence in court and also a federal criminal offence.
However, subsequently, the government started facing a lot of problems
when it declared its war on drugs in 1960s. Prosecutors had difficulty in
prosecuting drug mafia due to lack of evidence. The Supreme Court
decided a land mark case by the name of Katz v. United States60. In
Berger vs New York61, the Court declared the wiretapping law passed in
New York as unconstitutional under the Fourth Amendment. Thereafter,
the U.S. Congress passed the Omnibus Crime Control Act, 1968 to
regulate wiretapping by federal agencies in the U.S.
The offence of insider trading doesnt come within the ambit of those
offences in which permission for wire-tapping could be given. Then the
question arises as to how the courts can grant the permission for
wiretapping in cases of insider trading. In the Rajaratnam case for
example, the government obtained the authorisation for wiretapping in
relation to suspicion of money laundering and a manifest was also
60 389 U.S. 347 (1967)
61 388 U.S. 41 (1967)
41 | P a g e

included which said certain collateral offences such as securities

violation may also have been committed. The admissibility of this wiretapped recording was challenged before the court. The court held that
the evidence regarding insider trading was obtained in good faith on the
ground of reasonable suspicion. The SEC does not have powers to tap
phones. In the Rajaratnam case, FBI collected the evidence through
wiretap which was handed over to Rajaratnam as a part of the due
process followed in criminal trials. The SEC filed a motion to compel
production

of

documents

on

Rajaratnam

which

included

wiretap

evidence. In this way, the conviction of Rajaratnam was secured.

Even in the case of James Fleishman and Winifred Jiau of consulting
company Primary Global Research the government obtained conviction
by relying on wire-tapped recording. Around 20 persons have been
convicted of insider trading by relying on telephonic recordings.
Generally conviction in insider trading is solely based on circumstantial
evidence; therefore it is difficult to prove. A direct evidence like wire-taps
can make it considerably easy to get a conviction. The government also
obtained the convictions of brothers Zvi and Emanuel Goffer, who
illegally profited from Zvi Goffers role as a trader at the hedge fund
Galleon Group.

62

One of the major problems which the regulator engaged in prosecuting

insider face is to find a witness. Another problem that the SEBI faces in
insider trading cases is in establishing that the information available to
the trader was price sensitive in that it was likely materially to affect the
price of the security.

IV.4.2 India
62 Howard J. Kaplan , Joseph A. Matteo, Richard Sillett, THE HISTORY AND LAW OF
WIRETAPPING, ABA Section of Litigation 2012 Section Annual Conference April 18-20, 2012
http://www.americanbar.org/content/dam/aba/administrative/litigation/materials/sac_2012/291_history_and_law_of_wiretapping.authcheckdam.pdf
42 | P a g e

The convictions of Mr. Rajat Gupta and Mr. Raj Rajarantham started a
debate in India as to whether phone tapping must be allowed on
suspicion of fraud in securities markets. As we have analysed in earlier
chapters that the substantive insider trading laws in India are much more
stringent as compared to USA. Still SEC is much more efficient in
obtaining convictions in insider trading if we compare it with SEBI. The
difference comes in investigation. In India Section 5(2) of the Indian
Telegraph Act, 1885 lays down the law relating to telephone tapping. It
states:
(2) On the occurrence of any public emergency, or in the
interest of the public safety, the Central Government or a
State Government or any officer specially authorised in this
behalf by the Central Government or a State Government
may, if satisfied that it is necessary or expedient so to do in
the interests of the sovereignty and integrity of India, the
security of the State, friendly relations with foreign States or
public order or for preventing incitement to the commission
of an offence, for reasons to be recorded in writing, by order,
direct that any message or class of messages to or from any
person or class of persons, or relating to any particular
subject, brought for transmission by or transmitted or
received by any telegraph, shall not be transmitted, or shall
be intercepted or detained, or shall be disclosed to the
Government

making

the

order

or

an

officer

thereof

mentioned in the order.

Like SEC, even SEBI doesnt have the power to tap phones because of
the landmark judgment given in the case of PUCL v. Union of India63. The
court held that wire-tapping of telephones is against Article 21 of the
Constitution of India as it would infringe right to privacy and only
certain agencies like Intelligence Bureau, Director General Narcotics
63 AIR 1997 SC 568
43 | P a g e

Control Bureau, Revenue Intelligence and Central Economic Intelligence

Bureau and the Director, Enforcement Directorate have the power to tap
phones for the purposes indicated in Section 5(2). The court accepted the
fact that economic emergency is not one of those matters expressly
mentioned

in

the

statute.

Mere

'economic

emergency'

may

not

necessarily amount to a 'public emergency' and justify action under this

action unless it raises problems relating to the matters indicated in the
section. The court then defined public emergency as prevailing of a
sudden condition or state of affairs affecting the people at large calling
for immediate action and "public safety" would mean the state or
condition of freedom from danger or risk for the people at large.
In 2009, SEBI had written to the Telecom and Finance Ministry to grant
it power to access call records for the purpose of Investigation. However,
the request was denied on the ground that the name of SEBI was not
included in the list of agencies which were authorised by the government
to tap phones64.
After the 2013 amendment SEBIs investigative power has increased
providing it with necessary ammunition. After the amendment SEBI now
has the power to call upon records (including telephonic records) from
various

organizations

which

SEBI

may

feel

are

relevant

to

its

investigations. The SEBI does not have the powers to snoop in on

telephonic conversations but SEBI has the power to call upon records
like phonebook from other agencies for the purposes of investigation. It
should be kept in mind that telephonic records and telephonic records of
conversation are different. SEBI also has the authority to break open the
lock of any door, box, locker, etc. to get information from suspected
entities.65
64 http://articles.economictimes.indiatimes.com/2011-04-12/news/29409925_1_sebi-executivedirector-insider-trading-securities-exchange-board
65 http://articles.timesofindia.indiatimes.com/2013-06-14/india/39975284_1_home-ministry-accesscall-data-records-home-secretary
44 | P a g e

The telephone records can also be used to prove a link between an

insider and a trader and also to find out the common third party link
between an insider and a trader. For example in United States, the
analysis done by the SEC revealed a "third party number" which was
called by both the trader and an insider. The staff contacted the third
party who happened to be a real estate broker who had brokered a real
estate transaction between the trader and the insider. That transaction
turned out to be the mechanism by which the trader compensated the
insider for an illegal stock tip66.
Thus, it can be held that on paper SEBIs investigative powers are very
much similar with that of SEC. Even SEC doesnt has the power to record
telephonic conversations but FBI can do it and SEC can call upon this
conversation by applying before the court as we have seen in case of Raj
Rajarantham case and various others. Thus, this is the only difference
(although it is a major difference) between the SEBI and SECs
investigative power.
The Chapter IV in the 1992 regulations which dealt with boards right to
investigate, procedure for investigation has been removed after the 2015
amendment as it has already been comprehensively covered under
chapter VIA of the Securities and Exchange Board of India Act, 1992.

66 L. Hilton Foster, INSIDER TRADING INVESTIGATIONS,

http://www.sec.gov/about/offices/oia/oia_enforce/foster.pdf
45 | P a g e

V.CORPORATE GOVERNANCE AND INSIDER TRADING

IN INDIA:
To counter the menace of insider trading SEBI has adopted two-fold
mechanisms.

The

first

mechanism

provides

corporate

governance

standards which is useful in preventing the offence of insider trading.

Corporate governance standards come into play for preventing the
practice of insider trading. Chapter IV of SEBI (Prohibition of Insider
Trading) Regulations, 2015 provides corporate governance standards.
Regulation 5 talks about formulating a Trading Plan for those persons
who are perpetually in possession of UPSI and thus enabling them to
trade. This plan needs to be presented to a compliance officer for
approval and public disclosure. This plan is irrevocable and allows the
insider to trade in pursuance of pre-determined trading plan that has
been publically disclosed six months prior to commencement of such
trading. No trading outside the plan is permitted. This provision is
similar to rule 10b5-1 plains in U.S.
Regulation 6 states that insider as well as his immediate relatives is
required to make public disclosure of trading in securities and also of any
other person of whom such person take decisions. The trading in
derivatives would also be covered under this term securities. The
disclosure is to be made in such form as prescribed by SEBI and the
disclosures have to be maintained for at least 5 years by the company.
Regulation 7 talks about disclosures by certain persons. Regulation 7(1)
stipulates that every director, promoter and key managerial person of a
listed company must disclose their holding in securities within 30 days of
commencement

of

these

provisions.

Similarly

person

on

his

appointment as a director or key managerial person or becoming a

promoter must disclose his holdings within 7 days of his appointment or
becoming promoter as the case may be. Regulation 7(2) requires every
promoter, director and employee of a listed company to disclose to the
46 | P a g e

company the number of securities acquired or disposed of within two

trading days of such transaction if the value of the securities traded,
whether in one transaction or a series of transactions over any calendar
quarter, aggregates to a traded value in excess of ten lakh rupees or such
other value as may be specified.67 According to the note appended
disclosure has to be made as and when the threshold limit is crossed.
Thus, the disclosure has to be made more than once or not at all in a
calendar quarter, depending upon the acquisition or disposal crossing
the threshold. The provision has departed from the 1992 regulations
where the threshold limit was 2% of the shareholding or voting rights in
the company. Also what is interesting to note that in regulation 7(1) the
words director, promoter or key managerial person is used while in
regulation 7(2) the words director, promoter or employee is used. This
could be the unintended draftsman mistake or the government wants
every employee or only the insider employee of a company to be covered
by the regulation 7(2) i.e. continual disclosures. Regulation 7(3) is a
discretionary provision. It confers discretionary power on the company to
require any connected person or class of connected person to disclose
their holding and trading in securities of the company as it may call for.
Under Regulation 8 the Board of every listed company is required to
form and publish their own code of practices and procedures for
disclosure of UPSI in accordance with the principles set out in schedule
A. Schedule A ensures fair disclosure of UPSI by laying down standards
such as such as equality of access to information, publication of policies
such as those on dividend, inorganic growth pursuits, calls and meetings
with analysts, publication of transcripts of such calls and meetings etc.
Under Regulation 9 the BOD of every listed company and every market
intermediary registered with SEBI shall form a code of conduct to
regulate, monitor and report trading done by its employees and other
connected person in accordance with the standards set out in schedule B.
67 [2015] 125 CLA (Mag.) 1 T V Narayanaswamy

47 | P a g e

Even entities that normally operate outside the capital market like
auditors, accountancy firms, law firms, analysts, consultants, other
capital market participants etc. are also required to formulate such a
code of conduct.

Compliance Officer
Regulation 2(1)(c) defines compliance officer as any senior officer
reporting to the BOD or head of the organization in case BOD is not
there. Compliance officer is entrusted with duties of compliance of
policies, procedures, maintenance of records, monitoring adherence to
the rules for the preservation of unpublished price sensitive information,
monitoring of trades and the implementation of the codes specified in
these regulations.68 Compliance officer will also be responsible to
regulate, monitor and report conduct of connected person.
In Re Satyam Computer Services Limited69 case SEBI discussed the
role and duties of a compliance officer. The investigation launched
by the SEBI revealed that Satyams decision to acquire Maytas
Infra Ltd. (MIL), Maytas Properties Ltd. (MPL), the subsequent
withdrawal of the said proposal on December 17, 2008 and the
confessions made by Mr. Ramalinga Raju, the then Chairman of
SCSL on January 07, 2009 was price sensitive information. It was
observed that certain employees and clients had sold SCSL shares
between November 25, 2008 and December 16, 2008 till before the
announcement and some 80 clients sold before January 7, 2009.
The SEBIs charge against the compliance officer was that he has
failed to perform his duty by not closing the trading window prior
to its board considering the transaction involving the proposed
acquisition

of

shares

in

Maytas

Infra

68Ibid
69 ADJUDICATION ORDER NO. PG/AO-115/2011,
http://www.sebi.gov.in/cms/sebi_data/attachdocs/1322550235791.pdf
48 | P a g e

Limited and Maytas

Properties Limited70. If the compliance officer had closed the

trading window before the announcement then the employees and
other connected person wouldnt have been able to dispose of their
shares at a higher price. It was held that compliance officer does
not have to act only under the supervision of the company as it
would negate the purpose of appointing him. Therefore, the
compliance officer is independent and has to conduct his duties in
an impartial manner.

Trading Window
In Schedule B the concept of Trading Window is incorporated. Trading
Window means a period in which the companys directors, officers and
the designated employees and the other connected persons trade in
companys securities. The trading window can be closed by a compliance
officer on a reasonable expectation that a designated person or
designated class of people are in possession of UPSI. The time-frame for
re-opening of trading window has been set to 48 hours after the
information becomes generally available. 71 Earlier this time-frame was 24
hours. This trading window concept is also applicable on external
agencies having contractual or fiduciary relationship with company like
law firms, accountancy firms, etc.
The clause lays down the different kinds of information as relevant for
the purposes of closing the trading window. These are:
(1) Declaration of financial results, (2) Declaration of Dividends, (3) Issue
of rights, bonus, shares etc. (4) Information regarding a new project, (5)
Merger,

amalgamation

and

buy-back,

(6)

Disposal

of

70 http://indiacorplaw.blogspot.in/2011/12/insider-trading-role-of-compliance.html
71http://www.nishithdesai.com/fileadmin/user_upload/pdfs/NDA
%20Hotline/Regulatory_Hotline/Salient_Features_of_the_Regulations.pdf
49 | P a g e

whole

or

substantially whole of the undertaking, (7) any changes in policies, plans

and operations of the company.72

Pre-clearance of Trade
Under this clause trading done by designated persons shall be subjected
to pre-clearance by the compliance officer, if the value crosses the
threshold as stipulated by BOD and the designated person should not be
in possession of UPSI. The compliance officer is also entitled to seek
declaration that the designated person is not in possession of UPSI at the
time of applying for pre-clearance of trade. Also once the pre-clearance is
given the designated person has to execute the trade within 7 days or
any other time-frame which cannot exceed 7 days. If he fails to do so,
then fresh pre-clearance would be needed for the trade to be executed.

Short Swing Profits

In 2008, SEBI amended Clause 4.2 in Schedule I to include the provisions
relating to short swing profits. This clause 4.2 prohibited directors,
designated employees who buy or sell any number of shares of the
company from entering into an opposite transaction for a period of 6
months. Two exceptions have been carved out in this clause. The first
exception relates to initial public offering wherein the embargo on
trading is only for a period of 30 days and the second exception is in the
case of a personal emergency. The rationale behind this provision is to
prevent insiders who are in possession of UPSI from taking an advantage
of such information. Section 16(b) of the Exchange Act provides the
concept of short swing profits.
However, this amendment was not well received by certain class of
investors because:

72 Ibid
50 | P a g e

a. It puts a blanket ban on trading for 6 months even though the

designated person is not in possession of UPSI.
b. The amendments did not prescribe the principle of First in First
out (FIFO), i.e., the shares purchased first can be sold first.73
c. The amendment did not specify the method of calculation of
short swing profits.74
d. It is not clear whether this provision applies to promoters, the
employees and on the dependents of the directors.
e. Also it is not clear whether this provision applies on ESOPs
issued to employees or when buy-back or open offer is issued by
a company.
To remove the fallacy, SEBI made minor changes in this regard in 2015
amendment. Accordingly, a designated person cannot execute a contra
trade i.e. opposite of previous trade in less than six months or any other
time-frame provided the period cannot be less than 6 months. However,
the discretion has been given to compliance officer to allow trade within
6 months provided the trade does not violate these regulations.

Chinese Wall
In simple language Chinese Wall means creating an artificial wall which
precludes the flow of important information from one part of the office
into the other. The concept of Chinese wall has been evolved to tackle the
problem of conflict of interest that arises when the listed companies deal
with the underwriters. The House of Lords recognised this principle
when they defined a Chinese Wall as the existence of established
organisational arrangements which preclude the passing of information
in the possession of one part of the business to other parts of the
business in Bolkiah v. KPMG.75 This concept is very popular and used not
73 http://shodhganga.inflibnet.ac.in/bitstream/10603/13173/11/11_chapter%203.pdf
74 Ibid
75 [1998] UKHL 52, Lord Millet.
51 | P a g e

only in the field of finance but also in the field of law, journalism, science,
etc.
The perfect example to show the importance of Chinese Wall is when a
listed company may disclose to the investment banker that it will be
buying another company. The investment banker will simultaneously
have other clients as well who may be interested in the information. The
investment banker may share this information with his other clients who
will buy the shares and wait for the information to become public and
then sell the shares for a profit. Chinese Wall tries to address these type
of situations.
The term Chinese Wall is said to have originated in the year 1929 after
the catastrophic crash of U.S. Securities market. The concept of Chinese
Wall came into existence in case of In re Merrill Lynch, Pierce, Fenner &
Smith, Inc.76 where SEC settled the matter with Merill Lynch, if the latter
establishes a Chinese Wall in the firm. Merrill Lynch was the lead
underwriter for a potential public offering of debentures by Douglas
Aircraft Company.77 Merrill Lynch learned that the company was about to
issue a revised estimate of its earnings with substantially lower figures.
Merrill

Lynch's

underwriters

gave

this

information

to

the

sales

department, who in turn told several mutual funds and other large
institutional clients.78 During the three-day period before Douglas
publicly disclosed this information, Merrill Lynch and its clients sold the
stock to avoid substantial losses. As part of the settlement Merrill Lynch
reached with the SEC, the firm adopted a Statement of Policy that
"prohibits disclosure by any member of the Underwriting Division of

76 43 S.E.C. 933 (1968)

77 Ibid
78 Ibid
52 | P a g e

material information obtained from a corporation.., and not disclosed to

the investing public."79
After this case, other firms voluntarily agreed to implement such
measures to prevent leakage of information from one department to
another.80 However, allegations of insider trading against these firms
continued to rise and many breaches were observed by the SEC of this
rule. Therefore, the rule of Chinese Wall was given statutory recognition
under Section 15(f) of the Securities Exchange Act of 1934, which was
adopted as part of the Insider Trading and Securities Fraud Enforcement
Act of 1988.81
Law in India regarding Chinese Walls
The Chinese wall policy was introduced in India by the 2002 amendment,
Part B of Schedule I clause 2.4 which made it compulsory for all listed
companies and other organizations associated with the securities market,
to have Chinese wall policy as a part of their code. The amendment also
recognized the policy of Chinese wall as a valid defence. The Code
speaks of creation of insider areas and public areas within the
organisation, for the purpose of segregation of the two zones. Access to
insider areas (zones of confidential information) shall be restricted and
segregated from public areas and accordingly, employees engaged in the
former shall not communicate price sensitive information to the latter. If
in any exceptional circumstance, the employees of the public area have
to be given confidential information, it shall be on a need to know basis
and shall take place within the insider area.82

79 Ibid at 939
80 http://ir.lawnet.fordham.edu/cgi/viewcontent.cgi?article=1169&context=jcfl
81 15 U.S.C. 78o(f), 80b-4a (2003)
82 http://lawfarm.in/insider-trading-and-the-chinese-wall-defense/
53 | P a g e

In Schedule B of 2015 amendment, the policy of Chinese wall is provided.

The code provides that information shall be handled within the
organization

on

need-to-know

basis

and

therefore

UPSI

can

be

communicated to other person only in furtherance of discharge of duties

or legal obligation or for legitimate purposes. Under Regulation 9, a
company is under a duty to develop appropriate Chinese wall procedures
and also the process for allowing any designated person to cross the
wall
Advantages of Chinese Walls:
Chinese Walls are an important weapon in the battle against insider
trading. As discussed earlier, insider trading is illegal, and Chinese Walls
attempt to prevent insider trading by preventing the flow of material,
non-public information.83 Chinese Walls also have a beneficial purpose for
the broker-dealer. "At the same time that Chinese Walls contain
information within a department, they also allow other departments to
act freely without fear of 'contamination.84 Chinese Walls allow a brokerdealer to still engage in trading activities even if its investment bankers
receive material, non-public information. If a retail trader discovers
material, non-public information, the firm would have its hands tied and
be prevented from trading since this would be a violation of insider
trading laws. A Chinese Wall segregates this information from the retail
traders so that they can continue to engage in trading activities without
any fear of being tainted and guilty of insider trading.85
Disadvantages of Chinese Walls
It has been averred that the above policy is only equipped to impede
accidental exchange of information among the departments of an
83 Supra note 80
84 Ibid
85 Ibid
54 | P a g e

organisation.86 It cannot curb those situations when there is a deliberate

disclosure of information by the investment advisors to clients as in the
case of giving tips.87 More importantly, Chinese walls wont be able to
prevent insider trading by classic insiders of the corporation and their
tippees. These instances of insider trading are more common than insider
trading resulting from the breach of a Chinese wall particularly with the
emergence of discount brokers.88
However, at times the firms compliance with the Chinese Wall policy can
also be counterproductive in light of the duty it owes to its customers. It
is an uphill task to strike a balance between the duty to maintain
confidentiality of information obtained from its corporate clients and its
duty of providing accurate information of all material facts and
circumstances to its customers. This is exactly what happened in Slade v.
Shearson, Hammill & Co,89 where Slade did not act on the adverse
information of a companys financial stability that its underwriting
department was privy to and continued to recommend stock to its clients.
As a result, it was sued by its clients. The defense of a Chinese Wall did
not hold good in court as it was of the opinion that the firm was unable to
recognise its conflicting fiduciary relationships and its duty not to
recommend the said stock which it failed to fulfil.90 Hence, compliance
with the Chinese Wall policy can often conflict with other fiduciary duties
in securities trade, producing adverse consequences.
Also practically speaking this policy is not much effective as the cases of
insider trading is on rise every year.
86 ASIC v. Citigroup Global Markets Australia Pty Limited (2007)
87 http://lawfarm.in/insider-trading-and-the-chinese-wall-defense/
88 http://www.lepetitjuriste.fr/what-is-the-function-of-chinese-walls-in-preventing-insider-dealing/
89 517 F.2d 398, 400 (2d Cir. 1974)
90 http://ir.lawnet.fordham.edu/cgi/viewcontent.cgi?article=1169&context=jcfl
55 | P a g e

Responses to Market Rumors

Under schedule A the company is under an obligation to provide
appropriate and fair response to queries on news report and to market
regulators for verification of the market rumors. It is a well-known fact
that speculation plays a major role in determining prices in securities
market. Therefore in order to remove the effect of market rumors, the
company must clarify whether the rumors are true or false.

Disclosure to Analysts
Company must ensure that the information disclose to analysts and
research personnel must not be UPSI and should also upload the
recording of meeting with analysts and other investors on its official
website.

Penalty
The code of conduct under Schedule B empowers the company to impose
sanctions

and

take

disciplinary

actions,

including

wage

freeze,

suspension, etc.

VI CONCLUSION
Thus, it is submitted that the dissertation adequately deals with the
history of insider trading law in India and in USA and the rationale
behind the law. Then the author enters into a comparative analysis
56 | P a g e

between Indian law and U.S. law to test the hypothesis. The author
deduces that the definition of insider in Indian law has a wider scope
compared to USA. Indian position is unambiguous on the requirement of
motive. There is no requirement to prove motive under the Indian law by
SEBI, while in USA SEC has to prove the requirement of motive over and
above the breach of regulations. Even SEC has gone ahead and said that
proving of motive is very tough and cumbersome and which might allow
the offender to get away scot free. Also, on paper the investigative
powers of SEBI and SEC are very much similar.
After comparing the various substantive laws relating to insider trading
of both the countries the author test the hypothesis and come to the
conclusion that Indian laws are more stringent, unambiguous and are
adequate to deal with the menace of insider trading. Also on paper the
investigative power of SEBI and SEC are at par but SEC has develop a
cleverly crafted route to circumvent law and thus can obtain wire-tapped
recording from the court as seen in the example of Raj Rajarantham
case. Thus, the author would suggest that a change should be made in
this regard in India as phone tapping makes conviction of offenders a lot
easy.
The dissertation then discusses the corporate governance standards in
India which are laid down in Regulation 5,6,7,8 and 9 and in schedule A
and B. The author discusses the concept of trading windows, preclearance of trade, corporate disclosures, Chinese wall, etc. and comes to
the conclusion that corporate governance standards prescribed are
adequate and sufficient. One lacuna which the author found was in
regulation 7 which might lead to some confusion.
Thus, it can be said that the dissertation successfully tests the hypothesis
and reaches to the conclusion that the substantive laws and corporate
governance measures in India are adequate and SEBIs investigative
power is very much similar to that of SEC on paper.

57 | P a g e

BIBLIOGRAPHY
Books:
1. Henry Manne, INSIDER TRADING AND THE STOCK MARKET,
1966, 1st edition, The Free Press, New York,

2. A Ramaiya, GUIDE TO THE COMPANIES ACT, 2006, 16th edition,

part 2, wadhwa Nagpur.

Articles:
1. Greg Kramer, INSIDER TRADING: EXAMINING TIPPER AND
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2. Christopher M Gorman, ARE CHINESE WALLS THE BEST
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Goodwin v. Agassiz 186 N.E. 659 (1933)

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(1968)
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PUCL v. Union of India AIR 1997 SC 568

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59 | P a g e

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1. http://www.ourlegalsystem.com/theboemangroup/Investmyown/Firs
t_Page/Definitions/insider_trading_liability.htm
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df

3. http://www.lepetitjuriste.fr/what-is-the-function-of-chinese-walls-inpreventing-insider-dealing/

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5. http://www.lawteacher.net/free-law-essays/business-law/insidertrading-regulations-and-recent-developments-business-lawessay.php

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7. http://vipsight.eu/index.php?
option=com_content&view=article&id=101&Itemid=194
60 | P a g e

8. http://www.gibsondunn.com/publications/Documents/SEBIAnnounces-New-Insider-Trading-Regulations.pdf
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Prof. V. Umakanth,

http://indiacorplaw.blogspot.in/2013/03/review-of-insider-tradingregulations.html
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Prof. V. Umakanth,

http://indiacorplaw.blogspot.in/2013/03/review-of-insider-tradingregulations.html
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http://articles.economictimes.indiatimes.com/2011-04-

12/news/29409925_1_sebi-executive-director-insider-tradingsecurities-exchange-board
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http://www.thehindu.com/business/Industry/sebi-wants-call-

data-records-not-phonetapping-powers-sinha/article4756031.ece
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http://www.prsindia.org/theprsblog/?tag=search-and-seizure

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http://articles.timesofindia.indiatimes.com/2013-06-

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http://insidertrading.procon.org/view.resource.php?

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Planning Commission, Government of India, ABID HUSSAIN
COMMITTEE, 1989

62 | P a g e