CORPORATE GOVERNANCE

INSIDER TRADING AS A WHITE COLLAR CRIME: LIMITATIONS AND

SCOPE OF SEBI REGULATIONS, 2015

- ABHISHEK RUDRA

BA LLB – 3rd YEAR

SCHOOL of LAW

CHRIST (DEEMED TO BE UNIVERSITY)

BANGALORE
________________________________________________________________________________

INSIDER TRADING AS A WHITE COLLAR CRIME: LIMITATIONS AND

SCOPE OF SEBI REGULATIONS, 2015
-Abhishek Rudra

Abstract:

The paper is an endeavour to provide an insight into the developing trends of insider trading as a
menace in one of the fastest developing economy of the world such that it acts as a deterrent to the
growth of the share market. The paper begins with a meaning of the insider trading and traces the
purpose of prohibition of such menace in the share market and thereafter provides the instances of
misuse of price sensitive information and the breach of trust in relation to this issue. It is pertinent
to mention the history of any regulation for a better analysis of the scope and limitations connected
to it and therefore the paper dives into the committees and pre-1992 Regulations. Further, it brings
into light the measures that are in place for the prevention of Insider Trading in India and extends
the initial approaches of disclosure, Section 195 of the Companies Act, 2013, SEBI Regulation of
1992 and the recent Regulation of 2015 on the insider trading. With the aid of certain cases the
paper tries to bring the concern of insider trading in perpetually developing economy of India. As a
part of the flow, the paper further compares the provision against insider trading in United Kingdom
and the United States of America and traces the path of limitations and drawbacks that the current
provisions of Insider Trading in India suffers from. The paper concludes with some prospective and
reformative suggestions that could bring the insider trading regulations in India to the cutting edge
of the control of the share market and bring a parity in the economic imbalance that may accrue due
to any instance of insider trading.

Keywords: insider trading, SEBI, Regulations, disclosures, liability, organisations

 INTRODUCTION:

A reflection of the concept of insider trading can be found in the White Paper on the Conduct of
Company Directors 1977 (UK) which dealt inter alia with the subject of Insider Trading. That type
of conduct was not then subject to any legal sanctions, although it used to bring serious
consequences to the trading entities. Public confidence in directors require that they such people
should not use inside information to further their own interest. Furthermore, if they were to do so,
they would frequently be in breach of their obligations to the company and could be held for taking
unfair advantage of the people they are dealing with. To put this in much comprehensive words,
‘insider’ is a person who has the knowledge of facts not available to the general public and the
‘insider information’ is an information about a company that is obtained by an insider before the
public obtains it. This information is in all terms a ‘price-sensitive information’ which evidently
shall have an impact on the company’s securities price in the market.

In Indian context, the Insider trading refers to trading in shares of a company or are close to them on
the basis of undisclosed price sensitive information regarding the working of the company, which
they possess but is not available to others1. The word ‘insider’ has a wide connotation. It includes
directors, officers and employees of a company and related companies, persons with professional or
business relationship with a company, large beneficial shareholders, government officials, Stock
Exchange employees etc.

A. PURPOSE OF PROHIBITION ON INSIDER TRADING

In Lord Vane’s view, the rationale behind the prohibition on insider trading is “the obvious and
understandable concern about the damage to the public confidence which the insider dealing is
likely to cause and the clear intention to prevent so far as possible what amounts to cheating when
those with inside knowledge use that knowledge to make a profit in their dealing with others.”2

In order to keep the confidence of the investors in the integrity of the securities market, it requires,
firstly, a timely and adequate disclosure of price-sensitive information by the companies and
secondly, the prohibition of dealing on the strength of any such information disclosed. Consider the
facts scenario of R v Titheridge3, wherein a company called Joseph Stock and Sons Limited was the
object of a takeover bid. Mrs. Titheridge was secretary to the chairman of the merchant bank which
was advising the bidding company. She passed information to her husband who dealt in securities
of Joseph Stock in December, 1980. Both Mr. And Mrs. Titheridge pleaded guilty to insider dealing

1
Patel Committee’s Report, ¶ 7.25
2
Attorney General’s Reference No. 1 of 1988 BCC 765 affirmed by the House of Lords as reported at (1989) BCC 625.
3
(1983) 4 Co Law 117
 and were convicted. They were ordered to pay 4,000 fine. Another scenario might involve
the imminent announcement by a company of a particularly profitable year. Such news is likely to
force up the market value of shares in the company making them more expensive to acquire but also
more profitable to sell. R v Reardon- Smith (1985).

Let us consider some instances of insider information through a catena of cases which emerged as a
major concern in the late economic era of the US securities market. In Securities and Exchange
Commission v Texas Gulf Sulphur Co.4 wherein a test hole dug by the Texas Sulfur Company in
Ontario indicated a high copper and zinc concentration. The news of the success spread quickly and
the price of the stock soared more than double the rate and it prevailed even before the mining
actually took place and before the general body of the shareholders and the investing public came to
know about the actual set up. The court of appeal held that the directors were liable to pay the
profits along with the damages that the investors had suffered. In Diamond v Oreamuno5, a
shareholder of Management Assistance Inc. Filed a suit for an account of profits made by the
directors and officers in the breach of their fiduciary duty.

A.1. BREACH OF FIDUCIARY DUTY

Insider trading as it involves misuse of confidential information, is unethical and hence in breach of
trust position of trust and confidence. The position of directors in their relationship to the company
is no longer in doubt. Director are not only the agents, but they are in some sense and to some
extent, trustees or in the position of trustees. It is impossible now to dispute the position that they
are in some sense trustees. The directors have been held to be trustees of the assets of the company
and courts have directed them to reimburse the loss to the company where it was found that
directors had applied the company’s money in payment of an improper commission.

Directors are appointed to act in the interest of the company and an important area of their legal
responsibility stems from the law of trusts. They have a fiduciary relationship with the company.
The duties arising from the relationship are well defined , viz, to exercise their powers for the
benefit of the company, to avoid a conflict of interest and a duty, not a restriction to their right (by
contract or otherwise) and freely and fully exercise their duties and power. In addition to their
fiduciary duties, directors also owe a duty of care to the company not to act negligently in the
management of its affairs, the standard being that of a reasonable man looking after his own
affairs.6 Thus the directors are obliged to act bona-fide without using their powers for collateral
purpose.
4
401 F.2d 833 (2d Cir. 1968)
5
301 N.Y.S. 2d 78
 Moral and ethical reasons may translate as important in insider trading as it involves misuse of
confidential information, is considered to be unethical and immoral. The use of inside information
is patiently unfair to the persons dealing with insiders. By virtue of the confidential information, the
insider gains an unfair, secret advantage which will benefit him at the expense of the person he
deals with. From the legal view point, a more significant reason for trying to regulate insider trading
is that the insider is in a potential conflict-of-interest position.

A.2. HISTORICAL BACKGROUND

In May 1984, the Government of India constituted a high-powered committee called the Patel
Committee to make a comprehensive review of the functioning of the functioning of the stock
market and to make recommendations to the government in that regard.7 The Committee in its
report inter-alia recommended measures to prohibit the practise of, and also suggested legislation
on, insider trading and provided its draft. It indicated that there is no legislation in the country to
prohibit insider trading which enables circles close to the companies, to take advantage of the price
sensitive information which they come to know and to make quick profits on the Stock Exchanges
by trading in the shares of the companies concerned. The Sachar Committee had examined this
question of regulation of insider trading in 1978 and had made recommendations to the Government
in the matter, considering which, on the lines of the Australian legislations on the subject, a draft
legislation was enacted which later paved the way for the 1992 Insider Trading Regulations.8

In tune with the Cohen Committee’s stress on ‘the high code of conduct’, the SEBI, by its Press
Release issued on 19th August, 1992, insisted on framing ‘Internal Code of Conduct’ to check the
practise of insider trading.9 The Securities and Exchange Board of India Act, 1992 has empowered
SEBI to Prohibit insider trading in securities. It issued a list of types of information that would
constitute insider information in relation to business of the companies and its subsidiaries which
includes earning forecast or material changes therein, proposals for mergers and acquisition,
significant changes in investment plans, acquisition or loss of a significant contract, significant
disputes with major suppliers, consumers or-contractors and significant decision affecting the
product pricing, profitability, etc.

6
Swami, Subramanian - Corruption and Corporate Governance in India: Satyam, Spectrum, and Sundaram, 2009

7
Patel Committee Recommendations, No-7.26
8
Sachar Committee Recommendations, No-18.104 (iv)
9
Bharat’s SEBI Manual chapter 12, page no. 990, 4th edition
A.3. LAWS OF INSIDER TRADING IN UK AND USA

The Financial Services and Markets Act, 2000 ("FSMA") and the Criminal Justice Act, 1993
("CJA") give the statutory structure to insider exchanging administration in the UK. Be that as it
may, neither of the Acts characterizes the term 'insider trading'. Article 118(2) of the FSMA
characterizes 'showcase mishandle' as including conduct where an insider arrangements, or
endeavors to bargain, in a qualifying venture or related speculation based on insider data identifying
with the interest being referred to. The CJA, then again, denies managing in cost affected securities
based on insider data, support of someone else to bargain in cost influenced securities based on
insider data and knowing exposure of inside data to another. Criminal sanctions for insider
exchanging and showcase controls can bring about custodial sentences of up to 7 years and
boundless fines. Both the Indian and the UK laws have comparative meanings of 'value delicate
data' and in addition 'insider' (to the extent common obligation is concerned). In India, one basic
statute applies for both criminal and common obligation though in the UK, both the liabilities are
managed under various statutes.

The US has been one of the main authorities of Insider Trading. As a subsequent activity of the
Great Depression of 1929, the Securities Exchange Act of 1934 was ordered. Arrangements of the
Exchange Act have empowered the Securities Exchange Commission ("SEC") to forestall insider
exchanging the US. The US courts have given the imperative law identifying with insider
exchanging request to help the SEC, which can be outlined as the Abstain hypothesis and the
Misappropriation hypothesis. While per former, the insider must uncover information to people in
general before making the exchange or keep away from making the exchange at all, the later intends
to ensure the uprightness of securities markets against manhandle by outsiders to an organization
that may influence the organization's security cost when uncovered. Insider trading requirement
activities as of late feature the SEC's attack into more up to date territories, including moves made
against IT experts and programmers who abuse touchy corporate information, and suppliers of
political knowledge.

B. MEASURES IN PLACE TO PREVENT INSIDER TRADING

The rationale behind disclosures is to act as a deterrent to the indulgence of in insider trading while
disclosure of information about the company’s business reduces the chance of indulgence in insider
trading by enabling those who do not have otherwise an access to unpublished price-sensitive
information, to obtain such information and make use thereof with regard to share dealing and thus
depriving those who have access to price-sensitive information of abusing such information. Until
the promulgation of SEBI’s anti-insider regulations prescribing specific prohibition against insider
trading, the primary emphasis in the regulation of insider trading was placed on the requirement of
disclosure of certain insider’s transactions. An indirect solution, which reduces the opportunities for
insider trading is to make regular public announcements about the financial performance of the
company. However, India has not been a good ground for such efforts. Although they resemble
sections 195 and 198 of the English Companies Act, 1948, the Sachar Committee, 1978 had
suggested that the provision of sections 307 and 308 were inadequate and had no impact, to curb
insider trading.

B.1. SECTION 195 OF THE COMPANIES ACT, 2013

The provision seeks to prohibit any person from indulging in insider trading. The negative language
and the use of ‘shall’ point to the mandatory character of the provision. The section applies in
respect of securities of listed and unlisted companies as well. In the case of securities of listed
comapnies, the Securities and Exchange Board of India Regulations, 1992 will aplly in addition to
this section. The definition of insider trading given under the meaning of this section does not
explicitly provide that to constitute an act of insider trading the person in possession of price-
sensitive information relating to a company must use such information for dealing in securities of
the company, unlike regulation 3 of the SEBI Regulations. The proviso has an exception in the case
of any communication required in the ordinary course of business or profession or employment or
under any law. Moreover, the penalty extended from a minimum of 5 lakh rupees to a maximum of
25 crore rupees or three times the amount of profit made out of insider trading, whichever is higher,
or imprisonment for a term up to five years or both.

The inconsistencies between Section 195 and the 2015 SEBI Regulations are many. One of the most
striking conflicts is in relation to the defences for the offence. The 2015 SEBI Regulations provide a
multitude of defences to an insider. These include communication of Unpublished Price Sensitive
Information (UPSI) in furtherance of a legitimate purpose, any off-market transactions between
promoters who are in the possession of the same UPSI, any trades undertaken pursuant to a trading
plan, and Chinese walls in case of non-individuals, among others. These defences provide scope for
communication of UPSI without such communication amounting to insider trading. Many of these
defences have been added in the 2015 SEBI Regulations on the basis of the recommendations of the
Sodhi Committee.

On the other hand, Section 195 provides for only one defence – "communication required under the
ordinary course of business or profession". This defence has been incorporated on the basis of 1992
SEBI Regulations. While the scope of the defences under the 2015 SEBI Regulations has been
expanded significantly, these defences find no correlation to Section 195. Further, the defence of
 actions undertaken in ordinary course of business is generic in nature and it is difficult to bring the
defences under the 2015 SEBI Regulations under its scope.

B.2. SEBI’S PROHIBITION OF INSIDER TRADING REGULATIONS, 2015

SEBI’s Regulation of 1992 adopted the concept of Chinese Wall to prevent the misuse of
confidential information by the organizations which separates those areas of the organisation which
routinely have access to confidential information, considered ‘inside areas’ from those areas which
deal with sale, investment or marketing advise or other departments providing support services,
considered ‘public areas’. In order to monitor the Chinese wall procedures and trading in client
securities based on inside information, the organisation shall restrict trading in certain securities and
designate such list as restricted grey list and as the restricted list itself is a highly confidential
information, it shall not be communicated directly or even indirectly to anyone outside the
organisation and shall be maintained by the Compliance Officer only.10

The Securities and Exchange Board of India (SEBI) has notified the SEBI (Prohibition of Insider
Trading) Regulations, 2015 on 15th January, 2015. The new Regulations chalks out a stricter and
more focused regulatory regime and have put in place a stronger legal and enforcement framework
for prevention of Insider Trading. The Regulations prescribe that every employee shall disclose to
the Company (Compliance Officer) details of the trade within two trading days of the transaction, if
the value of securities traded in one or a series of transactions in any calendar quarter exceeds Rs.10
lakhs. The disclosures shall include those relating to trading by immediate relatives and by any
other person for whom the trading decisions are taken. Above all, a new concept of trading plans
has been introduced in India for an insider under the Regulations. If any Designated Person or
his/her immediate relative(s) intend(s) to trade in securities exceeding market value of Rs. 42 lakhs
during a calendar month, then he/she should apply to the Compliance Officer for pre-clearance,
even during the period when the window is open. Additionally, the trading window shall be closed
for adopting and considering financial results and other Unpublished Price Sensitive Information
(UPSI) matters. Also, the trading window needs to be closed when the Compliance Officer
determines that a designated person or class of designated persons can reasonably be expected to
have possession of unpublished price sensitive information. Moreover, the designated persons and
their immediate relatives shall not trade in securities when the trading window is closed.

C. LIMITATIONS AND SCOPE OF INSIDER TRADING REGULATIONS

10
Thummuluri Siddaiah,”Financial Services”, p. 233
The new controls have all the earmarks of being promising, more common sense, and to a great
extent in accordance with the worldwide way to deal with insider exchanging. They likewise appear
to be prepared to guarantee better consistence and authorization. It is, in this way, characteristic for
everybody to discuss the new standards. Most money related directions require steady changes to
keep pace with the regularly developing business sector elements. Insider exchanging is the same.
The current directions were told in 1992. In the previous two decades, the laws and comprehension
of insider exchanging (both comprehensively and in India) have developed essentially.
Notwithstanding a few revisions, certain arrangements of the current controls were ended up being
obstacles in smooth exchanges of recorded securities.

Aside from the straightforward fixes, the new controls likewise realize some huge changes which
will have handy impacts that are maybe not extremely surely knew yet, as is normal in a zone this
complex. For example, notwithstanding recorded organizations, the new controls apply to
organizations that are proposed to be recorded. It is hazy what "proposed to be recorded" means.
Does it imply that in the event that one gets some insider data about an organization which means to
go for a first sale of stock in two or three years, one wouldn't have the capacity to exchange the
securities of such organization? Sadly, it's extremely indistinct about what is implied by the
expression. It might be expected to cover organizations that have documented a draft red herring
plan with SEBI. This could make a few issues. The meaning of "associated people" now covers any
individual who has an association with an organization that is relied upon to put the individual
possessing insider data. The current directions secured a particular arrangement of individuals under
the meaning of associated individual. Be that as it may, the new directions cover even open
workers, for example, judges and officials, who might not have any expert association with the
organization, but rather who might know about a judgement or arrangement which, when made
open, may affect the cost of offers of the organization. Additionally, the new controls require the
consistence officer of the organization to screen exchanging by representatives and associated
people. Given the wide ambit of the meaning of an associated individual, it might be a tough
assignment for the consistence officer to do as such.

Exchanging isn't permitted by an individual while possessing insider data. There could be disarray
about whether a man who is an executive of an organization, for instance, and will probably
dependably be in control of some insider data, will be permitted to exchange at all in that element.
The new controls take into account the detailing of exchanging plans. Under this, a man can define
an exchanging plan, get it endorsed by the consistence officer and exchange understanding with it.
Nonetheless, such exchanging needs to consent to certain particular conditions to guarantee any
insider data in not abused. For example, the exchanging plan would be unveiled to people in general
and a man can't exchange inside a half year of such open divulgence. Further, once affirmed, the
individual can't pull out or veer off from the arrangement. The new directions disallow not just
 managing in securities when possessing insider data, yet in addition conveying or acquiring of
insider data, aside from where this is in encouragement of, in addition to other things, true blue
purposes. The expression "authentic purposes", as well, has not be characterized. As needs be, it is
misty what reasons for existing are honest to goodness enough to enable insider data to be conveyed
or acquired. The new controls likewise expect organizations to think of codes for controlling,
observing and announcing exchanging by representatives or associated people, and reasonable
divulgence of material data, for example, money related data, key business choices, and so on, by
the organization. Consistence with these codes has all the earmarks of being awkward, especially
for organizations with substantial investor and worker bases.

Since the charges of insider trading are mostly based on circumstantial evidence, it is difficult to be
detected and proved. Even in cases where it is detected, the rate of successful prosecution has been
very low. Despite of the presence of a robust regulatory mechanism, SEBI lacks the required
technological expertise, which is required to effectively carry out investigations. There has been an
acute shortage of resources and manpower. As a result, the rate of successful prosecution is
remarkably low. Further, under the Indian law, there is no provision to impose a penalty or even
ensue investigation on a foreign national who has committed the offence of insider trading. There is
no mention about the extra-territorial applicability of the regulations. In this era of globalisation of
securities trade, this is a huge drawback.

CONCLUSION

The recent actions taken by SEBI in the form of setting committees for suggesting measures for
improving surveillance of the markets are indeed commendable. The need of the hour is the
continuous adaptation and modification of the present laws in order to make the practice of insider
trading more deterrent so that insiders are prevented from indulging into such trades, thereby
securing and augmenting investor confidence in the securities market. But considering the scope of
a better policy in place for the continuously developing Creation of an ‘Insider Trading Policy’
where blackout dates shall be specified along with definition of ‘insider’, ‘insider information’ in
simple language. Companies should have internal watchdog who will monitor trades of stocks of
such company. Companies should appoint third parties like-accounting firms etc. which will verify
holdings of insiders. The government should create a separate department which will only deal with
complaints regarding insider trading and such information providers will be awarded if they give
any such information regarding any insider trading or potential insider trading. 11 All private
companies shall come under the jurisdiction of Right to Information Act, 2005 and then to a certain
11
“Insider trading” laws in India – Status before and after the enactment of Indian Companies Act, 2013, International Journal of
Law and Legal Jurisprudence Studies :ISSN:2348-8212:Volume 2 Issue 5
extent we can expect for a polished reform in the arena of Insider Trading Regulations by the
Securities and Exchange Board of India.