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AN ANALYSIS OF INSIDER TRADING IN COMPANIES IN INDIA AND ITS EFFECTS
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AN ANALYSIS
OF INSIDER TRADING IN COMPANIES IN INDIA AND ITS EFFECTS
AUTHORED BY
- A. SUGANTHINI
ABSTRACT
Insider trading is malpractice of
those who are directly related to a company or body corporate or has any
relation with the company. These persons use their position to get price
sensitive information related to value of shares etc. which is unpublished. In
simple words the term Insider trading is about trading with the use of inside
information i.e., information that has not yet been disclosed to the public.
However, insider trading is divided into two limbs as legal and illegal. Legal
Insider trading is done mainly by corporate insiders, who can be classified as officers,
directors, and employees buy and sell stocks in their own companies. But we are
more concerned with the illegal aspect of insider trading like secretive
information is disclosed or leaked out without concerning for the needs of the
investor.
KEYWORDS: Inside trading, unpublished, legal
insider trading
INTRODUCTION
Insider trading generally involves
the act of subscribing or buying or selling of the company’s securities, when
in the possession of any unpublished price sensitive information (‘UPSI’) about
the company[1]. It also
involves UPSI about the company to others who could subscribe or buy or sell
the company’s securities. Regulation on insider trading clearly says that it will
be considered illegal if the insiders of public limited company trade on basis
of price sensitive undisclosed information to make profit or avoid loss. Trades
made by these insiders in the company own stock, based on material non- public
information, are considered to be fraudulent since the insiders are violating
the trust or the fiduciary duty that they owe to the shareholders. The corporate
insider, simply by accepting employment, has made a contract with the
shareholders to put the shareholders’ interests before their own, in matters
related to the corporation. When the insider buys or sells based upon company
owned information, he is violating his contract with the shareholder.
EFFECTS OF
INSIDER TRADING
Insider trading is an unfair
practice, wherein the other stockholders are at a great disadvantage due to
lack of important insider non-public information[2].
Various other disadvantages of insider trading are as follows-
•
It is fraudulent for the investors at the time of
buying the shares- Insider Trading is a dominant evil in stock markets. It is
fraudulent and illegal because it is unfair to those who do not have access to
price sensitive information and when a person uses such information to make
money, he puts others at the risk of buying at a higher price or suffering a
higher loss.
•
Insider trading shakes the public/investor’s
confidence- Insider trading can shake the confidence of ordinary investors or
public. Too many insider trading scandals in a condensed period could leave
investors frustrated and wondering how they can make any money in stocks if
they are consistently being put at a disadvantage by unscrupulous insiders.
•
The corporate reputation is at stake and the overall
industry gets affected Corporates often experience substantial negative
publicity when insider trading is detected and revealed. Such negative
publicity and the resulting reputational losses likely have a deterring effect
on informed trading Further, the executives of firms with more reputational
capital; thereby have more to lose from negative publicity, to profit less from
insider trading. It is pertinent to note that even an individual behaviour can
also damage a firm’s reputation.
•
Harms the efficiency, fairness, and integrity of the
capital market- Trading on inside information, especially illegal insider
trading, can cause significant harm to the fairness and efficiency of capital markets.
UNPUBLISHED
PRICE SENSITIVE INFORMATION:
Unpublished Price Sensitive
Information is data relating to a company that has not been made public but could have an impact on
its share price[3].
It is against the law for holders of non-public material information to use the
information to their advantage in trading stocks. It is also illegal to share
this information with others who use for profits in the market.
·
Unpublished Price Sensitive Information refers to
corporate news or information that has not yet been made public and which could
also have an impact on its share price.
·
It is illegal to use this kind of information for one
and advantage in trading stocks or other securities.
·
Legally, it does not matter how Unpublished Price Sensitive
Information is obtained, or whether the person who acts on it is employed by
the company or not.
·
Insider trading is illegal when it involves the use of
non-public material information.
The study seeks to decode the pattern
of insider buying and selling across various styles. Is there a possibility of
insiders making abnormal profit and viability of following insider trades as an
investment idea to be followed by the outsiders? Whether the information
advantage in insider transactions reflects for outside investors to follow
insiders, and earn abnormal returns from insider trading disclosures? The focus
is on gaining a better understanding of the effects of insider trading on the
broad-based market in the immediate short run and the long run. Insider trading
regulations evolve over a period shedding light on the impact of regulations on
insider trading.
OBJECTIVES
1. To understand the term insider
trading.
2. To know about several regulations
and the laws that bound Insider trading
3. To identify the disclosure
requirements.
4. To assess the information content
of insider trading.
HYPOTHESIS
There is lack of Efficient laws to
curtail Insider trading and to protect the Investors.
The reason for the present study reduces
from the fact that there are very few studies on this subject with regard to
the emerging markets. Since India is an important emerging market, the findings
of the study will be of significance. The study is based on the existing laws
that is prevalent, as a result, the findings of the study shall be beneficial
to the ordinary investors who do not have access to inside information and
depend only on the publicly available information for investing. The study aims
to find out the importance to the regulators to understand the strategies
pursued by the insiders and that may help them to devise the regulations
accordingly. It also gives an opportunity to assess the effectiveness of
insider trading laws in creating a level playing field between insiders and
outsiders.
Understanding Unpublished Price
Sensitive Information:
It does not matter how the Unpublished Price
Sensitive Information was received or if the person is employed by the company.
For example, suppose someone learns about non-public material information from
a family member and shares it with a friend. If the friend uses
this insider information to profit in the stock market, then all
three of the people involved could be prosecuted. The best way to stay out of
legal trouble is to avoid sharing Unpublished Price Sensitive Information. Contrary to popular misconceptions, not
all insider trading is illegal. Insiders are legally permitted to buy
and sell shares of their company& stock, provided the transactions are
registered and filed with Securities Exchange Board of India (SEBI). The
illegal type of insider trading takes place when Unpublished Price Sensitive. Information
is used to obtain an unfair advantage.
Types of Unpublished Price Sensitive
Information:
There are many types of corporate
information that can be considered non-public material information. Sometimes,
this information comes from within the company affected. Alternatively, it can
come from regulatory agencies, lawmakers, credit agencies, or financial
institutions. Other examples of Unpublished Price Sensitive Information include
critical financial filings such as earnings reports. Upcoming corporate actions
that can move the price of a stock are often considered as Unpublished Price
Sensitive Information, too. Examples include prior knowledge of initial
public offerings (IPOs), acquisitions, stock buybacks, or splits. The
outcomes of pending legal proceedings can also be considered Unpublished Price
Sensitive Information. Such outcomes include decisions in lawsuits and rulings by
agencies like the Food and Drug Administration (FDA) and the National
Highway Traffic Safety Administration.
Insider trading is illegal when it is done by
using Unpublished Price Sensitive Information. Having information that is not
public and making investing decisions of that, particularly if those decisions
can impact the financial well-being of an entity, is considered illegal and is
a civil and criminal offense that is punishable with prison time and fines.
Unpublished Price Sensitive
Information can be disclosed at the discretion of a company in compliance with
the law. When a company discloses material public information on a large scale,
it is widely disseminated and can be used by all individuals, creating a fair
playing field for investors.
The Insider Trading Regulation states
that the unpublished price sensitive information(“UPSI“) means any information,
directly or indirectly related to the company or its securities that is not
generally available to the public, and which upon becoming generally available
to the public, is likely to materially affect the price of the securities. Such
information shall include the information relating to the following:
Ø Financial
results of the company
Ø Dividends
of the company
Ø Change in
capital structure of the company
Ø Any
mergers, demergers, acquisitions, delisting, disposals and expansion of the business
Ø Any change
in key managerial personnel
Ø Any
material events under the listing agreement.
The code of conduct is that the
Compliance Officer Senior level employee appointed by the listed company shall
report to the Managing Director \ Chief Executive Officer. · He shall be
responsible for setting forth policies, procedures, monitoring adherence to the
rules for the preservation of Price Sensitive Information. He shall maintain a
record of the designated employees. He shall also assist all the employees in
addressing any clarifications regarding the regulations and the company’s code
of conduct. · Officers comprising the top three tiers of the company management
and the employees designated by the company to whom these trading restrictions
shall be applicable shall include DESIGNATED EMPLOYEE who shall follow the code
of conduct. · All the directors and employees shall maintain the confidentiality
of all Price Sensitive Information. They shall not pass on such information to any
person directly or indirectly by way of making recommendation for the purchase
or sale of securities. · Files containing confidential information shall be
kept secure and Computer Files must have adequate security of login and
password etc.
The company shall specify a trading
period, to be called TRADING WINDOW for trading in the company’s securities. The
trading window shall be closed during the time of declaration of financial
results, declaration of dividends, issue of securities by way of
public\rights\bonus, any major expansion plans or executive of new projects,
amalgamation, mergers, takeovers and buy-back, disposal of whole or
substantially whole of the undertaking or any changes in polices, plans or
operations of the company. The TRADING WINDOW shall be opened 24 hours after
the information made to the public. · The directors are bound to pre clearance transactions.
· An undertaking for not breaching the code is necessary. · All directors or officers
or designated employees who buy or sell any number of shares of the company
shall not enter into an opposite transaction.
Any employee or officer or designated
officer, in violation of the code of conduct, shall be subjected to penalties
and other appropriate action to be taken by the company, such as, disciplinary
action like suspension, wage freeze or other actions. And the same decision
shall not preclude SEBI from taking any action in case of violation of SEBI
Regulations. · The SEBI shall be intimated about the violation by the company
or the Compliance Officer[4].
SEBI has incorporated some
significant changes to improve the then-existing Insider Trading Regulations,
1992. The regulation was amended to overcome certain loopholes that were highlighted
in the cases of Hindustan Lever Ltd. v. SEBI[5] and Rakesh
Agarwal v. SEBI[6]. The new
legislation was named “SEBI [Prohibition of Insider Trading] Regulations 2002.”
The definition of ‘deemed to be connected person’ (Insider) was amended to
include “a person who is an ‘intermediary’, ‘investment company’, ‘trustee
company’, ‘Asset Management Company’ or an ‘employee’ or ‘director’ thereof or
an ‘official of stock exchange’ or ‘of clearing house’ or ‘corporation’.” The
definition of ‘insider’ was amended again in 2008. In 2015, SEBI
(Prohibition of Insider Trading) Regulations, 2015 were notified by SEBI
which were further amended in 2018 as SEBI (Prohibition of Insider
Trading) (Amendments) Regulations, 2018.
In India, SEBI is the regulating
authority for insider trading. SEBI derives its power to form the regulations
for insider trading under the SEBI Act, 1992. It is the responsibility of SEBI to
regulate and safeguard the securities market in India. Also, SEBI keeps a check
on the insider trading of securities.
The Indian market has no depth
because of which it is highly volatile. However, there has been significant
growth in the capital market due to the increasing number of investors, more participation
of different companies, capitalisation, stock exchanges, foreign direct
investment, turnover, mutual funds, brokers, etc. The growing economic reforms
in the country are a big reason behind the development of the capital market.
The market has also improved its volume, transparent operations, and investment
holding methods by way of a depository.
The Harshad Mehta scam of 1992[7]
and other fraudulent practices in the Indian capital market
have negatively impacted the image of
the market that many investors fear the credibility of
investment in the security market,
nowadays. Some of the common reasons for these
apprehensions are:
Ø Activity of
insider trading;
Ø Less
transparency in transactions;
Ø Unwarranted
transactions;
Ø Lack of
knowledge to general investors.
Indian authorities have tried hard to
regulate and encourage investment in the market through its various agencies
namely, the Company Law Board (CLB), Reserve Bank of India, SEBI, and
various stock exchanges. There have been various regulations issued by SEBI to
control insider trading and other malpractices of market manipulations.
However, for the first time with respect to insider trading, SEBI issued the
SEBI (Insider Trading) Regulation, 1992 which was last amended in 2018.
SEBI Regulations:
Insider trading in India is
prohibited by the Companies Act, 2013 and the SEBI Act, 1992. SEBI
has formed the SEBI (Prohibition of Insider Trading) Regulations, 2015 which prescribe
the rules of prohibition and restriction of Insider Trading in India. The
Regulations passed by the Securities Exchange Board of India i.e., SEBI
(Prohibition of Insider Trading) (Amendments) Regulations, 2018, are applicable
mainly to “dealing in securities” which involves “buying, selling or agreeing
to buy, sell or deal in any securities by any person either as principal or
agent, by insiders on the basis of any private confidential information.” The
Regulations are only applicable to the exchange of listed securities.
The Regulations provide that the
communication or dissemination of any confidential information, by an insider,
is prohibited. The information communicated or disseminated must be
unauthorized. The information can be used by the person himself or any other
person on his behalf. If any person contravenes with any provision of the SEBI
Regulations, it amounts to an offence under the Act and is punishable with
imprisonment up to 10 years or a fine up to 25 crores, whichever is higher.
Under the SEBI Regulations, the adjudicating officer may impose a penalty on
any person who contravenes with the provisions of the regulations except for
the offence committed under section 24 of the Act. SEBI also has the power to investigate the case of Insider
Trading and related matters. The powers of Investigation may be exercised by
SEBI for two main reasons:
1. to
investigate into the complaints received from investors, intermediaries or any other
person on any matter having a bearing on the allegations of insider trading; and,
2.
to investigate upon its own knowledge or information
in its possession to protect the interest of investors in securities against breach of these
regulations. Under the Regulations, promoters of the company will be held
liable irrespective of their shareholding status if they are found violating
insider trading norms using unpublished price sensitive information of the
company in absence of any legitimate purpose.
There are certain exceptions to these
prohibitions by SEBI such as,
1. Disclosure
is allowed for legitimate purposes, performance of duties or discharge of legal
obligations. In the case of Dirks v. SEC, it was held that “persons like lawyers,
accountants, etc. who are actually outsiders will be construed as insiders from
the point at which the UPSI was shared with them under ordinary course of business.”
2. Disclosure
is allowed when there is an obligation to make an open offer; and where
disclosure is required in the best interest of the company. In the case of Samir
Arora v. SEBI, it was held that to attract a provision of Insider Trading, the unpublished
private information needs to be true.
Companies Act, 2013, passed by the
Indian parliament also devised the code of conduct for the administration of
insider trading regulations. The listed companies in India are guided by
Clause- 36 of the Listing Agreement of the stock exchanges, which states that,
the issuer will have to inform the stock exchange where the company is listed
immediately about events such as closure on account of power cuts, lockouts,
strikes, etc. All events which may have a posture on the operations or
performance of the firm, as well as price sensitive information have to be
reported at the beginning of the event as well as after the end of the event. This
is intended to facilitate the shareholders and the public to assess the information
and act accordingly. Over the years, to improve the fairness and transparency
of the capital markets, SEBI has made several amendments to its SEBI
(Prohibition of Insider Trading) Regulations, 1992.
Prohibition on insider trading
consists of the following key components:
(i)
prohibition on communicating UPSI by an insider
(ii)
prohibition on other persons on procurement of UPSI
and
(iii)
prohibition on trading by an insider while in
possession of UPSI.
As stated above, at stark variation
with the 1992 Regulations, the Regulations restricts communication by insiders
and by outsiders of UPSI of a company or its securities listed or proposed to
be listed. This provision intends to cast an obligation on all insiders who are
in possession of UPSI to handle such information with care and to deal with
information with them when transacting their business strictly on
‘need-to-know’ basis. SEBI’s intention is that to organisations develop
practices based on ‘need-to-know’ principles for treatment of information in
their possession. However, the charge of insider trading will not get attracted
in case such communication or procurement is in furtherance of legitimate
purposes, performance of duties or discharge of legal obligations.
In India, the other related
provisions other than the Insider Trading Regulations which govern insider
trading are Section 195 of the Companies Act, 2013, read with Section 12A and
15G of the SEBI Act, 1992 (“Act”).
Section 195 of the Companies Act,
2013 provides that no person, which includes any director or key managerial
personnel of a company, shall enter into insider trading. This section also defines
the terms ‘insider trading’ and ‘price-sensitive information’.
According to Section 12A(d) of the
Act, no person shall engage in insider trading, either directly or indirectly.
On the other hand, Section, 15G of the Act imposes a penalty for insider trading
which is not less than ten lakh rupees (Rs 10,00,000) but which may extend to twenty-five
crore rupees (Rs 25,00,00,000) or 3 times the amount of profits which are made out
of insider trading, whichever is higher.
The Insider Trading Regulations
provides the following restrictions on any communication or
procurement of UPSI and trading:
1. The
Regulations restricts/prohibits an insider to communicate, provide or allow access
to any UPSI which is related to a company or securities listed, to any person
including other insiders.
2. The
Regulations restricts/prohibits a person to procure any UPSI from an insider, which
is related to a company or securities listed, to any person including other insiders.
3. The
Regulations restricts/prohibits an insider, when in possession of UPSI, to
trade in securities that are listed or proposed to be listed on a recognized
stock exchange.
The exceptions to the above are;
The UPSI communicated or procured
under Regulation 3(1) and 3(2) respectively, shall be communicated or procured
only for the lawful purposes or for performance of duties or for discharge of
legal obligations.
A UPSI may only be communicated or
procured under the following circumstances:
1. If such
UPSI requires an obligation to make an open offer under the Takeover Code,
where the board of directors believes that the proposed transaction is or will be
in the best interest of the company.
2. If such
UPSI does not require or attract the obligation to make an open offer under the
Takeover Code but where the board of directors believes that the proposed transaction
is or will be in the best interest of the company and the information constituting
UPSI is made generally available to the public at least two trading days before
the proposed transaction is being effected as per the board of directors.
Exceptions related to Rule 4(1) of
the Insider Trading Regulations:
The transaction is an off-market
transfer between or among the promoters who were in the possession of the same
UPSI and both the parties had made an informed trade decision. Since the
parties have the same UPSI, there would be no unlawful gains. In the cases
involving non-individual insiders, the individuals who are in possession of
such UPSI, were different from the individuals taking trading decision or
decisions who did not own such UPSI when they decided to trade; and
Appropriate arrangement or
arrangements were taken place to ensure that there is no violation of these
regulations and no UPSI was communicated to the individuals taking trading decision
or decisions by the individuals owning the information and there is no evidence
showing breach of such arrangements. Most financial regulations require
constant modifications to keep pace with the ever-evolving market dynamics.
Insider trading is no different. With a view to do away with the lacunae and inadequacies
of the 1992 Regulations, SEBI has revamped the entire framework governing insider
trading in India. Hence, under the 2015 regulations, imperative changes
including widening the scope of ‘connected persons’, strengthening the
definition of an ‘insider’, rationalising disclosure events, removing redundant
provisions, among others, have been introduced. A unique feature of the
Regulations i.e., legislative notes interspersed within provisions will be an
effective tool for interpretation of these Regulations going forward. It may be
further stated that SEBI has overhauled the entire framework for regulation of
insider trading, which is seen to be a deep-rooted problem in India, with a
view to ensure a level playing field in the securities market and to safeguard
the interest of the investors. This move by SEBI will provide a much-needed
boost to the Indian capital market and facilitate further economic buoyancy.
However, on digging deep, one finds that some of the changes proposed and new
concepts introduced by the 2015 Regulations lack clarity. Therefore, it is anticipated
that the new regulations are interpreted by courts and authorities in a
progressive manner and timely clarifications are issued by the capital market
regulator.
CONCLUSION:
This study could help the individual
investors to understand the dynamics of the insider trading since the data used
in this study is in the public domain. Further, the results also can be helpful
to the securities market regulator, SEBI, and policymakers to understand the
insider trading pattern across various stock categories and devise the
regulations accordingly. If corporate insiders trade illegally, it is beyond
the scope of the study. It would be thought-provoking to see if similar studies
are conducted and inferences are drawn from the stock markets of the other
developing economies as well. Thus, the problems in establishing charges of
insider trading are largely related to the unavailability of sufficient proof
to establish mental intent and whether or not access to unpublished price
sensitive material was possible in the facts and circumstances of a particular
case. On an analysis of the regulatory mechanism in India, the only conclusion
that can be reached is that the laws prevalent in India are ill-equipped to
combat insider trading and are not conducive to the needs of a rapidly changing
economy and corporate structure. There are better equipped laws prevalent in
other countries when compared to India to prevent and penalize the practice of
insider trading.
[1] Baiman, S. and Verrecchia, R.E.
(1996). “The relation among capital markets, financial disclosure, production
efficiency, and insider trading.” Journal of accounting research”
[2] Chauhan, Y., Chaturvedula, C. and
Iyer.V. (2014). “Insider trading, market efficiency, and regulation A
literature review.”
[3] J Sarkar & Subrata Sarkar,
‘Large Shareholder Activism in Corporate Governance in Developing Countries:
Evidence from India, International Review of Finance’ (2000) 161-194.
[4] Hemant Singh, ‘How Securities and
Exchange Board of India (SEBI) Controls Capital Market of India?’ (Jagran Josh,
22 Sept 2019)
[5] (1998) 18 SCL 311 MOF
[7] 1992) 94 BOMLR 789, 1992 CriLJ 4032
Article Information
AN ANALYSIS OF INSIDER TRADING IN COMPANIES IN INDIA AND ITS EFFECTS
Authors: A. SUGANTHINI
- Journal IJLRA
- ISSN 2582-6433
- Published 2023/09/27
- Issue 7
About Journal
International Journal for Legal Research and Analysis
- Abbreviation IJLRA
- ISSN 2582-6433
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