8 Insider Trading And Fraudulent And Unfair Dealings In Securities And Their Implications

Prof.Dr Harpreet Kaur

 

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INTRODUCTION:

 

Although the term ‘insider trading’ is of recent origin not older than four decades but the act of insider trading must have been in existence since the companies started amalgamations and acquisitions or trading in securities. The Securities and Exchange Board of India which is regulatory authority for securities market in India framed SEBI (Prohibition of Insider Trading) Regulations, 1992. In view of the increase in insider trading offences, it was decided by SEBI to consider for amending the SEBI (Prohibiting of Insider Trading) Regulations, 1992. For the purpose, a high level committee under the Chairmanship of N.K Sodhi was appointed by SEBI which had given its suggestions to improve insider trading norms. While writing the module, SEBI (Prohibition of Insider Trading) Regulations, 2015 were enforced which replaced earlier regulations. Therefore, a comparison is being made in the module between these two regulations in order to understand the need for such replacement. All important aspects are presented in the comparison form in the module. It is an obligation of a person who receives any price sensitive confidential information that he should not use it for trading purposes. It is a general consensus that such a person should not be allowed to use such information during trading in securities as it will lead to loss to shareholders and other investors’ interest in the company who do not possess or have access to such information1. The person having some information about the company while trading may alter or manipulate the price of securities which should be refrained because this manipulation will be done at the cost of shareholders of the company.

 

Fraudulent and unfair trade practices are also prohibited by SEBI (Prohibition of Fraudulent and unfair Trade Practices relating to securities market) Regulations, 2003. These regulations prohibit a person from exercising such practices while in dealing in securities.

 

INSIDER TRADING:

 

Prohibition of insider trading: SEBI (Prohibition of Insider Trading) Regulations, 1992 provide for prohibition under regulation 3 that that no insider shall deal in listed securities of any company when he is in possession of any unpublished price sensitive information either on his own behalf or on behalf of any other person or communicate, counsel or procure any such information directly or indirectly to any person who while in possession of such information will not deal in securities. However, prohibition is not applicable to communications required in the ordinary course of business or profession or employment or under any law.

 

This prohibition is applicable to dealing in securities which means an act of subscribing, buying, selling or agreeing to subscribe, buy, sell or deal in any securities by any person either as principal or agent.

 

SEBI (Prohibition of Insider Trading) Regulations, 2015 under regulation 3 provides for communication or procurement of unpublished price sensitive information. It provides that an insider shall not communicate, provide or allow access to any unpublished price sensitive information to any person including other insiders. The information may be related to a company or securities listed or proposed to be listed. However, such communication is allowed when it is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.

 

It further provides that no person shall procure from any insider any published price sensitive information or cause the communication by any insider of any unpublished price sensitive information which is related to a company or related to securities listed or proposed to be listed. However, such procurement or communication is allowed when it is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.

 

However, an published price sensitive information may be communicated, provided or allowed access to or procured in following transactions:

 

a.where the transaction entails an obligation to make an open offer under SEBI (Substantial Acquisitions of Shares and Takeovers) Regulations, 2011 where board of directors board of directors of the company is of informed opinion that the proposed transaction is in the best interests of the company;

 

b.where there is no obligation of making an open offer but board of directors board of directors of the company is of informed opinion that the proposed transaction is in the best interests of the company and there is public disclosure of such unpublished price sensitive information at least two trading days prior to proposed transaction coming into effect.

 

 

Who is an insider?

 

‘Insider’ under section 2 (e) of 1992 regulations means any person who,

 

who is reasonably expected to have access to unpublished price sensitive information regarding securities of a company because he is or was connected to the company or he may also be deemed to have been connected with the company, who has received or has had access to such unpublished price sensitive information.

 

‘Insider’ under section 2 (e) of 2015 regulations means any person who,

 

i) a connected person; or

 

in possession ofor having access to unpublished price sensitive information.

 

Connected person:

 

It is also necessary to understand who is a ‘connected person’ as per the regulations.

 

‘Connected person’ under 1992 Regulations means any person who:

  1. is a director of a company or is deemed to be a director of that company, or
  2. occupies the position as an officer or employee of the company or holds a position involving a professional or business relationship between himself and the company and who may reasonably be expected to have an access to unpublished price sensitive information. The business or professional relationship may be temporary or permanent.

Explanation to the definition provides that the ‘connected person’ will mean any person who is connected person six months prior to an act of insider trading.

 

Under 2015 Regulations, ‘connected person’ means,

 

(i) any person during the six months prior to the concerned act

a.   is or has been associated with a company, directly or indirectly, in any capacity including

–  by reason of frequent communication with its officers or

–  by being in any contractual, fiduciary or employment relationship or

–  by being a director, officer or an employee of the company or

b. holds any position including a professional or business relationship between himself and the company whether temporary or permanent, that allows such person, directly or indirectly, access to unpublished price sensitive information or is reasonably expected to allow such access.

ii.  following are ‘deemed connected persons:

(a). an immediate relative of connected persons specified in clause (i); or

(b). a holding company or associate company or subsidiary company; or

(c). an intermediary as specified in section 12 of the SEBI Act or an employee ordirector thereof; or

(d). an investment company, trustee company, asset management company oran employee or director thereof; or

(e). an official of a stock exchange or of clearing house or corporation; or

(f). a member of board of trustees of a mutual fund or a member of the boardof directors of the asset management company of a mutual fund or is anemployee thereof; or

(g). a member of the board of directors or an employee, of a public financialinstitution as defined in section 2 (72) of the Companies Act, 2013; or

(h). an official or an employee of a self-regulatory organization recognised orauthorized by the Board; or

 

(i). a banker of the company; or

 

(j). a concern, firm, trust, Hindu undivided family, company or association ofpersons wherein a director of a company or his immediate relative or banker of the company, has more than ten per cent of the holding or interest;

 

What is Price Sensitive Information?

 

SEBI (Prohibition of Insider Trading) Regulations, 1992, provided separate definitions for unpublished and price sensitive information.

 

According to s. 2, “unpublished” meant information, which is neither published by the company or its agents and nor is specific in nature. Speculative reports in print or electronic media were not considered as published information.

 

According to SEBI (Prohibition of Insider Trading) Regulations, 1992, “price sensitive information” means any information which relates directly or indirectly to a company and which if published is likely to materially affect the price of securities of company. Following are deemed to be price sensitive information:

 

(i)  periodical financial results of the company;

(ii)  intended declaration of dividends (both interim and final);

(iii)  issue of securities or buy-back of securities;

(iv)  any major expansion plans or execution of new projects.

(v)  amalgamation, mergers or takeovers;

(vi)  disposal of the whole or substantial part of the undertaking;

(vii)  and significant changes in policies, plans or operations of the company.

 

According to s. 2(n), 2015 Regulations “unpublished price sensitive information” means any information, relating to a company or its securities, directly or indirectly, that is not generally available which upon becoming generally available, is likely to materially affect the price of the securities and shall, ordinarily including but not restricted to, information relating to the following: –

 

(i) financial results;

(ii) dividends;

(iii) change in capital structure;

(iv) mergers, de-mergers, acquisitions, delistings, disposals and expansion of business and such other transactions;

(v) changes in key managerial personnel; and

(vi) material events in accordance with the listing agreement.

 

It is also necessary here to understand what is ‘ generally available information’. S. 2 (e) of 2015 regulations provides that ‘generally available information” means information that is accessible to the public on a non-discriminatory basis.

 

Code of internal procedure and conduct: Regulations have made it compulsory for all listed companies and other organizations associated with securities market like intermediaries, clearing houses, professional firms such as law firms, accountancy or auditing firms, auditors, consultants etc. to frame code of internal procedures and conduct as per Model Code given by the regulations. Companies and other entities have to ensure compliance of the code. They also have to abide by the code of corporate disclosure practices.

 

Under new regulations, board of directors of every listed company has to formulate and publish a code of practices and procedures for fair disclosure of unpublished price sensitive information to be followed in the company.

 

The board of directors of every listed and market intermediary as well as every other person who handles unpublished price sensitive information during the course of business operations is required to formulate a code of conduct for regulating, monitoring and reporting trading by its employees and other connected persons for compliance purposes. They are also required to identify and designate a compliance officer for the purposes.

 

Disclosures under 1992 Regulations:

 

SEBI (Prohibition of Insider Trading) Regulations, 1992 have also mandated certain disclosures to be made by persons or companies under the regulations. Any person holding more than 5% shares or voting rights in any listed company has to disclose to the company within two days of intimation or acquisition of shares or voting rights. He is under duty of continual disclosure. He has to inform the company of any change from his last reported shareholding or voting rights if such change exceeds 2% in any of them and even if such change reduces his shareholding or voting rights to less than 5%. Any director or officer of a listed company has to disclose number of shares or voting rights held and positions taken by him or his dependents within two days of becoming director or officer of the company. He has to disclose any change in his position where change exceeds Rs 5 lakh in value or 25000 shares or 1% of total shareholding or voting rights, whichever is lower. Any promoter or person part of the promoter group of a listed company has to disclose number of shares or voting rights held by such person within two days of becoming such promoter or joining the promoter group. He has to disclose any change in his position where change exceeds Rs 5 lakh in value or 25000 shares or 1% of total shareholding or voting rights, whichever is lower.

 

Disclosures under 2015 Regulations:

 

New regulations require that the person concerned should disclose not only his trades but also trading done by his immediate relatives and any other person for whom trading decisions were taken by him. If trading of derivatives of securities is permitted then disclosure should also be made trading of derivatives.

 

Initial disclosures are required to be made by certain persons. Every existing promoter, key managerial person and director of every listed company is required to disclose his shareholding in the company within thirty days of enforcement of regulations. Every person who becomes promoter, director or key managerial personnel of the company is also required to make initial disclosure of his shareholding in the company within seven days of appointment or becoming a promoter.

 

Continual disclosure requires every prompter, employee and director of the company to disclose number of securities acquired or disposed of within two working days of such transaction if traded value is in excess of ten lakhs rupees. In turn, the company is under duty to disclose such information to the stock exchanges where securities are listed within two trading days of receipt of such disclosure or becoming aware of such information.

 

Besides, a listed company may require any other connected person to make disclosure in holdings and trading in securities of the company.

 

Trading plans: Every insider is required to submit his trading plan and executes his trades as per the pre-determined trading plan.

 

Prohibition on insider trading of securities in Companies Act, 2013:

 

The Companies Act, 2013 has prohibited insider trading under s. 195. S. 195 defines ‘insider trading’ as:

 

‘an act of subscribing, buying, selling, dealing or agreeing to subscribe, buy, sell or deal in any securities by any directors or key managerial personnel or any other officer of a company either as a principal or agent if such director or key managerial personnel is reasonably expected to have access to any non-public price sensitive information regarding securities of company, or

 

an act of counseling about procuring or communicating directly or indirectly any non-public price sensitive information to any person’.

 

According to s. 195 ‘price sensitive information’ means any information which relates, directly or indirectly to a company and which if published is likely to materially affect the price of securities of the company.

 

It provides that no person including any director or key managerial personnel of a company shall enter into insider trading. This prohibition does not apply to any communication required in the ordinary course of business or profession or employment. Such an offence is punishable with imprisonment for a term extending to five years or with fine not less than five lakh rupees but extendable up to twenty five crore or three times the amount of profit made out of insider trading, whichever is higher, or with both.

 

PROHIBITION OF FRAUDULENT AND UNFAIR TRADE PRACTICES IN SECURITIES MARKET:

 

SEBI (Prohibition of Fraudulent & Unfair Trade Practices Relating to Securities Markets) Regulations, 2003 [SEBI (FUTP) Regulations, 2003] prohibit fraudulent and unfair trade practices in dealings in securities. Dealing in securities includes buying, selling, subscribing to any issue of securities or agreeing or otherwise transacting in any way in any security by any person as principal, agent or intermediary. Regulation 3 provides that a person shall not directly or indirectly:

 

(a)  buy, sell or otherwise deal in securities in a fraudulent manner;

(b) use or employ, in connection with issue, purchase or sale of any security on stock exchange, any manipulative or deceptive device or contrivance in contravention of the provisions of the Act or rules, regulations. Securities may be listed or proposed to be listed;

(c) employ any device, scheme or artifice to defraud in connection with dealing in or issue of securities, listed or proposed to be listed;

(d) engage in any act, practice, course of business which operates or would operate as fraud or deceit upon any person in connection with any dealing in or issue of securities, listed or proposed to be listed in contravention of the provisions of the Act or rules, regulations.

 

What is ‘Fraud’?

 

Regulations also define the term ‘fraud’. ‘Fraud’ includes any act, expression, omission or concealment committed by a person or by any other person with his connivance or by his agent while dealing in securities in order to induce another person or his agent to deal in securities. It is immaterial whether such act etc. was done in a deceitful manner or not or whether or not there is any wrongful gain or avoidance of any loss. It also includes the following:

 

a knowing misrepresentation of the truth or concealment of material fact in order that another person may act to his detriment;

 

a suggestion as to a fact which is not true by one who does not believe it to be true;

 

An active concealment of a fact by a person having knowledge or belief of the fact;

  1. a promise made without any intention of performing it;
  2. a representation made in a reckless and careless manner whether it be true or false;
  3. any such act or omission as any other law specifically declares to be fraudulent;
  4. vii. deceptive behaviour by a person depriving another of informed consent or full participation;
  5. a false statement made without reasonable ground for believing it to be true.
  6. the act of an issuer of securities giving out misinformation that affects market price of the security, resulting in investors being effectively misled even though they did not rely on the statement itself or anything derived from it other than the market price.

 

However, the regulation does not apply to general comments made in good faith regarding economic policy of Government, economic situation of the country, trends in securities market or matters of similar nature. Such comments may have been made in private or public.

 

Prohibition of manipulative, fraudulent and unfair trade practices:

 

Regulation 4 says that no person shall indulge in a fraudulent or an unfair trade practice in securities. Dealing in securities is be deemed to be a fraudulent or an unfair trade practice if it involves fraud and may include all or any of the following:

  1. indulging in acts creating false or misleading appearance of trading in the securities market;
  2. dealing in a security not intended to effect transfer of beneficial ownership but intended to operate only as a device to inflate, depress or cause fluctuations in the price of such security for wrongful gain or avoidance of loss;
  3. advancing or agreeing to advance any money to any person thereby inducing any other person to offer to buy any security in any issue only with the intention of securing the minimum subscription to such issue;
  4. paying, offering or agreeing to pay or offer, directly or indirectly, to any person any money or money’s worth for inducing such person for dealing in any security with the object of inflating, depressing, maintaining or causing fluctuation in the price of such security;
  5. any act or omission amounting to manipulation of the price of a security;
  6. publishing or causing to publish or reporting or causing to report by a person dealing in securities any information which is not true or which he does not believe to be true prior to or in the course of dealing in securities;
  7. entering into a transaction in securities without intention of performing it or without intention of change of ownership of such security;
  8. selling, dealing or pledging of stolen or counterfeit security whether in physical or dematerialized form;
  9. an intermediary promising a certain price in respect of buying or selling of a security to a client and waiting till a discrepancy arises in the price of such security and retaining the difference in prices as profit for himself;
  10. an intermediary providing his clients with such information relating to a security as cannot be verified by the clients before their dealing in such security;
  11. an advertisement that is misleading or that contains information in a distorted manner and which may influence the decision of the investors;
  12. an intermediary reporting trading transactions to his clients entered into on their behalf in an inflated manner in order to increase his commission and brokerage;
  13. an intermediary not disclosing to his client transactions entered into on his behalf including taking an option position;circular transactions in respect of a security entered into between intermediaries in order to increase commission to provide a false appearance of trading in such security or to inflate, depress or cause fluctuations in the price of such security;encouraging the clients by an intermediary to deal in securities solely with the object of enhancing his brokerage or commission;an intermediary predating or otherwise falsifying records such as contract notes;an intermediary buying or selling securities in advance of a substantial client order or whereby a futures or option position is taken about an impending transaction in the same or related futures or options contract;planting false or misleading news which may induce sale or purchase of securities.
  14. xix.mis-selling of units of a mutual fund scheme. Mis-selling means sale of units of a mutual fund scheme by any person by making a false or misleading statement, or concealing or omitting material facts of the scheme, or concealing the associated risk factors of the scheme, or not taking reasonable care to ensure suitability of the scheme to the buyer;
  15. xx.illegal mobilization of funds by sponsoring or causing to be sponsored or carrying on or causing to be carried on any collective investment scheme by any person.
  16. SEBI Board may order for investigating the matter where it has reasonable ground to believe that any dealing in securities has been detrimental to interests of investors or securities market or nay intermediary or any other person has contravened the Act, rules or regulations.

SEBI had conducted investigation of trading by certain persons including Vibha Sharma from December, 2009 to March, 2010. Vibha had a trading account with Eureka Stock and Share Broking Services Ltd. Her husband Jitender Sharma was an equity dealer with Central Bank of India. Investigations revealed that for a period of 16 days net quantity at the end of each trading day was zero and for 14 days there was a complete match between sell order of Vibha and buy order of Central Bank. SEBI found them guilty under FUTP Regulations and imposed a fine. They appealed to Securities Appellate Tribunal (SAT) against SEBI decision. The issue before SAT was again the same that arose in an earlier case of Dipak Patel v SEBI3, whether trading done in the securities market by a person other than an intermediary on the basis of information about forthcoming orders of another trader in the market is in violation of the FUTP regulations? SAT dismissed the appeal and held them guilty under the regulations. SAT departed from its earlier decision in Dipak Patel case and held front running even by a person other than an intermediary is illegal. SEBI introduced amendments to FUTP Regulations that acts or omissions are prohibited if they fall under purview of regulation 3 irrespective of the category of persons committing them.
 

Few examples of insider trading violations:

Samir Arora v SEBI4:

 

Samir Arora was fund manager of Alliance Capital Mutual Fund registered with SEBI. Alliance Capital Asset Management India Ltd (ACMIL) is the Asset Management Company of ACMF. ACMIL is subsidiary of Alliance Capital (Mauritius) Ltd. Their parent company is alliance Capital Management (ACM). The Mutual Fund had a shareholding of around 10% in DGL (Digital GlobalSoft Ltd). A merger was proposed between DGL and HP ISO. A condition precedent to this merger was de-merger of HP ISO from HP. Although the fact of merger was in public domain but de-merger was not and it could have made significant influence over prices of shares of DGL. This merger ratio was known to Samir Arora as he had good rapport with management of DGL. It was alleged that this merger ratio could have negative effect that is why he could time offloading his shares. There was no direct evidence but SEBI found him guilty of insider trading and he was prohibited from dealing in securities for five years.

Reliance Industries case5:

 

A complaint was received by SEBI about sale of 10.05% shares of L&T by Reliance Industries Ltd to Grasim India Ltd. It was complained that immediately before the L&T deal RIL had increased its stake in L&T to 10.05%. Earlier its stake was 6.62% only. In earlier deal RIL had paid only Rs 150/- per share whereas it sold shares at Rs 306.6/- per share. In its investigation SEBI found that Ambanis were reasonably expected to have access to this knowledge as they were directors on the Board of L&T. RIL was deemed to connected person with L&T. Ambanis were held to be ‘insiders’ but no violation of Insider Trading Regulations were not violated because unpublished price sensitive information of L&T by RIL or Ambanis was not available to them by virtue of them being insiders.

Case of Sadhna Nabera6:

 

In the case, SEBI had alleged that appellants had dealt in shares of Sun Infoways Ltd on the basis of unpublished price sensitive information which was related to its taking over of business of Zap Infotech. DilipNabera was an auditor of Sun Infoways Ltd. He held 10, 500 shares of the company in the name of DilipNabera HUF. His wife SadhnaNabera also held 5,300 shares in the company. She was whole time director of Adhunik Finance Ltd and held 50% shares of the company. Knowledge of proposed takeover was with Dilip personally as this information was not in public domain. Expecting an effect of this takeover on shares of Sun Infoways Ltd, Dhilip, Sadhna and Adunik traded in shares of Sun Infoways Ltd. When Dilip was appointed as auditor of the company he had disclosed about his and Sadhna’ s shareholding in the company but he did not disclose about Sadhna’s shareholding in Adhunik. He contended that Adhunik traded as a sub-broker for its clients but these trades were not owned by them. On the basis of definitions of insider and connected person, SEBI held them guilty of insider trading and penalty was imposed. On appeal, Securities Appellate Tribunal (SAT) reversed the order as it could not find them guilty of insider trading. According to SAT, an auditor is not expected to be in possession of unpublished price sensitive information as it’s a policy decision where auditors is not involved. Dilip and his wife did not trade in shares of Sun Infoways Ltd after joining it. They traded only after they left the company and the information became public information.

 

Summary: In this module, we covered the concept of insider trading, its prohibition in India and latest developments relating to development of this concept. Distinction between Prohibition of Insider Trading Regulations of 1992 and Regulations of 2015 was highlighted in the module. The module also briefly discussed certain practices relating to fraudulent and unfair trade practices in securities market, their prohibition and related recent developments in such regulations.

 

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References:-

 

1. A Singh, Introduction to Company Law, Eleventh edition, 2014, Eastern Book Company

2. A Singh, Company Law, fifteenth edition, 2011, Eastern Book Company

3. Companies Act 2013 with Rules, Taxmann, 2014

4. Company Law, Mayson, French and Ryan, twenty second edition, 2005-06

5. Securities Law, Hudson, Sweet & Maxwell, 2008

6. International Securities Law Handbook, Best and Solier, third edition, Wolters Kluwer, 2010

7. Bare Act: Companies Act, 2013

8. Bare Act: Securities and Exchange Board of India Act, 1992

9. Bare Act: Securities (Contracts) Regulation Act, 1956

 

Web links:

 

1. http://www.sebi.gov.in/sebiweb/home/list/1/3/0/0/Regulations

2. http://www.sebi.gov.in/acts/insideregu.pdf

3.http://www.mondaq.com/india/x/264962/Securities/SAT+Extends+Prohibition+Of+Front+Running+To+Persons+Other+Than+Intermediaries

4.http://articles.economictimes.indiatimes.com/2013-08-12/news/41332696_1_sebi-board-futp-securities-market-regulator-sebi

5. http://www.sebi.gov.in/cms/sebi_data/boardmeeting/1381381841296-a.pdf

6. http://www.sebi.gov.in/cms/sebi_data/attachdocs/1378786495636.pdf