Insider trading in India: regulations and controlling authority

Introduction

Transparency, openness, and disclosure are credited with supporting a corporate organisation’s successful functioning and governance. To accomplish these qualities, it is necessary to maintain a positive relationship between management and stakeholders and accept investors’ trust.

Investors are attracted to organisations with outstanding corporate governance, which improves their trust. The directors of the companies that make up the Board of Directors play a significant role in determining the company’s future. The board’s decisions can influence the stock market’s reaction to investors. As a result, the board’s meetings and decisions are considered confidential. Confidential information is only provided when necessary for the company’s success.

As a result, it’s critical to keep the information private until released to the public. Over time, it has been noted that to get an unfair edge over others, employees of the organisation can obtain sensitive information and frequently engage in unfair trade. This is an unequal and ethically incorrect activity with potentially negative repercussions. As a result, it is critical to stop these activities throughout the world. Different governments are making attempts to prevent such acts through worldwide rules.

With the emergence of the concept of trading securities in the global market, the problem of insider trading arose. The capital market in India is regulated by the SEBI (Securities and Exchange Board of India). It was founded in 1992 as part of the SEBI Act of 1992. Enacting legislation and establishing an entity capable of efficiently regulating the securities market was vital for investor protection.

The Bhabha committee suggested in 1952 that directors be required to report information about share sales and purchases in a separate register maintained by the firm. As a result, Sections 307 (which requires corporations to keep a register of their directors’ shareholdings in the company) and 308 (which mandates that directors and people deemed to be directors disclose their shareholdings in the company) were added to the Companies Act, 1956.

Managers of the company were brought to the scope of section 308 by the Companies Amendment Act of 1960. The Sachar Committee suggested in 1978 that strict legislation be enacted to acknowledge trader transaction facts so that it could be determined that no undue benefit had been made by using price-sensitive information.

In a study suggesting that the Securities Contract (Regulation) Act (“SCRA”), 1956 be amended to allow exchanges to impose severe procedures prohibiting insider trading of information, a committee led by G. S. Patel defined the phrase “Insider Trading.” The Abid Hussain Committee recommended in 1989 that insider trading be classified as a civil and criminal offence and that SEBI impose stronger regulations to curb the unfair practice of insider trading. The SEBI (Insider Trading) Regulations, 1992, prohibited unfair trade practices in the securities market. In the year 2002, the restrictions were changed.

Insider trading is when a company trades undisclosed price-sensitive information behind its back to obtain an unfair advantage or prevent a loss. Insider trading is defined by the Securities Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 as a breach of fiduciary duty by corporate officers toward shareholders. The restrictions on insider trading were created to ensure that securities are transferred and traded relatively in the market. However, claiming that a country has successfully solved the problem of insider trading is problematic.

What is insider trading?

Insider trading is the practice of trading in a company’s securities using confidential knowledge (unpublished price-sensitive information). Because it is not disclosed, the unpublished price-sensitive information is unknown to the general public and is tied to its board of Directors’ choices. Insider trading is defined as using such knowledge to make an unlawful profit or loss. The information is referred to as ‘price-sensitive’ since it can influence the market price of a company’s securities.

“Insider trading is defined as the act of buying, selling, subscribing, or agreeing to subscribe in a company’s securities, directly or indirectly, by key management personnel or a company director who is expected to have access to Unpublished Price Sensitive Information concerning the company’s securities, and it is deemed to be insider trading.”

Unpublished price-sensitive information

If information is not disclosed publicly and is relevant to the company’s decisions, it is said to be price-sensitive; if known, it can alter the price of securities in the market; Financial statements, dividend declarations, public rights issues, merger or amalgamation information, buy-back of securities, information on de-mergers, policy revisions, or changes in the company’s operations are all examples of unpublished price-sensitive information.

Fairtrade is defined as trading that adheres to all of the norms and rules of fair dealing. In contrast, unfair trading is defined as trading that violates such rules and regulations to gain an unfair advantage. Insider trading is also a word used to describe unfair trading that involves the use of unpublished price-sensitive information. It is unethical and moral to reveal such information in the market since it gives the individual who has the info an unfair advantage. In contrast, traders who do not have the knowledge are left in a disadvantageous situation.

Members of a firm can trade in their company’s stocks in India, but they must provide transaction records to maintain openness and limit the use of proprietary information. SEBI has enacted several policies governing insider disclosure to restore investor confidence and guarantee trade transparency. Insider trading has been deemed a criminal offence in the country to ensure fair market trade. 

Who is an insider?

“Insiders” are individuals who have access to confidential, price-sensitive information about the company. They utilise this information against uneducated investors to make enormous profits before the public is aware of it. Partners, directors, officers, and employees of a company and related companies, persons with some official relationship with a company, professional or business (e.g., auditors, consultants, bankers, and brokers), stockholders, government officials, and stock exchange employees, among others, are all considered “insiders.”

It should be highlighted that the board of directors and staff have direct access to price-sensitive information and are thus free to use it in any way they see fit. There may be times when an insider can provide knowledge to an outsider and thereby deal with the outsider without taking responsibility. Insiders can participate in a variety of other illegal activities while going unreported. As a result, it is critical to call attention to such flaws in the system.

Insider trading is defined as the willing exchange of securities in return for confidential information that is not publicly available and can potentially alter the price of these securities significantly.

For example, if a firm’s director is aware that the company is experiencing financial difficulties, he sells his shares in anticipation of a public statement on a dividend cut. Similarly, suppose a director buys additional stock in a firm after knowing about the discovery of diamonds or gold on the company’s land before a public release. In that case, he is engaging in insider trading since he expects the stock price to climb due to the news. As a result, an insider who knows the company is in financial trouble may sell his stock knowing that the news would be announced publicly shortly.

Suppose someone may reasonably be considered to have access to undisclosed price-sensitive information. In that case, any person with any professional or business relationship can become a connected person and hence an insider. The relationship and the access to unpublished price-sensitive information that such a relationship facilitates are required.

What are the effects of insider trading?

Those unaware of the confidential information bear the brunt of insider trading’s impact. They do not trade in securities as a result of this. Insider trading is immoral and constitutes a breach of fiduciary duty due to the breach of trust and confidence. Misuse of insider information is frowned upon for a variety of reasons:

Insiders gain an unfair advantage over those who lack information; a) It creates a conflict of interest because it benefits the insider’s self-interest rather than the company’s; c) It harms the market reputation and discourages investment.

The advantageous person’s conditional purchase or selling of securities only while in possession of confidential knowledge has an impact on the value of such securities. Furthermore, the beneficial person’s possession of secret information implies that the beneficial person has a relationship within the firm that provides vital information to that person. He could work for the company as a director, employee, or professional adviser. This is bad for the company, but it is also bad for the public.

Consider the following hypothetical insider trading scenario: a director of a merchant bank was coaching a company on the process of conducting a takeover of another company. It was well known that disclosing information about a takeover bid might result in an instant increase in the target company’s or the acquiring company’s stock price. Insider trading would be defined as the merchant banker purchasing certain shares in advance of publication at the pre-bid price and selling them immediately after the bid announcement.

Directors or workers must not use insider knowledge to enhance their personal interests to maintain fair trade. It would be a breach of their responsibility to the corporation if they did so. People will become disinterested in such businesses. Such procedures should be continuously monitored to ensure that investor distrust does not jeopardise the market’s integrity. These techniques are immoral and unethical because they have the potential to harm a huge number of unwitting investors.

Countries have expressed their opposition to such activities over time. The United States was the first country to address the issue of insider trading successfully. To govern the transfer of private information, the United Kingdom has set many obligations and duties on the Directors. In this regard, India has also adopted a number of regulations. Examples of such legislation are the Companies Act and the SEBI Regulations of 1992. On the other hand, the country has been ineffective in combating such abuses.

Insider trading in India

Indian law development

Following the recommendations of the Thomas Committee, which assessed US legislation in 1948, the Indian government began to prioritise the issue of insider trading following independence. Sections 307 and 308 of the Companies Act, 1956 were enacted. As a result, requiring specific disclosures from core insiders, such as directors and staff.

For the first time in the 1970s, insider trading was labelled as “undesirable behaviour.” However, the Companies Act of 1956 lacked an appropriate enforcement provision.

The Sachar Committee in 1979, the Patel Committee in 1986, and the Abid Hussain Committee in 1989 all recommended enacting separate legislation in this area. SEBI was established in 1992 as a result of this. In its report, the Committees made the following observations:

Sachar Committee (1979)

The Companies Act of 1956 and the Monopolies and Restrictive Trade Practices Act (MRTP) of 1969 were reviewed by the committee in June 1977. The committee’s report recommended that:

• Insiders must notify their intention to trade.
• Insiders must not trade securities before or after two months after the end of the accounting year.
• Insiders’ share dealings must be recorded in a company register.
• Compensation and civil remedies must be provided.

Patel Committee (1986)

The committee was established in May 1984 to conduct a thorough investigation of stock exchange dealings and give suggestions. The committee underlined the country’s critical need for insider trading legislation, citing the lack of such regulation as the principal cause of these activities.

Abid Hussain Committee (1989)

In 1989, it was founded. Insider trading should be declared a civil and a criminal offence, according to the committee. SEBI was advised to draught regulations in this regard. SEBI established rules to prevent the practice of insider trading in response to the committees’ recommendations: – 

• ‘SEBI [Insider Trading] Regulation-1992’
• SEBI [Substantial Acquisition of Shares & Takeover] Regulations 1994.’
• ‘SEBI [Prohibition of Fraudulent & Unfair Trade Practice relating to securities market] Regulations-1995.’

SEBI has made several substantial revisions to the 1992 Insider Trading Regulations, which were in place. In the instances of Hindustan Lever Ltd. v. SEBI and Rakesh Agarwal v. SEBI, the regulation was revised to close the flaws that had been exposed. “SEBI Regulations 2002” is the name of the new regulation.

“An individual 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,” according to the definition of ‘deemed to be connected person’ (Insider). In 2008, the definition of “insider” was changed once more. SEBI Regulations, 2015, were notified in 2015, and SEBI (Prohibition of Insider Trading) (Amendments) Regulations, 2018, were notified in 2018.

Regulatory authority

Insider trading is regulated in India by India’s Securities and Exchange Board (SEBI). The SEBI Act of 1992 gives SEBI the authority to create insider trading regulations. The Securities and Exchange Board of India (SEBI) regulates and safeguards the Indian securities market. SEBI also keeps an eye on insider trading in securities.

Because the Indian market lacks depth, it is extremely volatile. However, the capital market has experienced substantial expansion due to the increased number of investors, increased participation by various enterprises, capitalisation, stock exchanges, foreign direct investment, turnover, mutual funds, brokers, and other factors.

The country’s developing economic reforms are a major factor in the capital market’s development. Through a depository, the market’s volume, transparency, and investment holding techniques have all increased.

The Harshad Mehta scam of 1992 and other fraudulent acts in the Indian capital market have tarnished the market’s image to the point where many investors now doubt the market’s integrity. The following are some of the most typical explanations for these fears:

• Activity of insider trading;
• Less transparency in transactions;
• Unwarranted transactions;
• Lack of knowledge to general investors.

The Company Law Board (CLB), the Reserve Bank of India (RBI), the Securities and Exchange Board of India (SEBI), and several stock exchanges have all worked hard to regulate and encourage investment in the Indian market.

SEBI has implemented several policies to prevent insider trading and other market manipulation tactics. On the other hand, SEBI published the SEBI (Insider Trading) Regulation, 1992 for the first time, which was last revised in 2018.

SEBI Regulations

The Companies Act of 2013 and the SEBI Act of 1992 prohibit insider trading in India. The SEBI Regulations, 2015, were enacted by SEBI to provide the rules prohibiting and restricting insider trading in India. 

The SEBI (Prohibition of Insider Trading) (Amendments) Regulations, 2018, are primarily applicable to “dealing in securities,” which includes “buying, selling, or agreeing to buy, sell, or deal in any securities by any person, either as principal or agent, by insiders based on any private, confidential information.” The Regulations only apply to the trading of publicly traded securities.

According to the regulations, insiders are barred from communicating or disseminating confidential information. Authorised information must be conveyed or distributed. The information can be utilised by the individual or by someone acting on his behalf. Any violation of the SEBI Regulations is a criminal offence under the Act, punishable by up to ten years in prison or a fine of up to Rs. 25 crores, whichever is higher.

Except for the offence committed under section 24 of the Act, the SEBI Regulations allow the adjudicating officer to impose a penalty on anyone who violates the regulations’ requirements. SEBI also has the authority to look into insider trading cases and similar issues. SEBI’s powers of investigation may be used for two key reasons:

• to look into complaints received from investors, intermediaries, or anyone else on any topic relating to claims of insider trading; and, 
• to look into its own knowledge or information to protect the interests of investors in securities from violations of these regulations.

According to the Regulations, if promoters of a company are found to be breaking insider trading norms by using unpublished price-sensitive information of the firm for no legitimate reason, they would be held accountable, regardless of their shareholding level.

There are some exceptions to SEBI’s regulations, such as: 

• Disclosure is permitted for reasonable reasons, such as the execution of duties or fulfilling legal requirements. “Persons like lawyers, accountants, and others who are genuinely outsiders will be regarded as insiders from when the UPSI was communicated with them in the ordinary course of business,” the court ruled in Dirks v. SEC.
• When there is a legal obligation to make an open offer, and when disclosure is essential in the company’s best interests, disclosure is permitted. In the case of Samir Arora v. SEBI, it was decided that unpublished confidential information must be factual to trigger an Insider Trading provision. 

Loopholes

The Indian authorities have had a difficult time regulating the practice of insider trading. According to SEBI’s Annual Report for the fiscal year 2016-2017, insider trading cases accounted for 14 per cent of all investigations (34 cases) in 2016-2017, compared to 12 instances in 2015-2016. With each passing year, the crime of insider trading grows in severity, as does the clamour for more stringent rules.

Only 15 of the 34 instances investigated were completed, which is a serious source of concern. Insider trading claims are made based on hearsay, and the lack of actual evidence makes it difficult to identify and prove the crime. Although the regulatory system is relatively strong, the number of successful cases is quite low. This is because SEBI lacks the technical knowledge needed to conduct efficient investigations. One of the reasons for SEBI’s failure is a severe lack of resources and staff.

Furthermore, Indian law does not apply in circumstances where a foreign national has committed the crime of insider trading. There is no provision for a penalty or an investigation in such instances. The regulations’ extraterritorial applicability is not addressed in the Acts. 

Suggestions and conclusion

Since 1992, there has been a significant evolution in the legislation outlawing insider trading to a large extent. Insider trading is seen as a serious offence by the authorities, periodically revising the statutes to include new and more punitive penalties. To some extent, SEBI has been successful in prosecuting insider traders.

The Board of Directors of a company play a critical role in the preservation of unpublished price sensitive information, so it is essential to hold those who are considered “insiders” in the company accountable for their unlawful dissemination of price-sensitive information to eliminate insider trading and protect investors’ interests in the market.

Because it is impossible to regulate the behaviour of insiders entirely, those in senior management positions, such as directors, officers, and other company members, should set strong ethical standards in their organisations to guarantee that the firm’s goodwill is not harmed. This is not something that can be forced upon anyone. The Indian government should also concentrate on developing procedures or technologies that will aid in the speedy resolution of pending cases.