Critical Analysis on Law’s Relating to Insider Trading in India

I. Introduction

India’s position as a global economic force, inter alia, mandates the need for a robust regulatory framework for its securities market, to boost the confidence of both the domestic and the international investors that their money is safe in a fair and transparent securities market. In the recent years, India has witnessed large price fluctuations in the shares of public companies during the periods of mergers or acquisitions and illegal trading on the basis of unpublished price sensitive information, which has caused great concern to the Indian securities market. If the fiduciaries who run the companies for the benefit of the shareholders gain unjust enrichment at the cost of the company and its shareholders, it becomes a heinous crime. Although illegal insider trading is a global phenomenon, a study by the IMF reports that it is relatively high in countries such as India, China, Russia, etc., resulting in high volatility in share prices. Indian studies also have reported that insider trading activity is observed amongst companies belonging to the same business group prior to merger announcements.

II. Fundamentals of insider trading

(A) Meaning of Insider Trading

Insider trade with all investors is a familiar word that is usually related to criminal behaviour. The definition does, however, encompass lawful and criminal behaviour. Insider trade is simply stated to be a dealing by a business insider in stocks of a company or other shares. This can also be defined as legal trade in insiders.

The term "Insider" is defined in clause (e) of regulation 2 as:

"Insider means any person who, is or was connected with the company or is deemed to have been connected with the company, and who is reasonably expected to have access, by virtue of such connection, to unpublished price sensitive information in respect of securities of the company, or who has received or had access to such unpublished price sensitive information."

Illegal insider trading discourages business investment while hindering the growth of the stock market by its negative effects.

A business insider is usually a director or official of a company. A company insider is a classical insider. The group of insiders inside an organization often comprises the "constructive insiders," whose ties with the company are legally privatized to corporate records. The constructive insiders are considered for instance an organization' s contractor, accountant, attorney or analyst who works for a company and is subjected to inside knowledge. This means that, whether a corporate or building insider of a firm is engaged in shares of the corporation, the insider is considered to be dealing in insiders.

The only legitimate misconception would only happen if the company's corporate or constructive insider trades in the shares of the company understanding that he has an unpublic pricing sensitive inside the details. Insider trade may also not always be a prohibited business

In India, the first effort to curtail insider dealing was a condition of transparency in respect of shareholdings of corporate directors.² Since then, significant change in policy has been achieved. Today, the 1992 Insider Trading Regulations of the Securities and Exchange Board of India set down the laws regulating these crimes.

(B) Need to regulate Insider Trading

The main aim of the insider trading legislation is to safeguard the interests and reputation of the investment industry in stocks. An optimal securities market represents the uncertainties involved and the returns for investors correctly. The lawyers who forbid insider trade would not treat all the cases of inside trade as criminal, but sought to ban the use of non-public material knowledge on some cases of insider trade. This ensures that all traders in the stock industry have the knowledge available on the market equally. Moreover, most lawmakers around the world wanted to pass a legislation that would allow an honest director of a corporation, at the same time, to deal in the corporate shares and handle in good faith the enterprise. However, lawmakers were not able to predict when a director of a firm (the insider) would be unable to check the identities of the individuals he trades with to make all the company filings. Consequently, the expectation of the insider manager who trading in the shares of the firm was to reveal publicly before trading the material information that affected the securities' prices. Otherwise, the managers should stop trade. In addition to the principle of 'info parity.' Theory, the argument above also seems to be a principle underlying the creation of all countries of insider trade laws.

Besides the above reasons, the regulation of insider dealing has economic and non-economic reasons.³ Economic damage to consumers and companies and demands for knowledge rights are major economic causes. The non-economic explanations include broadly the defense of the obligatory scheme of transparency and the principle of equity of insider trade.

The prohibition of insider dealing becomes completely indispensable for the successful operation of the compulsory disclosure scheme, as it means that the company has no personal use of insider's secrecy obligations. This is the most non-economic justification that stock dealing and investor rights should be banned. India is responsible for the public dissemination of all relevant information by the corporations by major regulations pertaining to corporate governance and the stock sector. That include the Company Act 2013, the Securities Contract Regulation Act 1956 Listing Agreement, The statutes of the Substantive Share and Take-Overs Regulations (SEBI) of 1992,⁴ which require different types of disclosure to the regulators from enterprises, are specific for insider trading.

III. Insider trading laws

(A) Development of Law’s to curb Insider Trading

In its 125 year old stock exchange, the trade by insiders in India was unimpeded until about 1970. This was recognised as unequal in the late 1970s. In 1979, the Sachar Committee stated in its report that staff, such as directors, auditors, corporate clerks and so on, could have knowledge which would be price sensitive and may be used to influence stock values that could trigger financial misfortunes for the investor public. The corporation recommends that the Companies Act 1956 be amended to limit and ban employee/insider trafficking. An order to discourage insider dealing, penalties were also recommended.

In 1986, the Patel Committee proposed that the Companies Act 1956 concerning equity contracts be revised in order to curtail insider dealing and inappropriate stock transactions.⁵ It proposed substantial fines, including jail charges, aside from the refund to the stock markets of profits or damages avoided.

The Abid Hussain Committee recommended in 1989⁶ that civil and penal prosecutions should penalize insiders' trading practices and also proposed that the SEBI should devise the rules and codes for the prevention of unfair dealings.

SEBI has adopted the regulations known as the Securities and Exchange Board of India (I Trading) Regulations 1992, following the Committee's recommendations by exercising the powers bestowed on them by section 30 of the Securities and Exchange Board Act 1992. In accordance with Article 24 and Section 15 G, of SEBI Act 1992, this 1992 law prohibits this fraudulent activity and an individual found guilty of that offense is punishable. These laws were revised dramatically in 2002 and renamed the SEBI (Insider Trading Prohibition) Regulations in 1992.

The Insider Trading Regulations are essentially draconian, in that they define what insider trading constitutes and then try to prosecute this act in different ways. Moreover, all listed entities must comply; all industry intermediaries (such as brokers) and all consultants (such as merchant bankers, professional firms, etc.).

No specific rules for the offense of insider trading in India existed before these regulations were established. Now, the meanings of "insider" were given in accordance with these rules, and it has been forbidden to negotiate with, communicate or advise on matters including insider trading. Regulation 4 of the SEBI Regulation⁷ allows a person responsible for insider trading who is liable to be fined, a person who is concerned with securities or who sends some information or advice to a person dealing with securities, in violation of that Rule with imprisonment for a term which may extend to one year or with a fine or with both under the provisions of section 24 of the Securities and Exchange Board of India Act 1992.

The SEBI Act (Swiss Trade Act) Rules prevent "insiders" from trading on their behalf in exchange stocks, on the basis of unpublished price sensitive information, from disclosing this information or from counselling others on the basis of this information,⁸ rather than in the usual course of business.⁹ "Securities dealing" means either as a principal or as an intermediary selling or accepting exchange. The recipients who were granted details by the insider shall not be held liable.¹⁰

The term ban of the insider's stock dealing was inserted in Section 195 by virtue of the Enactment of the Companies Act, 2013. In 2015, in order to revamp the current regulatory system on the capital markets, SEBI substituted the 1992 rules with the 2015 SEBI (prohibition of insider trading) Legislation. Section 195 of the Act bars a corporation from engaging in insider trading with its directors or main management staff. Under this Law, "insider trade" means an act by which the manager or main manager or any other employee of an enterprise is either principal or agent, purchasing, sale, selling or agreeing to purchase, sell, or contract in any security, where it is fairly anticipated that the individual may have access to any information that is priced non-publicly and vulnerable to securities of the enterprise.

The Hindustan Lever Case was the first case where SEBI took action against violators of insider trading law¹¹

In this case, Unilever, a common parent company subsidiary, was Hindustan Lever Limited (HLL) and Brooke Bond Lipton India Ltd (BBLIL). On 19 April 1996, a merger announcement was announced between BBLIL and HLL. SEBI has been alerted of the fusion information and the insider trade leaks on the market and in the newspapers. The SEBI had therefore begun research on the subject. SEBI concluded that, on the basis of the UPSI, HLL, as an insider, had acquired BBLIL shares for the imminent merger from the Unit Trust of India (UTI). This violated the provisions of the Inside Trading Regulations and the SEBI Act. This led to a lack of UTI. In its exercise of its powers, SEBI had ordered the HLL to pay UTI in accordance with Section 11B of the SEBI Act, as specified in Regulation 11 of the Insider Regulations. Due to the insider dealing of Rs.3.04 crores SEBI estimated the loss in UTI. The reason for the measure was the distinction between the BBLIL stock exchange price at which the UTI shares were sold to HLL after the merger was announced and the share price before the merger was announced, minus premiums. As corrective actions SEBI justified its decision.

In the appeal authority, a centralized government, the UTI and the HLL filed separate appeals against the SEBI order. All of the main questions under discussion before the appeals office in this case was the meaning of the word 'insider' in accordance with Regulation 2(e). The appellants' authority noted in this respect that there are three components to the concept of "insider":

(i) the person should be a natural person or legal entity;

(ii) the person should be a connected person or a deemed connected person; and

(iii) acquisition of the UPSI should be by virtue of the connection.

The SEBI had also interpreted in its order, the third requirement of ‘acquisition of UPSI’ by the insider by virtue of the connection with the company by envisaging two alternate situations:

(i) where the insider is reasonably expected to have access to UPSI by virtue of the connection with the company; or

(ii) where the insider has actually received or had access to such UPSI.

SEBI argued that if, regardless of his status within the organization, a related entity genuinely discovers or gains those knowledge individually, he or she will fall within the category of "insider," which is why SEBI considers that HLL was an insider. The Appellate Authority confirmed this.

The appeal authority, however, overturned the order of SEBI, inter alia, on the following grounds:

(i) the news on the merger was not a UPSI as it was well known and recognized by the market;

(ii) the merger information could not significantly affect the price at which the transaction was concluded;

(iii) the SEBI’s decision to award compensation to UTI suffers from procedural deficiencies;

(iv) SEBI’s direction to HLL to compensate UTI lacks jurisdiction;

(v) SEBI's litigation guidance under Section 24 of the SEBI Act has not been properly enforced because it did not set out the grounds for prosecution and SEBI has not invoked its relevant adjudicating powers under Section 15G of the SEBI Act.

However in view of the corporate governance crisis in the contemporary era, the question of the insider trade has become increasingly relevant in the Indian context. The regulatory position for the continued monitoring of insider trade transactions using the model authorized in SEBI Regulations is being pursued by SEBI, which argues that the SEBI regulations would regulate the stock market in order to restore investors' trust.¹²

The PJ Thomas Committee assessed the extent and the degree of controls that could be imposed on financial markets in 1948 on the regulatory existence of insiders' trade in Indian circles relatively quickly.

Since the beginning of the 20th century in the United States insider dealing was controlled by the US Supreme Court, by the Strong v. Repide case of 1909,¹³ which sets out the value of informing investors.

The United States was one of the leading insider trading enforcement agencies. The Securities Exchange Act of 1934 was implemented as a follow-up to the 1929 Great Depression. The Securities Exchange Commission ("SEC") has been able to prohibit the insider trade in the United States under the Exchange Act.

IV. Comparative analysis & enforcement of insider trading

Comparative Analysis deals with the ongoing changes in the SEBI Regulations from time to time and the other Legislative enactments of Laws for Insider Trading with the changes made due to the Judicial Precedent and its overall impact on the Insider Trading in India.

(A) Provision’s & Judicial Precedents

The constitutional right to exercise any profession or to carry on any trade, industry or occupation is provided under Article 19(1)(g) of the Indian Constitution. Yet Article 19 makes fair limitations on this constitutional right (6). The state has the power and legislate to prohibit certain unequal trade practices under this reasonable ban.

In the case of M/S Eskay K N I T (India) Ltd. and Ors.Vs. Union of India & Ors,¹⁴ the High Court in Rajasthan has ruled that the illicit insider's commercial activities were illegal and the State has the power to lay down legislation for the avoidance of such fraudulent business activity pursuant to clause 6 of Article 19.

While the definition of illegal insider trading under the Indian Constitution is very limited, the constitutional provisions above strongly prohibit these unethical trading practices.

Via Section 193, the company's 2013 Act introduces a whole new system. The new description of insider trading is given in Section 195 of the 2013 Act. This description of the insider trade is very precise, and this definition says that the insider trade requires an acte of: - subscribing; - purchasing; - dealing or deciding to subscribe; - buying, selling or dealing, as a basis of such price sensitive information about the shares of that firm, in all securities by any director or key official of a company. Any such price sensitive information is often considered insider trading to be an act of communication (directly/indirectly) to any other entity.

In the case of Indiabulls Insider Trading Case¹⁵, This investigation is one of the most recent cases of insider dealing. The executive director of Indiabulls was accuse of illegal trade in Indiabulls to Rs. 87 lakhs if he had the privately-owned classified sales knowledge of the subsidiary of Indiabulls venture limited. In the management committee of Indiabulls, according to the Regulator, the Executives Director of the venture limited Indiabulls was thus an insider and also an insider for her husband. In the year 2017–19 these illegal gains were made. The SEBI directed the IVF to be strictly punishable and both the managing director and husband of the firm would jointly and severally impose Rs. 87,4 lakhs. In addition, no loan is due without SEBI's previous authorisation.¹⁶

(B) Power of Investigation

Securities rules include the regulatory system, the monitoring program and the implementation programme, which are all three basic components. The implementation of securities laws depends primarily on the strength, strategy and productivity of the regulators. The investigation powers remain the cornerstone of the enforcement system, within the different powers of the regulator. As in others, the Indian regulators have been challenged by compliance. This feature has occasionally been the subject of international reviews and reports.

In its 2004 review of the Indian securities regulatory system, the World Bank noted that the key problems in the Indian securities industry prevailed, while a number of laws and regulatory reforms had occurred. It is not necessary to guarantee the optimum growth of the stock industry where there are only insider trade rules. One of the main worries outlined by the World Bank in the above-mentioned study was to ensure proper alignment with corporate governance activities with restrictions and regulation of affiliate dealings and insiders trading.

The punitive role of the regulatory system is enforcement; that is, the tangible effects of failure to comply with the regulations and breaches of securities law.

In an observational analysis of the so-called 'Security Rules and Enforcement,'¹⁷ the cost of capital for shares was not influenced by the presence of the insider trading laws alone. Good regulation of insider trade legislation will nevertheless influence securities' capital costs.

The International Organization of Securities Commissions (IOSCO) also addressed the problems relating to securities compliance and established three principal concepts for the successful application of securities legislation:

Principle 10: Thorough inspection, inquiry and monitoring powers should be given to the regulator.

Principle 11: Robust regulatory powers should be provided to the regulator.

Principle 12: the regulatory structure shall ensure the efficient and credible use and execution of appropriate compliance programs through the review, audit, monitoring and enforcement forces.

Accordingly, many attempts have been made by the Member States to conform with these standards. Efforts were mostly made by incorporating legal measures to improve forensic competences.

In India SEBI shall provide for the investigation and inspection of any individual accused of committing the contravention of the Insider Regulations in Regulations 4A and 5 of the Insider Regulations. SEBI initiates an inquiry on account of insiders' trading cases received from customers, intermediaries or someone else or suo moto, on the basis of its own intelligence about any potential offence. SEBI can choose an internal investigative agency to investigate until it first knows the need for an investigation. The SEBI was only able to open an investigation before 2002 based on "accessible written content." After 2002, the SEBI thesis extended extensively.

Under Section 11C, SEBI's general powers of enquiry are prescribed and the enquiry starts on the appointment of an investigative body. According to Section 11C (3), an I.A. may request the supply of material, books or registers or documentation or records relating to the investigation by any intermediary or individual connected with the securities market. The I.A. is authorized to investigate individuals under oath. Failure to cooperate with the I.A. could result in arrest and a conviction which could lead to a jail term of up to one year or a fine up to Rs.1 crore.

V. Enforcement: remedies & sanction’s

Civil and criminal law enforcement approaches in various states are narrowly categorized. The distinction is that, while civil redress consists only of injunction, cash penalty, dismissal and private prosecution, etc., the criminal penalties are serious and impose detention and/or monetary punishment. Since reviewing world practice, the criminal penalties prove to be more efficient from a deterrent point of view. But the burden of evidence on the regulator is much greater in matters of criminal penalties, making it impossible to secure an adequate sanction.

The status of the Indians differs significantly from that of the other nations. There is no specific provision for injunctive redress in insider trading proceedings under the Indian Securities Statute. The word "injunction" is not referred to either in the SEBI Act or in the Insider Regulations.

It should be recalled, however, that these laws provides for injunctive relief after an in-depth review of a number of aspects of the SEBI Act and the Insider Regulations. Section 11(4), for example, states: For example: “without prejudice to the provisions contained in sub-sections (1), (2), (2A) and (3) of Section 11(4) and Section 11B of the SEBI Act, the SEBI may, by an order, for reasons to be recorded in writing, in the interests of investors or securities market, take any of the following measures, either pending investigation or inquiry or on completion of such investigation or inquiry, namely:

(i) suspend the trading of any security in a recognised stock exchange;

(ii) restrain persons from accessing the securities market and prohibit any person associated with securities market to buy, sell or deal in securities;

(iii) Impound and retain the proceeds or securities in respect of any transaction which is under investigation;

(iv) Direct any intermediary or any person associated with the securities market in any manner not to dispose of or 328 alienate an asset forming part of any transaction which is under investigation.”

These steps can also be taken in relation to any public company or corporation listed on the stock exchange (not intermediary under section 12 of the SEBI Act), where SEBI Board has reasonable grounds for believing that such corporation is engaging in insider traders or in fraudulent and unfair business practices in connection to SEBI Board. SEBI also gives broad powers to the SEBI to order in the interest of investors and the stock industry, as provided for in Article 11B of the SEBI Act. Furthermore, if the SEBI considers that an individual has breached or is likely to breach some rule after an inquiry or It may pass an order requiring the individual to stop and refrain from committing or causing such infringement, using the particular power conferred under Section 11d of the SEBI Act; or the rule or provisions of the SEBI Act. This may also be directed to businesses where fair reasons exist to suspect they have committed themselves to stock dealing or market abuse. Thus, it is obvious that someone who wants to trade in the holding of insider knowledge should be prohibited from doing business in advance of the trade so that an irreparable harm can be prevented.

Although SEBI's right to order disgorgement was being challenged by the appellant, the regulator relies upon the ruling in B. P. Plc v. SEBI,¹⁸ in which the high court in Bombay affirmed SEBI's instructions to pay interests to the aggravated investors. In addition, the supposed gains have always been divided into punishment instead of restitution.¹⁹

There is no clear criminal punishment under the Indian Insider Regulations. The criminal repercussions on insider trading are, however, found primarily in Section 24 of the SEBI Act which is liable if any individual violates any of the SEBI Act's provisions and regulations, as well as the SEBI Act's rules and regulations. Consequently, this clause for the punishment of criminals is not exclusive to the application of insider trade legislation alone. If conviction is effective in accordance with Section 24 of the SEBI Act, it will lead to a penalty of up to ten (10) years in prison and / or fines extending to or against Rs.20 crores.

While the implementations of legislative provisions have been inconsistent time and time again, the extent of evidence and the position on the presumption of proof have undermined the implementation mechanism, in India the penalties and compliance systems still seem to be solid. However, the main emphasis must be on the investigation of cases of insider dealing.

With respect to compliance, legal sanctions such as the suspension of and withdrawal orders, the debarment of infringements, cash fines, instructions for conversion of shares or equivalently paid amounts into the investment security equity funds and criminal proceedings are prescribed for the SEBI Act and Insider Regulations. In addition, it adds to the Indian compliance process by the implementation of a (plead bargaining) arbitration system, whereby violators must pay the SEBI a mutually negotiated sum based on the seriousness of the crime and on the estimates of benefit or loss arising out of a deal.

Although in a very few cases Indian insider trading legislation has been reviewed, each time that the courts have examined insider trading law or the SEBI solution, the regulation has been amended.

Compliance is one of Indian regulators' most daunting obstacles. It is necessary to use advanced methods to prosecute cases of insider trading to identify the violations, conduct an inquiry and gather the facts. The problem with insider trading is that the actual act in securities purchases and sales is legit. Maintaining market interest, raising public understanding of the financial system, maximizing the security of customers, and reducing financial crimes are ideal objectives for a securities regulator.

VI. Conclusion

The SEBI in the Insider Regulation bars an insider from engaging with shares when having unpublished information which is price-sensitive (Section 12A of the SEBI Act and Regulations 3 and 4 of the Insider Regulations). The Insider Regulations define the terms 'insider' and 'precious knowledge which is not released.'

In recent years, insider dealing has decreased dramatically. It is because of the SEBI's strict and hurricane operations and stringent SEBI rules and guidelines. It is now time for us to look to the future for the effectiveness of or the ability to put an end to the insider trade with recent reforms and amendments in the SEBI banning.²⁰

The SEBI must also incorporate the idea of offering incentives or rewards which is already a successful scheme in US where 10% of recovered money is given as a reward to the people helping expose the Insider Trading with Evidence of such practice, this is also reduced by causing fear in insiders' minds that they will be revealed.

Insider Trading practice is a corrupt practice of making money off the market using privileged information that shouldn’t have been used or disclosed at the first place, thus the practice in itself is unethical and results in the general people panicking or un-stabilizing the market which could have a very drastic effects in the growth and economy of the country and a result such practices should be discontinued and strong actions should be taken against such individuals indulging in such practices.

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