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Dogma of Insider Trading A Comparative Study MOHIT SINGHVI VAISH ASSOCIATES ADVOCATES Email: [email protected]

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Dogma of Insider Trading A Comparative Study MOHIT SINGHVI VAISH ASSOCIATES ADVOCATES Email: [email protected]

Dogma of Insider Trading: A Comparative Analysis

2 Mohit Singhvi, Associate_ Vaish Associates Advocates

Introduction

With the advent of colossal frauds and scams in the Indian and capital markets across

the globe, the regulators and governments of major economies have increasingly turned towards making stringent corporate governance standards and have appended penalties for violation of the same in order to curb the menace of misappropriation of the information, funds and other weapons used as tools to make huge illegal capital. The law and economics debate about the popularity of prohibiting insider trading by corporate insiders on material, non-public information is long-standing. The developing economies, coupled with growth of the capital market, necessitated the comprehensive legislation and a statutory body to promote orderly and healthy growth of the securities market, on a whole.

The concept of insider trading is based on the availability of unpublished price sensitive information about a company listed in the stock market. Use of such information by the persons having access to it for trading in the stocks for purpose of making personal gains is called ‘Insider trading’. It is a clear cut instance of dealing in company’s security with a view to make huge profits or avoiding a loss while in possession of information that, if generally known, would affect their portfolio. Insider trading is opposed to public policy, involves abuse of confidential information and is equivalent to betrayal of fiduciary position involving faith and confidence. Famous examples of it includes transacting on the advance knowledge of a company’s discovery of a rich mineral ore,1 on a forthcoming cut in dividends by the board of directors,2 and on an unanticipated increase in corporate expenses.3

Insider trading has been explained by the Patel Committee4 in its report as “trading in shares of a company by the persons who are in the management of the company or are close to them on the basis of undisclosed price sensitive information regarding the working of the company which they possess but not available to others.

The Apex Court in the case of Rakesh Agarwal v. SEBI5 stated that, “Insider trading takes place when insiders or other persons, who by virtue of their position in office or otherwise, have access to unpublished price sensitive information relating to the affairs of a company, and deal in securities of such company or cause the trading of securities while in possession of such information or communicate such information to others who use it in connection with the purchase or sale of securities."

Insider-trading is a term commonly used and also often heard by those who are regularly involved in trading in the stock market. Though the term has a surreptitious ring to it

1 Securities and Exchange Commission v. Texas Gulf Sulphur Co., 401 F. 2d 833 2 In Re: Cady, Roberts & Co. 3 Diamond v. Oreamuno, 24 N.Y. 2d 494 4 High powered Committee on Stock Exchange Reforms, 1986 5 2004 49 SCL 351 SAT

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and stock market regulators around the globe spend considerable time framing laws to combat this menace, it is not always an evil. It need not be concluded that the persons connected to the company are barred from possessing, buying and selling its shares. They are permitted to deal in the securities of the company, provided they make adequate disclosure about the transaction to the regulator and the exchanges on which the shares are listed.6

In India, law governing Insider trading is enumerated in the Securities and Exchange Board of India (Prohibition7 of Insider Trading) Regulations 1992, (“Regulations”) framed by the board in exercise of the powers conferred under section 30 of the Securities and Exchange Board of India Act, 1992, are intended to prevent and curb the nuisance of insider trading in the capital market. In the U.K. the law relating to Insider trading is dealt in accordance with the provisions enshrined under the Criminal Justices Act, 19938. The first country to take step to tackle the problem of insider trading effectively was the United States. In the USA, the Securities and Exchange Commission is empowered under the Insider Trading Sanctions Act, 1984 to inflict civil penalties besides initiating criminal proceedings. As far as the emergence of laws relating to Insider trading in the European Union is concerned, the first wide-ranging development outside the United States in efforts to ban insider trading was the European Community Directive Coordinating Regulations on Insider Trading, adopted on November 13, 1989 (the "EC Directive").

6 Inside of Insider trading by Lokeswarri S. K., http://www.thehindubusinessline.in/iw/2007/04/29/stories 2007042902001300.htm 7 Inserted by the SEBI (Insider Trading) (Amendment) Regulations, 2002, w.e.f. 20.02.2002. 8 This Act replaced the provisions first introduced in sections 68-73 of the Companies Act 1980 and consolidated into the Company Securities (Insider Dealing) Act, 1985.

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Who Is An Insider?

Before getting into the technicalities of the concept, let us examine the pertinence of the terminology used in the whole process. As per section 2 (e) of the Regulations “Insider” means any person who,

(i) 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

(ii) who has received or has had access to such unpublished price sensitive information.

The persons who have access to such information may be those closely associated with the company either as:

(1) top management as promoters or directors; (2) executives and employees; (3) persons associated with the company in their professional capacities as lawyers,

auditors, financial consultants, etc; (4) persons working in banks and financial institutions dealing with the company; (5) persons manning the firms having business relationship with the company and (6) persons not falling in above categories but have come in possession of price sensitive

information.

Some other important terms are defined as follows: As per section 2 (h) (a) of the Regulations "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.

As per section 2 (c) of the Regulations, “connected person”9 means any person who—

(i) is a director, as defined in clause (13) of section 2 of the Companies Act, 1956, of a company, or is deemed to be a director of that company by virtue of sub-clause (10) of section 307 of that Act; or

(ii) occupies the position as an officer or an employee of the company or holds a position involving a professional or business relationship between himself and the company whether temporary or permanent and who may reasonably be expected to have an access to unpublished price sensitive information in relation to that company.

9 “connected person” shall mean any person who is a connected person six months prior to an act of insider trading.

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Prohibition on Insider Trading In India

The entire scheme behind eliminating insider trading as stated earlier is to ensure that persons by virtue of their position in the company and based on the confidential information available to them by virtue of their position in the company do not gain an unfair advantage. Chapter II of the SEBI (Prohibition of Insider Trading) Regulations, 1992 deals with prohibition on dealing, communicating or counseling on matters relating to insider trading and contains Regulations 3, 3A, 3B and 4. Regulation 3 reads as follows:

No insider shall-

(i) either on his own behalf or on behalf of any other person, deal in securities of a company listed on any stock exchange when in possession of any unpublished price-sensitive information; or

(ii) communicate or counsel or produce directly or indirectly any unpublished price sensitive information to any person while in possession of such unpublished price sensitive information shall not deal in securities.

Provided that nothing contained above shall be applicable to any communication required in the ordinary course of business or profession or employment or under any law. Also, Regulation 3A says that “no company shall deal in securities of another company or associate of that other company while in possession of any unpublished price sensitive information.”

Regulation 3B sets out certain exceptions to which Regulation 3A will not apply. Regulation 4 states that “any insider who deals in securities in contravention of the provisions of Regulation 3 or 3A shall be guilty of insider trading.” Regulation 3 and Regulation 4 of the Regulations does not require anything else to be proved to proceed against the person except that the person is an insider and that he had dealt with the securities on the basis of the unpublished price sensitive information. The requirement for establishing a breach of fiduciary duty to successfully make out a violation of insider trading under Regulation 4 is implicit in the provisions of Regulation 3, and necessarily needs to be read into the same, that this requirement is imported into Regulation 3, by the use of the defined term "insider", that an insider is necessarily a "connected person" or "a person deemed to be connected" with the company.

Apart from the provisions mentioned above, Chapter VI-A of the Securities and Exchange Board of India Act, 1992 (“SEBI Act”) provides for Penalties and Adjudication, which provisions were introduced in SEBI Act by the Amendment Act 9 of 1995. Section 15-A to section 15 HB are in the form of mandatory provisions imposing penalty in default of the provisions of the SEBI Act and the Regulations made therein. The provisions of penalty for non-compliance of the mandate of the SEBI Act is with an object to have an effective deterrent to ensure better compliance of the provisions of the SEBI Act and Regulations, to protect the

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interests of investors in securities and to promote the development of the securities market as held in the case of The chairman, SEBI v. Shriram Mutual Fund and Anr.10

The Scheme of the SEBI Act of imposing penalty is very clear. The proceedings under Chapter VI A are neither criminal nor quasi-criminal. The penalty leviable under this Chapter or under these sections is penalty in cases of default or failure of statutory obligation or in other words breach of civil obligation. The scheme of penalty under Chapter VI A of the SEBI Act has no element of criminal offence or punishment therefore, there is no question of proof of intention or any mens rea and hence it is not an essential element for imposing penalty under SEBI Act and the Regulations.

Also, it was held in the case of Hindustan Lever Ltd. V. SEBI11 that "it can be conclusively said that while entering into the transaction for purchase of 8 lakhs shares of BBLIL from UTI, HLL was acting on the basis of the privileged information in its possession, regarding the impending merger of BBLIL with HLL. It also may be stated that, by its very nature, when it comes to motives and intentions, there may not always be any direct evidence. However, the chain of circumstances, the timing of the transaction, and other related factors, as discussed earlier, demonstrates beyond doubt that the transaction was founded upon and effected on the basis of unpublished price sensitive information about the impending merger.”

It is equally pertinent to note that section 24 of the SEBI Act deals with the persons who can be made liable to criminal prosecution for violating the provisions of SEBI Act, rules, Regulations. As per section 24 the offender "shall be punishable with imprisonment for a term which may extend to ten years or with fine, which may extend to twenty five crore rupees or with both". This penalty is the revised one brought in vide amendment effected to the SEBI Act on 29.10.2002. Prior to the said amendment the person found guilty of an offence "was punishable with imprisonment for a term which shall not be less than one month but which may extend to three years or with fine which shall not be less than two thousand rupees but which may extend to ten thousand rupees or with both." Further in terms of section 15G of SEBI Act persons indulging in insider trading are liable to a monetary penalty not exceeding twenty-five crore rupees or three times the amount of profits made out of insider trading whichever is higher.12 The monetary penalty provided in section 15G is in the case of adjudication of the offences by an adjudicating officer appointed by SEBI. Penalty provided in section 24 is "without prejudice to any award of penalty by the adjudicating officer under the SEBI Act."

PROCEDURE

On receipt of a complaint from shareholder, investor, intermediaries and any other person or suo- moto13, to protect the interest of the investors in securities, the SEBI can conduct an investigation into cases of insider by giving reasonable notice to the insider or in the

10 AIR 2006 SC 2287 11 (1998 SCL 311) 12 Prior to the amendment to the section on 29.10.2002 the maximum penalty leviable was rupees five lakhs. 13 Regulation 5(2), Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations 1992

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interest of the investors or in public interest, without any notice. The insider, i.e. the person being investigated, is under an obligation14 to produce books of accounts/ documents furnish required information/statements, allow access to his premises extend reasonable facility for examining book, records etc. and its copies, thereof. The examining authority is empowered to examine and record the statements of directors, partners or employees etc., which have also to extend their assistance and cooperation to the authorities till the time investigation continues.

Upon the findings of the inspection report prepared by the investigating authority and submission of the same to the board within reasonable time15, the SEBI is empowered to give such directions to protect the interest of the investors, and in order to comply with the provisions of the SEBI Act rules and Regulations as it deems fit for the following purposes:

(1) direct the insider not to deal in securities in any particular manner;

(2) prohibit him from disposing off any securities acquired in violation of these Regulations;

(3) restrain him from communicating/counseling any person to deal in securities;

(4) declaring the transactions as null and void;

(5) directing the person who acquired the securities in violation of these Regulations to deliver the securities back to the seller; and

(6) directing the person to transfer an amount or proceeds equivalent to the cost price or market price of securities, whichever is higher to the investor protection fund of a recognized stock exchange.

Under the present Regulations, the board has powers to initiate criminal proceedings against the insider; but here it is essential to be abreast of the fact that in case of criminal prosecution the offence has to be proved ‘beyond reasonable doubt’. The very nature of insider transaction is such that it is difficult to adduce evidence as it is nothing else but the leakage of information which is the sole determinant of the market fluctuations. As far as the law relating to insider trading in India is concerned, the SEBI has taken reasonable steps to ensure that the investors are safe and are not cheated by the insiders. Also, the recent amendment16 which substituted the word ‘Central Government’ by ‘Securities Appellate Tribunal’ is a step ahead in order to completely curb the unfair game of “insider trading”.

CODE OF CONDUCT

SEBI via Chapter IV of the Regulations which deals with policy on disclosures and internal procedure for prevention of insider trading has taken a step forward to curb the menace of Insider Trading. Regulation 12 (1) of the Regulations states that:

14 Regulation 7, Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations 1992 15 Regulation 8, Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations 1992 16 SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2008

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All listed companies and organisations associated with securities markets including: (a) the intermediaries as mentioned in section 12 of the Act, asset management company and trustees of mutual funds; (b) the self-regulatory organisations recognised or authorised by the Board; (c) the recognised stock exchanges and clearing house or corporations; (d) the public financial institutions as defined in section 4A of the Companies Act, 1956; and (e) the professional firms such as auditors, accountancy firms, law firms, analysts, consultants,

etc., assisting or advising listed companies,

shall frame a code of internal procedures and conduct as near thereto the Model Code specified in Schedule I of these Regulations without diluting it in any manner and ensure compliance of the same. These Regulations have primarily been made to prohibit trading in shares of the company on the basis any information which relates directly or indirectly to a Company and which if published, is likely to materially affect the price of shares of the Company. According to clause 3.217 all Directors/Officers/Designated Employees and their respective of the Company shall conduct all their dealings in securities the Company only during the trading window as decided by the company which shall be opened 24 hours after the information mentioned below is made public and shall not deal in any transaction involving the purchase or sale of the Company’s shares during the period when trading window is closed i.e.

a) Declaration of Financial Results (quarterly, half yearly and annual).

b) Declaration of dividends (interim and final).

c) Issue of securities by way of public/rights/bonus etc.

d) Any major expansion plans or execution of new projects.

e) Amalgamation, mergers, takeovers and buy-back.

f) Disposal of whole or substantially the whole of the undertaking.

g) Any changes in policies, plans or operations of the Company.

17 Schedule 1 appended to the Regulations.

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Legal Mechanisms in UK, US And EU

LAW IN THE UK

In the UK, insider dealing was made a specific criminal offence in 1980 and was incorporated in the Company Securities Insider Dealing Act, 1985, which was re-enacted in 1993 and is now contained in Part V of the Criminal Justice Act, 1993. The Criminal Justice Act, 1993 places exclusive reliance upon criminal sanctions for its enforcement. The criminal sanctions imposed by it are, on summary conviction, a fine of not exceeding the statutory maximum and/or a term of imprisonment not exceeding six months, and on conviction on indictment an unlimited fine and/or imprisonment for not more than seven years. But the requirement of mens rea has made the enforcement of the legislation often difficult. In addition to the traditional criminal penalties which may be visited upon insiders, it seems that the disqualification sanction is available against some insiders in some cases, the effect of which is to disable the person disqualified from being involved in the running of companies in the future because of the breach of his/her duty towards the company. In Kelly v Cooper18 Lord Brown Wilkinson giving the Judgment of the board stressed the scope of fiduciary duties and in particular the alleged duty not to put them in a position where their duty and their interests conflicted. Such insiders owe a fiduciary duty to the company not to misuse or misappropriate such information for an unlawful purpose i.e. to make secret profits or personal gains for themselves.19 Section 52 of the Criminal Justice Act, 1993 creates three separate offences, each of which may only be committed by an individual and within the UK.20

Interestingly, under the law21 as it exists in the UK, only individuals can be held liable. In India individuals as well as corporations can be guilty of the offense. In this regard the law in India is similar to the law in the United States where corporate liability is recognized under certain circumstances. In Attorney-General's Reference (1) of 1988,22 Lord Lane while referring to White Paper on the conduct of a company director referred to paragraph 22 of the Paper this is inter alia stated:

"....Public confidence in directors and others closely associated with companies requires that such people should not use inside information to further their own interests. Furthermore, if they were to do so, they would frequently be in breach of their obligations to the companies, and could be held to be taking an unfair advantage of the belief with whom they were dealing".

As per section 57 of the Criminal Justice Act, 1993, an individual can only be in that position if the information he has is inside information and he knows both that it is inside information and that he has it from an inside source. There is also the concept of ‘potential insiders’ under the Act. The potential insiders are those directly connected with the company in

18 (1993) AC 205 19 Chiarella v. United States, 455 US 222 20 http://www.lawyersclubindia.com/mobile/articles/display_article_list_mobile.asp?article_id=3078 21 section 52(2), Part V of the Criminal Justice Act, 1993 22 [(1988) IAC 971]

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question, those who come across the information professionally. To make them actual insiders, and so liable for any of the three offences, it must be shown that the potential insider knows both that it is inside information and came from an inside source. In the UK, insider trading is considered a criminal offence and hence knowledge is an essential ingredient to be proved in an insider trading case and, it will be necessary for the prosecution to establish that the individual charged with the offence of insider dealing has intentionally dealt in the securities knowing that he is connected with the company. It is no defence that the accused obtained the information without having actively sought it.23 The mens rea or the intent therefore assumes significance.

Unlike the Indian Regulations, the UK enactment also provides for defenses24 available to an individual against action for insider trading. An individual is not guilty of insider dealing if he shows -

1. he did not at the time of dealing expect the deal to result in profit attributable to the fact

2. that the information in question was price sensitive information in relation to the securities.

3. that he believed on reasonable ground that information had been disclosed widely enough to ensure that none of those taking part in the dealing would be prejudiced by not having information

4. that he would have done what he did even if he did not have the information.

LAW IN THE US

After the United States stock market crash of 1929, Congress enacted the Securities Act of 1933 and the Securities Exchange Act of 1934, aimed at controlling the abuses believed to have contributed to the crash. Section 17 of the Securities Act of 193325 contained prohibitions of fraud in the sale of securities which were greatly strengthened by the Securities Exchange Act of 1934.26

Section 16(b) of the Securities Exchange Act, 1934 prohibits short-swing profits made by corporate directors, officers, or stockholders owning more than 10% of a firm’s shares. Under section 10(b) of the 1934 Act, SEC Rule 10b-5, prohibits fraud related to securities trading. The Insider Trading Sanctions Act, 1984 and the Insider Trading and Securities Fraud Enforcement Act, 1988 provide for penalties for illegal insider trading to be as high as three times the profit

23 Cf. Attorney-General Reference: No. 1 of 1988(1989) 24 Sec. 53(1) 25 http://www.sec.gov/about/laws/sa33.pdf 26 http://www.sec.gov/about/laws/sea34.pdf

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gained or the loss avoided from the illegal trading.27 To implement section 10 (b), the SEC adopted Rule l0b-5, which provides, in relevant part:

It shall be unlawful for any person, directly or indirectly:

(a) to employ any device, scheme, or artifice to defraud,

(b) to make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or

(c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of a security.

In order to establish the offence of insider trading, it is essential to establish a breach of such duty owed to the company by the insider. The Supreme Court of United States of America in United States v. Carpenter28 held that, "It is well established, as a general proposition, that a person who acquires special knowledge or information by virtue of a confidential or fiduciary relationship with another is not free to exploit that knowledge or information for his own personal benefit but must account to his principle for any profits derived there from."

The U.S. Supreme Court, while considering the Appeal in the case of Dirks v. SEC29, held that, "In some situations the insider will act consistently with his fiduciary duty to shareholders and yet release of the information may affect the market. For example, it may not be clear - either to the Corporation insider or to the recipient analyst - whether the information be viewed as material non-public information. The Corporation Official may mistakenly think information already has been disclosed or that it is not materially enough to affect the market. Whether disclosure is a breach of the duty therefore depends in large part on the purpose of the disclosure. This standard was identified by the SEC in Cady Robert's Case to eliminate use of the inside information for personal advantage. Thus the test is whether an insider personally will benefit directly or indirectly from his disclosure. Absent some personal gain, there has been no breach of duty to shareholders. And absent a breach by the insider there is no derivative breach"

The Securities Exchange Act, 1934 in the United States imposes statutory limit on insider trading, requiring public disclosure of insider’s transactions in the shares of their companies and providing for recovery of ‘shortswing’ profits made by them.30 Since the depths of the Great

27 http://www.sec.gov/news/testimony/2006/ts092606lct.htm 28 463 U.S. 646 (1983) 29 Dirks v. United States, SEC 403 (646) 30 section 10(b) of the Act provides: "It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange--(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in

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Depression, the Securities and Exchange Commission has tried to prevent insider trading in U.S. securities markets. Even before the thirties, insiders were liable under the common law if they fraudulently misled uninformed traders into accepting inappropriate prices. But the Securities Exchange Act of 1934 went further by forbidding insiders from even profiting passively from superior information. The Act provides remedial measures for protection of investors against sharp practices and fraudulent schemes by insiders in making short-term, speculative profits. The Act permits the Commission to bring suit against insider traders to seek injunctions, which are court orders that prohibit violations of the law under threat of fines and imprisonment.

Unlike in the UK, the Securities and Exchange Commission in the USA has been empowered under Insider Trading Sanctions Act, 1984 to seek imposition of civil penalties, in addition to criminal proceedings. Since criminal cases are difficult to prove and drag on for years, leading ultimately to jail terms, the SEC has been consciously following civil proceedings that offer a much wider range of sanctions, including trading bans and forcing repayment of illegally-obtained profits. Being a civil agency, the SEC has sweeping powers to gather evidence prior to a trial and it does not need to prove each element of its case beyond a reasonable doubt. It only has to show ‘a preponderance of evidence’, which works very effectively in cases where the guilt is closely linked to the motivations of the defendant in an insider trading case. The above explains us very clearly why the SEC handles a much larger number of cases more effectively.

The amount of a civil penalty can be up to three times the profit gained or loss avoided as a result of insider trading. With minor exceptions, any person who provides information leading to the imposition of a civil penalty may be paid a bounty. However, the total amount of bounties that may be paid from a civil penalty may not exceed ten percent of that penalty. The United States Supreme Court has time and again held that the liability arising out of such transaction is based on two theories i.e. the ‘classic theory’ or the ‘misappropriation theory’. The classic view of 10b and 10b-5 is that liability shall be imposed for "trading in the securities of his corporation on the basis of material, non-public information." Inside information in the U.S. is "material nonpublic information".31

The theory is that the insider is breaching a trust owed to the corporations’ shareholders. Direct benefit to the tipper is a precondition for the liability of the tipper who does not trade on the information they wrongly divulge.32 Likewise, the tippee will not be liable under Rule 10b-5 unless the plaintiff shows benefit to the tipper. The above rule was re-affirmed by the US Supreme Court in S.E.C. v. Sargent33.

contravention of such rules and Regulations as the (SEC) may prescribe as necessary or appropriate in the public interest or for the protection of investors." 31 United States v. Svoboda 347 F.3d 471, 475 32 SEC v. Warde, 151 F. 3d 42, 48-49 33 229 F.3d 68, 77 (C.A.1 (Mass.), 2000)

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The misappropriation theory was developed in the case of United States v. O' Hagen34 The court in held that: "a person commits fraud 'in connection with' a securities transaction, and thereby violates section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information." The theory is that the fiduciary has wrongly used confidential information.35

LAW IN THE EU

Insider trading law shows the influence of the EC on the Member States law most clearly. Prior to the Insider Trading Directive, insider trading was treated differently in each Member State, being a criminal offence in some states, yet perfectly legal in others.36 Here, the EC has acted to create a Community standard and today insider trading is regarded as wrongful activity throughout the European Union. The EC Directive states in the preamble that the smooth operation of the secondary market in transferable securities depends to a large extent on the confidence it inspires in investors and that the factors on which the confidence depends include the assurance afforded to investors that they are placed on an equal footing and that they will be protected against the improper use of insider information.

The directive also states37 that, each member state shall prohibit, any person, who by virtue of his membership of the administrative, management or supervisory bodies of the issuer, or by virtue of his holding in the capital of the issuer, or because he has access to such information by virtue of the exercise of his employment, profession or duties; possesses inside information “from taking advantage of that information with full knowledge of the facts by acquiring or disposing of for his own account or for the account of a third party, either directly or indirectly, transferable securities of the issuer or issuers to which that information relates.”

The E.U. Insider Trading Directive is obviously heavily influenced by U.S. Securities law, although some terms and consequences are more clearly defined in E.U. law. Private action as a rule in the U.S. state intervention is an exception to the generality, whereas state intervention is the norm in Europe and private rights of action are the exception. Also there are some divergences. There is no per-se prohibition of short-swing trades in E.U. law.38 Most interestingly, until the Directive, insider trading was not regarded as a wrong in many European countries. The Directive represents a successful implementation of the U.S. capital market system. Hence, as is followed in USA there should be, in addition to criminal proceedings, deterrent civil penalties and high levels of compensation to be paid by the defaulter, which shall reduce the possibilities of committing the crime.

34 521 U.S. at 652, 117 S.Ct. 2199. 35 United States v. Chestman 36 Insider trading was legalized in Germany until 1994. 37 Art 2(1) of the EC Directive of November 13, 1989, coordinating Regulations on insider dealing (89/592/EEC) 38 INSIDER TRADING IN U.S. AND E.U. LAW: A COMPARISON by Eric Engel

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The first community prohibition of insider trading was the 1989 Directive, replaced by a more comprehensive Directive 15539, which covers shares, a variety of option contracts as well as prohibiting market manipulation. Unlike the 1989 Directive, the 2003 Directive prohibits market manipulation as ‘trading or disseminating information in order to give false or misleading signals as to price movements’. The 2003 Directive also covers shares, unit trusts, money markets instruments, futures, swaps, options, derivatives and any other instrument trading on a regulated market or for which a request to trade has been made. The prohibition of “tipping”, as well as the exception for trades in the ordinary course of business is also found in the Directive 2003/6.40

Arguendo, the European Directive's has the same elements of act constituting Insider

trading i.e. materiality and publicity. However, "Unlike the U.S. insider trading laws, determination of illegal trading is based not on breach of a fiduciary duty, but rather, on possession of non-public information."

39 Council Directive 2003/6, 2003 O.J. (L 96) 16-26 (EC) 40 INSIDER TRADING IN U.S. AND E.U. LAW: A COMPARISON by Eric Engel

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Concluding Remarks

As far as the conventional economics is concerned, insider trading crops up when there is information asymmetry, resulting in one party having a lead over the general market, having an access to sensitive information. Public policy orders that a person having access to such information should not be permitted to use the same for his personal and hence the need to protect the interest of the general public is of paramount importance and is the major reason why the need for such stringent Regulation arises.41

The need of the law relating to insider trading is of the obvious and understandable concern about the damage to public confidence which insider is likely to cause. Insider trading undoubtedly undermines investor confidence in the fairness and integrity of the capital markets. The law relating to the fiduciary duty of the director cannot be applied to all insiders because it concentrates on the relationship between the director and the company rather than on the relationship between the director and the shareholders or other investors in the market.

However, in the case of Bajaj Auto Ltd. v. NK Firodia42 it was held that “directors act in a fiduciary position both towards the company and towards the general body of shareholders; and that, in exercising their powers; they must act for the paramount interest of the company and towards the general interest of the shareholders.”

Also, the United States Supreme Court in Strong v. Repide43 has extended the duties of directors to imply a fiduciary obligation to shareholders in situations where directors were acting contrary to the interests of other shareholders. From the point of view of company law, perhaps a more significant reason for attempting to regulate insider trading by law is that the insider with access to confidential information is thereby in a conflict-of-interest situation. For example, he may be in such a position within the company as to be able to dictate or at least influence when the public disclosure of price-sensitive information is to be made. In that situation his decision and his own desire to trade advantageously in the company’s shares may conflict; in other words the best interests of the company may wrongly take second place to his own self-interest.

Rationale behind prohibition of Insider trading is the smooth operation of the securities market and its healthy growth and development depends on the quality and integrity of the market which can alone inspire confidence in investors. Insider trading leads to loose of confidence of investors in securities market as they feel that market is rigged and only the few, who have inside information, will get benefit and make profits from their investments. In Samir C. Arora Vs SEBI44, It was observed that activities like insider trading fraudulent trade practices and professional misconduct are absolutely detrimental to the interests of ordinary investors

41 http://www.econlib.org/library/Enc/InsiderTrading.html 42 AIR 1971 SC 321 43 213 U.S. 419 (1909) 44 Decided on August 9, 2003

Dogma of Insider Trading: A Comparative Analysis

16 Mohit Singhvi, Associate_ Vaish Associates Advocates

and are strongly deprecated under the SEBI Act, 1992 and the Regulations made there under. No punishment is too severe for those indulging such activities.

It is an accepted fact that the practice of insider trading requires to be checked and those who indulge in insider trading should be severely dealt with by awarding harsh penalties, as insider trading is outright cheating and not compatible with fair market transactions. It is true that Regulations 3 and 4 per se are sections without specific mention of the requirement of the motive or intention, but if read with the objective of prohibiting the insider trading it clarifies that motive is essential for creating a liability on an insider. What is sought to be prohibited is gaining unfair advantage by the insider by indulging in insider trading. As far as my understanding is concerned, I see no sense in making motive essential for proving the act of insider trading, unless it is established that he misappropriated and manipulated the non-public information and gained an unfair advantage over the other investors.

Undoubtedly, this kind of activity should be universally condemned as unfair and unethical. After all, one person, solely by virtue of personal connections or occupation by possessing knowledge, gains an advantage that the average investor does not have, and is also hit by the prejudicial principles of unfairness, inequality and injustice. Over the years, the urge of prohibiting the corrupt practice of Insider trading has been shown by number of economies by enumerating stringent laws relating to insider trading. Some of the examples are as follows:

• Hong Kong regulators unveiled new measures to combat insider trading, including the introduction of new electronic surveillance capability. Its provisions are found in Securities (Insider Dealing) Ordinance 1990 (cap 395) (‘the Hong Kong Ordinance’)

• Malaysia amended its securities laws, for the first time giving investors a private right of

action against insider traders.

• The main provisions relating to insider trading in New Zealand are found in Securities Amendment Act 1988 (‘the New Zealand Act’)

• Vietnam announced a decree establishing its first public securities market, which

includes prohibitions on insider trading.

• The government of Egypt announced that it is working on a comprehensive reform of its Regulation of the Cairo Stock Exchange, to bring it into line with world standards.

• The Netherlands Securities Board launched an investigation into whether the

Amsterdam Exchanges have sufficient systems in place to detect and investigate insider trading.

• The Swiss Federal Supreme Court, recently in 2007 proposed a change in the existing

law and held that, inter-alia all the price-sensitive facts are subject to Insider trading provisions.

Dogma of Insider Trading: A Comparative Analysis

17 Mohit Singhvi, Associate_ Vaish Associates Advocates

• The main provisions governing insider trading in Australia are found in ss1002-1002U,

1013, 1005, 1015 Corporations Law (‘the Australian Act’)45

The countries who are yet to incorporate the law relating to insider trading, must awake at the earliest and shake hands with the countries already prohibiting the menace and, shall cooperate in this noble endeavor to eradicate it from the grass root level. As far as the law relating to insider trading in India is concerned, SEBI must take a step ahead to protect the interest of the investors and the securities market and shall make provision to compensate the parties injured by the insider’s activities as prevailing in the US, in addition to section 15 and section 24 of the Act. The recent developments herald a new era of universal recognition that insider trading, which in the words of the Former SEC's Chairman Levitt:

"has utterly no place in any fair-minded law-abiding economy.”

45 A Comparative Analysis of Insider Trading Regulation- Who is Liable & what are the Sanctions? by Victor CS Yeo