[ICLS Mid Career Training Programme] 07.01.2013 | Session I

Insider Trading: Overview & Objective

ByMANOJ KUMAR

Assistant Vice PresidentCorporate Professionals Capital

Private Limited

What is Insider Trading?

• Insider trading is dealing in securities of a listed company by any person who has knowledge of material inside information which is not available to general public.

• It is breach of a fiduciary duty or other relationship of trust, and confidence.

• It is a crime if made to get wrongful gain or avoid losses

Insider Trading: Genesis

• Insider Trading is one of the most prevailing form of Securities Market Offence worldwide. The genesis Insider Trading is human GREED!

• It is really difficult for persons with privileged information which could help him to gain substantial profit or allow avoidance of loss to control the temptation of using these privileged information

• But possession of privileged information put the person in a fiduciary position and misusing this position is a Breach of Trust and Fraudulent act

• When a company get listed - its promoters, directors and other key employees as well as other persons who have more information than general investors become the trustee of Investors’ interest and are in fiduciary duty to not to use them for their personal benefit. Thus, Insider Trading is a Crime

Insider trading evolution and theories

International Perspective

Insider Trading: International Perspective

• Initially, Insider Trading was considered fraud under Common Law in all major jurisdictions and there was no specific law. Later with the development of Capital Market specific laws were formulated:

• UK Common law prohibits Insider Trading. The relevant laws are • The Criminal Justice Act 1993, Part V, Schedule 1, and • The Financial Services and Markets Act 2000, which defines an offence of Market Abuse

• The USA Laws against Insider Trading:• Securities and Exchange Act of 1934 (indirect)• Insider Trading Sanction Act, 1984• Insider Trading & Securities Fraud Enforcement Act, 1988• United States Securities Exchange Commission Rule 10b5-1

• European Union Laws:• European Community Directive Coordinating Regulations on Insider Trading, 1989• Insider Dealing and Market Abuse Act of 1994• Financial Markets Abuse Act in 2002• EU Market Abuse Directive 2003

Insider Trading: Misappropriation Theory

A person commits fraud when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of information. [U.S. v. O’Hagen, 117 S.Ct. 2199, 2207 (1997)]

According to the SEC duty of trust or confidence arises when:•Person agrees to maintain information in confidence.

• Person communicating material non-public information and person receiving it have a pattern or practice of sharing confidences and there is an expectation of confidence.

• Person receives material nonpublic information from spouse, parent, child, or sibling.

Insider Trading: Privileged Information

Privileged Information is defined as:“Information of a precise nature which has not been made public, relating, directly or indirectly, to one or more issuers of financial instruments or to one or more financial instruments and which, if it were made public, would be likely to have a significant effect on the prices of those financial instruments or on the price of related derivative financial instruments”.

Same concept applies to every type of financial instrument.A clearer definition of privileged information helps companies to know what has to be publicly disclosed and therefore prevents

risk of insider trading.

Insider Trading & Corporate Governance

Insider trading has many governance implications, affecting:• The organization of companies;• The duties of directors of managing boards and supervisory

boards and other corporate insiders;• The permitted flow of information within companies;• The disclosure duties imposed to companies.

The main problem in insider trading is conflict of interests and the misuse of power –in this case it relates to the power over privileged information.

Therefore, there is a strong connection between corporate governance and insider trading.

EU Directive unifies treatment given to price-sensitive information and to privileged information.

The same concept applies either to:• information to be provided by companies; and to• Information not to be misused by insiders.

Earlier, companies were required to disclose or abstain (to misuse information) – rather focusing on the prohibitive side of insider trading.

Now the Directive indicates companies should abstain and disclose.

Insider Trading: Abstain and Disclose

Insider Trading: Timely & Sufficient Disclosure

Greater concern with disclosure duties regarding privileged information. Companies must inform the public as soon as possible of inside information

which directly concern them. There should not Selective Disclosure; Public access to information concerning such transactions as soon as

possible Internet facilitates quick and cost-effective communication of price-

sensitive information to the public. Imposes duty to disclose such information on the company’s website.

Persons who produce or disseminate research concerning financial

instruments or issuers of financial instruments and persons who

produce or disseminate other information recommending or

suggesting investment strategy, intended for distribution channels or

for the public, take reasonable care to ensure that such information

is fairly presented and disclose their interests or indicate

conflicts of interest concerning the financial instruments to which

that information relates.

Disclosure of conflict of interests

Conclusion

Based on the European experience, it is possible to conclude that the modern approach towards Insider Trading is:• Broader - considering e.g. types of securities

concerned;• More ambitious - given the range of

professionals involved (not only insiders);• More connected with governance issues;• Eminently preventive and more focused on

clear and effective guidance regarding timely disclosure of price-sensitive information.

Insider Trading: Indian Perspective

Securities & Exchange Board of India Act, 1992

SEBI (Insider Trading) Regulations, 1992

SEBI (PIT) (Amendment) Regulations, 2002

SEBI (PIT) (Amendment) Regulations, 2003

SEBI (PIT) (Amendment) Regulations, 2008

SEBI (PIT) (Amendment) Regulations, 2011

19.11.1992

20.02.2002

11.07.2003

19.11.2008

16.08.2011

04.04.1992

Evolution of Law

A few Initial Judgements

Evolution of Law …cont

• Rakesh Agarwal, MD of ABS Industries Ltd. (ABS), was involved in negotiations with Bayer A.G (a company registered in Germany), regarding their intentions to takeover ABS.

• Insider trading transaction:- Rakesh Agarwal, through his brother in law, Mr. I. P. Kedia had purchased shares of ABS from the market and tendered the said shares in the open offer made by Bayer thereby making a substantial profit and thus was held for acting in violation of Regulation 3 and 4 of the Insider Trading Regulations.

Hon’ble SAT held that:- Dealing in securities while possessing the unpublished price sensitive

information is not sufficient to hold the appellant guilty.- The dealing should result in an advantage to him.- The law prohibits the gaining of the unfair advantage by the insider.- The appellant has acted in the interest of the company and was not held

guilty.

Rakesh Agrawal v. SEBIMANU/SB/0208/2003

DSQ Holdings Ltd. vs. SEBI (Decided on 15.10.2004 SAT)

• DSQB (earlier Usta Te Biotech Ltd.) was originally promoted by KND Engineering & Technologies Ltd., jointly with Tamil Nadu Industrial Development Corporation. The erstwhile management in DSQB entered into an agreement in April, 1994 with Square ‘D’ group promoted by Shri Dinesh Dalmia. Soon thereafter, the new management announced a rights issue which opened for subscription on 03/07/1995 and closed on 02/08/1995.

• Insider trading transaction:- The appellants were found to have traded in the securities of the DSQB during June, 1994 to December, 1994 and also after the closure of the Rights issue while possessing UPPSI .

SAT held that the matters regarding the Rights issue of DSQB was first discussed in the Board Directors Meeting on 30/07/1994. Thus the period between 31/07/1994 to 30/09/1994 was the period under the price information on the Rights issue was "unpublished and price sensitive“.

• Mr. Dilip Pendse was director of Tata Finance Ltd and Niskalp Investments and Trading Co. Ltd. which is subsidiary of Tata Finance Ltd. Mr. Talaulikar was also director of the above companies. TFL came out with rights issue between 30-3-2001 and 30-4-2001. It was observed that Niskalp, a subsidiary of TFL, had suffered huge losses which was not disclosed in the Letter of Offer leading to failure of offer.

• Insider Trading Transaction: Mr. Talaulikar transferred his family shares on 4-4-2001 at a higher price while possessing UPSI that Niskalp had suffered losses. It was alleged Mr. Pendse was guilty of Counseling and arranging transfer of shares while in possession of UPSI.

SAT held that -- Mr. Pendse and Mr. Talaulikar are both professionals and were insiders

therefore, Mr. Talaulikar required no advise from the Mr. Pendse as alleged.- Mr. Talaulikar is responsible as he was the director of Niskalp at the time

when the funds were transferred.

Dilip S Pendse vs. SEBI (Decided on 20.11.2008 SAT)

Samir C Arora vs. SEBI (decided by SAT on15-10-2004)

• The merger of Digital Globalsoft (DGL) and HP ISO (Hewlett Packard) was proposed. Digital appointed Bansi Mehta and Co. to recommend merger ratio. The merger ratio was discussed in the Board Meeting of DGL on May 12, 2003. The Board, however, did not announce the merger and decided to seek fairness opinion from a third party. Later on, on June 6, 2003 the merger ratio was announced. This resulted in fall of price of the DGL scrip from Rs. 500.50 to Rs. 371/-.

• Insider trading Transaction: The Appellant was alleged to have sold the entire holdings of Alliance Capital Mutual Fund & Alliance Capital Management LP between May 8, 2003 and May 12, 2003 while possessing UPPSI.

The Hon’ble SAT held that- Information accessed was not correct information.- There was nothing to show how the information generated by Shri Bansi Mehta

could have reached the Appellant, particularly when SEBI has nowhere doubted the credentials of Shri Bansi Mehta and Soonawala.

- Several other funds had also sold the same scrip in the same month in substantial numbers

Rajiv B. Gandhi, Sandhya R. Gandhi & Amishi B. Gandhi Vs. SEBI [2008] 84 SCL 192(SAT)

• Rajiv B. Gandhi (Gandhi) appellant No. 1 is the Company Secretary and Chief Financial Officer of Wockhardt Limited (for short the company). Sandhya Gandhi appellant No. 2 is his wife and Amishi Gandhi (appellant No. 3) is his sister.

• Insider trading transaction:- The appellants had sold 3600 shares on 21.1.1999 (before the board meeting held on April 22, 1999 at 11.30 a.m called for demerger) and 22.1.1999 (in the first half hour before the market could react to the news) on the basis of unpublished price sensitive information.

The Hon’ble SAT held that- The words “on the basis of” are significant and mean that the trades

executed should be motivated by the information in possession of the insider

- Facts necessary to establish the contrary being especially within the knowledge of the insider, the burden of proving those facts is upon him

S. Ramesh, S. Padmalata and Asis Bhaumik v. SEBI [2005] 59 SCL 521(SAT)

• Appellant, Asis Bhaumik, Executive Director of Sahney Paris Rhone Ltd (SPRL) and S. Ramesh was the Company Secretary of the Company. He purchased shares of SPRL through Mr. Ramesh and his wife and through his family members in and around August 1997 at Rs. 79 and later tendering the shares in the open offer announced by RIH on behalf of Delco Remi Ltd. in November 1997 at as Rs. 117.40 per share.

• Alleged Violations: Appellant had unfairly gained enrichment by buying the shares and later tendering in the offer.

SAT held that the term "insider" has the following three essential ingredients:- Insider is a person; and- who is connected or 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 or who has received or has had access to Unpublished Price Sensitive Information.

To sum up …..

INSIDER TRADING is the misuse of privileged position & breach of trust and hence can disturb whole structure of Securities Market. It can also be a big menace for small investors as they can loose their hard earned money in the hands of corporate insiders, hence its effective prevention is very significant. The importance of policing insider trading has assumed international

significance as regulators attempt to boost the confidence of investors Prevention of Insider trading is necessary to create a Level Playing Field for

Investors in Capital Market Effective measures to prevent Insider Trading would create trust &

confidence among the Investor Communities and help to develop securities market

Thanking you ….

MANOJ KUMARAssistant Vice President

Corporate Professionals Capital Private Limited

D-28, South Extension –I, New Delhi-110 049Ph: +91.11.40622200 | Fax: +91.11.40622201;

M: +91.9910688433 | E: manoj@indiacp.com