INSIDER TRADINGREGULATIONS & PRACTICES

June 7, 2013

STRUCTURE OF PRESENTATION

Introduction Why to curb insider trading Regulatory aspects of insider trading Case Studies Challenges Way forward

EVOLUTION OF INSIDER TRADING REGULATIONS IN INDIA

Subsequently, India came out with Securities and Exchange Board of India (Insider Trading) Regulations, 1992, which were drastically amended in 2002 and renamed as SEBI (Prohibition of Insider Trading) Regulations, 1992

1948

• Thomas Committee recommendations incorporated in the Companies Act, 1956 under Sections 307 and 308, which required shareholding disclosures by the directors and managers of a company

1979

• Sachar Committee recommendations-• Amendments to the Companies Act, 1956

to restrict or prohibit the dealings of employees / insiders

• Penalties to prevent the insider trading

1986

• Patel Committee recommendations-• Amendments in Securities Contracts

(Regulations) Act, 1956 to make exchanges curb insider trading and unfair stock deals

• Heavy fines including imprisonment, apart from refunding the profit made or the losses averted to the stock exchanges

1989

• Abid Hussain Committee recommendations-• Insider trading activities may be penalized

by civil and criminal proceedings • SEBI should formulate the regulations and

governing codes to prevent unfair dealings

INTRODUCTION

Insider trading essentially denotes an act of an insider dealing in a company’s securities while in possession of unpublished price sensitive information about the company.

Any person who may be connected with the company or deemed to have been connected with the company, and who is reasonably expected to have access to unpublished price sensitive information or who has received or has had access to such unpublished price sessitive information.

WHO ARE INSIDERS?

WHY TO CURB INSIDER TRADING?

Prohibition of Insider Trading is required to make Securities Market:

• Fair & Transparent

• To have a level playing field for all the participants in the market

• For free flow of information & avoid information asymmetry

• To prevent insiders from making a huge profit or save tremendous loss when the public cannot react to this information

WHO CAN BE A CONNECTED PERSON ? It could be director of company, or is deemed

to be a director of the company by virtue of sub-clause(10) of Section 307 of the Companies Act 1956

He or she could be officer or professional of the company or holding a business relationship with the company and who may be reasonably expected to have access to UPSI

Connected person means any person who is a connected person six months prior to an act of insider trading

DEEMED TO BE CONNECTED PERSONS COMPANY UNDER SAME MANAGEMENT INTERMEDIARY/STOCK EXCHANGE/ CLEARING HOUSE

OR EMPLOYEE/DIRECTOR THEREOF MEMBER OF BOARD OF DIRECTORS OF PUBLIC

FINANCIAL INSTITUTION EMPLOYEE OR OFFICIAL OF SRO MEMBER OF BOARD OF TRUSTEES OF MUTUAL FUND BANKER OF COMPANY RELATIVES OF THE ABOVE CONCERN.FIRM,TRUST,HUF,COMPANY OR AOP

WHEREIN ANY OF THE CONNECTED PERSONS HAS MORE THAN 10% OF THE HOLDING OR INTEREST

WHAT IS PRICE SENSITIVE INFORMATION???

The price sensitive information is defined in Regulation 2(h)(a) of the prohibition of Insider Trading“It means any information which relates directly or indirectly with the company & which if published is likely to materially affect the price of the security’s of the company”

Unpublished information means Means information which is not published by the

company or its agents Speculative reports in print or electronic media shall

not be considered as published information

INFORMATION DEEMED TO BE PRICE SENSITIVE

Periodical financial results Intended declaration of the dividend(both

interim & final) Issue of securities or buy-back of securities Any major expansion plans or execution of

new projects Amalgamation & mergers or takeovers Disposal of the whole or substantial part of

the undertaking Any significant changes in policies, plans or

operations of the company

REGULATION 3 AND 3(B) OF PROHIBITION OF INSIDER TRADING

Regulation 3No insider should deal in security, while possession of UPSI He/she should not communicate o

procure the UPSI to others

Regulation 3BThis regulation enables a company to defend itself in a proceeding involving insider trading if it can prove that there is “Chinese Wall” within the company

DISCLOSURES FOR PROHIBITION OF INSIDER TRADING

Initial Disclosure Buying the stake greater than the 5% of the

paid up capital of the company ,the acquirer should inform the Stock Exchange within two working days of acquiring the stake.

The new director should disclose all its trade position in Equity or derivatives with in two working days of his appointment.

CONTINUED…….

Continuous Disclosure If the shareholder holds more than 5% and

change his holding by 2% or more. Any change of promoter/director/officer beyond

Rs. 5 Lacs or 25000 shares or 1% of total shareholding or voting rights whichever is lower.

Additional Disclosures All holdings in securities of that company Periodic statements of all transactions Annual statement of all holdings Any other disclosure of company to stock

exchange

MODEL CODE OF CONDUCT FOR PREVENTION OF INSIDER TRADING

A compliance officer is required to be appointed by the company.

There should be pre-clearance of trade by the officer of designated employees. Designated employees include :

i. Employees from top three tiers of management.ii. Employee designated by the company from time to time to

whom the trading restriction shall be a applicable.

Trading window ,is closed at the time of UPSI activities like Results, Issue of securities etc.

Trading window is opened 24 hours after the information is made public

There are several forms in accordance with disclosures & code of conduct.

CONTINUED…….

All directors/officers/designated employees who buy or sell any number of shares of the company shall not enter into opposite transaction during the next six months following the prior transaction

All directors/officers/designated employees shall not take positions in derivative transactions in shares of company at any time

In case of subscription in IPOs, the above entities shall hold their investments for a minimum period of 30 days. The holding period starts when securities are actually alloted

HOW SEBI’s CODE OF CONDUCT SEEKS

TO PREVENT INSIDER TRADING

Disclosure

Compliance Officer

Corporate Announcements

Chinese Walls

Minimum holding period

Trading Window

Pre-clearance

Setting forth policies and procedures

CODE OF CORPORATE DISCLOSURE PRACTICES

PROMPT DISCLOSURE TO STOCK EXCHANGE TIMELY REPORTING OF SHAREHOLDINGS

/OWNERSHIP AND CHANGES IN OWNERSHIP NORMS FOR ANALYSTS AND INSTITUTIONAL

INVESTORS ONLY PUBLIC INFORMATION TO BE PROVIDED PREFERABLY RECORD THE DISCUSSION BE CAREFUL WHILE HANDLING UNANTICIPATED

QUESTIONS SIMULTANEOUS RELEASE OF INFORMATION

INVESTIGATION OF INSIDER TRADING

• Regulation 4A deals with the power to make inquiries and inspection

• SEBI can also appoint the outsider auditor for the enquiry & auditor would have the same power as the SEBI possess.

• Before undertaking any investigation SEBI shall give a reasonable notice to insider for that purpose.

• Where SEBI is satisfied that in the interest of investors or in public interest no such notice should be given, it may by an order in writing direct that the investigation be taken up without such notice.

SEBI’S POWER TO MAKE INQUIRIES AND INSPECTION

Regulation 4A

• If the SEBI suspects that any person has violated any provision of these regulations, it may make inquiries with such persons.

• The SEBI may appoint officers to inspect the books and records of insider(s) for the purpose of inspection.

• The SEBI can investigate and inspect the books of account, either records and documents of an insider on prima facie.

• SEBI can investigate into the complaints received from investors, intermediaries or any other person on any matter having a bearing on the allegations of insider trading.

PENAL PROVISIONS FOR INSIDER TRADING

Civil Proceedings

• Directing the insider not to deal in securities acquired in violation of the regulations

• Prohibiting from disposing of any such securities acquired

• Restraining the insider to communicate or counsel any person to deal in securities

• Declaring the transactions(s) in securities as null and void

• Directing the person to deliver the securities back to the seller

• Directing the person to transfer an amount to the Investor Protection Fund

Monetary Penalties

•Upto Rs. 25 crore or three times the amount of profits made whichever is higher

Criminal Proceedings

•Imprisonment upto 10 years•Fine upto Rs. 25 crore

CASE STUDIES

THEORIES OF INSIDER TRADING

Classical theory

Misappropriation theory

UNITED STATES

Section 16

a) Covers officer, directors, and 10% equity holdersb) §16(a) -> Disclosure

Provision ->Every corporate insider should report

holdings and transactions. Facilitates §16(b)

c) §16(b) -> Recovery of Short-swing Profits ->These

insiders must disgorge profits from selling stock held less than six months

Rule 10b-5

a) Covers i) material corporate

misstatements or non diclosures,

ii) insider trading, and iii) corporate

mismanagement cases regarding transactions in shares or other securities

b) Today a major weapon to curb insider trading, as a

catch-all anti-fraud provision

SE Act, 1934

Penalty: Civil penalties such as payment of fine upto 3 times the profit earned or loss avoided and Criminal

Prosecution

CASE STUDIES - USA

In Re Cady, Roberts and Co.

Robert Gintel was a broker and partner of Cady, Roberts and Co. Cowdin was a Director of Curtiss-Wright Corp (CWP) and an associate at Cady, Roberts. Gintel received inside information about CWP from Cowdin and used that information to sell shares of CWP.

Held, violation. Reasoning - Individuals who are outside the company

could also be considered as ‘Insiders” and found guilty of insider trading if they have a “special relationship” with the company

DAVID CARPENTER, KENNETH P. FELIS AND R. FOSTER WINANS VS. UNITED STATES

Winans was a reporter for the Wall Street Journal and one of the writers of a daily column which discussed selected stocks and gave information about those stocks. The contents of the column were the Journal's confidential information. Winans passed on the contents of the column to a few people before its publication. Those people traded in the stocks and made profits, which was shared with Winans.

Held, Violation. Reasoning - (1) Winans had knowingly breached a duty of

confidentiality by misappropriating pre-publication information. (2) The deliberate breach of Winans' duty of confidentiality and concealment of the scheme was a fraud and deceit on the Journal. (3) The contention that the newspaper is the only alleged victim of fraud and has no interest in the securities traded was rejected.

UNITED STATES VS. O'HAGAN

Grand Metropolitan PLC (Grand Met) retained the law firm of Dorsey & Whitney to represent it regarding a potential tender offer for the Pillsbury Company's common stock. Respondent O'Hagan, a Dorsey & Whitney partner, who did no work on the representation, dealt in the shares of Grand Met.

Held, violation. Reasoning - (1) A person who trades in securities for

personal profit, using confidential information misappropriated in breach of a fiduciary duty to the source of the information can be held liable. (2) A company's confidential information qualifies as property to which the company has a right of exclusive use; the undisclosed appropriation of such information constitutes fraud akin to embezzlement.

UNITED STATES VS. RAJ RAJARATNAM

In the Galleon cases, the SEC had charged number of defendants for widespread and repeated insider trading in the securities of around 15 companies generating illicit profits totaling nearly $90 million

Raj Rajaratnam was arrested for insidertrading and conspiracy ; was found guilty and sentenced to jail

Number of other defendants also found guilty Investigation relied inter-alia on telephonic

evidence

CASE STUDIES – INDIA

oHLL-BBLIL MERGER

o RAKESH AGARWAL vs. SEBI

oRAJIV GANDHI VS SEBI

oReliance Industries Ltd vs SEBI

HLL-BBLIL MERGER CASE

HLL–BROOKBOND LIPTON INDIA LTD Focus on legal controversy involving BBLIL’s merger with HLL.

SEBI, suspecting insider trading, conducted enquiries.

In August 1997, SEBI charged HLL of insider trading by using Unpublished Price-Sensitive Information.

HLL bought 8 lakh shares of BBLIL from UTI at Rs 350.35 per share (At a premium of 9.5% of the ruling market price of Rs 320) just two weeks before the formal announcement knowing that the HLL and BBLIL were going to merge.

SEBI held that HLL was using unpublished, price-sensitive information to trade, and was therefore guilty of insider trading.

HLL–BROOKBOND LIPTON INDIA LTD

In March 1998, SEBI passes an executive order in this regard

SEBI directed HLL to pay UTI Rs 3.4 Crore in compensation, and also initiated criminal proceedings against the five directors of HLL and BBLIL.

HLL appealed against the SEBI verdict to the Union Ministry of Finance.

HLL contended that before the transaction, the merger was the subject of wide speculation by the market and the media.

After the formal announcement, press articles mentioned that the merger was no surprise to anyone.

HLL–BROOKBOND LIPTON INDIA LTD

HLL pointed out that the share price of BBLIL moved up from Rs 242 to Rs 320 between January and March, before the transaction, indicating that the merger was “generally known information”.

HLL contended that to be considered as an insider, it should have received information “by virtue of such connection” to the other company.

According to HLL, it was an initiator and the transferee, and it was the “primary party” to the merger and no primary party to the merger can be considered an insider from the point of view of insider-trading.

HLL argued that only the information about the swap ratio could be deemed to be price-sensitive and that this ratio was not known to HLL or its directors before the purchase of shares from UTI.

HLL–BROOKBOND LIPTON INDIA LTD

HLL also argued that the news of merger was not price sensitive as it had already been announced by the media before the official announcement.

HLL claimed that the purpose of the purchase of shares was to enable Uniliver to acquire 51% shares of BBLIL.

In July 1998, the Appellate Authority of the Finance Ministry dismissed the SEBI order.

RAKESH AGARWAL VS. SEBI

RAKESH AGARWAL VS. SEBI

One of the most famous case highlighting the vulnerability of the SEBI’s 1992 regulations.

Rakesh Agarwal, MD of ABS Industries Ltd was involved in negotiations with Bayer A.G, regarding their intention to takeover ABS.

As per SEBI, Rakesh Agarwal had access to the Unpublished price-sensitive information.

SEBI alleged that prior to the announcement of acquisition, Rakesh Agarwal, through his brother-in-law, had purchased shares of ABS and tendered the said shares in the open offer made by Bayer.

RAKESH AGARWAL VS. SEBI

Rakesh Agarwal contended that he did this in the interest of the company.

Pursuant to Bayer’s condition to acquire at least 51% shares of ABS, he, through his brother-in law bought the shares and later sold them to Bayer.

The SEBI directed Rakesh Agarwal to “deposit Rs 34,00,000 with Investor Education & Protection Funds of Stock Exchange, Mumbai and NSE.

SAT held that the SEBI order directing Agarwal to pay Rs 34 lakh couldn’t be sustained, on the grounds that Rakesh Agarwal did that in the interests of the company.

The matter was later settled on consent basis and Mr. Rakesh Agarwal paid Rs 48 lakhs

RAJIV B. GANDHI VS. SEBI

Rajiv Gandhi (RG) was the CFO and Company Secretary of Wockhardt Limited. Sandhay Gandhi (SG) and Amishi Gandhi (AG) were the spouse and sister of RG. SG & AG traded in the shares of Wockhardt Limited. Having regard to date and time of trades, their close relationship with one another, it was alleged that they were insiders and that their trades were executed on the basis of the UPSI.

Held, Violation Reasoning – Appellants failed to rebut the presumption on which

the allegation was made and not even attempted to offer an explanation as to the basis which prompted them to trade

Adjudicating order imposed a penalty of Rs, 5 lac each on the Company Secretary Mr. Rajiv B. Gandhi and two relatives, For separate proceedings under Sec. 11B of SEBI Act 1992 initiated against them, they have consented to pay Rs. 5 lac and undergo a voluntary debarment for 18 months and agreed to refrain from acting as the compliance officer of a listed co. for 18 months.

RELIANCE INDUSTRIES LTD VS SEBI

Reliance Petroinvestments Ltd. was alleged to be in possession of unpublished price sensitive information (hereinafter referred to as "UPSI") while trading in the scrip of IPCL prior to announcement of declaration of interim dividend and amalgamation of IPCL with Reliance Industries Ltd.

Imposed penalty of Rs. 11 crores.

CHALLENGES

INSIDER TRADING– EMERGING ISSUES

Non availability of telephone/e-mail records

Multiple layers of Bank Transactions Delay in submission of information by

banks/Clients Inadequate information in bank

statements Inadequate data to prove connections Requirement for information from Other/

Foreign Regulators

INSIDER TRADING – EMERGING ISSUES

Easy availability of “front entities” Easy to float a company without much finance

and infrastructure i.e. Fly-by-night companies. Principle of Natural Justice” i.e. inspection of

documents, cross examination, etc. Use of Benami SIM cards Dependence on suspect for information Issue of regulatory jurisdiction/ overlap –

because of cross-market and cross-time zone and cross-region dependencies (such as derivatives with an underlying assets trading elsewhere)

WAY FORWARD

Committee set up by SEBI to review insider trading regulations

New Regulation for Insider Trading soon

Stricter disclosure requirements on connected persons to company