This article has been authored by Anna Mary Mathew, a third-year student at Tamil Nadu National Law University.
Insider trading is a topic that is in the limelight for a long period of time, and in the past couple of years the number of people charged for insider trading has been increasing tremendously. This has created the need to revamp the insider trading laws so as to accommodate more stringent rules to curb the increasing trend in the practice of insider trading within the country. This brings us to the elephant in the room “will these revamped laws be sufficient to restrain the widespread trade malpractices?”
What is insider trading?
Insider trading is an unfair trade practice by which the trade of a company’s securities are done by people who have access to non-public information which are very crucial for making investment decisions in a company. Having access to this UPSIs (Unpublished Price Sensitive Information) can give an upper hand over people who do not have access to the same. A UPSI or an Unpublished Price Sensitive Information is the information which is directly or indirectly connected to the business of a company and publishing it can materially affect the price of the securities of the company.
Plainly put, insider trading is the trading of a company’s securities done by the insiders of the company on the basis of Unpublished Price sensitive Information. An insider has been defined in Section 2 (e) of the prevention of insider trading Regulation Act, 1992. The keywords of the section is that an insider is a person who is connected/deemed to be connected to the company and has access to unpublished price sensitive information.
An example for the case of a connected person is, if say for instance a lawyer comes to know that through a confidential meeting that is going to be held for unfair trade practices then he can easily presume that this is without doubt going to bring down the reputation of the company and as a result the demand of the stocks are also going to plummet. Now, on the basis of this information if the lawyer sells his shares then he will be stated to have committed insider trading as he had in his possession a confidential information and based on which he sold out his share of the company’s security.
Through regulation 3 of the Securities and Exchange Board of India (Insider trading) (Amendment) regulation, 2002 it is very clearly stated that a person should not communicate, counsel or prepare directly or indirectly any unpublished price sensitive information. Now, if “A” trades on the basis of this information then he will be considered as culpable. Additionally, insider trading is just not limited to actual trading of a security by a connected person but it also involves giving of the material information to other people by the insider.
Regulation relating to the insider trading law states that any act done by an insider in contravention of regulation 3 and 3A of the Securities and Exchange Board of India (Insider trading) (Amendment) regulation then it will be charged as insider trading. Therefore, we can conclude that in India the criteria to determine if a person has committed insider trading or not is if the act of the person can be concluded as in violation to regulation 3 and 3A of the Securities and Exchange Board of India (Insider trading) (Amendment) regulation.
After reading through regulation 3 and 3A we can say that the prohibition of insider trading will apply if an insider has the possession to the UPSI, then he is prohibited by law to trade on the basis of this information, or to communicate or counsel this information to any other person who deals with the securities of the company. However, if the UPSI is provided as a requirement of the business then it is excluded from the scope of regulation 3, as the sharing of UPSI then becomes legal.
Are all forms of insider trading illegal?
As insider trading creates an unfair advantage to one group of people over the other it is quite simple to presume that it is illegal and it can even hamper the confidence of the investor in the stock market. Nonetheless, even though prima facie it might seem illegal not all instances of insider trading is illegal. An illegal insider trading can certainly attract criminal and civil penalties. Therefore, a distinction between legal insider trading and illegal insider trading has to be drawn.
There are instances when officers in a company such as directors, employees, shareholders and other key managerial personnel buy the shares of that company itself, this can be considered as insider trading. It will only be considered as illegal if they have made the trade on the basis of an unpublished information. Under American law if any insider trades the company’s securities then they should be cognizable about reporting it to SEC (U.S. Securities and Exchange Commission). A similar law has to be adopted in the Indian context as well.
In the T.K Viswanathan committee report, it was recommended that by following 3(2) of the PIT (Prevention of Insider Trading) regulation, communication and procurement of UPSI is permitted when it is based for the furtherance of a legitimate purpose. This legitimate purpose can be defined by the Board of Directors of every listed company or market participants. The explanation for the same has to be added to regulation 3(2) additionally. However, if the price sensitive information is available publicly and if trade is made in accordance to the same by the insider, then legal protection can be given as this is a legitimate method of trading.
It was also recommended by the committee that phone calls can be tapped to prevent insider trading and fraudulent trades. This would have been ideal to get a more substantial understanding of who were actually conducting insider trading. This was however, not amended into the act due to very obvious reasons of infringes the privacy rights.
Recent amendments to insider trading laws
The most prominent amendments made to the regulation 2020 as recommended by the T K Viswanathan committee is that by:
(1) Making a structure database available: All the information regarding who is an inside and who has access to the unpublished price sensitive information along with who the insiders give the unpublished price sensitive information to has to be provided in the structural database.
(2) Making the disclosure (PIT violation with regard to listed entities market India intermediaries and fiduciaries) of shareholding automated: Currently, the listed entities, market intermediaries and fiduciaries are supposed to report the violations if any to stock exchanges that is, they have to submit a form identifying the violation to stock exchanges where the securities are traded instead of submitting it to the stock market regulator.
(3) SEBI based on the recent amendment has added additional categories of transactions as an exception to the closure of window restriction. It has also added another feature of allowing offers for sale to be carried on while the window is closed.
From the first prevention of insider trading act introduced by SEBI in 1992 there has been a massive change in the provisions and these are added according to the requirement of the hour. The act has ensured that most of the cases of insider trading is brought under the purview and is charged. However the problem with insider trading in every scenario is that it is very difficult to prove it. In the year 2017 and 2018 out of 85 cases of insider trading taken up by SEBI for investigation only 25 has been completed, they find it very difficult to show a link between a person having access to UPSI and trading the securities based on the same.
Along with this there is another predicament which is, when we are allowing directors and key managerial personnel (who clearly are insiders) to trade the company’s securities it might lead to a situation of insider trading, because it is very normal to presume that this insiders might be in possession of the unpublished price sensitive information and it will be very difficult to pinpoint out if the trade that they have done is solely on the basis of their personal capacity without resorting to external material information. Therefore, by creating a legal and illegal form of trading acts like a double-edged sword, as there can be instances of insider trading but if this insider is disallowed altogether from trading the company’s securities then this can create a restraint on his right to freely trade. Therefore, with the successful implementation of the current amendments made to the Prevention of Insider Trading Act it is expected that there will be tremendous changes in the cases of insider trading in India.
The current law of insider trading is sufficient in itself and no revamping is required. In fact 12 cases of insider trading had been reported in 2020 and they were all penalised for it. This resolves one of the major problems faced by SEBI as, previously the law wasn’t sufficient to charge the suspects and they were let off scot-free.