Corporate Governance Dissertation Mohit

8/18/2019 Corporate Governance Dissertation Mohit

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RESEARCH DISSERTATION ON

CRITICAL STUDY

ON

INSIDER TRADING LAW

SUBMITTED TO: Prof. (Dr.) Mamta Biswal

(FACULTY OF LAW)

SUBMITTED BY : Mohit Gu ta (!!B"#$)

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A CRITICAL ANALYSIS WITH RESPECT TO CORPORATE GOVERNANCE NORMS IN I NDIA

Area of Research

CORPORATE GOVERNANCE


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TABLE OF CONTENTS

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SYNOPSIS

TITLE OF THE PAPER

Insider Trading Law: A comparative and critical analysis with respect to

corporate governance norms in India.

RESEARCH PROBLEM

The area of research chosen for this dissertation is the role of Corporate

Governance to curb insider trading in India. It is a much known fact that asnancial markets are developing! the white collar crimes are also becoming

more and more sophisticated and so do the laws to deal with them. In recent

years! because of massive frauds in nancial markets and also to bolster the

con dence of investors! the legislators and regulators have turned towards

making corporate governance standards mandatory and also attaching

penalties if there is any violation of these standards. The act of insider

trading can be held as one of the most violent crimes as it destroys the

con dence of investors. The two decade old insider trading law proved to be

inept in curbing insider trading in India and as a result of this "#$I recently

overhauled the %&&' regulations and passed "ecurities and #(change $oard

of India )*rohibition of Insider Trading+ ,egulations! '-% . In this globali/ed

world regulations and policies need to be highly dynamic and change

according to the international environment and the changing domestic

economic condition! so it becomes imperative to study the ade0uacy of

present laws. The dissertation addresses the problem of why there are no

convictions on insider trading in India and whether the corporate governance

measures are ade0uate to deal with problem of insider trading and the

changes brought by '-% regulations and its e1ect.

RESEARCH OBJECTIVE

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Through the dissertation the author aspires to achieve the following

ob2ectives:3

• To trace the history of insider trading law in India and rationale of

having a law against insider trading.• To study the changes brought by the recent amendment and its

subse0uent e1ect on nancial markets.• To study the law of insider trading in the 4nited "tates of America

which has always been at the forefront of implementing the law against

insider trading and its comparison with Indian Law.• The study also focuses on the ob2ective why it is di1icult to prosecute

the o1enders and the concepts of corporate governance which deal with

insider trading.

RESEARCH QUESTION

Certain 0uestions dealt with in this research are as follows:

%. 5hat is the history of Insider Trading Law6'. 5hat is the rationale behind implementation of insider trading law6

7. 5hat are the changes brought by '-% amendment and its e1ect68. 5hether the substantial laws regarding insider trading in India are

su1icient6. 5hether the corporate governance standards in India are in tune with the

standards provided in other countries66. 5hat are reasons because of which the conviction against traders is

di1icult to obtain6 Are the laws which empower "#$I to investigate

inade0uate6

HYPOTHESIS

The 9ypothesis in this research is as follows:

%. That the corporate governance standards which have mandated by "#$I to

deal with insider trading in India which have been mandated by "#$I are at

par and incorporate all signi cant concepts. The reason for not obtaining

convictions in India on insider trading is the lack of investigative powers of

"#$I.

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RESEARCH SCOPE

The area selected for research is very vast and thus there are various aspects

which fall within the ambit of the study. 9owever! it is not possible to

encompass all of them. 9ence the scope of this dissertation is to trace thehistory of insider trading law! relevant legislations! changes brought by the

'-% amendment and its e1ect. The dissertation will also make a comparative

analysis between 4nited "tates and India and to analy/e reasons as to why

convictions for insider trading are di1icult. The study will deal with di1erent

case laws of India and the 4nited "tates of America.

RESEARCH METHODOLOGY

The methodology adopted for research! is doctrinal in nature. Also the

very sub3methods of octrinal study i.e. descriptive and analytical

methods have been used individually as well as in a combined form as

and when re0uired! to do 2ustice to the topic of study. ;rom the collectedmaterial and information! researcher proposes to analy/e the topic of the

study and tries to reach the core aspects of the study.

TENTATIVE CHAPTERIZATION

.

I. INTRODUCTION

II. HISTORY OF INSIDER TRADING

II.% I< IA

II.'. 4


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III.7 Classical Theory

III.8 #1icient =arket 9ypothesis

IV. COMPARATIVE ANALYSIS OF LAW OF INSIDER TRADING IN INDIA & UNITED STATES OF AMERICA V. CORPORATE GOVERNANCE AND INSIDER TRADING IN

INDIA:

>.% i1erent Concepts of Corporate Governance in "chedule I ?II

>.%.% Compliance @1icer

>.%.' *reservation of *rice "ensitive information

>.%.7. Trading 5indow

>.%.8. *re3clearance of Trade

>.%. . "hort "wing *ro ts

>.%. . ,eporting ,e0uirements:

>.%.B. *enalty

>.%. Chinese 5all

>.' C@,*@,AT# I"CL@"4,#"

>I.7.% ,esponses to =arket ,umors

>I.7.' isclosure to Analysts

VI CONCLUSION

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ACKNOWLEDGEMENT

;irst of all I would like to o1er my hearty devotion to the Almighty

without whose blessings this dissertation would not have been

accomplished. There after I e(press my regards to give this very useful

dissertation to our university. I would like to take this opportunity to

e(press my gratitude to *rof. ) r.+ =amta $iswal for giving us an

opportunity to undertake this pro2ect and for his advice! support and

guidance.

I would also like to e(press my appreciation for the co3operation! help

and support of other members of G


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LIST OF ABBREVIATIONS

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. D8l.......................................................................................................................... D8lhi3. 76........................................................................................................................ 7itio6#. *C..................................................................................................................*i


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!3. %CC................................................................................................%u r8m8 Court Cas8s!#. %C=..............................................................................................%u r8m8 Court =our6al!1. % B' ..%8;uriti8s a67 >;ha6


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The paper attempts to study the history of insider trading law,

rationale behind the insider trading laws, laws on insider

trading under the SE I !"rohibition of Insider Trading#

$egulations, %&&' and the circumstances leading to the

comprehensive changes brought in '(%). The paper shall

compare the insider trading laws in India with that of the *S+

and the difference between the investigating powers of SE I and

Securities E change ommission of *S+. The paper will also

study the corporate governance measures on insider trading

such as closure of trading windows, short swing profits and

hinese alls and implementation of these measures in the

financial markets.

I. INTRODUCTION

This paper will study the corporate governance measures on insider

trading implemented by "#$I and its e1ect on nancial markets and the

paper will also make a comparative analysis of Indian Law on insider

trading and 4"A law on insider trading.

Chapter ' will trace the history of insider trading law in India and in 4"A

and the changes brought by '-% amendment. The insider trading law

originated in 4"A back in % th century and thus it is very imperative to

trace their history on insider trading law in order to comprehend the

development of insider trading law. This chapter will also discuss the

recommendations given by the various committees on insider trading law.

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Chapter 7 will discuss the rationale behind the insider trading law and

what it e(actly seeks to outlaw because insider trading per se is not

illegal. This chapter will also discuss the various doctrines on insider

trading law like misappropriation theory and classical theory. The studyof rationale and doctrine is important in order to understand the

ob2ectives of the insider trading law.

In Chapter 8 the author will make a comparison of insider trading law in

India and in 4"A. This comparison would be in two parts. The rst part

would compare the substantive law of both the countries in order to

dispel the notion that insider trading law in India are not su1icient and

would prove the hypothesis that Indian laws are in fact more stringent

than the laws of 4"A. Also the author would enter into a comparative

analysis of re0uirement of DmotiveE and DintentionE under the laws of 4"A

and India to prove the o1ence of insider trading. The second part would

compare the investigative powers of "#$I and "#C and would discuss

how di1icult it is for the regulator to prove the o1ence of insider trading

and whether any reforms is re0uired.

Chapter focusses on the corporate governance provisions provided by

"#$I in order to pre3empt the o1ence of insider trading. Corporate

governance is a means of self3governance whereby a company discloses

its accounts and nancial statement. Corporate governance standards

provide for a proactive approach as it tries to prevent the commission of

o1ence itself. This chapter will also discuss the several important

provisions which help in tackling insider trading to test the hypothesisthat the corporate governance laws regarding insider trading are

ade0uate in India. It will also discuss important measures such as trading

window! chinese wall! compliance o1icer! short swing pro ts! corporate

disclosure to analysts! addressing market rumours and reporting

re0uirements.

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Chapter is the concluding chapter in which the author would record its

nding that whether the hypothesis is proved or disproved and would

make recommendations on insider trading law if any.

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II. HISTORY OF INSIDER TRADING

II.1 INDIA

The rst thing we should know that not all insider trading is illegal.

Insider trading can be said to be illegal when a person trades in

securities of a publicly listed company based on information not available

to the public at large and which can inFuence the market price of the

securities of such a company.

The securities market in India came into e(istence in % B with the

establishment of $ombay "tock #(change )$"#+. 9istory of Insider

trading in India can be traced back to %&8 with the formation of Thomas

committee by the government of India. Though the issue of insider

trading in India came into light in %&8-s! it was prevalent even before

that but it did not receive the necessary public indignation. The

committee observed and analysed that insider trading occurred due topossession of information by some people before everybody else and

misuse of such information. Thus! the committee recommended a special

legislation to deal with insider trading and setting up of a body which

should be very much similar to 4.". "ecurities #(change Commission

)"#C+. The government of India failed to take any step based on these

recommendations.

In %& '! the Bhaba committee was constituted to revamp the then

e(isting Companies Act! %&%7. In its report the committee observed the

fraudulent dealing in securities by the directors of the companies. It is

also interesting to note that the committee never used the word insider

trading anywhere in its report. Thus section 7-B and 7- were

incorporated in the Companies Act! %& which dealt with insider

trading. "ection 7-B mandated the companies to maintain a registry to

record the shareholding of directors in the company and section 7-

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imposed a duty on the director to make disclosure of its shareholding in

the company. Through Companies Amendment Act! %& - this

re0uirement of disclosure was also imposed on companyEs managers as

well.

In %&BB Sachar Committee was constituted by the government to analyse

the provisions of Companies Act! %& and =,T* Act! %& &. The

committee pointed out that section 7-B and section 7- is inade0uate to

curb the menace of insider trading. The committee also identi ed certain

category of persons as insider a broader category of the same was

provided by Thomas Committee.

In %& ! Patel Committee was constituted by the government which

de ned insider trading as! HInsider trading generally means trading in

the shares of a company by the person 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 which is not available to others . % The Committee recommended the

government to amend "ecurities Contract ),egulation+ Act )"C,A+! %&to enable the e(changes to prevent insider trading. This committee

heavily relied on 4"A and 4J regulations to make recommendations.

The ne(t committee constituted by the government was Abid Hussain

Committee in %& &! which recommended that insider traders must be

convicted under civil as well as criminal laws and "#$I should formulate

a separate regulation to prevent the o1ence of insider trading.

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perpetrators in Ra%esh Agar&al 's SEBI # and Hindustan e'er '. SEBI

which will be discussed in detail later. The '--' amendment regulations

were preventive in nature. It introduced Chapter I> including two

schedules regarding disclosures and corporate governance in theregulations. "chedule A provides for a model code of conduct for the

prevention of insider trading for listed companies and "chedule $

provides for a model code of corporate disclosure practices.

;urther this act was amended in '--7! '--B! '-- and '-% respectively.

The '--7 amendment provided changes in multiple forms which are used

for disclosing information under the said regulations. The '--B

amendment introduced regulation %%A which lays down the manner of

service of summons and notices to be followed. The '-- and '-%

amendment brought comprehensive changes in the act. Through '--

amendment provision for e3 ling of disclosures was made. ,egulation

%7)B+ was introduced to enable electronic ling of disclosures in

accordance with the system devised.

@n Kanuary % ! '-% "#$I noti ed the SEBI (Prohibition o$ Insider Trading) Regulations !""# which was e1ective from =ay % th ! '-% . The

key changes brought in by this amendment are as follows:

• Compli !"# O$i"#%: The '-% amendment provides for the

appointment of a compliance o1icer. ,egulation ')%+)c+ de nes

compliance o1icer as! Hany senior o1icer! designated so and

reporting to the board of directors or head of the organisation in

case board is not there! who is nancially literate and is capable of

appreciating re0uirements for legal and regulatory compliance

under these regulations and who shall be responsible for

compliance of policies! procedures! maintenance of records!

monitoring adherence to the rules for the preservation of

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unpublished price sensitive information! monitoring of trades and

the implementation of the codes speci ed in these regulations

under the overall supervision of the board of directors of the listed

company or the head of an organi/ation! as the case may be.8

;rom above de nition it is clear that compliance o1icer must be a

senior o1icer who reports to the $oard of irectors )$@ + of the

company. "o! generally speaking a C#@ or managing director of a

company can be regarded as the compliance o1icer for the

purpose of this regulation. A company secretary cannot be

regarded as a compliance o1icer even though it ful ls the

0uali cations prescribed and is fully competent to discharge the

duties because it doesnEt report to the $@ .

• Co!!#"' P#%(o!: Through '-% amendment the scope of the

term Dconnected personE has been enlarged. Through this

amendment immediate relatives will be presumed to be connected

persons but this presumption is rebuttable. It was done as "#$I in

past has faced di1iculties in prosecuting an immediate relative.

This new de nition is also intended to bring within its ambit the

persons who do not occupy any position in a company but are in

regular touch with the company or its o1icers as the might have

access to unpublished price sensitive information )4*"I+.

• I!(i'#%: Any person who is a connected person or is in possession

or has access to 4*"I is an insider. The importance has been laid

on the possession or having access to 4*"I and not on the sourcethrough which a person is in possession or has access to 4*"I.

@nus is on the regulator to prove that person is in possession or

has access to 4*"I after which the onus shifts on the person to

prove that he was not in possession of 4*"I or he has not traded

by relying on 4*"I.

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• T% 'i!): The term DtradingE is provided a wide construction in

order to curb activities which are not strictly related to buying!

selling or subscribing! like pledging for e(ample when in

possession of 4*"I. Agreement to buy or sell has also beenbrought within the ambit of these regulatory provisions.

• G#!#% ll* A+ il ,l# I!-o%m &io!: The '-% regulation de ne

Dgenerally available informationE as an information which is

accessible to the public on a non3discriminatory platform! like

stock e(change website.

• U!p ,li(/#' P%i"# S#!(i&i+# I!-o%m &io! 0UPSI : The


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to comply with the '-% ,egulations and are re0uired to be

approved by the designated compliance o1icer. The '-%

,egulations further restrict the trading plan from including trades

that are to be made twenty days prior to the end of a nancialperiod for which results are to be declared by the concerned

company.

II.3.UNITED STATES:

iscussion of history of insider trading in 4.". is imperative as the rst

instance of insider trading is seen in this country and also it is a

forerunner in preventing the o1ence of insider trading.

In %B&-! 4.". epartment of Treasury had incurred massive debts due to

the American 5ar of Independence. In order to nance this debt! the

government issued public bonds worth 4" - million for the rst time.

The then Assistant "ecretary of 4.". epartment of Treasury! =r. 5illiam

uer )and in this sense an insider+! bought the bonds in huge amounts

which led to shooting up of price of the bonds and to nance such a huge

amount of purchase! uer borrowed the money from other people. 5hen

it became clear in %B&' that uer will not be able to pay this debt! the

market bubble burst and the price of bonds crashed B. This event is known

to be the rst recorded instance of insider trading.

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InFuence by this incident! '8 brokers thought self3regulation was the

best answer to preclude such incident and gathered to sign the

Button&ood Agreement in !*"# which stipulated that the assembled

brokers would only trade with other mutually recognised brokers. In% %B! the buttonwood group became the


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more transparency in nancial statements so investors can make

informed decisions about investments! and )'+ to establish laws against

misrepresentation and fraudulent activities in the securities markets %%.

4.". Congress also passed the Securities E/change Act !" 0. The"ecurities #(change Act de ned insider trading as H &hen a +erson sells

a securit1 &hile in +ossession o$ material non2+ublic in$ormation in

'iolation o$ a dut1 to &ithhold the in$ormation or re$rain $rom trading3.

In %&8'! the Commission was in a predicament when a president of the

company was buying shares at a low price by misrepresenting the

nancial statements. The act only dealt with fraud in sale of securities.

Thus! the "#C created the "ecurities #(change Act ,ule %-b3 ! which

e(tended the application of section %B)a+ )%+ i.e. prohibition of fraudulent

behaviour in sale of securities also to purchase of securities.

In %& %! the "ecurities #(change Commission held tipping as a violation

of the rule %-b3 In The 4atter o$ Cad1 Roberts 5 Co !# . The board of

directors of Curtiss 5right Corporation decided to reduce the companyEs

0uarterly dividend. @ne of the directors of this company was also apartner of the stock brokering rm Cady! ,oberts ? Co. 9e provided the

necessary information to the rm and therefore the rm sold all the

shares of the company. Thus its customers avoided the losses. This act by

the director was held to be tipping by "#C. An insider who knows

con dential information does not himself trade! but rather informsNtips

Nsomeone else! who does trade. It also involved trading on an

impersonal stock e(change! instead of a face3to3face transaction... The

"#C held that Gintel had violated ,ule %-b3 . %7

In %& ! 4.". ;ederal Court held in SEC 's Te/as ,ul$ Sul+hur !0 held that

anyone who possessed material non3public information was re0uired

11 %88 su ra 6ot8 #

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either to disclose it or abstain himself from trading on the basis of such

non3public information.

In %& -! the 4nited "tates "upreme Court in Chiarella 's 6nited States !7

held that trading on material non3public information in itself was not

illegal under anti3fraud provisions as the nancial printer owed no duty

to shareholders. Thus in order to deal with similar situations popping up

in future! the "#C promulgated ,ule %8e37 which made it illegal for

anyone to trade on the basis of material non3public information if they

knew the information came from an insider.

In 8ir%s 's SEC !9 the 4" "upreme Court decided the liability of tipper on

the basis of motive. The court held that tippee is under a duty to disclose

information or abstain from trading when the tipper sought an improper

bene t for his information. $ut when tipper acts for non3personal

bene ts there could be no liability.

In %& 8! Insider Trading "anctions Act was passed which increased civil

and criminal penalties for trading while in possession of material non3

public information. In %& Insider Trading and "ecurities ;raud#nforcement Act was passed to rope in persons who fail to take ade0uate

steps to prevent insider trading.

In '-%'! "tock Act was passed which mandated the president! the vice

president!! cabinet members! lawmakers and their sta1s! must publicly

report all trades valued at %!--- or above within 7- days of the

transaction and in no case later than 8 days after the transaction

occurred.

14 $"! F.47 #22 (47 Cir. !1 #)

15 $$- U.%. 444@ 4$# (!1#")

16 463 U.S. 646 (1983)

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III. RATIONALE FOR THE LAW OF INSIDER TRADING

The debate whether to ban insider trading or not is going on for decades

with some thinkers believing that insider trading should not be

considered as a crime at all %B. The insider is allowed to trade in securities

on the basis of information generally available to public. Thus insider

trading is not illegal per se. It is illegal when a person trades on the basis

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con dence in securities market because of the very fact that there is no

fairness! e0uality and in long run they would lose their money. This would

make it problematic for the companies to raise funds in capital markets.

All this will lead to slow growth rate of economy and increase inunemployment.

III.! E"#alit$ an% ai'n ((

The insider trading law seeks to level the playing eld for the insiders

and other investors. The insider has access to 4*"I which can a1ect the

price of securities! thus they have an upper hand over the other

investors. This could dissuade other investors from investing in the

securities market.

III.) Cla((ical T* o'$

According to DclassicalE theory a corporate insider violates a duty to

corporate shareholders to either disclose his intent to trade or to abstain

from trading! on the basis of material non3public information. The tippee

of a corporate insider assumes the tipperOs duty to shareholders if the

tippee knows or should know that the tip constitutes a breach of the

tipperOs duty. This breach of duty to shareholders constitutes the

deception necessary for liability under our general anti3fraud statute in a

classical insider trading case. % According to classical theory there e(ists

a duciary relationship between the insider and other investors and thus

the insider owes a duty to not break that trust reposed in him. In %& -Es

the 4.". "upreme Court in Chiarella 's 6nited States !" held that the

printer owed no duty towards investors as there e(ist no duciary

relationship between them! thus over3turning his conviction. The classical

theory applies not only to o1icers! directors! and other permanent

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insiders of a corporation! but also to attorneys! accountants! consultants!

and others who temporarily become duciaries of a corporation.

III.+Mi(a,,'o,'iation T* o'$

This theory relies on the principles that all information generated by or

through the company belongs to the company. Conse0uently! persons

who come into possession of such information in circumstances that

warrant con dentiality are not permitted to misappropriate the

information for their personal gain or bene t. '- =isappropriation theory

is comparatively a modern theory on insider trading. It was endorsed by

4.". "upreme Court in the case of 6nited States 's :;Hagan #! . @E9agan

was an attorney and thus claimed that he was not an insider and outside

the purview of classical theory approach. The Court held that by using

the law rmEs con dential information to trade in securities he has

misappropriated the information. The Court held that a corporate

Houtsider violates "ection %-)b+ and ,ule %-b3 Hwhen he

misappropriates con dential information for securities trading purposes!

in breach of a duciary duty owed to the source of the information!

rather than to the persons with whom he trades. '' The Hmisappropriation

theory premises liability on a duciary3turned3traderEs deception of those

who entrusted him with access to con dential information. '7 Also it is

premised on the argument that companies own a proprietary right to

information and! in particular! the e(clusive right to the use of the

information. '8 The misappropriation theory is designed to protect the

integrity of the securities markets against abuses by DoutsidersE to a

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corporation who have access to con dential information that will a1ect

the corporationEs security price when revealed! but who owe no duciary

or other duty to that corporationEs shareholders. '

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com+an1 or &ho has recei'ed or has had access to such

un+ublished +rice sensiti'e in$ormation.3

The following essentials can be deduced from the above de nition for a

person to be an insider:

%+ The person must be connected with the company. The word

DpersonE referred in this de nition can be either a natural person or

a legal person.

'+ That by the virtue of the personEs position in company it is

reasonably e(pected of him to have access to price sensitive

information.

7+ "uch price sensitive information must not be published.

The second element of de nition which states that person can be

reasonably e(pected to have ac0uired information by virtue of such

connection has serious lacunae because the words b1 'irtue o$ such

connection could be interpreted to mean that the person should haveac0uired information by virtue of such connection to the company.

Therefore! it can be argued that if a person who has ac0uired a tip but

not by virtue of his connection to the company! then such a person cannot

be held to be under the ambit of insider as de ned by the regulations.

$ut in Hindustan le'er case #9 the court had upheld the argument of "#$I

that procurement of 4*"I by an insider could be independent of the

insiderEs connection with the company. To remove any doubt and any

other interpretation "#$I amended the de nition in '--'.

The amended regulation de ned insider as any person who:

)i+ is or was connected with the company or is deemed to have been

connected with the company and

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)ii+ is reasonably e(pected to have access to unpublished price sensitive

information in respect of securities of company! or has received or has

had access to such unpublished price sensitive information

The de nition of insider had undergone an amendment in '-- which

neither deleted nor added any words it 2ust rephrased it by making a

minute change in the position of comma. The e1ect of this change was

huge. The scope of the term DinsiderE was increased. After the '--

amendment! the de nition of insider is a person who

)i+ is or was connected with the company or is deemed to have been

connected with the company and is reasonably e(pected to have accessto unpublished price sensitive information in respect of securities of

company

)ii+ or has received or has had access to such unpublished price sensitive

information

Therefore! if a person is in possession of unpublished price sensitive

information then he is an insider according to the de nition even though

he is not connected to the company at all 'B .

,ecently on =ay % ! '-% comprehensive amendments were noti ed in

insider trading regulations. A noteworthy feature of new regulations is

that a note is appended below every regulation which provides a very

clear e(planation of the regulation.

,egulation ')g+ now de nes DinsiderE as any person who is

i) a connected +erson= or

ii) in +ossession o$ or ha'ing access to un+ublished +rice sensiti'e

in$ormation=

27 htt : i67ia;or law.9lo


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in connection &ith the

+urchase or sale o$ securities.3

The de nition uses the words Dany personE which widens the scope of

term DinsiderE. 9owever! the de nition of who is an insider and the scopeof the words Dany personE has been laid down 2udicially by the courts in

the 4nited "tates. It has been laid down that a person will be an insider if

he has knowledge of or access to material unpublished price sensitive

information because of his duciary relationship to the company and its

shareholders ' . A duciary relationship e(ists when one person acts in

the best interest of another person. Their relationship e(ists on trust. The

de nition of insider has been e(panded to also include tippee and tipper.

In Securities E/change Commission '. :bus #" ! the ' nd Circuit reconciled

the liability of the tippee with the liability of the tipper. The court said the

Hoch$elder decision of the "upreme Court applies to tipper liability and

the ti++er should ha'e actual %no&ledge that the information was non3

28 '6 +8 Ca7 +o98rts (!1 !) $" % C 1"3

29 12 F.27. 43 (4 67 Cir. 4"!4)

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tippee while in India a same standard is provided in the de nition of

DinsiderE which will apply to tipper and tippee.

IV.3KNOWLEDGE AND MOTIVE:

IV.3.1 INDIA

The knowledge and motive re0uirement for conviction in India for insider

trading o1ence is very ambiguous. The author would e(amine that

whether knowledge and motive is re0uired for conviction under section

'8 of "#$I Act! %&&' by relying on legislations and case3laws. The

ambiguity was created because of the "AT ruling in Ra%esh Agar&al

case.

The facts of this case are as follows ,akesh Agarwal was = of A$"

Industries Ltd. and for survival of his company he entered into

negotiations with $ayer AG for takeover. ,akesh Agarwal asked his

brother3in3law! to purchase shares of A$" in order to facilitate the

takeover of shares in the open o1er made by $ayer.

The "AT held that even though ,akesh Agarwal had access to 4*"I hehad no intention to make pro ts for himself and whatever he had done

was in the best interest of his company. The "AT held that ,akesh had

made those purchase in order to ensure that $ayer gets %P of shares of

A$".

Therefore! it is apparent from the 2udgment that the "AT was of the

opinion that pro t element is implicit in the concept of insider trading

33 4""$ $1 %CL 2-! %AT

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and therefore! a person will be held liable only when the pro t element

is satis ed. The court went further and said that if a penal provision of

law is silent on re0uirement of mens rea than the presumption would

be that it is present and therefore the legislator has to speci callye(clude the presumption of mens rea.

Q=ens rea 3 There is a presumption that in any statutory crime

the common law! mental element! mens rea! is an essential

ingredient. A crime may or may not contain an e(press de nition

of the necessary state of mind. A statute may re0uire a speci cintention! malice! knowledge! willfulness or recklessness. @n the

other hand it may be silent as to any re0uirement of mens rea

and in such a case in order to determine whether or not mens rea

is an essential element of the o1ence! it is necessary to look at

the ob2ects and terms of the statute. It has always been a

principle of the common law that means rea is an essential

element in the commission of any criminal o1ence against thecommon law. In the case of statutory o1ences it depends on the

e1ect of the statute ..... There is a +resum+tion that mens rea is

an essential ingredient in a statutor1 o?ence ! but this

presumption is liable to be displaced either by the words of the

statute creating the o1ence or by the sub2ect matter with which it

deals 78 Q

,egulation 8 states that any insider who deals in securities in

contravention of the provisions of ,egulation 7 or 7A of the Insider

Trading ,egulations shall be guilty of insider trading. Thus! a person

may be convicted if there is a breach of regulations and in absence of

mens rea! thereby making it strict liability crime.

34 State of 2aharashtra v 2ayer /ans 3eorge A'+ !1- %C 344

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In SEBI 's 8S@ Biotech td. 7 the court re2ected the Dgenuine

corporate policy intentionE and held that in India intention or mens rea

to make pro t is irrelevant for conviction under "#$I Act! %&&'. Also in

SEBI 's Cabot International Ca+ital Cor+oration9

it was held by the$ombay 9igh Court that the scheme of penalty under "#$I regulations

and "#$I Act is penalty for failure of statutory obligation or breach of

civil obligation. There is no element of any criminal o1ence as

contemplated under criminal proceedings and hence mens rea is not an

essential element for imposing penalty under the "#$I Act and "#$I

,egulations. This view was upheld by the "upreme Court which stated

that "ection % G of the "#$I Act deals with defaults or failure of

statutory civil obligations under the "#$I Act and "#$I ,egulations!

while "ection '8 of the "#$I Act deals with criminal o1ences under the

said Act and its punishment. "ince the proceedings pertaining to

"ection % G are neither criminal nor 0uasi3criminal! there is no

0uestion of proof of mens rea as an essential element for imposition of

penalty and that the penalty is attracted once the contravention of

statutory obligations under the "#$I Act and ,egulations is established

regardless of the intention of the parties! and the Ono mens rea! no

penaltyO principle is erroneous. 7B The "AT was also of the view that

making mens rea an essential re0uirement for the charge of insider

trading under the "#$I Act sets the stage for various market players to

violate statutory regulations with impunity and subse0uently plead

ignorance of law or lack of mens rea! which frustrates the ob2ect of

"ection % G! that is to give teeth to "#$I to ensure strict compliance of

the "#$I Act and "#$I ,egulations. 7 These 2udgments have been

35 MA&U %B ""22 4""2

36 (4""$) -! %CL 2"3 (Bom)

37 % B' ?. %hriram Mutual Fu67@ A'+ 4"" %C 44#3

38 +aNi? B. Ga67hi a67 Oth8rs ?. % B'@ A 8al &o. -" 4""3@ %AT Or78r 7at87 Ma 1@ 4""#

33 | P a g e


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subse0uently approved by a three32udge bench of the "upreme Court. 7&

"ection %& of the Companies act! '-%7 which prohibits insider trading

by directors and other key3managerial personnel does not make mens

rea criteria and the actEs applicability is e(tended on unlisted

companies and private companies.

IV.3.3 Mo&i+# i! &/# U!i' S& (:

8ir%s 's SEC 0 and Chiarella 's 6nited States 0! are two basic cases for

understanding the concept of mens rea in insider trading. ,ule %-b3

states that

HIt 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 e(change!

)a+ To employ any device! scheme! or arti ce to defraud!

)b+ To make any untrue statement of a material fact or to omit to

state a material fact necessary in order to make the statements

made! in the 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 any security.Q

39 U6io6 of '67ia ?. Dharm867ra T8>til8s Pro;8ssors a67 oth8rs (4""#) 4""# %CC (!2) 2 1. %88 also@/a69a %oftwar8 '67ia P?t. Lt7. ?. D . C'T (4""1) !44 TT= (Pu68) 34!.

40 %u ra &ot8 !

41 %u ra &ot8 !-

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The "upreme Court in 8ir%s case held that for the tipper to breach his

duciary duty! it was necessary for the tipper to communicate insider

information to a tippee for monetar1 or +ersonal bene t and not for

reasons such as a genuine desire to fraud8'

. The court stated thatpresence of some personal gain was a pre3re0uisite for the commission of

the o1ence of insider trading. $ecause the tippeeOs duty was derivative of

the tipperOs duty! there could be no liability for the tippee absent a breach

of duty by the insider 87 .

The "upreme Court in Chiaralla case 00 held that it is absolutely necessary

to prove breach of duciary duty fraudulently by insider which was

reposed on him by the shareholders and the company.

In 6nited States 's :;Hogan 07 held that the insiderEs action must

constitute a wilful violation of the securities crimes to 0ualify for criminal

penalty.

Thus in India for a criminal penalty under section '8 to be attracted

there must be violation of regulations and in 4.". over and above proving

violation of regulations "#C also has to prove mens rea which is very

di1icult and cumbersome to do. Thus Indian position in relation to this

aspect is far stricter in comparison to 4.".

42 '9i7@ at 2

43 '9i7@ at . 3

44 %u ra &ot8 !-

45 -4! U.%. $4

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IV.5USE V. POSSESSION IN THE UNITED STATES AND

IN INDIA:

IV.5.1 T/# U(# +. Po((#((io! i! U!i' S& (:

The debate whether to have insider trading law based on the

2urisprudence of Dknowing possessionE or DuseE has been going on for

decades and the position of 4.". seems to be unclear on this point. In

Cad1 Roberts 5 Co. 09 in ruling that insider trading constitutes Dfraud

and deceitE reliance was placed on the theory of Ddisclose or abstain ruleE.

According to this rule an insider in possession of material non3public

information should either disclose the information before trading or

abstain from trading. This rule was also accepted in Te/as ,ul$ Sul+hur

46 $" %. .C. 1"3@ 1!2 (!1 !)

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Co. case 0* . #ven "#C has been inconsistent in its interpretation of the

above mention rule as it is evident from the e(ample of In'estors

4anagement Co. case 0 and Sterling 8rug Inc. case 0" . In in'estors

4anagement Co. the "#C e1ectively endorsed a QuseQ re0uirement!asserting that a re0uisite element for insider trading liability is Qthat the

information be a factor in decision to e1ect the transaction. - 5hile in the

other case the theory of DuseE was re2ected and the rule of Dknowing

possessionE was adopted by "#C.

In 6nited States ' Teicher 7! the court adopted the Dknowing possessionE

by placing their arguments on three factors. The rst being that section

%-)b+ and ,ule %-b3 re0uire only that a deceptive practice be conductedDin connection with the purchase or sale of a security.E ' The court noted

that the phrase Qin connection withQ has been construed 0uite Fe(ibly!

suggesting that such an interpretation supports the more Fe(ible and

less restrictive Qknowing possessionQ standard. 7 The second reason for

placing reliance on DpossessionE theory was because of Ddisclose or

abstainE rule. The court held that either the person should disclose the

material information before trading or if he doesnEt want to disclose thenhe should abstain from trading. ;inally the court said that the Qknowing

possessionQ standard because it is simple to apply! re0uiring only a

determination of whether the trader possessed material! non3public

47 $"! F.47 #22 (47 Cir. !1 #)

48 $$ %. .C. Do; 8t 22@ $ (!13!)

49 !$ %. .C. Do; 8t #4$ (!13#)

50 htt : s;holarshi .law.u 866.87u ;


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information. 8 The QuseQ standard! on the other hand! re0uires factual

in0uiries into the state of mind and motivations of the trader. The court

also argued that DuseE standard would make it di1icult for "#C to prove

the o1ence of insider trading. The court also stated that if any person isin possession of material non3public information than a strong

presumption or inference could be raised against the person that he

traded on the basis of that information however this presumption is

rebuttable.

9owever in the case of SEC 's Alder 79 the %% th Circuit Court advocated

the standard of DuseE by relying on "upreme CourtEs various previous

observations. The court held that though "#C had e(pressly adopted theDknowing possessionE test in ,ule %8e37! the "#C has not amended ,ule

%-b3 or promulgated other rules to adopt Dknowing possessionE

standard.

"hortly after this case! the


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Thus because of the wavering decisions and ambiguity the "#C

implemented ,ule %-b 3% in '--- which states that rule %-b3 Es

prohibition of insider trading is violated whenever someone trades Hon

the basis of material non3public information. "#C further providedde nition of trading Don the basis ofE material non3public information as

H Purchase or sale o$ a securit1 o$ an issuer is on the basis o$;

material non2+ublic in$ormation>i$ the +erson ma%ing the

+urchase or sale &as a&are o$ the material non2+ublic in$ormation

&hen the +erson made the +urchase or sale. 7 3

Therefore ,ule %-b 3% formally re2ects the Alder position.

IV.5.3. I!'i

In H '. SEBI 7" case ! there was a debate going on whether the words Donthe basis ofE mentioned in regulation 7 mean that the person trading has

to trade on the basis of the insider information. There was an ambiguity

as to whether the legislators intended for the rule of DuseE to apply by

using the words Don the basis ofE. In H '. SEBI case the allegation

levelled against 9LL was that being an insider it had purchased the

securities of $rook $ond Lipton India Ltd )$$IL+ on the basis of

unpublished price3sensitive information. 9LL argued that the transactionwas not motivated by the news of the impending merger but for the

purpose of enhancing the share of 4nilever in $$IL to % per cent

independent of the merger. Thus it was not Don the basis ofE insider

information as they had no motive. Though the Appellate Authority

re2ected this contention and stated that there was enough circumstantial58 !3 C.F.+. 4$".!"9-E!(9

59 %u ra &ot8 2

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evidence to show that the transaction was motivated by the knowledge of

the impending merger but it was very di1icult and cumbersome for "#$I

to prove that the transaction was done Don the basisE of insider

information.

This prompted the '--' amendment in which the words Don the basis ofE

were replaced by the words Dwhen in possession ofE. Thus "#$I e(pressly

removed the re0uirement of motive.

,egulation 8 of "#$I )*rohibition of Insider Trading+ ,egulations '-%

states that when a person who trades in securities has been in possession

of 4*"I! it would be presumed that his trades were motivated by 4*"I.

Thus! the onus shifts on the insider who has to prove that he was

innocent according to the defences mentioned in the regulation 8. The

Indian law is based on the rule of DpossessionE.

The Indian position is much clearer because the regulation 8 raises the

presumption against the insider once it is proved that the person is an

insider and he was in possession of 4*"I by the $oard. The act goes one

step forward in cases of a Dconnected personE. In connected person theonus is on the person to prove that he was not in possession of 4*"I once

it is established that he is a Dconnected personE. The Indian Law is much

more stringent compared to 4"A in this regard.

IV.6I!+#(&i) &i+# Po7#%( i! I!'i 8 U!i' S& (9

IV.6.1 U!i' S& (

The conviction of widely popular case of RaDat ,u+ta and RaD

RaDarantham was possible because of the use of recorded telephonic

conversations. In this case ,a2at Gupta C#@ of Goldman "achs was

convicted for disclosing corporate secrets to his friend ,a2 ,a2arantham.

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,a2at Gupta was ordered to pay ne of %7.& million and a two year

imprisonment was imposed which was upheld by "upreme Court. It is

also interesting to note that =r. Gupta had made no pro t or gain from

this transaction. ,a2 ,a2arantham was imposed a ne of &'. millionpenalty and an %% year prison time. This case is e(traordinary not 2ust

because of the amount of ne imposed and prison time but also because

e(clusive focus was placed on the telephonic conversations recorded

between =r. ,a2arantham and his sources. There were around 8-

wiretapped recording which was placed before the court.

In the 4nited "tates! the federal and state agencies have the power to

tap phones. 9owever! prior permission has to be taken from a court of

law in order to tap phones. 4se of wiretaps has increased considerably in

4.". in last decade in order to obtain direct evidence. The

Communications Act !" 0 in the 4nited "tates had made wire3tapping

inadmissible evidence in court and also a federal criminal o1ence.

9owever! subse0uently! the government started facing a lot of problems

when it declared its war on drugs in %& -s. *rosecutors had di1iculty in

prosecuting drug ma a due to lack of evidence. The "upreme Court

decided a land mark case by the name of at- '. 6nited States 9 . In

Berger 's Fe& Gor% 9! the Court declared the wiretapping law passed in


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included which said certain collateral o1ences such as securities

violation may also have been committed. The admissibility of this wire3

tapped recording was challenged before the court. The court held that

the evidence regarding insider trading was obtained in good faith on theground of reasonable suspicion. The "#C does not have powers to tap

phones. In the ,a2aratnam case! ;$I collected the evidence through

wiretap which was handed over to ,a2aratnam as a part of the due

process followed in criminal trials. The "#C led a motion to compel

production of documents on ,a2aratnam which included wiretap

evidence. In this way! the conviction of ,a2aratnam was secured.

#ven in the case of Kames ;leishman and 5inifred Kiau of consulting

company *rimary Global ,esearch the government obtained conviction

by relying on wire3tapped recording. Around '- persons have been

convicted of insider trading by relying on telephonic recordings.

Generally conviction in insider trading is solely based on circumstantial

evidence therefore it is di1icult to prove. A direct evidence like wire3taps

can make it considerably easy to get a conviction. The government also

obtained the convictions of brothers Rvi and #manuel Go1er! who

illegally pro ted from Rvi Go1erEs role as a trader at the hedge fund

Galleon Group. '

@ne of the ma2or problems which the regulator engaged in prosecuting

insider face is to nd a witness. Another problem that the "#$I faces in

insider trading cases is in establishing that the information available to

the trader was price sensitive in that it was likely materially to a1ect theprice of the security.

IV.6.3 I!'i

62 *owar7 =. /a la6 @ =os8 h A. Matt8o@ +i;har7 %ill8tt@ T* *'%TO+Y A&D LAW OFW'+ TAPP'&G@ ABA %8;tio6 of Liti


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The convictions of =r. ,a2at Gupta and =r. ,a2 ,a2arantham started a

debate in India as to whether phone tapping must be allowed on

suspicion of fraud in securities markets. As we have analysed in earlier

chapters that the substantive insider trading laws in India are much morestringent as compared to 4"A. "till "#C is much more e1icient in

obtaining convictions in insider trading if we compare it with "#$I. The

di1erence comes in investigation. In India "ection )'+ of the Indian

Telegraph Act! % lays down the law relating to telephone tapping. It

states:


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Control $ureau! ,evenue Intelligence and Central #conomic Intelligence

$ureau and the irector! #nforcement irectorate have the power to tap

phones for the purposes indicated in "ection )'+. The court accepted the

fact that economic emergenc1 is not one o$ those matters e/+ressl1 mentioned in the statute. 4ere economic emergenc1 ma1 not

necessaril1 amount to a +ublic emergenc1 and Dusti$1 action under this

action unless it raises +roblems relating to the matters indicated in the

section. The court then de ned public emergency as prevailing of a

sudden condition or state of a1airs a1ecting the people at large calling

for immediate action and Qpublic safetyQ would mean the state or

condition of freedom from danger or risk for the people at large.

In '--&! "#$I had written to the Telecom and ;inance =inistry to grant

it power to access call records for the purpose of Investigation. 9owever!

the re0uest was denied on the ground that the name of "#$I was not

included in the list of agencies which were authorised by the government

to tap phones 8 .

After the '-%7 amendment "#$IEs investigative power has increasedproviding it with necessary ammunition. After the amendment "#$I now

has the power to call upon records )including telephonic records+ from

various organi/ations which "#$I may feel are relevant to its

investigations. The "#$I does not have the powers to snoop in on

telephonic conversations but "#$I has the power to call upon records

like phonebook from other agencies for the purposes of investigation. It

should be kept in mind that telephonic records and telephonic records of conversation are di1erent. "#$I also has the authority to break open the

lock of any door! bo(! locker! etc. to get information from suspected

entities.

64 htt : arti;l8s.8;o6omi;tim8s.i67iatim8s.;om 4"!!E"$E!4 68ws 41$"114- ! s89iE8>8;uti?8E7ir8;torEi6si78rEtra7i6;ha6


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The telephone records can also be used to prove a link between an

insider and a trader and also to nd out the common third party link

between an insider and a trader. ;or e(ample in 4nited "tates! the

analysis done by the "#C revealed a Qthird party numberQ which wascalled by both the trader and an insider. The sta1 contacted the third

party who happened to be a real estate broker who had brokered a real

estate transaction between the trader and the insider. That transaction

turned out to be the mechanism by which the trader compensated the

insider for an illegal stock tip .

Thus! it can be held that on paper "#$IEs investigative powers are very

much similar with that of "#C. #ven "#C doesnEt has the power to record

telephonic conversations but ;$I can do it and "#C can call upon this

conversation by applying before the court as we have seen in case of RaD

RaDarantham case and various others. Thus! this is the only di1erence

)although it is a ma2or di1erence+ between the "#$I and "#CEs

investigative power.

The Chapter I> in the %&&' regulations which dealt with boardEs right toinvestigate! procedure for investigation has been removed after the '-%

amendment as it has already been comprehensively covered under

chapter >IA of the "ecurities and #(change $oard of India Act! %&&'.

66 L. *ilto6 Fost8r@ '&%'D + T+AD'&G '&0 %T'GAT'O&%@htt : www.s8;.


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V.CORPORATE GOVERNANCE AND INSIDER TRADING

IN INDIA:

To counter the menace of insider trading "#$I has adopted two3foldmechanisms. The rst mechanism provides corporate governance

standards which is useful in preventing the o1ence of insider trading.

Corporate governance standards come into play for preventing the

practice of insider trading. Chapter I> of "#$I )*rohibition of Insider

Trading+ ,egulations! '-% provides corporate governance standards.

R#) l &io! talks about formulating a Trading *lan for those persons

who are perpetually in possession of 4*"I and thus enabling them to

trade. This plan needs to be presented to a compliance o1icer for

approval and public disclosure. This plan is irrevocable and allows the

insider to trade in pursuance of pre3determined trading plan that has

been publically disclosed si( months prior to commencement of such

trading.


47/62

company the number of securities ac0uired or disposed of within two

trading days of such transaction if the value of the securities traded!

whether in one transaction or a series of transactions over any calendar

0uarter! aggregates to a traded value in e(cess of ten lakh rupees or suchother value as may be speci ed. B According to the note appended

disclosure has to be made as and when the threshold limit is crossed.

Thus! the disclosure has to be made more than once or not at all in a

Dcalendar 0uarterE! depending upon the ac0uisition or disposal crossing

the threshold. The provision has departed from the %&&' regulations

where the threshold limit was 'P of the shareholding or voting rights in

the company. Also what is interesting to note that in regulation B)%+ the

words Ddirector! promoter or key managerial personE is used while in

regulation B)'+ the words Ddirector! promoter or employeeE is used. This

could be the unintended draftsman mistake or the government wants

every employee or only the insider employee of a company to be covered

by the regulation B)'+ i.e. continual disclosures. ,egulation B)7+ is a

discretionary provision. It confers discretionary power on the company to

re0uire any connected person or class of connected person to disclose

their holding and trading in securities of the company as it may call for.

4nder R#) l &io! = the $oard of every listed company is re0uired to

form and publish their own code of practices and procedures for

disclosure of 4*"I in accordance with the principles set out in schedule

A. "chedule A ensures fair disclosure of 4*"I by laying down standards

such as such as e0uality of access to information! publication of policies

such as those on dividend! inorganic growth pursuits! calls and meetingswith analysts! publication of transcripts of such calls and meetings etc.

4nder R#) l &io! > the $@ of every listed company and every market

intermediary registered with "#$I shall form a code of conduct to

regulate! monitor and report trading done by its employees and other

connected person in accordance with the standards set out in schedule $.

67 [2015] 125 CLA (Mag.) 1 T !a"a#a$a%&a'#

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#ven entities that normally operate outside the capital market like

auditors! accountancy rms! law rms! analysts! consultants! other

capital market participants etc. are also re0uired to formulate such a

code of conduct.

Compli !"# O$i"#%

,egulation ')%+)c+ de nes compliance o1icer as any senior o1icer

reporting to the $@ or head of the organi/ation in case $@ is not

there. Compliance o1icer is entrusted with duties of compliance of

policies! procedures! maintenance of records! monitoring adherence to

the rules for the preservation of unpublished price sensitive information!monitoring of trades and the implementation of the codes speci ed in

these regulations. Compliance o1icer will also be responsible to

regulate! monitor and report conduct of connected person.

In Re Sat1am Com+uter Ser'ices imited 9" case "#$I discussed the

role and duties of a compliance o1icer. The investigation launched

by the "#$I revealed that "atyamEs decision to ac0uire =aytasInfra Ltd. )=IL+! =aytas *roperties Ltd. )=*L+! the subse0uent

withdrawal of the said proposal on ecember %B! '-- and the

confessions made by =r. ,amalinga ,a2u! the then Chairman of

"C"L on Kanuary -B! '--& was price sensitive information. It was

observed that certain employees and clients had sold "C"L shares

between


49/62

Pro+erties imited * . If the compliance o1icer had closed the

trading window before the announcement then the employees and

other connected person wouldnEt have been able to dispose of their

shares at a higher price. It was held that compliance o1icer doesnot have to act only under the supervision of the company as it

would negate the purpose of appointing him. Therefore! the

compliance o1icer is independent and has to conduct his duties in

an impartial manner.

T% 'i!) Wi!'o7

In "chedule $ the concept of Trading 5indow is incorporated. Trading5indow means a period in which the companyEs directors! o1icers and

the designated employees and the other connected persons trade in

companyEs securities. The trading window can be closed by a compliance

o1icer on a reasonable e(pectation that a designated person or

designated class of people are in possession of 4*"I. The time3frame for

re3opening of trading window has been set to 8 hours after the

information becomes generally available. B% #arlier this time3frame was '8hours. This trading window concept is also applicable on e(ternal

agencies having contractual or duciary relationship with company like

law rms! accountancy rms! etc.

The clause lays down the di1erent kinds of information as relevant for

the purposes of closing the trading window. These are:

)%+ eclaration of nancial results! )'+ eclaration of ividends! )7+ Issue

of rights! bonus! shares etc. )8+ Information regarding a new pro2ect! ) +

=erger! amalgamation and buy3back! ) + isposal of whole or

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substantially whole of the undertaking! )B+ any changes in policies! plans

and operations of the company. B'

P%#?"l# % !"# o- T% '#

4nder this clause trading done by designated persons shall be sub2ected

to pre3clearance by the compliance o1icer! if the value crosses the

threshold as stipulated by $@ and the designated person should not be

in possession of 4*"I. The compliance o1icer is also entitled to seek

declaration that the designated person is not in possession of 4*"I at the

time of applying for pre3clearance of trade. Also once the pre3clearance is

given the designated person has to e(ecute the trade within B days orany other time3frame which cannot e(ceed B days. If he fails to do so!

then fresh pre3clearance would be needed for the trade to be e(ecuted.

S/o%& S7i!) P%o@&(

In '-- ! "#$I amended Clause 8.' in "chedule I to include the provisions

relating to Dshort swing pro tsE. This clause 8.' prohibited directors!

designated employees who buy or sell any number of shares of the

company from entering into an opposite transaction for a period of

months. Two e(ceptions have been carved out in this clause. The rst

e(ception relates to initial public o1ering wherein the embargo on

trading is only for a period of 7- days and the second e(ception is in the

case of a personal emergency. The rationale behind this provision is to

prevent insiders who are in possession of 4*"I from taking an advantage

of such information. "ection % )b+ of the #(change Act provides the

concept of short swing pro ts.

9owever! this amendment was not well received by certain class of

investors because:

72 Ibid

5# | P a g e


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a. It puts a blanket ban on trading for months even though the

designated person is not in possession of 4*"I.b. The amendments did not prescribe the principle of ;irst in ;irst

out );I;@+! i.e.! the shares purchased rst can be sold rst. B7

c. The amendment did not specify the method of calculation of short swing pro ts. B8

d. It is not clear whether this provision applies to promoters! theemployees and on the dependents of the directors.

e. Also it is not clear whether this provision applies on #"@*s

issued to employees or when buy3back or open o1er is issued by

a company.

To remove the fallacy! "#$I made minor changes in this regard in '-%

amendment. Accordingly! a designated person cannot e(ecute a contra

trade i.e. opposite of previous trade in less than si( months or any other

time3frame provided the period cannot be less than months. 9owever!

the discretion has been given to compliance o1icer to allow trade within

months provided the trade does not violate these regulations.

C/i!#(# W ll

In simple language DChinese 5allE means creating an arti cial wall which

precludes the Fow of important information from one part of the o1ice

into the other. The concept of Chinese wall has been evolved to tackle the

problem of conFict of interest that arises when the listed companies deal

with the underwriters. The 9ouse of Lords recognised this principle

when they de ned a Chinese 5all as the He(istence of establishedorganisational arrangements which preclude the passing of information

in the possession of one part of the business to other parts of the

business in $olkiah v. J*=G. B This concept is very popular and used not

73 htt : sho7h


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only in the eld of nance but also in the eld of law! 2ournalism! science!

etc.

The perfect e(ample to show the importance of Chinese 5all is when a

listed company may disclose to the investment banker that it will be

buying another company. The investment banker will simultaneously

have other clients as well who may be interested in the information. The

investment banker may share this information with his other clients who

will buy the shares and wait for the information to become public and

then sell the shares for a pro t. Chinese 5all tries to address these type

of situations.

The term DChinese 5allE is said to have originated in the year %&'& after

the catastrophic crash of 4.". "ecurities market. The concept of Chinese

5all came into e(istence in case of In re 4errill 1nch Pierce enner 5

Smith Inc. *9 where "#C settled the matter with =erill Lynch! if the latter

establishes a Chinese 5all in the rm. =errill Lynch was the lead

underwriter for a potential public o1ering of debentures by ouglas

Aircraft Company.BB

=errill Lynch learned that the company was about toissue a revised estimate of its earnings with substantially lower gures.

=errill LynchOs underwriters gave this information to the sales

department! who in turn told several mutual funds and other large

institutional clients. B uring the three3day period before ouglas

publicly disclosed this information! =errill Lynch and its clients sold the

stock to avoid substantial losses. As part of the settlement =errill Lynch

reached with the "#C! the rm adopted a "tatement of *olicy thatQprohibits disclosure by any member of the 4nderwriting ivision of

76 $2 %. .C. 122 (!1 #)

77 '9i7

78 '9i7

52 | P a g e


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material information obtained from a corporation..! and not disclosed to

the investing public.Q B&

After this case! other rms voluntarily agreed to implement such

measures to prevent leakage of information from one department to

another. - 9owever! allegations of insider trading against these rms

continued to rise and many breaches were observed by the "#C of this

rule. Therefore! the rule of Chinese 5all was given statutory recognition

under "ection % )f+ of the Securities E/change Act o$ !" 0 which was

adopted as part of the Insider Trading and Securities raud En$orcement

Act o$ !" . %

La- in In%ia ' a'%in C*in ( Wall(

The Chinese wall policy was introduced in India by the '--' amendment!

*art $ of "chedule I clause '.8 which made it compulsory for all listed

companies and other organi/ations associated with the securities market!

to have Chinese wall policy as a part of their code. The amendment also

recogni/ed the policy of Chinese wall as a valid defence. The Code

speaks of creation of Dinsider areasE and Dpublic areasE within the

organisation! for the purpose of segregation of the two /ones. Access to

insider areas )/ones of con dential information+ shall be restricted and

segregated from public areas and accordingly! employees engaged in the

former shall not communicate price sensitive information to the latter. If

in any e(ceptional circumstance! the employees of the public area have

to be given con dential information! it shall be on a Dneed to knowE basis

and shall take place within the insider area. '

79 '9i7 at 121

80 htt : ir.law68t.for7ham.87u ;


54/62

In "chedule $ of '-% amendment! the policy of Chinese wall is provided.

The code provides that information shall be handled within the

organi/ation on need2to2%no& basis and therefore 4*"I can be

communicated to other person only in furtherance of discharge of dutiesor legal obligation or for legitimate purposes. 4nder ,egulation &! a

company is under a duty to develop appropriate Chinese wall procedures

and also the process for allowing any designated person to Dcross the

wallE

A%/anta ( o C*in ( Wall(0

Chinese 5alls are an important weapon in the battle against insidertrading. As discussed earlier! insider trading is illegal! and Chinese 5alls

attempt to prevent insider trading by preventing the Fow of material!

non3public information. 7 Chinese 5alls also have a bene cial purpose for

the broker3dealer. QAt the same time that Chinese 5alls contain

information within a department! they also allow other departments to

act freely without fear of Ocontamination. 8 Chinese 5alls allow a broker3

dealer to still engage in trading activities even if its investment bankersreceive material! non3public information. If a retail trader discovers

material! non3public information! the rm would have its hands tied and

be prevented from trading since this would be a violation of insider

trading laws. A Chinese 5all segregates this information from the retail

traders so that they can continue to engage in trading activities without

any fear of being tainted and guilty of insider trading.

Di(a%/anta ( o C*in ( Wall(

It has been averred that the above policy is only e0uipped to impede

accidental e(change of information among the departments of an

83 %u ra 6ot8 #"

84 '9i7

85 '9i7

54 | P a g e


55/62

organisation. It cannot curb those situations when there is a deliberate

disclosure of information by the investment advisors to clients as in the

case of Hgiving tips . B =ore importantly! Chinese walls wonEt be able to

prevent insider trading by classic insiders of the corporation and theirtippees. These instances of insider trading are more common than insider

trading resulting from the breach of a Chinese wall particularly with the

emergence of discount brokers.

9owever! at times the rmEs compliance with the Chinese 5all policy can

also be counterproductive in light of the duty it owes to its customers. It

is an uphill task to strike a balance between the duty to maintain

con dentiality of information obtained from its corporate clients and itsduty of providing accurate information of all material facts and

circumstances to its customers. This is e(actly what happened in Slade '.

Shearson Hammill 5 Co ! & where "lade did not act on the adverse

information of a companyEs nancial stability that its underwriting

department was privy to and continued to recommend stock to its clients.

As a result! it was sued Sby its clients. The defense of a Chinese 5all did

not hold good in court as it was of the opinion that the rm was unable torecognise its DconFicting duciary relationshipsE and its duty not to

recommend the said stock which it failed to ful l. &- 9ence! compliance

with the Chinese 5all policy can often conFict with other duciary duties

in securities trade! producing adverse conse0uences.

Also practically speaking this policy is not much e1ective as the cases of

insider trading is on rise every year.

86 A%'C ?. Citi


56/62

R#(po!(#( &o M % #& R mo%(

4nder schedule A the company is under an obligation to provide

appropriate and fair response to 0ueries on news report and to market

regulators for veri cation of the market rumors. It is a well3known fact

that speculation plays a ma2or role in determining prices in securities

market. Therefore in order to remove the e1ect of market rumors! the

company must clarify whether the rumors are true or false.

Di("lo( %# &o A! l*(&(

Company must ensure that the information disclose to analysts and

research personnel must not be 4*"I and should also upload the

recording of meeting with analysts and other investors on its o1icial

website.

P#! l&*

The code of conduct under "chedule $ empowers the company to impose

sanctions and take disciplinary actions! including wage free/e!

suspension! etc.

VI CONCLUSION

Thus! it is submitted that the dissertation ade0uately deals with the

history of insider trading law in India and in 4"A and the rationalebehind the law. Then the author enters into a comparative analysis

56 | P a g e


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BIBLIOGRAPHY

Boo (:

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59/62

. Gaurav *ingle! Analysis of "#$I )*,@9I$ITI@< @; I


60/62

% . Securities E/change Commission '. :bus &7 ;.7d. 'B )' nd

Cir. '-%'+

%&. Slade '. Shearson Hammill 5 Co 7%B ;.'d 7& )'d Cir. %&B8+

'-. State o$ 4aharashtra ' 4a1er Hans ,eorge AI, %& "C B'''%. Strong '. Re+ide '%7 4.". 8%&! 8'- )%&-&+''. 6nited States ' Smith %&& 4.". App. L# I" '-B -'7. 6nited States ' Teicher & B ;.'d %%' )'d Cir.+'8. 6nited States '. :;Hagan '% 4.". 8'! )%&&B+

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preventing3insider3dealingW

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6# | P a g e

http://www.ourlegalsystem.com/theboemangroup/Investmyown/First_Page/Definitions/insider_trading_liability.htmhttp://www.ourlegalsystem.com/theboemangroup/Investmyown/First_Page/Definitions/insider_trading_liability.htmhttp://www.ourlegalsystem.com/theboemangroup/Investmyown/First_Page/Definitions/insider_trading_liability.htmhttp://www.ourlegalsystem.com/theboemangroup/Investmyown/First_Page/Definitions/insider_trading_liability.htm


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. http:WWwww.gibsondunn.comWpublicationsW ocumentsW"#$I3

Announces3


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R#po%&(

< J "odhi Committee report! '-%8.

*lanning Commission! Government of India! A$I 94""AI<

C@==ITT##! %& &

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