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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"#$)
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A CRITICAL ANALYSIS WITH RESPECT TO CORPORATE GOVERNANCE NORMS IN I NDIA
Area of Research
CORPORATE GOVERNANCE
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TABLE OF CONTENTS
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COMPA+AT'0 A&ALY%'% 44
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SYNOPSIS
TITLE OF THE PAPER
Insider Trading Law: A comparative and critical analysis with respect to
corporate governance norms in India.
RESEARCH PROBLEM
The area of research chosen for this dissertation is the role of Corporate
Governance to curb insider trading in India. It is a much known fact that asnancial markets are developing! the white collar crimes are also becoming
more and more sophisticated and so do the laws to deal with them. In recent
years! because of massive frauds in nancial markets and also to bolster the
con dence of investors! the legislators and regulators have turned towards
making corporate governance standards mandatory and also attaching
penalties if there is any violation of these standards. The act of insider
trading can be held as one of the most violent crimes as it destroys the
con dence of investors. The two decade old insider trading law proved to be
inept in curbing insider trading in India and as a result of this "#$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 $iswal for giving us an
opportunity to undertake this pro2ect and for his advice! support and
guidance.
I would also like to e(press my appreciation for the co3operation! help
and support of other members of G
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LIST OF ABBREVIATIONS
!. 5...............................................................................................................................A674. A'+ .....................................................................................................All '67ia +8 ort8r 2. Bom....................................................................................................................Bom9a$. BOD ...Boar7 of Dir8;tors-. Cal......................................................................................................................Cal;utta
. 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.
;inally on
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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$i"#%: The '-% amendment provides for the
appointment of a compliance o1icer. ,egulation ')%+)c+ de nes
compliance o1icer as! Hany senior o1icer! designated so and
reporting to the board of directors or head of the organisation in
case board is not there! who is nancially literate and is capable of
appreciating re0uirements for legal and regulatory compliance
under these regulations and who shall be responsible for
compliance of policies! procedures! maintenance of records!
monitoring adherence to the rules for the preservation of
2 4""$ $1 %CL 2-! %AT
3 (!11#) !# %.C.L 2!! AA@ *8r8i6aft8r r8f8rr87 to as /00 v SE I1
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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 #
12 (!1 !) $" % C 1"3
13 See 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
of 4*"I.
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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. '
I>.C@=*A,ATI># A
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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""#
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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.
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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
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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
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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
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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 $2 %. .C. 122 (!1 #)
77 '9i7
78 '9i7
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material information obtained from a corporation..! and not disclosed to
the investing public.Q B&
After this case! other rms voluntarily agreed to implement such
measures to prevent leakage of information from one department to
another. - 9owever! allegations of insider trading against these rms
continued to rise and many breaches were observed by the "#C of this
rule. Therefore! the rule of Chinese 5all was given statutory recognition
under "ection % )f+ of the Securities E/change Act o$ !" 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
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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
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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
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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
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R#po%&(
< J "odhi Committee report! '-%8.
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C@==ITT##! %& &