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Analyzing the grounds to allege Insider Trading

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Insider trading is essentially dealing in a company’s securities on the basis of confidential information, relating to the said company, which is not published or not known to the public (unpublished price- sensitive information), thus making personal profits or avoid loss. This behavior is and has been a cause of concern to security markets across the since their respective inception. The growing magnitude of the world’s securities markets in the past decades has further raised the concerns of the securities market regulators across the globe.

In simple terms, insider trading means that an individual buys or sells a stock based on information that is not available to the general public.

In order to curb and avoid this practice various committees were set up by the Indian Government throughout the decades and worked on the recommendations given by them, those being:

  • 1948, Thomas Committee– recommended restrictions to impose short swing profits
  • 1950 Bhabha Committee- recommended distinction between the directors who buy or sell shares while in possession of general information and those who buy or sell shares based on the specific information
  • 1977 Sachara Committee– recommendations, one relating to fuller disclosure of transactions by those who have price-sensitive information and another prohibition of transactions by such persons during certain specified period unless there are exceptional circumstances.
  • 1984 Patel Committee– Recommended measures to prohibit the practice of insider trading and suggested draft legislation by way of amendments to the Securities Contracts (Regulation) Act.
  • JJ Irani Committee– recommended that international best practices should be adapted to the Indian situation while enabling a framework that ensures credibility of corporate operations in the minds of the stakeholders.
  • 1989 Abhid Hussian Committee– proposed to consider insider trading as a major offence, punishable with civil as well as criminal penalties. The committee recommended that the SEBI should be asked to formulate the necessary legislation, empowering itself with the authority to enforce the provisions.
  • 2014 Sodhi Committee– recommendations to the legal framework for prohibition of insider trading in India and has focused on making this area of regulation more predictable, precise and clear by suggesting a combination of principles-based regulations and rules that are backed by principles.
  • 2018 Vishwanathan Committee– recommendations for compliance officer to be financially literate, insertion of structured digital data base containing names of persons with whom information is shared.

 To encourage and maintain a fair securities market the Securities Exchange Board of India (SEBI) formulated SEBI (Prohibition of Insider Trading) Regulations, 2015, which prescribes code of fair disclosure and conduct to be followed by listed companies and entities connected with them. This comprises of five chapters and five schedules encompassing the various regulations relating to Insider Trading.

“Insider”, “connected person” and “unpublished price sensitive information,” are the key concepts that requires to be understood to address the key issues or elements of Insider trading.

As per the SEBI (Prohibition of Insider Trading) Regulations, 2015, regulation 2(1) (g) defines the term “insider”. Here insider means a connected person or an individual who is in possession of or having access to unpublished price sensitive information. The regulation also states that anyone in possession of or having access to unpublished price sensitive information should be considered an “insider” regardless of how one came in possession of or had access to such information. This individual can be a corporate officer, from the board of directors, employee or someone who has received the non-public information from the company. 

As per the SEBI (Prohibition of Insider Trading) Regulations, 2015, regulation 2(1) (d) defines the term “connected person”. The definition of deemed to be a connected person /connected person is inclusive and very elaborate. Its ambit ranging associated personal to employees. It specifies the time period of such association in few instances, the roles and responsibilities exercised and the position held. SEBI in its recent judgments has considered nexus and relationship of various persons through social media networking websites to identify individuals as Connected Persons. It also includes who have access to unpublished price sensitive information or is reasonably expected to allow such access.

As per the SEBI (Prohibition of Insider Trading) Regulations, 2015, regulation 2(1) (n) defines the term “unpublished price sensitive information”. This means any information, relating to a company or its securities, directly or indirectly, that is not generally available which upon becoming generally available, is likely to materially affect the price of the securities. It usually contains information relating to financial results, dividends, change in capital structure, mergers, de-mergers, acquisitions, delisting, disposals and expansion of business and such other transactions, ) changes in key managerial personnel and material events in accordance with the listing agreement.

The SEBI (Prohibition of Insider Trading) Regulations, 2015 also provides for initial as well as continual disclosures by members of the company by the directors/ employees/ designated employees/promoter/promoter group at regular interval.

Grounds to allege Insider Trading

It is clear that the behavior of the insider trading is against the fair security markets. It affects/ is unfair to the market players who make investment decisions based of the generally available information. Thus, Insider information gives an undue advantage.

An Insider Trading allegation can be based on circumstantial evidence and a review of the company’s financial information. In order to make a determination whether or not an allegation of Insider Trading exists, it is important to understand the various factors that could lead to such an allegation.

Factors such as financial information that was not disclosed to the public, a company’s history of Insider Trading, or the behavior of a specific individual are considered. In order to determine whether or not there is enough evidence to support an allegation of Insider Trading, it becomes important to review the company’s financial information and see if any activity appears to be out of character. It also becomes important to review the company’s history of Insider Trading in order to see if any recent examples of this behavior can be linked to the company.

Few situations or examples includes:

  • A lawyer representing the CEO of a company came to know in a confidential meeting that the CEO is going to be charged for accounting fraud the next day. Thus, the said lawyer immediately sells 1,000 stocks of the company because he knows that the stock price is going to go way down on news of the indictment of the CEO.
  • A situation where a friend/relative is working in the marketing department at an automobile company. In a conversation such a friend/ relative discloses about the company’s new car model is to be launched next month, and it’s going to be a sure hit in the Indian market.Now, the person takes market decisions based on such information. Let’s say such a person buy 1000 shares when the prices are around Rs430 per share (investing Rs 4,30,000). The automobile company launches the new car model and receives wonderful response. Stock prices rocketed and the said person sell them 20 days later Rs 520 per share for Rs 5,20,000 approximately. Thus making a profit of Rs 90,000 in 20 days.
  • An employee working in a government is aware that new laws and regulation are to be passed that will significantly benefit the real estate companies. The said government employee secretly buys stocks of the real estate companies and then pushes for the implementation of the regulation as quickly as possible.

It is a task of extreme toil to state all the combinations for instances of insider trading. But any individual who gets to know of such behavior can allege the practice of insider trading.

In order to identify or detect this behavior whistleblowers, compliance officers, audit reports, information by fellow directors or by persons of authority who have witnessed such behavior is of paramount importance.

A whistleblower is a person, who could be an employee, contractor, or a supplier of a company, or a government agency, disclosing information to the public or some higher authority about any wrongdoing, which could be in the form of fraud, corruption, etc. To protect whistleblowers from losing their job or getting mistreated there are specific laws. Most companies have a separate policy which clearly states how to report such an incident. A whistleblower can file a lawsuit or register a complaint with higher authorities. Thus, leading to criminal investigation against the company or any individual department. Internal and external are two types of whistleblowers. Internal whistleblowers are those who report the misconduct, fraud, or indiscipline to senior officers of the organization such as Head Human Resource or CEO. External whistleblowing is a term used when whistleblowers report the wrongdoings to people outside the organization such as the media, higher government officials, or police.

Auditors report can also assist in identifying the lacunas or ill behavior in a company. Auditor’s report reflects the validity and reliability of a company’s financial statements and is prepared by an independent practicing Chartered Accountant. Audit reports enumerates on whether or not the financial statements prepared by a business comply with GAAP (Generally Accepted Accounting Principles) standards. In addition, it points out any misrepresentations of financial information. The content of an Auditor’s Report needs to be clear and precise, providing sufficient evidence to justify the auditor’s opinion.

Indian Insider trading stories

  • Rajat Gupta was a former member of the board of directors of Goldman Sachs. He was convicted of insider trading charges in 2012. His charges were of leaking board room meetings information about Goldman to Mr. Raj Rajaratnam, the founder of the Galleon Group and a hedge fund investor, who traded on the information so received. The information even included about Warren Buffet’s $5 billion bailouts at the height of the crisis and prompted Mr. Raj Rajaratnam, to hedge himself against the fluctuations in stock price. Even though Mr. Rajat Gupta was not believed to have had any real financial gain, according to his attorneys, and that the two friends were discussing the deal in their position as investors themselves. The timing of it and the fact that the reveal took place before the public announcement leads to his conviction as a guilty of Insider trading.
  • Indian markets regulator, SEBI had imposed a penalty of ₹42 lakh on a director of Acclaim Industries for violating Insider trading regulations. Abhishek Mehta was managing director and promoter of the firm at the time of the violation. SEBI said it conducted a probe from January to December 2012 regarding the change in the shareholding of Mr. Abhishek Mehta after the company’s board approved the proposal of merger of the firm with Database Software Technology Pvt Ltd (DSTPL) in January 2012. In the course of the investigation, it was observed that in February 2012, the board of Acclaim Industries decided not to merge the firm with DSTPL. But the above mentioned decision was not revealed to the stock exchange. Mr. Abhishek Mehta violated insider trading norms by selling shares and reducing his shareholding in Acclaim Industries, when in possession of unpublished price-sensitive information, and therefore imposed fine on him.

Conclusion

It is of paramount priority to hold individuals/ insiders accountable for unauthorized dissemination of possessed price-sensitive information. Directors of a company play a significant role in the preservation of unpublished price-sensitive. Authorities majorly rely on data and facts from which conclusions could be drawn. Various modes of communication ranging from emails to calls, trading patterns, statements, and affidavits are thoroughly scrutinized. Such behavior needs to be reported to uphold desired principles of a fair security market.

References:

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Article by ADITYA G S

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