DR.

RAM MANOHAR LOHIA NATIONAL LAW

UNIVERSITY
2019-2020

WHITE COLLAR CRIME

PROJECT ON:

INSIDER TRADING SCENARIO IN INDIA

SUBMITTED TO: SUBMITTED BY:

Mr. MALAY PANDEY MONISH NAGAR

Assistant professor (Law) Enroll no-150101081; sec-B

Dr. Ram Manohar Lohia IXth Semester

National Law University,

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 ACKNOWLEDGMENT

I would really like to thank Mr. MALAY PANDEY(Asst. Professor law, RMLNLU) for
allowing me to make a project on this topic. She also guided me throughout the process of
the making of the draft.

I would also like to thank God for giving me strength to complete my final draft. I
would also like to thank my parents for encouraging me to work on the topic. Last but
not the least I would like to thank my friends who helped me to find more on the topic
and prepare a research paper of my best efforts.

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Definition of Insider Trading
Insider means any person who is a connected person or in possession of or having access to
unpublished price sensitive information1. Insider Trading is a term subject to many definitions
and connotations and its encompasses both legal and prohibited activity. Insider Trading takes
place legally every day when corporate insiders-officers, directors or employees-buy or sell stock
in their own companies within the confines of company policy and the regulations governing this
trading. In simple terms ‘insider trading’ buying or selling a security, in breach of a fiduciary
duty or other relationship of trust, and confidence, while in possession of material, nonpublic
information about the security. Thus, in nutshell, insider trading is the buying, selling or dealing
in securities of a listed company by a director, member of management, employee of the
company, or by and other person such as internal auditor, advisor, consultant, analyst etc. who
has knowledge of material inside information which is not available to general public.

Who may be called insider:

The Regulation defines that a “connected person” means any person who—

a) is a director, as defined in clause (13) of Section 2 of the Companies Act, 1956(1 of 1956)
of a company, or is deemed to be a director of that company by virtue of sub clause (10)
of section 307 of that Act or

b) occupies the position as an officer or an employee of the company or holds a position

involving a professional or business relationship between himself and the company
whether temporary or permanent and who may reasonably be expected to have an access
to unpublished price sensitive information in relation to that company;

Price Sensitive Information means any information, which relates directly or indirectly to a
company and which if published, is likely to materially affect the price of securities of company

Insider trading occurs when someone makes an investment decision based on information that is
not available to the general public. In some cases, the information allows them to profit, in
others, avoid a loss. (In the Martha Stewart - Im Clone scandal, the latter happened to be the
case.)

 Insider trading was not considered illegal at the beginning of the twentieth century; in fact, a
Supreme Court ruling once called it a “perk” of being an executive. After the excesses of the

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(Prohibition of Insider Trading) Regulations, 2015, Chapter 1 Section 2(g).

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1920's, the subsequent decade of depression, and the resulting shift in public opinion, it was
banned, with serious penalties being imposed on those who engaged in the practice.2

 History of Insider Trading

The first ‘insider trader’ case was reported in the US way back in 1792. William Duer, the
then Assistant Secretary in the US Department of Treasury used his official position to gather
insider knowledge and involved in speculative trading in the newly issued debt of the US
government. He was indicted and spent his days behind bars.

In the early 1920s JP Morgan & Co., served as an unofficial central bank of the U.S and
reportedly used its high influence with the Republican Party to make profits. Then the inevitable
happened. In early 1929, there was an unprecedented boom in the New York Stock Exchange
and in September the sell off started plunging the prices to new lows and triggering a panic
among investors, and banks.

The Great Depression began to set in. Following this the chaotic economic scenario in the 1920s
that saw financial excesses made and the decade long Great Depression and the shift in public
opinion and all these contributed to the introduction of tough laws on insider trading done to
manipulate profits.

Even till a few decades of the 20th century, insider trading was not considered illegal. In fact in
the 1960s the world followed the Massachusetts Supreme Court ruling in
the Goodwin v. Agassiz case that insider information is a ‘perk.’ However, in 1964 the Securities
Act Amendments laid down disciplinary controls for brokers and dealers.3

Liability for insider trading

Liability for inside trading violations cannot be avoided by passing on the information in an
“I scratch your back; you scratch mine” or quid pro quo arrangement as long as the person
receiving the information knew or should have known that the information was material non-
public information. In the United States, at least one court has indicated that the insider who
releases the non-public information must have done so for an improper purpose. In the case of a

2
http://beginnersinvest.about.eom/cs/newinvestors/a/102702a.htm.
3
http://economictimes.indiatimes.com/understanding-insider-trading/brief-history-of-insider-trading

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person who receives the insider information (called the “tippee”), the tippee must also have been
aware that the insider released the information for an improper purpose.4

One commentator has argued that if Company A's CEO did not trade on the
undisclosed takeover news, but instead passed the information on to his brother-in-law who
traded on it, illegal insider trading would still have occurred (albeit by proxy by passing it on to a
“non-insider” so Company A's CEO wouldn't get his hands dirty).5

 Insider Trading Law in United States:

The America has been the leading country in prohibiting insider trading and the first country
to tackle insider trading effectively with true spirit.Being a global master it is important to
discuss insider trading in American perspective. While Congress gave us the mandate to protect
investors and keep our markets free from fraud, it has been our jurists, albeit at the urging of the
Commission and the United States Department of Justice, who have played the largest role in
defining the law of insider trading for corporate system.

The Economy of US A crushed in 1929 due to prolonged lack of investors confidence in the
securities market followed by Great Depression of US Economy, led to the enactment of
Securities Act of 1933 in which Section 17 of the contained prohibitions of fraud in the sale of
securities which were greatly strengthened by the Securities Exchange Act of 1934. The 1934
Act addressed insider trading directly through Section 16(b) and indirectly through Section
10(b). Section 16(b) of the Securities Exchange Act of 1934 prohibits short-swing profits (from
any purchases and sales within any six month period) made by corporate directors, officers, or
stockholders owning more than 10% of a firm's shares. Under Section 10(b) of the 1934 Act,
SEC Rule 10b-5, prohibits fraud related to securities trading. Further the Insider Trading
Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988
provide for penalties for illegal insider trading to be as high as three times the profit gained or the
loss avoided from the illegal trading. Much of the development of insider trading law has
resulted from court decisions. In SEC v. Texas Gulf Sulphur Co.6 a federal circuit court stated
that anyone in possession of inside information must either disclose the information or refrain
from trading. (1966).

4
United States v. Newman, 773 F.3d 438 : 2d Cir. 2014.
5
Larry Harris, Trading & Exchanges, Oxford Press, Oxford, 2003. Chapter 29 “Insider Trading”
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1996

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The Supreme Court of the United States in 1984 ruled in the case of Dirks v. SEC that tippees
(receivers of second- hand information) are liable if they had reason to believe that the tipper had
breached a fiduciary duty in disclosing confidential information and the tipper received any
personal benefit from the disclosure. (Since Dirks disclosed the information in order to expose a
fraud, rather than for personal gain, nobody was liable for insider trading violations in his case.)

The Dirks case also defined the concept of “constructive insiders,” who are lawyers, investment
bankers and others who receive confidential information from a corporation while providing
services to the corporation. Constructive insiders are also liable for insider trading violations if
the corporation expects the information to remain confidential, since they acquire the fiduciary
duties of the true insider.

In United States v. Carpenter (1986) the U.S Supreme Court cited an earlier ruling while
unanimously upholding mail and wire fraud convictions for a defendant who received his
information from a journalist rather than from the company itself. The journalist R. Foster
Winans was also convicted.7

“It is well established, as a general proposition, that a person who acquires special
knowledge or information by virtue of a confidential or fiduciary relationship with another is
not free to exploit that knowledge or information for his own personal benefit but must
account to his principle for any profits derived therefrom.”

However, in upholding the securities fraud (insider trading) convictions, the justices were evenly
split.

In 1997 the U.S Supreme Court adopted the misappropriation theory of insider trading in United
States v. O'Hagan, 521 U.S 642 (1997). O'Hagan was a partner in a law firm representing Grand
Met, while it was considering a tender offer for Pillsbury Co. O'Hagan used this inside
information by buying call options on Pillsbury stock, resulting in profits of over $4 million.
O'Hagan claimed that neither he nor his firm owed a fiduciary duty to Pillsbury, so that he did
not commit fraud by purchasing Pillsbury options.

Insider trading in Indian Scenario

7
Christopher Cox, U.S Securities and Exchange Commission Speech by SEC Chairman: Remarks at the Annual
Meeting of the Society of American Business Editors and Writers

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 In India Section 3 of the SEBI seeks to prohibit dealing, communication and counseling on
matters relating to, insider trading. Section 3 provides that no insider shall either on his own
behalf of any other person deal in securities of a company when in possession of any
unpublished price sensitive information on communicate, counsel or procure, directly or
indirectly any unpublished price sensitive information to any person, who while in possession of
such unpublished price sensitive information shall not deal in securities. However, these
restrictions are not applicable to any communication required ordinary, course of business or
profession or employment or any law.

Section 3 A prohibits any company from dealing in the securities of another company or
associate of that other company while in possession of any unpublished price sensitive
information.

Insider Trading Regulations have been tightened by SEBI during February 2002. New rules
cover ‘temporary insiders’ like lawyers, accountants, investment bankers etc.8

 Directors and substantial shareholders have to disclose their holding to the company
periodically. The New Regulations have added relatives of connected persons, as well as, the
companies, firms, trust, etc. in which relatives of connected persons, bankers of the company and
of persons deemed to be connected persons hold more than 10%. The definition of relative under
the New regulations is in line with that of the Companies Act, 1956, which ranges from parents
and siblings to spouses of siblings and grandchildren. The term “connected person” is defined to
mean either i) a director or deemed to be a director, ii) occupies the position as an officer or an
employee or having professional or business relationship whether temporary or permanent, with
the company. Thus, there are two categories of insiders:

 Primary insiders, who are directly connected with the company and secondary insiders who are
deemed to be connected with the company since they are expected to have access to unpublished
price sensitive information. The jurisprudential basis for the ‘person-connected’ approach seems
to be founded in the equitable notions of fiduciary duty.

The secondary insider, who would have traded with an unfair informational advantage, may
escape from being caught simply because there can be no trace of how he derived this
information in the first place, insider by reason of his connection with the company. In reality,
much of the flow of the price-sensitive information often does not operate by way of such
established networks of relational links between individuals. Very often, such price-sensitive

8
Academyofcg.org/marchissue.htm.

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information is communicated and spread out through very loosely connected and informal
networks of brokers, clients and even between friends and through electronic networks etc. or an
elaborate nexus of company official, brokers, traders. These individuals are very often privy to
strategic policy decisions or developments that may influence the valuation of a company's scrip
on the bourses.

Satyam Scam Case9

Mumbai: In a fresh order in the nearly seven-year old Satyam scam case, regulator Sebi
asked 10 entities linked to the main accused B Ramalinga Raju — including his mother, brother
and son — to disgorge over Rs. 1,800 crore worth of illegal gains made by them.

Besides, they will also have to pay close to Rs. 1,500 crore as interest on the disgorgement
amount, as the penalty has been levied with effect from January 7, 2009 — the day Satyam
Computer's founder and then Chairman B Ramalinga Raju admitted to a massive long-running
fraud at the company.

The latest penalties for insider trading follows an earlier disgorgement order passed by Sebi in
July last year, wherein the regulator had barred Raju and four others from the markets for 14
years and also asked them to return Rs. 1,849 crore worth of unlawful gains with interest.

That order was against Ramlinga Raju himself, his brother B Rama Raju (then Managing
Director of Satyam), Vadlamani Srinivas (ex-CFO), G Ramakrishna (ex-vice
president) v. Prabhakara Gupta (Ex-Head of Internal Audit).
In an order, Sebi has also fixed individual liability of Raju, his two brothers and other individuals
and companies related to the promoter family.Those against whom the latest order has been
passed include SRSR Holdings (controlled by Raju brothers), IL&FS Engineering and
Construction (formerly known as Maytas Infra that was controlled by Raju and his two sons),
Raju's mother B Appalanarasamma, his two sons — Teja Raju and Rama Raju Jr, his brother
Suryanarayana Raju, B Jhansi Rani (wife of Suryanarayana), Chintalapati Srinivasa (then
Director of Satyam) and his father Anjiraju Chintalapati (since deceased), as also Chintalapati
Holdings Pvt. Ltd.

With regard to IL&FS Engineering and Construction (IECCL), Sebi however said it was neither
an insider in Satyam Computers and Maytas, nor did it have access to the ‘unpublished price
sensitive information’, and therefore it has been spared of any debarment action.

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Press Trust of India Last Updated: September 10, 2015 20:08 (1ST).

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Samir C Arora v. SEBI Case10

Securities and Exchange Board have set out in its order banning Arora — the former star
Asia-Pacific fund manager of Alliance Capital Management — from trading in August are far
from convincing.

There are three main charges. One, that Arora played a pivotal role in thwarting Alliance
Capital's efforts to sell its India operations by resorting to unethical means.

 Secondly, he did not make disclosures or sometimes made wrongful disclosures when some of
Alliance's holdings in certain stocks breached limits that required informing the respective
companies.

 Thirdly, he sold his entire holding in Digital Global Soft based on unpublished, price-sensitive
information.

 In this case, SEBI conducted investigations into the management, conduct and other affairs of
the Alliance Capital Asset Management (I) Pvt. Ltd. (ACAML). Samir Arora was the fund
manager of the company. Knowing that the company was inviting bids for takeover of the same,
he made special arrangement with Henderson Global Investors. For helping this
company takeover his present company, he purchased shares and when the price rose sold off the
shares to get a considerable profit. The Authority found him guilty and directed him not to buy,
sell or deal in securities, in any manner, directly or indirectly, for a period of five years.

The conduct of Samir Arora is not in consonance with the high standards of integrity, fairness
and professionalism expected from a fund manager. His conduct erodes the investors' confidence
and is detrimental to their interests as well as the safety and integrity of the securities market. His
association in the securities market in any capacity is prejudicial to the interests of the investors
and the safety and integrity of the securities market.

 Accountability of Company
Every listed company has the following obligations under the SEBI (Prohibition of Insider
Trading) Regulations, 1992

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corporateinsiderstrading.wordpress.com/category/famous-cases/.

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 To appoint a senior level employee generally the Company Scecretary, as the Compliance
Officers;

 To set up an appropriate mechanism and to frame and enforce a code of conduct for internal
procedures.

 To abide by the Code of Corporate Disclosure practices as specified in Schedule ii to the SEBI
(Prohibition of Insider Trading) Regulations, 1992

 To initiate the information received under the initial and continual disclosures to the Stock
Exchange within 5 days of their receipts;

 To specify the close period;

 To identify the Price Sensitive Information

 To ensure adequate data security of confidential information stored on the computer;

 To prescribe the procedure for the pre-clearance of trade and entrusted the Compliance Officers
with the responsibility of strict adherence of the same

 Penal Provisions

No separate penalties have been prescribed under the Regulations. Reference is made
however to the penalty provisions under the SEBI Act, 1992 which shall apply. As per the Act,
insider trading is publishable with a penalty of INR 250,000,000 (Rupees Two Hundred Fifty
Million Only) or 3 times the profit made out of insider trading, whichever is higher. SEBI is also
empowered to prohibit an insider from investing in or dealing in securities, declare violative
transactions as void, order return of securities so purchased or sold. Any person contravening or
attempting to contravene or abetting the contravention of the Act may also be liable to
imprisonment for a term which may extend to ten years or with fine which may extend to INR
250,000,000 (Rupees Two Hundred Fifty Million Only) or with both.

 The Regulations, also, prescribe certain disciplinary sanctions that may be taken by companies
or market intermediaries to require due compliance of the Regulations.

 Conclusion
Eventually India has a low rate of fraud perpetrated by company insiders. Around 84 percent
of the fraud involves the hand in glove relationship between the employees and a third party.
However, lower rates of employee fraud do not mean that the management in Indian companies

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is honest and that shareholders get a better deal in India than elsewhere. The surveillance
mechanism in countries like the United States is quite tough, ruling out such a probability. In
India company insiders with privileged access to information indulge in rampant insider trading
for personal gains rather than to benefit the shareholders. The obvious conclusion drawn is that it
is those who retain the controlling interests in the company and not the employees who take the
shareholders for a ride.
———

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