PROJECT REPORT ON

:: INSIDER TRADING ::

:: BUSINESS ETHICS ::

SUBMITTED BY :

PRASHANT M. KANADE

MFM – 17

MASTER’S DEGREE IN FINANCIAL MANAGEMENT – 3rd YEAR

BATCH – 2008-2011

UNDER THE GUIDANCE OF

PROF. ROSSIE MURRAY

LALA LAJPATRAI INSTITUTE OF MANAGEMENT

MAHALAXMI, HAJIALI, MUMBAI – 400034.

Insider Trading refers to the trading (buying as well as selling) of a company’s speculative financial

instruments like shares, bonds or stock options, by the insiders such as officers, directors, or major

share holders (holding more than a specified percentage of the company’s shares) or any individual

who has access to privileged non-public information by virtue of his official duties. Such individuals

include Govt Officials, auditors, etc.

Legal and Illegal Insider Trading :

Insider trading based on material non-public information is considered to be fraudulent since the

insiders are benefiting themselves from information availed in the course of their duty at the cost of

shareholders. Such act is considered to be violation of the trust or the fiduciary duty towards the

shareholders.

However, any insider trading which is not based on privileged non-public information is

perfectly legal.

In common parlance, Insider Trading has a negative resonance and invariably refers to illegal trading

only.

Example of Illegal Insider Trading :

The CEO sells holding of his stock in company before releasing news to the public that company is

likely to lose a massive lawsuit or its supply contract with a major customer will not be renewed

upon expiry next month.

The CEO's son sells the company stock after learning from his dad about the imminent fall in share

prices due to negative development in the company. However, in this case, it is not the CEO’s son

but CEO himself who is guilty of insider trading since he has tipped his son of non-public

information.
The Judge dealing with the lawsuit realizes that the company will lose the lawsuit and therefore sells

the stock before the pronouncement of judgment.

However, catching insider trading is difficult without installing a software which can maintain

database of holding of shares by insiders, track their trades and report any large transaction prior to

large movement in stock prices. Even then, proving insider trading can be difficult, because traders

often hide behind proxies. Most trading by promoters is actually never known and is therefore never

reported or investigated. In some recent cases where trading was done in own name, offenders got

away scot-free due to inability of prosecutors to establish the offence beyond doubt.

Laws on Inside Trading - United States :

United States Stock Market is the single largest stock market as also one of the best regulated

markets in the world. It has been actively pursuing against illegal insider trading. Like SEBI in India,

Securities Exchange Commission (SEC) is the regulatory body in US.

SEC 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.

Stiff penalties for illegal Insider Trading which can be as high as three times the profit gained or the

loss avoided from the illegal trading.

Laws on Inside Trading – India :

The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations,

1992, was amended on 22nd February, 2002 which mandates every company to frame a

Code of Conduct for prevention of insider trading.

Employees, including Directors, when in possession of any unpublished price sensitive

information, as defined in the Regulations, pertaining to the Company, shall not:

 Buy/sell securities of the Company, either on their own behalf or on behalf of any other

person.

 Communicate, counsel or procure any unpublished price sensitive information to / from any

person.
The Designated Employees shall cover the following:

 Directors, Executive and Non-Executive;

 Managers at Levels 1 & 2, or its equivalent;

 Employees in Finance and Secretarial functions located at the Corporate

Headquarters; and

 Such other employees as may be determined by the CMC from time to

time.

Not An Insider :

So does that mean you are not an insider unless you are on the company's management team,

financial or development teams, or someone hired to handle the material information? In a word,

"No".

The SEC includes in its definition of insiders those who have "temporary" or "constructive"

access to the material information. If the President of a company tells you that the company's

best hope for a breakthrough product isn't going to get regulatory approval, you are now every

bit as much an insider as he is, with respect to that information. It is illegal for him to trade based

on that knowledge before it becomes public knowledge. It is equally illegal for you to do so

because you are now a "temporary insider". This remains true regardless of how many times the

information is passed. If the president tells his barber, who tells her baby sitter, who tells her

doctor, who tells you, the barber, baby sitter, doctor and you are all "temporary insiders".

Anyone who has material information is prohibited from trading, based on that knowledge, until

the information is available to the general public. The US Supreme Court ruled recently, that this

even applies to someone with no ties to the company. Possession of material information makes

you an insider, even if you stole the information.

Window', i.e. the period during which trading in the securities of the Company is prohibited

Designated Employees shall make the disclosures of shares and other securities held in the

Company by them and their dependant family members, to the Compliance Officer.

Significant Penalties :

Sections 10(b) and 14(e) of the Securities Exchange Act of 1934 give the SEC the authority to

seek a court order requiring violators to give back their trading profits. The SEC can also ask the

court to impose a penalty of up to three times the profit the violators realized from their insider

trading.

In addition to the financial penalties, there are criminal penalties. Many now feel those penalties

are not strong enough and are working to increase them substantially. A bill in the US Senate, for

instance, seeks to make defrauding shareholders a felony punishable by up to 10 years in prison.

Manage This Issue :

Police your insiders yourself. Don't allow insider trading. Don't engage in it yourself. It is in your

company's best interest to prevent insider trading so you don't have the SEC investigating you.

Even if the company and all its officers eventually are cleared by the SEC of any wrong doing,

the investigation itself can have lasting detrimental effects on the company.

Don't share material information with anyone who is not an insider. Make sure all insiders

understand the responsibility this places on them. Make sure everyone in the company

understands the circumstances under which they might become "temporary insiders' and how

they must treat that situation.

Digital Global soft and HP ISO were planning a merger in 2003. Samir Arora was the head of equity

investments in India for Alliance Mutual Fund. Samir was aware of the impending merger

announcement and sold shares of Digital Global thereby saving the loss to his company.

Added to this before selling, he made statements of promising returns from the scrip. SEBI ruled

Samir Arora guilty of insider trading. However, when Samir Arora appealed, SAT overruled SEBI on

following grounds: -

(a) Samir could not have known the exchange ratio as it was given in sealed

cover.
(b) Further, Samir sold many other scrips along with Global Soft.

(c) Other research houses had downgraded Digital Soft and recommended sale.

(d) Mere fact that MD of Global Soft and Samir were good friends does not

lead one to believe that Samir had all the inside information.

Despite all the circumstantial evidences, Samir Arora got scot-free because of legalities. There will

not be many cases with better evidences than this case. If the law enforcement agencies are going to

take such lenient view of the offences, this law will also become, as many other laws are, like a

Pomeranian Dog (which barks a lot but never bites and is used only as a decorative pet without any real use),

without any conviction to their credit.

Case Study 2 - Mr. Rajat Gupta:

Rajat Kumar Gupta (born December 2, 1948) is an Indian-American corporate officer and the

current special advisor on management reforms to the Secretary-General of the United Nations.

He is also Chairman of the International Chamber of Commerce, a former independent director

at Goldman Sachs and a former consultant and managing director (CEO) at McKinsey &

Company.
On March 1, 2011, the U.S. SEC levied civil insider trading charges against Gupta. He is

accused of passing along non-public information to the former head of the Galleon Group hedge

funds, Raj Rajaratnam, who is set to go on trial for insider trading. Gupta is described by

regulators as an investor in Galleon funds, as well as a friend and business associate of

Rajaratnam.

Insider trading charges :

On April 15, 2010, the Wall Street Journal reported that federal prosecutors in the United States

were investigating Gupta's involvement in providing insider information to Galleon hedge-fund

founder Raj Rajaratnam during the financial crisis, , specifically about the $5 billion Berkshire

Hathaway investment in Goldman Sachs at the height of the financial crisis in September, 2008.

At an event at ISB in August, 2010, Gupta refused to comment on the charges against him.

Coverage of the event noted that Anil Kumar -- who, like Gupta, graduated from IIT, was senior

partner at McKinsey, and also co-founded the ISB -- had already pleaded guilty to charges in the

same case.

On March 1st, 2011, the SEC filed a civil complaint against Gupta for insider trading. It is

alleged that he illegally tipped Rajaratnam with insider information about Goldman Sachs and

Procter & Gamble. Gupta had served on the boards of both companies and left both boards

respectively as the news of the charges broke. Rajaratnam, it is alleged, "used the information

from Gupta to illegally profit in hedge fund trades.... The information on Goldman made

Rajaratnam's funds $17 million richer.... The Procter & Gamble data created illegal profits of

more than $570,000 for Galleon funds managed by others, the SEC said." Gupta was said to have
"vigorously denied the SEC accusations."

Gupta is being represented by Gary Naftalis of Kramer Levin Naftalis & Frankel LLP in

connection with the charges. Mr. Naftalis "strongly denied that [Gupta had] done anything

wrong" in 2010 when Gupta's name was first mentioned relative to the case, and said the SEC

charges were "totally baseless" in March, 2011. At the later time, Naftalis went on to say "that

Gupta is not accused of receiving anything in exchange for information provided [and that]

Gupta lost his entire investment in Galleon by fall 2008."

"In one instance, the S.E.C. claims that Mr. Gupta discussed with Mr. Rajaratnam confidential

information about Goldman’s earnings results for the fourth quarter of 2008. After a board call

during which Mr. Blankfein and David Viniar, the chief financial officer, previewed the bank’s

awful quarter for the directors, Mr. Gupta is said to have hung up the phone and called Mr.

Rajartnam 23 seconds later. The next morning, the S.E.C. says, Galleon funds sold their

Goldman holdings, avoiding losses of more than $3 million," according to a later March, 2011,

report.

THANK YOU !!