Insider trading- Analysing the Indian Perspective

-Arjun Nihal Singh

Insider trading, the occurrence of which has become rampant in many industrialized
countries, the research seeks to examine the legal mechanism prevalent in India and assess
the extent to which it has been implemented by interpreting cases taken up by the Courts. The
research shall further draw a comparison between the legal frameworks of India and USA
pertaining to insider trading and shall highlight the merits and demerits of each by analysing
cases which have taken place at an international level which have led to the breach of
fiduciary duties by connected persons and mis-appropriation of large amount of funds
involving Raj Rajaratnam, the billionaire founder of the Galleon hedge fund, which is one of
the most controversial and widely deliberated issues in the field of securities regulation
followed by Rajat Gupta’s scam. The research shall also analyse whether India would benefit
from assimilating certain features from the legal system of the United States, and if so which
features would help India strengthen its regulatory mechanism. The study shall be limited to
the laws of these two jurisdictions only. Further, the research will not be delving into the
question of whether insider trading should be legalized or not since that a question more of
economics and less of law.

I. INTRODUCTION

Insider trading, in its essence, means dealing in the securities of a company on the basis of
certain confidential information relating to the company which is not published or not in the
public domain, i.e. ‘unpublished price sensitive information.’ Such information, had it been
published, would have materially affected the price and worth of the securities of that
company and includes information relating to the periodical financial results of the company,
any major expansion plans, new projects, mergers, takeovers, amalgamations, issue or
buyback of securities, significant changes in policy, etc. An ‘insider’ is a person who has
received or had access to such information or is so connected with the company that it is
reasonable to expect that he would have had access to such information. For instance, if the
director of a company, has information that the company has discovered oil on lands owned
by it, before such information is released to the public, and thereafter, in anticipation of the
increase in the market value of the securities of the company once such information is made
public, purchases a large number of shares of the company, he would be guilty of and liable
for insider trading.

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Insider trading, classically involves the breach of a fiduciary duty by the officers of a
company or by connected persons including merchant bankers, share transfer agents, trustees,
brokers, investment advisors, bankers, brokers, sub brokers, etc. Once an insider receives
unpublished price sensitive information by virtue of his position in the company or his
connection with the company, he owes a fiduciary duty to the company not to abuse his
position and misuse such information. Moreover, insider trading also requires an element of
manipulation or deception by the insider i.e. he should have used such information to make
secret profits or unlawful personal gain. Insider trading is considered lawful when the insiders
(i.e. directors, employees, officers, executives) of the Company who are in possession of
price sensitive information, buy or sell securities of their own Company within the confines
of Company’s policy and regulations governing this trade1. The Modus operandi initiates
when insiders act as initiators of price change by receiving the information much earlier than
others. An insider, first of all, buys the stock of the Company at the existing market price. He
then spreads some price sensitive information relating to the Company to select group of
people, who on the basis of such information will buy such stocks and would further spread
the information. When this information reaches a large number of persons, it pushes up the
sales volume and price of the stock. After a certain price of the stock is reached, insider sells
his stock, as do the ones close to him before others do the same. As now everyone tries to sell
his or her stock, its price will fall down. When information is available to everyone, the stock
reaches back to its realistic price level, which results in huge loss to common investors2. The
rationale behind the prohibition of Insider Trading is “the obvious need and understandable
concern about the damage to public confidence which insider dealing is likely to cause and
the clear intention to prevent, so far as possible, what amounts to cheating when those with
inside knowledge use that knowledge to make a profit in their dealings with others3”. SEBI,
the market regulator, has to deal sternly with companies and their Directors indulging in
manipulative and deceptive devices, insider trading etc. or else they will be failing in their
duty to promote orderly and healthy growth of the Securities market. Economic offence,
people of this country should know, is a serious crime which, if not properly dealt with, as it

1
Thummuluri Siddaiah, Financial Services, Pearson Education India, 2011, pg 226
2
Ibid. pg 226.
3
Attorney General’s Reference No.1 of 1988 (1988) BCC 765 cited in Dr. K.R. Chandratre et al., Compendium
on SEBI, capital issues and listing, Bharat Publishing House, 1996, pg 663.

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should be, will affect not only country's economic growth, but also slow the inflow of foreign
investment by genuine investors and also casts a slur on India's securities market.4

II. THE LEGAL REGIME TO CONTROL INSIDER TRADING IN INDIA

Insider trading is extremely detrimental to the growth of a healthy market. Even a small
quantity of securities traded on the basis of inside information may also affect the integrity of
the market5.

The security market in India was developed through the establishment of the Bombay Stock
Exchange way back in 1875. The concept of Insider Trading can also be traced with its
establishment. It was realized that such a system is detrimental to the interest of the Indian
stock exchange6. Before the establishment of Securities Exchange Board of India (SEBI),
Insider Trading was mainly tackled by the provisions under the Companies Act, 1956 that
required disclosure by directors etc. of the Company.

The first governmental effort to regulate Insider Trading was the formation of Thomas
Committee in 1947, which gave its recommendation in 1948 on the basis of which the
provisions relating to Insider Trading were incorporated in the Companies Act, 1956 7 in the
shape of a disclosure requirement. Sections 307 and 308 were incorporated under the
Companies Act as a solution to reduce the problem of Insider Trading. These provisions were
modelled on the basis of Section 195 and 198 of the English Companies Act, 19488. In 1977,
the Sachar Committee was constituted to review the Companies Act, 1956 and the
Monopolies and Restrictive Trade Practices Act, 1969. In its report submitted in 1979, it
stated that unfair profits, can, on occasion, be made in share dealings by the use of
confidential information, not generally available to the investing public, by certain insiders
having access to such price sensitive information. It recommended that amendments be made
to Sections 307 and 308 of the Companies Act, 1956 to prohibit and restrict dealings by
insiders and their relatives.

Thereafter, the High Powered Committee on Stock Exchange Reforms, the Patel Committee,
was constituted in 1984 and in its report submitted in 1986 recommended that the Securities
Contracts (Regulation) Act, 1956 be amended to make stock exchange manipulations
4
N. Narayanan v. Adjudicating Officer, SEBI, AIR 2013 SC 3191
5
Supra n. 2, pg 226
6
Byomakesh Nayak, “An Overview of Insider Trading Regulations in India”, available at
www.airwebworld.com
7
Anand Kumar Tripathi, “The Concept of Insider Trading in India”, CLC/VI/2011, pg.174.
8
Anand Kumar, “Insider Trading and Regulatory Framework in India”, (2011) 3 Comp LJ, pg 118

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including insider trading punishable. Thereafter in 1989, the Working Group on the
Development of the Capital Market, the Abid Hussain Committee, recommended inter alia, a
ban on insider trading and penalty for the same and that the SEBI, be asked to formulate the
necessary legislation which should give it authority to enforce the same. In 1991, a
consultative paper was issued by SEBI which made provisions for the curbing of insider
trading.

In 1992, the SEBI brought out certain regulations which are referred to as the Securities and
Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 [‘SEBI
Regulations’]. There were certain drawbacks in the Insider Trading Regulations as they were
short with only 12 Regulations and were not sufficient to deal with the problem of Insider
Trading, these Regulations suffered from the following major drawbacks, such as the
definition of ‘insider’ given in the Regulations is not happily framed it appears to be an
ambiguous one9,the regulations did not contain any provision prescribing penalty for
contravention of the provisions of the regulations thereof and the power to seize the
documents and to detain suspected offenders/violators under these Regulations10.

Thus these regulations have been amended on a number of occasions, the latest being the
amendments made in the year 2011, wherein, Regulation 13 has been amended to include
Sub- Regulation (2A) and (4A). Under Sub- Regulation (2A) any person who is a promoter or
part of promoter group of a Listed Company is also required to disclose to the Company the
number of shares or voting rights held by such person, within two working days of becoming
such promoter or person belonging to promoter group. Further, Sub- regulation (4A) requires
a promoter or part of promoter group of a listed company to disclose to the company and the
stock exchange where the securities are listed, the total number of shares or voting rights held
and change in shareholding or voting rights, if there has been a change in such holdings of
such person from the last disclosure made and the change exceeds Rs. 5 lakh in value or
25,000 shares or 1% of total shareholding or voting rights, whichever is lower. This
disclosure also has to be made within a period of two days. In the amendments made in 2008
provisions were made to prohibit the practice of insider trading and empower SEBI to
investigate the same including the power to make enquiries and inspections, appoint an
investigating authority which shall submit a report to it, appoint auditors and give directions.

9
Dr. K.R. Chandratre et al., Compendium on SEBI, capital issues and listing, Bharat Publishing House, 1996,
pg 671-672.
10
Ibid.

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It is no longer necessary for person to be connected to the Company to be an insider. Thus, as
per the amended definition, now insider is also a person who holds or has access to price
sensitive information, whether or not he is connected to the Company. Section 15G of the
SEBI Act, 1992 also provides a penalty of twenty five crores or three times the amount of
profits made out of insider trading whichever is higher. Thus, at present the SEBI Act, 1992
and SEBI Regulations together constitute the legal framework in place to combat insider
trading in the securities market. However, surprisingly these Regulations doesn’t define
Insider Trading but the terms ‘Insider’11, ‘Connected person’12, and ‘Unpublished Price
Sensitive Information’13 have been defined in the Regulations. Thus, under the amended
Regulations the definition of ‘unpublished price sensitive information’ was removed and the
terms ‘price sensitive information’ and ‘unpublished’ were separately defined under section
2(k) and 2(ha) respectively14.

The Companies Act, 1956 did not have any express provisions laid down for insider trading
other than section 307 and section 308 but under the Companies Act, 2013 a new section has
been added i.e. Section 19515.

The Companies Act, 2013 prohibits directors and key managerial personnel from
purchasing call and put options of shares of the company, its holding company and its
subsidiary and associate companies as if such person is reasonably expected to have access
to price-sensitive information (being information which, if published, is likely to affect the
price of the company's securities). Earlier these provisions were contained in regulations

11
Regulation 2(e)
12
Regulation 2(c)
13
Regulation 2(k)
14
Lalu John Philip, “Insider trading law – A Critical Analysis”, (2011) 103 CLA (Mag.) 41, pg 42.
15
Section 195: Prohibition on insider trading of securities
(1) No person including any director or key managerial personnel of a company shall enter into insider trading:
Provided that nothing contained in this sub-section shall apply to any communication required in the ordinary
course of business or profession or employment or under any law.
Explanation.--For the purposes of this section,--
(a) "Insider trading" means--
(i) an act of subscribing, buying, selling, dealing or agreeing to subscribe, buy, sell or deal in any securities by
any director or key managerial personnel or any other officer of a company either as principal or agent if such
director or key managerial personnel or any other officer of the company is reasonably expected to have access
to any non-public price sensitive information in respect of securities of company; or
(ii) an act of counselling about procuring or communicating directly or indirectly any non-public price-sensitive
information to any person;
(b) "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 the company.
(2) If any person contravenes the provisions of this section, he shall be punishable with imprisonment for a term
which may extend to five years or with fine which shall not be less than five lakh rupees but which may extend
to twenty-five crore rupees or three times the amount of profits made out of insider trading, whichever is higher,
or with both.

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framed by SEBI, as the capital market regulator. Now, it has also been informed that SEBI
is expected to discuss changes in certain norms for listed firms so as to make them in line
with the rules in the new Act.16
An analysis of the legal regime prevalent in India involves addressing five aspects: firstly, the
scope and ambit of the concept of ‘insider trading’ under the SEBI Regulations as they stand
today and the scope and ambit of the concepts of ‘unpublished price sensitive information’,
‘insiders’, ‘connected persons’ and ‘persons deemed to be connected persons’ which define
the extent and applicability of these regulations; secondly, the procedure to investigate
instances of insider trading and the powers available under the SEBI Regulations to combat
insider trading; thirdly, the disclosure requirements under the SEBI regulations; fourthly, the
requisites as to internal procedure prescribed under the SEBI Regulations; and lastly, the
liability regime prevalent in India to penalise the practice of insider trading. These five
aspects have been dealt with separately hereafter.

III. THE SCOPE AND APPLICABILITY OF THE SEBI REGULATIONS

As aforementioned, first it is essential to examine who would qualify as an ‘insider’ under the
Indian law. Regulation 2(e) provides for the definition of an ‘insider’ which has been defined
in two clauses: firstly, a person who is or was connected with the company or is deemed to
have been connected with the company and who is reasonably expected to have access to
unpublished price sensitive information in respect of securities of a company, and secondly, a
person who has received or has had access to such unpublished price sensitive information.
To qualify within the first clause of the definition, it appears that one must be (a) either a
‘connected person’ within the scope of Regulation 2(c) or a ‘person deemed to be a
connected person’ within the scope of Regulation 2(h) and (b) must be reasonably expected
to have access to unpublished price sensitive information. Regulation 2(c) has defined a
‘connected person’ to include firstly, a director or a person deemed to be a director or
secondly, any person who (a) occupies the position of an officer of the company, (b) occupies
the position of an employee of the company (c) any person who 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 access to unpublished price
sensitive information in relation to that company. It has been further clarified that a

16
http://www.mondaq.com/india/x/270182/Corporate+Commercial+Law (last visited on 6/10/2013)

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connected person means a person who is a ‘connected person’ within the scope of the
definition for a period of six months prior to an act of insider trading.

The parameters of the definition of a person ‘deemed to be a connected person’ have been
even more widely defined and have brought within its ambit a whole range of individuals.
Secondly, the definition has as previously mentioned, by virtue of the 2002 amendment,
brought within its ambit intermediaries17, investment companies, trustee companies, asset
management companies or their employees or directors, or an official of a stock exchange,
clearing house or corporation. Thirdly, the definition specifically brings within its ambit the
following intermediaries: merchant banker, share transfer agent, registrar to an issue,
debenture trustee, broker, portfolio manager, investment advisor, sub-broker, investment
company or an employee thereof, a member of the Board of Trustees of a mutual fund, a
member of the Board of Directors of the Asset Management Company of a mutual fund and
any employee thereof who has a fiduciary relationship with the company. Fourthly, a
Member of the Board of Directors, or an employee, of a public financial institution has been
brought within the ambit of the definition. Fifthly, an official or an employee of a self-
regulatory organisation recognised or authorised by the Board of a regulatory body is also
deemed to be a connected person within the ambit of Regulation 2(h). Sixthly, a relative of all
the aforementioned persons and by virtue of the 2002 amendment all relatives of connected
persons have also been deemed to be connected persons. Seventhly, the banker of the
company has been included within the ambit of the definition. Lastly, by virtue of the Second
Amendment of 2002, Regulation 2(h) has also been stretched to include a concern, firm,
trust, Hindu undivided family, company or association of persons wherein any ‘connected
person’, relative of a connected person or aforementioned categories of persons (one to five),
or the banker of the company have more than 10 per cent of the holding or interest.

It is essential to point out that to qualify as an ‘insider’ within the first clause of Regulation
2(e), in addition to being a ‘connected person’ or a person ‘deemed to be a connected
person’, a person must also fulfil the requisite of being reasonably expected to have access to
unpublished price sensitive information. It has been observed that the segregation of the first
clause of Regulation 2(e) from the second clause has had the effect of bringing even

17
As per Section 12 of the SEBI Act an intermediary includes a stock broker, sub broker, share transfer agent,
banker to an issue, trustee of trust deed, registrar to an issue, merchant banker, underwriter, portfolio manager
and investment advisor.

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‘outsiders’ of the company within the ambit of the ‘insider’ and hence has broadened the
definition beyond its desirable limits.18

IV. WHAT IS ‘UNPUBLISHED PRICE SENSITIVE INFORMATION’?

Before, analysing the provisions of law which determine what exactly would constitute
‘insider trading’, it is important to first establish what exactly constituted ‘unpublished price
sensitive information’. The SEBI regulations as they stand today do not define ‘unpublished
price sensitive information’, as was the case prior to the 2002 amendment regulations, but
define the terms ‘price sensitive information’ and ‘unpublished’ separately. Regulation 2(ha)
defines ‘price sensitive information’ to mean 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. Further, certain information has been deemed to be price sensitive
information firstly, periodical financial results of the company; secondly, intended declaration
of dividends (both interim and final); thirdly, issue of securities or buy-back of securities;
fourthly, any major expansion plans or execution of new projects; fifthly, amalgamation,
mergers or takeovers; sixthly, disposal of the whole or substantial part of the undertaking; and
lastly, significant changes in policies, plans or operations of the company. Further,
Regulation 2(k) has defined ‘unpublished’ information to mean information which is not
published by the company or its agents and is not specific in nature. Further, the Explanation
to the Regulation has specifically clarified that speculative reports in the print or electronic
media would not be considered ‘published information’. Thus, the 2002 amendment sought to
take away the defence which was provided by the un-amended definition i.e. that any
information which was generally known in the media or otherwise could not have qualified as
unpublished price sensitive information.19

V. WHICH ACTIONS CONSTITUTE THE OFFENCE OF INSIDER TRADING?

In order to highlight the functioning of the regulatory mechanism in India and its various
advantages and shortcomings, it is essential to examine the various instances of insider
trading in India and the extent to which the laws which existed at the relevant time were able

18
Parekh, Sandeep, “Insider trading laws should not become a booby trap”, Economic Times, as available on
<http://economictimes.indiatimes.com/markets/analysis/Insider-trading-laws-should-not-become-a-booby-
trap/articleshow/3806148.cms> (last visited on 06/10/2013).
19
Vyas, Amit K, ‘SEBI (Prohibition of Insider Trading) Regulations, 1992: concept of unpublished price
sensitive information radically amended’, Chartered Secretary, The Institute of Company Secretaries of India,
Vol. 32, 2002 (May) 597-9p, 598.

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to keep pace with the growing manipulation in the stock market. In the following paragraphs
an attempt has been made to analyse some of the major insider trading scams which the
country has seen in the last couple of decades.

Since the various concepts that would circumscribe and sculpt the ambit of insider trading
have been elucidated above, the next inevitable question that arises is which acts exactly,
would constitute the offence of insider trading. The answer to this question lies in Chapter II
of the SEBI Regulations on the conjoint reading of Regulations 3, 3A, 3B and 4. Regulation 4
provides that any insider who deals in securities20 in violation of Regulations 3 or 3A shall be
guilty of insider trading. Regulation 3 prohibits certain actions: it provides that no insider
shall, firstly, either on his own behalf or on behalf of any other person, deal in securities of a
company listed on any stock exchange when in possession of any unpublished price sensitive
information; or secondly, communicate or 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. Apart from the
prohibitions in Regulation 3, Regulation 3A specifically provides that no company shall deal
in the securities of another company or associate of that other company while in possession
of any unpublished price sensitive information. However, Regulation 3B provides certain
defences which a company against which proceedings have been instituted on the basis of
Regulation 3A, may avail of. It provides that if the company that entered into a transaction in
the securities of a listed company when the unpublished price sensitive information was in
the possession of an officer or employee of the company, it may plead exception if it can
establish: firstly, that the decision to enter into the transaction or agreement was taken on its
behalf by person(s) other than that officer or employee; secondly, that the company had put in
place such systems and procedures which demarcated the activities of the company in such a
way that the person who entered into transaction in securities on behalf of the company could
not have had access to information which was in the possession of any other officer or
employee; thirdly, that the company had in operation at that time, arrangements that could
reasonably be expected to ensure that the information was not communicated to the person(s)
who made the decision and that no advice with respect to the transactions or agreement was
given to those person(s) by that officer or employee; or lastly, that the information was not so
communicated and no such advice was given. Moreover, it provides that a company which is

20
Regulation 2(d) defines ‘dealing in securities’ to mean an act of subscribing, buying, selling or agreeing to
subscribe, buy, sell or deal in any securities by any person either as principal or agent.

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in possession of unpublished price sensitive information may, in a Regulation 3A proceeding,
take the defence that acquisition of shares of a listed company was as per the SEBI
(Substantial Acquisition of Shares and Takeovers) Regulations, 1997 if the same can be
substantiated with proof.

VI. THE HINDUSTAN LEVER LTD. CASE

The case of Hindustan Lever Ltd. v. SEBI21 was one of the first ever case of Insider Trading
in India where SEBI scrutinized the involvement of a big Company (HLL) on Insider
Trading. This case relates to Hindustan Lever Ltd who was alleged to be involved in Insider
Trading transactions when it purchased 8 lac shares of Brooke Bond Lipton India Ltd
(BBLIL) from Unit Trust of India (UTI) on the basis of unpublished price sensitive
information regarding the impending merger of HLL and BBLIL.

However, SAT reversed the order of SEBI on the ground that proposed merger was
generally known and that and cited press reports which revealed the prior market knowledge
of the proposed merger. The most significant fall out of this case was the subsequent
amendment introduced in the SEBI Regulations, which was aimed at removing the loophole
in the law that any information which was generally known in the media could not constitute
unpublished price sensitive information. The amendment to Regulation 2(k) introduced in
2002, clearly provided that speculative reports in the print or electronic media would not be
considered ‘published’ information.

VII. THE RAKESH AGRAWAL CASE

The case of Rakesh Agrawal v. SEBI22 has been a major milestone in developing the insider
trading laws prevalent in India. This case relates to the alleged involvement of Mr. Rakesh
Agrawal, who was the then Managing Director of ABS Industries Ltd., in Insider Trading
transactions while he had access to the price sensitive information regarding the merger of
ABS Industries Ltd. to Bayer AG. After a detailed consideration of issues and evidence the
SAT found that his intention in acquiring the share was to facilitate the entry of Bayer and
not to gain unfair personal gain. SAT held that although it was true that in the process the
shares purchased at a lower price fetched a higher price when offered in the public offer, this
gain was only incidental, and certainly not to cheat. Thus, SAT held that Rakesh Agrawal

21
[1998] 18 SCL 311 (SAT).
22
[2004] 49 SCL 351 (SAT).

10

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was not guilty of insider trading. SEBI appealed from the decision of SAT to the Hon’ble
Supreme Court which has settled the matter by its consent order whereby Mr. Rakesh
Agrawal has agreed to pay Rs. 48,00,000 towards the settlement23. Also with respect to the
prosecution initiated by SEBI in 2001, the offence was compounded by payment of Rs.
4,90,000 by the accused to SEBI.

VIII. THE SAMIR ARORA CASE

The case of Samir Arora v. SEBI24 was another important case in the evolution of insider
trading laws in India. The case relates back to 2003 wherein Samir C. Arora, the fund
manager of Alliance Capital Mutual Fund was alleged to be involved in Insider Trading
transactions when he disposed off the entire scrip of Digital Global Soft (DGL) held by him
on the basis of the alleged unpublished price sensitive information of the merger ratio of
DGL with HPI (Hewlett Packard)25. It was alleged that based on inside information, Samir
Arora had first moved up the price of the scrip from Rs. 537.55 on 2nd May, 2003 to Rs.
597.25 on May 7, 2003 with certain statements made by him to the Business Standard on
April 30, 2003 which was published on May 5, 2003 and then sold all the holdings of the
funds managed by him over the next four trading days thereby averting a loss of about Rs. 23
crore to the Funds managed by him. The SEBI found that he was prima facie guilt of the
offence of insider trading. SEBI passed orders debarring him from accessing the securities
market for a period of five years.

On an appeal to the SAT, after carefully analysing the contentions of both parties concluded
that the price sensitive information which Samir Arora was alleged to have accessed was not
correct information because the merger was not infact announced on May 12, 2003. It held
that information which finally turns out to be false or at least uncertain cannot be labelled as
information. Thus, it was concluded by the SAT that the sale of securities prior to the board
meeting could only be considered to be based on Samir Arora’s analysis and assessment of
the information available in the public domain.

23
Consent Order dated 23.01.2008
24
[2005] 59 SCL 96 (SAT).
25
Lalu John Philip, “Insider Trading law – A critical Analysis”, (2011) 103 CLA (Mag.) 41.

11

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IX. A COMPARISON BETWEEN THE LEGAL SYSTEMS IN INDIA AND THE
UNITED STATES

It is essential to keep in mind that the two regimes are in such different stages of their growth,
the regime of the United States having evolved considerable over the eight decades, whereas
in India, the regulatory regime is only about two decades old.

Firstly, the regulatory mechanism to curb insider trading in India is under the supervision of
the SEBI. The counterpart of SEBI in the United States of America is the Securities and
Exchange Commission [‘SEC’]. The SEBI and the SEC both have supervisory and regulatory
roles in the mechanisms of both legal systems. In India, there is no separate legislation to
govern insider trading, which is governed by the SEBI (Prohibition of Insider Trading)
Regulations, 1992 and certain provisions of the SEBI Act, 1992, whereas in the United States
of America, the law governing insider trading is predominantly governed by the provisions of
the Securities Exchange Act, 1934 which provides the substantive provisions the violation of
which would give rise to penalty.

The next important aspect of both jurisdictions which must be compared would be whether or
not it is essential for there to be a breach of fiduciary duty for there to arise a liability for
insider trading. In the United States of America, there has been a gradual, yet consistent
demise of fiduciary principles as far as affixing liability for insider trading has been
concerned. The most significant case which emphasized the need for there to be a fiduciary
breach was the decision of the United States Supreme Court in Chiarella v. United States,26
wherein the Supreme Court, clearly held that there was no policy of equal access to
information underlying the securities laws that creates a general duty to disclose material,
non-public information or refrain from trading, and this duty had to stem from a special
relationship between the trader and the shareholders of the issuer corporation. The Supreme
Court’s decision in the Chiarella Case came to be coined the ‘classical theory’ of insider
trading.

In the Indian regime, a similar movement away from the breach of a fiduciary duty
requirement to affix liability has been observed especially after the 2008 amendment. Prior to
the 2008 amendment in Regulation 2(e), the SAT made some interesting observations with

26
445 U.S. 222 (1980).

12

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respect to the fiduciary duty requirement in case of Rakesh Agrawal v. SEBI.27 It observed
that:

“The requirement for establishing a breach of fiduciary duty to successfully make

out a violation of insider trading under Regulation 4 is implicit in the provisions
of Regulation 3, and necessarily needs to be read into the same.

The next essential aspect of both regimes which needs to be compared is the liability of a
person who has traded on the basis of misappropriated information. In the United States of
America, the ‘misappropriation theory’ of insider trading has now come to be widely
accepted i.e. if a person misappropriates material non-public information for the purpose of
trading in breach of a duty of confidence or loyalty, there is a violation of Section 10(b) and
Rule 10b-5.

In India, it would appear that the SEBI has infact even gone beyond the parameters of the
insider trading theories laid down in the United States of America, especially in view of the
2008 amendments. By creating Regulation 2(e)(ii), the SEBI has expanded the liability under
Regulation 3 to any person who may have been in receipt of unpublished price sensitive
information. Thus, in India, it appears to not merely a person who is alleged to have
misappropriated information in violation of any duty or confidence, business or personal,
may be liable, but any person who has ‘received’ unpublished price sensitive information.
Thus, on a conjoint reading of Regulations 2(e)(ii), Regulation 3 and Regulation 4, it appears
that any person in receipt of unpublished price sensitive information who deals in securities
would be liable for insider trading, despite the fact that he may not have breached any duty
either to the company, or to any person who was the source of the information.

Another significant area of controversy in both the legal regimes of India and the United
States is the ‘possession v. use’ i.e. whether liability for insider trading may be affixed if
there is a trade while the insider was in possession of the relevant information or whether it is
essential to prove that the relevant information was actually used in the trade. In the United
States, it was held that it was not necessary to prove a causal relationship between the
misappropriated information and the dealing in securities. The dealing in securities ‘on the
basis of’ material non-public information has been interpreted to mean trading while being
‘aware’.

27
[2004] 49 SCL 351 (SAT).

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In the Indian regime, Regulation 3 adopts the ‘possession’ standard and prohibits an insider
from dealing in securities ‘while in possession of’ unpublished price sensitive information.
The exact position in the Indian regime remains unclear.

The liability regime in both jurisdictions is similar in the sense that both jurisdictions provide
for a criminal liability. However, the law of the United States of America contains various
different provisions with respect to liability which are not found under the Indian law. Under
the Indian regime, Section 15G of the SEBI Regulations provides a civil penalty of twenty
five crore rupees or three times the amount of profits made out of insider trading whichever
is higher.28 The criminal prosecution for insider trading is envisaged in Section 24(1) which
provides for a punishment of a maximum of ten years imprisonment, or a maximum fine of
25 crores or both. Section 24(2) also provides that if the person concerned does not pay the
civil penalty imposed by the adjudicating officer, he may be punished with imprisonment
which may extend to ten years, but which shall not be less than one month, and a fine that
may extend to twenty five crores or both.

In the United States of America, the criminal liability is envisaged in Section 32(a) of the
Securities Exchange Act, 1934 .Under Section 32(a) it is provided that if a person is
convicted of a ‘wilful’ violation he shall be fined upto $5,000,000, or imprisoned not more
than 20 years, or both, except that if not a natural person, a fine upto $25,000,000 may be
imposed. Which now brings us to the landmark case of Raj Rajaratnam, a New York hedge
fund manager, In October 2009, the Justice Department charged him with fourteen counts of
securities fraud and conspiracy. Rajaratnam, who was found guilty on all fourteen counts on
May 11, 2011, had allegedly cultivated a network of executives at, Intel, McKinsey, IBM,
and Goldman Sachs. These insiders provided him with material non-public information.
Preet Bharara, the government’s attorney, argued in the case that Raj Rajaratnam had made
approximately $60 million in illicit profits from inside information. There were many players
i.e Raj Rajaratnam was the manager of the hedge fund Galleon Group, which managed $6.5
billion at its height. Rajat Gupta is a former director at Goldman Sachs and head of
McKinsey consulting. On September 23, 2008, Warren Buffet agreed to pay $5 billion for

28
Under Section 15G, SEBI Act, 1992 liability is incurred by an insider who: (1), either on his own behalf or on
the behalf of any other person, deals in securities of a body corporate listed on any stock exchange on the basis
of unpublished price sensitive information or (2) communicates any unpublished price sensitive information to
any person, with or without his request for such information, except as required in the ordinary course of
business or under any law, or (3) counsels, or procures for any other person to deal in any securities of anybody
corporate on the basis of unpublished price sensitive information. [The apparent disconnect between Regulation
3 and Section 15G has been previously discussed].

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preferred shares of Goldman Sachs. This information was not announced until 6 p.m., after
the NYSE closed on that day. Before the announcement, Raj Rajaratnam bought 175,000
shares of Goldman Sachs. The next day, by which time the infusion was public knowledge,
Rajaratnam sold his shares, for a profit of $900,000. In the same period of time financial
stocks as a whole fell. Rajat Gupta had called Rajaratnam immediately after the board
meeting at which Warren Buffet’s infusion had been announced, and told him of the money
Goldman expected to receive. This information was material to the price of Goldman stock,
thus inciting Rajaratnam to make the trade, something he would otherwise not have done. By
buying 175,000 shares of Goldman stock immediately before the market closed on September
23, 2008, Rajaratnam inflated its price, making this reflect the then-unknown fact that
Berkshire Hathaway would invest $5 billion in the bank. It is clear that Rajaratnam’s actions
caused Goldman Sachs stock to more accurately reflect its true value.29

On a comparison of the regulatory regime in India and in the United States of America, it is
apparent that the regulatory regime in the United States is not only more aggressive, but it has
also evolved significantly over the last eighty years. In comparison, the Indian regulatory
regime is at a nascent stage in its growth.

X. THE LACUNAE IN THE FRAMEWORK AND IMPLEMENTATION OF THE

REGULATORY MECHANISM

The implementation of the regulatory mechanism highlights some significant glitches which
need to be plugged. These have broadly been enumerated hereunder:

Firstly, the definition of ‘insider’ under Regulation 2(e), is conspicuously ambiguous. It

appears from a plain reading of the provision that to prove that one is an insider either of the
two must be established: firstly, to qualify as an ‘insider’ within the ambit of Regulation 2(e)
(i) two elements need to be established: (a) proof of a connection with the entity concerned
(b) a reasonable belief of his having had access to unpublished price sensitive information.
Secondly, to qualify as an insider within the ambit of Regulation 2(e)(ii), although a
relationship with the company is not essential, it is essential to actually prove receipt of the
information. From a prima facie reading, it appears, as though, ‘outsiders’ would also be
within the definition of ‘insider’ under the SEBI Regulations.

29
http://sevenpillarsinstitute.org/case-studies/raj-rajaratnam-and-insider-trading-2 (last visited on 12/11/2013)

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Secondly, there seems to be a disconnect in Section 15G of the SEBI Act, 1992 which
provides the penalty for insider trading. There is a grey areas which appear to emerge on a
reading of this provision, in clauses (i) and (iii) of Section 15G, liability arises when an
insider or a person to whom he has communicated unpublished price sensitive information to
deals in securities, ‘on the basis of’ such information. The phrase ‘on the basis of’ was used
in Regulation 3 prior to the 2002 amendment, after which the phrase ‘on the basis of’ was
substituted with the phrase ‘when in possession of’. However, a similar amendment has not
been made in Section 15G which has given rise to an anomalous situation. Thus, it is unclear
whether mere possession is sufficient to affix liability of insider trading under the Indian law.
thirdly, another area of concern, which has the potential to raise controversy, is the scope and
ambit of what constitutes ‘unpublished price sensitive information’. This is evidenced by the
Hindustan Lever Limited Case wherein it was successfully argued that since certain
information was being speculated by the media, it did not qualify as unpublished price
sensitive information. The amendment of 2002 in Regulation 2(k) has to some extent reduced
this controversy. However, there seems to be a contradiction between the Regulation 2(k) and
the decision of the SAT in the Samir Arora Case. In the case of Samir Arora, it was held that
information which ultimately turns out to be incorrect or uncertain cannot be held to qualify
as ‘unpublished price sensitive information’. However, Regulation 2(k) provides that
‘unpublished’ information means information which is not published by the company, or its
agents, and is not specific in nature. Thus, there seems to be a fundamental contradiction in
this regard between the decision of the SAT and the SEBI Regulations.

fourthly, the most significant predicament which arises is the degree of ‘mens rea’ necessary
to establish a charge of insider trading. The failure to establish the requisite mens rea is a
major dilemma for the enforcing agencies, especially given the covert nature of the offence of
insider trading. A clear example is the Rakesh Agrawal Case wherein it was held to establish
a violation of Regulation 3 it was necessary to prove an element of ‘deceit’ or ‘manipulation’,
which the SEBI was unable to prove in the facts of that case. The SAT specifically rejected
the contention of SEBI that it was not necessary to establish a ‘profit motive’ to establish a
charge of insider trading. Thus, it was clear that the element of mental intent, although not
specifically contemplated by Regulation 3, cannot be ignored for the purpose of establishing
a charge of insider trading.

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Lastly, it is not merely the proof of the existence of a negative mental intent that creates
difficulty in implementation but also the ambiguity in the degree of proof necessary to prove
the facts necessary to establish the offence of insider trading.

XI. CONCLUSION

Thus, the problems in establishing charges of insider trading are largely related to the
unavailability of sufficient proof to establish mental intent and whether or not access to
unpublished price sensitive material was possible in the facts and circumstances of a
particular case. On an analysis of the regulatory mechanism in India, the only conclusion that
can be reached is that the laws prevalent in India are ill-equipped to combat insider trading
and are not conducive to the needs of a rapidly changing economy and corporate structure.
On analysis of the laws prevalent in both countries, it is concluded that the laws in force in
the United States are better equipped than the laws prevalent in India to prevent and penalise
the practice of insider trading. Further elucidated are certain suggestions as to reform the
Indian regime such as

I. The ambit of Regulation 2(e)(ii) of the SEBI Regulations, post the 2008 amendments
have widened the definition of an ‘insider’ beyond its desirable limits and this needs
to be limited.

II. Disconnect between Regulation 3 of the SEBI Regulations, and Section 15G of the
SEBI Act, 1992 must be resolved.

III. The element of Mental Intent has to statutorily incorporated

IV. Affirmative defences for pre-planned trades envisaged in Rule 10b5-1 should be
incorporated into the SEBI Regulations.

V. Indian regulatory mechanism would be able to substantially bolster its enforcement

mechanism if it incorporated a provision along the lines of Section 21A (e) of
Securities Exchange Act, 1934 whereby the SEC has the powers to award bounties to
the extent of 10% of the civil penalties imposed on the insider under Section 21A
(a)(2) to informants who played a significant role in providing information which led
to the conviction of the insider.

Though the legal regime in India would have to develop and evolve significantly. Moreover,
the regulatory mechanism in India must be vigilant to evolve itself to keep pace with the fast

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growing securities market so as to prevent unfair practices like insider trading from
hampering its balanced growth and shaking the confidence of the common investor.

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