A “TERM PAPER” ON
“INSIDER TRADING IN INDIA” SUBMITTED IN PARTIAL FULFILLMENT OF DEGREE OF MASTER OF BUSINESS ADMINISTRATION
DEPARTMENT OF MANAGEMENT STUDIES
Faculty of Commerce and Management Studies J. N. V. University, Jodhpur
Supervised by
Submitted by
Dr. (Mrs.) Swapna Patawari
Swati Surana
MBA, Ph.D.
M.B.A. (Semester 2nd)
CERTIFICATE
FACULTY OF COMMERCE AND MANAGEMENT, JAI NARAIN VYAS UNIVERSITY, JODHPUR.
This is certifying that Term Paper titled
“INSIDER TRADING IN INDIA” Has been satisfactorily completed by
MISS SWATI SURANA As a partial fulfillment of Term Paper work for MASTER OF BUSINESS ADMINISTRATION During academic year 2007-2009
Supervised by
Submitted by
Dr. (Mrs.) Swapna Patawari
Swati Surana
MBA, Ph.D.
M.B.A. (Semester 2nd)
ACKNOWLEDGEMENT
It gives me immense pleasure in submitting this term paper “INSIDER TRADING IN INDIA ”. I am grateful to Dr. (Mrs.) Swapna Patawari Professor, DMS J.N.V.University, Jodhpur under whose guidance I have had privilege of doing this dissertation work. She took an active interest in my work and had an encouraging influence over me. She has been a ladder of inspiration with the concrete support and strength without whom the term paper would not have been completed.
Miss.Swati Surana M.B.A (SEM-2nd)
Chapter Scheme •
Introduction
•
Who is insider?
•
What is Inside Information? When Information ceases to be inside?
•
Price sensitive information
•
How does Insider Trading Work?
•
Who does insider-trading affect?
•
Transactions, which gives indication of insider trading
•
SEBI’s efforts to curb insider trading
•
The Difficulty in framing insider trading Laws
•
Various case studies
•
Finding and Analysis
•
Recommendation and suggestions
•
Conclusion
•
Bibliography
INTRODUCTION: Insider trading is one of the most violent crimes on the faith of fair dealing in a capital market. The scope and stringency of the violation and penalties differ wildly from country to country. Trading by an insider of a company in the shares of a company is not per se a violation of law. For instance, a person (an investigative journalist for example may interview an insider and thus become one) may come across insider information by his perseverance in uncovering a corporate fraud and disclose the fraud. A person can create inside information by his future actions, for instance a future tender offer bidder knows that the price of the target company will go up by his actions. In fact trading by insiders, including directors, officers and employees of the company in the shares of their own company is a positive feature, which companies should encourage because it aligns its interests with those of the insiders. What is prohibited is the trading by an insider in breach of a duty of trust or confidence in the stock of a company on the basis of non-public information to the exclusion of others. Insider trading violations may also include "tipping" such information and securities trading by the person "tipped". If insider trading is allowed unchecked in the capital markets, persons with insider information will have a consistent edge in trades executed with such information and those without the information will be consistent losers on the market. The latter category of people, which includes the vast majority of investors, would slowly realize the loser game they are playing in this ‘market for lemons’ and would believe that all transactions are thus biased against them. Slowly the typical investor would desert the market, retarding or destroying important functions of the stock market like capital formation.
In layman's language, the term "Insider Trading" is about trading with the use of inside information i.e. information that has not yet been disclosed to the public. In the fastest growing capital market system, stock exchanges occupy a very crucial position by enabling the corporate sector to mobilise capital from household savings and channelise such savings into productive areas of investment. The growth of securities market has brought the single most unfair and unhealthy practice viz, Insider Trading, by which persons connected with companies use unpublished price sensitive information to deal
in the securities of a company with a view to make profits or avoid losses by use of such information. Although the precise explanation of Insider Trading is very difficult to define, the following activities of an insider constitute insider trading: 1) Taking advantage of inside information with full knowledge of the facts by dealing for his own account or for the account of a third party, either directly or indirectly, in transferable securities to which the inside information relates; 2) Disclosing inside information to a third party unless such disclosure is made in the normal course of the exercise of his employment, profession or duties. Recommending or procuring a third party to deal in transferable securities. Transferable securities include shares; debt securities; securities equivalent to shares and debt securities; contracts or rights to subscribe for, acquire or dispose of such securities index contracts (i.e. a contract the purpose of which is to secure a profit or avoid any loss by reference to fluctuations in an index); future options and financial futures in respect of such securities. Who is An Insider?
The concept of 'Insider' is very important one, and on this concept only, the whole play of insider trading rests. Broadly, there are two types of insiders—Primary Insiders and Secondary Insiders, A primary insider is a person who has access to inside information by virtue of his relationship to an issuer of securities. While a secondary insider is person who acquires inside information from a primary insider. The characterizations of an insider as any person who possesses inside format ion because he has access to it by virtue of the exercise of his employment, profession or duties, brings out two types of insiders. One is internal insider who obtains inside information in the exercise of his duties as officer or employee of the company. The other one is external insider who obtains information because his connection with the company on account of his employment and profession.
Above explanations of an insider, bring a concluding definition of the insider and that is what explained by Greek law, "a person becomes an insider if he acquires confidential information as a result of offering services under any capacity on a permanent or temporary basis to an issuer or for an issuer". The Securities Exchange Board of India has given a very wide definition, which merely defines an insider as: The term "insider" is defined in clause (e) of regulation 2 as: "insider means any 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, by virtue of such connection, to unpublished price sensitive information in respect of securities of the company, or who has received or had access to such unpublished price sensitive information." The definition has two limbs. The two limbs form the two essential ingredients of the definition, both of which may be split and presented as follows: Insider means any person Who, is or was connected with the company Or
who is deemed to have been connected with the company, And Who is reasonably expected to have access, by virtue of such connection, to unpublished price sensitive information in respect of securities of the company, Or Who has received or had access to such unpublished price sensitive information. In order to brand a person an insider any one of the two tests stipulated in the first limb, and one of the three tests stipulated in the second limb, of the definition must be established. Clause (c) of regulation 2 defines the expression "connected person" and the following persons will be treated as connected persons: •
a director or shadow director of a company,
•
an officer or employee of the company,
•
A person having professional or business relationship with a company, if he may reasonably be expected to have access to unpublished price-sensitive information in relation to that company.
Clause (h) of regulation (2) defines the phrase "deemed to have been connected", these secondary insiders are connected persons, but they are not directly connected with the companies. Person is deemed to be a connected person if such person — (i) is a company under the same management or group or any subsidiary company thereof within the meaning of section (1B) of section 370, or subsection (11) of section 372, of (he Companies Act, 1956 (1 of 1956) or sub-clause (g) of section 2 of the Monopolies and Restrictive Trade Practices Act, 1969 (54 of 1969) as the case may be: or (ii) Is an intermediary as specified in section 12 of the Act. Investment Company, Trustee Company, Asset Management Company or an employee or director thereof or an official of a stock exchange or of clearing house or Corporation; Or
(iii) is a merchant banker, share transfer agent, registrar to an issue, debenture trustee, broker, portfolio manager, Investment Advisor, sub- broker, Investment Company or an employee thereof, or is a member of the Board of Directors of the Asset Management Company of a mutual fund or is an employee thereof who have a fiduciary relationship with the company; (iv) is a member of the Board of Directors, or an employee, or a public financial institution
as defined in Section 4A of the Companies Act, 1956; or
(v) is an official or an employee of a self regulatory organisation recognised or authorised by the Board of a regulatory body; or (vi) is a relative of any of the aforementioned persons; (vii)
is a banker of the company;
(viii)
relatives of the connected person;
(ix) is a concern, firm, trust, Hindu Undivided Family, company or Association of Persons wherein any of the connected persons mentioned in clause 3(1)above this regulation or any of the person mentioned in sub-clause (5) ,(6),(7) here in above has have more than 10% of the holding or interest. Relatives of connected person shall be relative of another, if and only if, (A) They are members of Hindu Undivided Family; or (B) They are husband and wife; or (C) The one is related to the other in the manner indicated below:
⇒ ⇒ ⇒ ⇒ ⇒ ⇒ ⇒ ⇒ ⇒ ⇒ ⇒
MALE Father Son (including step-Son) Father's Father Mother's Father Son's Son Son's Daughter husband Daughter's Son Daughter's Son Daughter's Daughter's husband Brother (Incl.-step-Brother) Sister's husband
⇒ ⇒ ⇒ ⇒ ⇒ ⇒ ⇒ ⇒ ⇒ ⇒ ⇒
FEMALE Mother (Incl. step mother) Sons' Wife Daughter (Incl. step-daughter) Father's Mother Mother's Mother Sons' Son's wife Son's Daughter Daughter's Sons' wife Daughters 's Daughter Brother's wife Sister (Incl. step-sister)
What is Inside Information? When Information ceases to be Inside?
These questions play a pivotal role in insider trading. The CS (ID) Act of UK uses the term unpublished information as inside information, that is to say, the information which is not generally known to those persons who are accustomed or would be likely to deal in the relevant securities. French Law prohibits the exploitation of information before the public has knowledge of it. The ECD defines inside information as, "information which has not been made public of a precise nature relating to one or several issuers of transferable securities which, if it were made public, would be likely to have a significant effect on the price of the transferable security or securities in question. This definition does not seem to be of a satisfactory nature because this definition on the one hand restricts inside information to that 'which has not been made public' and on the other hand it seems to be uncertain whether information ceases to be inside when it is published or when it becomes generally available to investors. Here, the 'information which has not been made public' must not be equated with information, which is not yet published. Further, in this context, it was rightly said in the case of Mitchell v. Taxes Gulf Sulpher Co. that (he information loses its insider status only when a good faith investor acting with due care can obtain knowledge, a point in time which may well be after publication is effected. Materiality or non-materiality of the inside information is fundamental to the very concept of Insider Trading. Information is material only when, if disclosed, its effect on the market price would be likely to be significant. Here, it must be understood that not all information unknown to the public is necessarily inside information, since otherwise managers and employees of undertakings would never be permitted to trade in the securities of their company, as they always possess unpublished information. It is, therefore, not sufficient that the information would influence most investors in arriving at a decision whether to sell or buy but must also be likely have a material effect on the market price of the particular security. The concept of certainty and specificity is related with the concept materiality. The information must be something more than a simple rumor, and must have a minimum degree of certainly.
Price sensitive information 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. The following shall be deemed price sensitive information:— (i) Periodical financial results of the company; (ii) Intended declaration of dividends (both interim and final); (iii) Issue of securities or buy-back of securities; (iv) Any major expansion plans or execution of new projects; (v) Amalgamation, mergers or takeovers; (vi) Disposal of the whole or substantial part of the undertaking; and (vii) Significant changes in policies, plans or operations of the company. (b)
Listing Agreement requires all listed companies to immediately inform Stock
Exchange(s) in respect of the following events, which are considered to be, price sensitive: —
Change in the general character or nature of business
—
Disruption of operations due to natural calamity
—
Commencement of Commercial Production/ Commercial Operations
—
Developments with respect to pricing/ realization arising out of change
in the regulatory framework —
Litigation/dispute with a material impact
—
Revision in Ratings
—
Any other information having bearing on the operation/performance of the
company as well as price sensitive information which includes but not restricted 10; (a) (b)
issue of any class of securities; Acquisition,
merger,
de-merger,
amalgamation,
restructuring,
scheme
of
sub-divisions
of
arrangement, spin off or setting division of the company, etc; (c)
Change
in
market
lot
of
the
company's
shares,
equity shares of the company; (d)
Voluntary delisting by the company from the stock exchange(s);
(e) (f)
Forfeiture of shares; Any action which will result in alteration in the terms regarding
redemption/cancellation/retirement in whole or in part of any securities issued by the company; (g)
Information regarding opening, closing of status of ADR. GDR or any other
class of securities 1o be issued abroad; h) Cancellation of dividend/rights/bonus, etc; Price sensitive information is required to be disseminated to the stock exchange on an immediate and continuous basis.
How does Insider Trading Work? In an insider trading case in 1989, a former stockbroker was convicted of trading based on insider information. He received the insider information about a company “after its president told his sister, who told her daughter, who told her husband,” who in turn told the defendant who traded on the information. This is an example of just how far removed insider information can get.
It is very difficult to express opinion on the extent and magnitude of insider trading in India. During the last five years or so, this practice has almost been perfected so well by the regular players that today it is accepted as part and parcel of the day to day stock exchange operations. Promoters of several new ventures admit, albeit off-1he-record, that they are forced to play into the hands of big brokers by participating in modified forms of insider trading to brighten the market prospects for their issues. Advance knowledge "of an imminent take-over bid. Knowledge of a forthcoming placement of new shares in combination with the implementation of financial recovery programmes, and knowledge of a significant change in the investment policy of a unit trust are some of the examples of insider trading. There are many types of ways of insider trading. Let us take a simple case of bonus issue vis-à-vis insider trading. Suppose A Ltd. is coming out with a bonus issue. The share price of A Ltd. will definitely be affected by such an action of the company. The management personnel who are privy to this information may contract to buy large
quantity of the company's shares directly in their own names or indirectly in the names of their main family members or friends. After this, the information is 'leaked out' so that the general public enters into the market, which will ensure the price to rise. Moreover, advise of brokers, saying to their customers that one must buy the shares of A Ltd., because management of the company is also buying. Such practices bring more and more buy orders and thus lead to substantial increase in prices, and that is what the original 'tip makers' wait for. When this happens, the insiders unload and depart with the cream of appreciation safely. The early investors who had taken the plunge also make some money but, most of the investors have entered the market rather late, they are left in the lunch holding large chunks of shares purchased at high prices. Thus, the majority of the new investors do not gain at all.
Motivated reports strategically published in newspapers and magazines are also one form of insider trading. Several investors act on the motivated reports and suffer their own fate, by the time they realise their mistake the insider has got away with the benefits. Insider trading also takes the form of manipulation. Under the listing agreements entered into by the companies with the stock exchange concerned, the publication of half yearly working results are mandatory. Now the normal practice of dressing the half yearly results in such a manner so as to show a result contrary to the general trend is
very common feature of companies. Suppose, A Ltd. is expected to do reasonably well at the year end, the management of A Ltd. shows almost a break picture for the half year. The individuals close to the management will unload all their holdings a few days before the publication of the results. The common investor of A Ltd. will be watching the share prices coming down. Then the poor half yearly results will be published which will further bring down the prices. After a few months, the insiders will slowly buy back the holdings and spread the news that the company has started doing well and the prospects of (he company are bright. Yet another form of insider trading takes the form of market support provided by the management by resorting to very heavy purchases of its company's shares through various intermediaries. Such practice is particularly used when the company is coming out with a big right issue and the management cannot afford the price to fall below a specified minimum. Generally, after the issue is over subscribed the price comes down and the investor who has subscribed for the new issue realise that the issue was not worth the price paid by him. This aspect of insider trading has almost become a permanent feature of the share market operations of today's corporate world. Such unfair practices are more common and frequent during or near the time of declaration of annual or half yearly profits, bonus or rights issue or issue of convertible debentures, new profits schemes of amalgamations or takeovers etc. Sometimes, insider trading is resorted to by connected persons through speculators or brokers under the benami transactions. Whatever form insider trading may assume, it is obvious that the common investors are the ones who always lose.
Who Does Insider Trading Affect? For understanding the effects of insider trading, it is helpful to categorize the agents involved or affected into several groups. Economic analysis of insider trading typically considers the following parties: insiders, market professionals, liquidity traders, and
Investors, who are defined as follows. Insiders, as defined earlier, are the officers, directors, and other key employees of a firm who, by the nature of their employment, obtain or possess confidential information regarding the firm’s prospects. An example of an insider is the chief executive officer or the chief engineer of the firm. Market professionals are informed non-insiders, including securities analysts, brokers, or arbitrageurs, who have acquired private information regarding the firm’s prospects by spending their own resources and who do not have any fiduciary relationship with the firm. For example, a security analyst may have called the firm’s major customers and learned that they are not interested in buying its new product line. Liquidity traders, sometimes referred to as “noise” traders, are short-term stock market participants who have some, usually negligible, holdings of the firm’s shares and trade in order to hedge risk or balance their portfolios without consideration of a firm’s prospects. An example of a liquidity trader is a large pension fund that buys and sells the firm’s shares from time to time in order to meet the investment and redemption needs of its clients. Investors may be small or large shareholders who have a long-term investment objective such that they “buy and hold.” While not privy to management’s private information, investors have a significant beneficial interest in the firm’s actual performance. For instance, the heir to a substantial holding of the firm’s stock who does not take an active role in its daily management is an investor. Insider trading involves and affects each of the above classes of agents. If insiders were allowed to trade on their privileged information, they would of course reap trading profits. At the same time, insiders who are professional managers may receive reduced compensation from investors to reflect the profits managers can earn from trading. Insider trading also affects liquidity traders, who face the prospects of incurring losses when trading with agents possessing superior information. On the other hand, if they avoid trading, they will lose the diversification/hedging benefits that prompt them to trade in the first place. In addition, insider trading implies that informed non insiders or market professionals face informed competitors in the financial marketplace. The rivalry between informed insiders and informed noninsiders
may drive the latter out of the market, making prices less informative, or, by furthering competition, increase the speed with which information is released to uninformed traders. Insider trading has an impact on investors through its effects on both investors’ trading profits (when they buy and sell holdings for liquidity reasons) and managerial incentives to create value. If insider trading were not prohibited by law, investors, especially large shareholders, would need to decide their firm’s policy toward insider trading. The legal and economic literature on insider trading attempts to weigh the trade-offs discussed above to formulate optimal policies. Different authors focus on different classes of actors and different types of effects. Given the number of classes of actors involved in and affected by insider trading and the multiplicity of effects, differences in focus have led to rather discordant assessments of insider trading and conflicting policy recommendations.
Transactions, which gives indication of insider trading Certain types of transaction can alert securities regulators that the investor who initiated them must have been acting based upon inside knowledge -- in other words, knowing some significant piece of news before the general public. A transaction will be considered suspicious based upon a combination of criteria: •
The timing is just a little too good. Anyone can make an investment at any time, but
someone who buys soon-to-be profitable put options or sells a stock short in the few trading days immediately before a major decline in the stock's price will seem to have been more than ordinarily lucky. This criterion is suggestive when present, but is not mandatory. For example, a short sale could have been made quite some time before it would turn out to be profitable. But the longer in advance a short sale or put-option purchase is made, the more uncertainty there will be as to whether events will play out according to plan; so generally the inside trader doesn't make illicit trades very long in advance. •
The transaction itself is too specific. For example, if someone bought puts on United
Airlines and American Airlines but not on Delta Airlines, investigators will be sure that the
trader knew in advance that these two airlines were targets of the attack. (On the other hand, this works both ways: If there were similar trades in a third airline but not in others, investigators can conclude that one or more flights of that airline were supposed to have been hijacked as well.) •
The transaction is too large. One of the most reliable indicators of illegal insider
trading is that the perpetrator has traded at an abnormally high level. In other words, someone who normally makes trades of a few thousand dollars now and then, but suddenly begins to make much bigger plays, may well be doing so because s/he has some form of inside knowledge. If inside-traders kept their trades to reasonable levels, they would seldom, if ever, be caught -- since their trades would not seem especially abnormal and they could be explained as part of their regular investment strategy. However, people typically get caught up by their own greed: when they know for certain that something significant is going to happen to the price of a stock, they cannot resist the temptation to make as much money as possible on their knowledge. •
Transactions deviate from normal trading levels. In the options markets, there is
normally a reasonably even balance between call and put options on any given stock; and there is normally a reasonably predictable level of activity in options on any particular stock. When the balance between puts and calls is grossly disrupted and the level of volume in options trading is far beyond normal, investigators can be pretty sure that something is up. •
The transaction is too speculative. In other words, the transaction is one that would be
unreasonably risky -- if not out-and-out stupid -- were it not that the perpetrator was trading based upon inside knowledge. For example, a large purchase of stock options that were both significantly "out of the money" and relatively close to their expiration date, but suddenly turned out to be valuable based upon some news affecting the underlying stock, would seem to represent an unreasonable degree of prescience.
SEBI, s efforts to curb insider trading Close period/closed trading window
Close period means the prohibited period specified for trading and dealing in the securities of the company. The Regulations require that dealing in securities of a listed company be prohibited at the time of:(a)
Declaration of Financial results (quarterly, half-yearly and annual)
(b)
Declaration of dividends (interim and final)
(c)
Issue of securities by way of public/rights/bonus etc.
(d)
Any major expansion plans or execution of new projects
(e)
Amalgamation, mergers, takeovers and buy-back
(f)
Disposal of the whole or substantially whole of the undertaking
(g)
Any change in policies, plans or operations of the company.
The 'Close period' should continue upto 24 hours after the information referred to above is made public. The 'close period' could commence from the time of announcement of the meeting of the Board of Directors of a company with respect to all price sensitive information and end 24 hour after the decision of the Board is made public. In case of matters which are not required to be dealt in the Board meeting, the close period should be from the time the preliminary discussions in respect of the matters commence and end 24 hours after the information is made public. Pre-clearance of trades • All directors/officers/designated employees of the company who intend to deal in the securities of the company (above a minimum threshold limit to be decided by the company) should pre-clear the transaction as per the pre-dealing procedure as described hereunder. •
An application may be made in such form as the company may notify in this regard, to the Compliance Officer indicating the estimated number of securities that the designated employee/officer/director intends to deal in, the details as to the depository with which he has a security account, the details as to the securities in such depository mode and such other details as may be required by any rule made by the company in this behalf.
•
An undertaking shall be executed in favour of the company by such designated employee/director/officer incorporating, inter alias, the following clauses, as may be applicable :
(a) That the employee/director/officer does not have any access or has not received “Price Sensitive Information” upto the time of signing the undertaking. (b) That in case the employee/director/officer has access to or receives “Price Sensitive Information” after the signing of the undertaking but before the execution of the transaction he/she shall inform the Compliance Officer of the change in his position and that he/she would completely refrain from dealing in the securities of the company till the time such information becomes public. (c) That he/she has not contravened the code of conduct for prevention of insider trading as notified by the company from time to time. (d) That he/she has made a full and true disclosure in the matter. Compliance Officer The organisation/firm has a Compliance Officer (senior level employee) reporting to the Managing Partner/Chief Executive Officer. The Compliance Officer shall be responsible for setting forth policies and procedures and monitoring adherence to the rules for the preservation of “Price Sensitive Information”, pre-clearing of all designated employees and their dependents trades (directly or through respective department heads as decided by the organisation/firm), monitoring of trades and the implementation of the code of conduct under the overall supervision of the partners/proprietors. The Compliance Officer shall also assist all the employees/directors/partners in addressing any clarifications regarding SEBI (Prohibition of Insider Trading) Regulations, 1992 and the organisation/firm’s code of conduct. The Compliance Officer shall maintain a record of the designated employees and any changes made in the list of designated employees. Other restrictions •
All directors/officers/designated employees shall execute their order in respect of securities of the company within one week after the approval of pre-clearance is
given. If the order is not executed within one week after the approval is given, the employee/director must pre-clear the transaction again. •
All directors/officers/designated employees shall hold their investments in securities
for a minimum period of 30 days in order to be considered as being held for investment purposes. The holding period shall also apply to subscription in the primary market (IPO’s). In the case of IPO’s, the holding period would commence when the securities are actually allotted. • In case the sale of securities is necessitated by personal emergency, the holding period may be waived by the compliance officer after recording in writing his/her reasons in this regard.
The Difficulty in framing insider trading Laws Specific information v general information: Generally, inside information is that which is likely to materially affect the price of securities if it were public. The problem here is drawing the line between specific information and mere hunches based on rumors or guesswork and research or fact-finding on commercial or economic trends or businesses.
Sanctions: Sanctions may be civil or criminal or both. Any form of sanction runs into the difficulty of identifying the insider and obtaining the necessary discovery, especially if the insider arranged the transactions from abroad through a bank that raises the bank secrecy defense against foreign. A further problem with civil liability arises from the fact that there is no relationship between the insider dealer and his counterpart in the market. It is not practicable to show which counterpart dealt with the insider amongst the many transactions that may have taken place between the time the insider dealt and the time the inside information became public. If the insider were to be liable for losses to all counterparts in the market (e.g. the difference between the price with and without the information) then the liability could be vast and disproportionate to the offense. In the Texas Gulf Sulphur case it has been estimated (as opposed to an actual
award) that the liability to sellers of the shares was in the region of US $ 350 million - that is US$ 150 million more than the net worth of the corporation.
Conflict of duties Conflict of duties often arises when dealing in securities. When directors told a broker that the dividend would be cut. If the broker sold the company’s stock for his client’s price sensitive information, there may be a conflict between his duty not to trade and his duty to act in the best interests of his customer. The prohibition on insider trading is usually overriding. The broker was liable notwithstanding that he had a conflicting duty to do his best for his clients.
Share price of XYZ co. Will go down because of bad financial results. Therefore, you sell the stock.
Negative profits Generally, where an insider holding securities is influenced not to sell because of inside information and thereby avoids a loss, it is impracticable to impose liability because of the
difficulty of proving intent to sell which was subsequently doused by the inside information. In the US, the plaintiff must have purchased or sold a security. Thus, a counter party has no claim where he refrains from doing anything but would have dealt if he had known. Therefore, a defendant who suffers a loss when insiders sell on unfavorable news and the price falls as a result may have no standing since he did not sell.
Intent Intent is usually an important factor in establishing guilt. There must be actual knowledge by the insider that he is an insider and that the information is inside information, i.e. the insider dealing must be knowing and deliberate.
Exemption for stabilization: Stabilization is essentially insider trading because the managers are dealing in bonds while in the possession of insider information. As they knew the market’s reaction to the original invitations. The main purpose of stabilization is to even out the market in the primary distribution period so that it reflects the real value of the securities and not speculative dealings.
Territoriality A major problem for the control of insider dealing is the territorial scope of the prohibition. If the prohibition is strictly territorial it is a simple matter for the insider to trade from abroad or on a foreign stock exchange - through a dummy company if necessary. As regards the UK position, the CJA applies (in the case of dealing) where the individual was in the UK when he did an act constituting or forming part of the offense or where the regulated market or professional intermediary is in the UK. In the case of offenses of disclosing inside information, or encouraging insider dealing, the offense is committed if the individual or the recipient was in the UK when the disclosure or encouragement took place. The US Rule applies where the fraud is achieved “by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange”. Insider dealing abroad may be subject to US jurisdiction if the fraud has an effect on the US securities markets.
HLL-BBLIL Merger versus SEBI
"...it can be conclusively said that while entering into the transaction for purchase of 8 lakh shares of BBLIL from UTI, HLL was acting on the basis of the privileged information in its possession, regarding the impending merger of BBLIL with HLL. It also may be stated that, by its very nature, when it comes to motives and intentions, there may not always be any direct evidence. However, the chain of circumstances, the timing of the transaction, and other related factors, demonstrates beyond doubt that the transaction was founded upon and effected on the basis of unpublished price sensitive information about the impending merger." - Excerpt from SEBI order that tried to establish an insider trading case against HLL management.
THE BACKGROUND The HLL-BBLIL merger announcement was made on April 19 1996. But the two stocks especially that of BBLIL, started seeing heightened activity from February itself. The BBLIL stock was quoting at Rs. 242.00 in end January, with average daily volumes of around 16,000 shares. By the end of February, the stock had shot up to Rs. 341.00 and 45,250 shares were
traded on the last trading day of that month; the average price and trading volumes that month were Rs. 304 and 30,315 shares respectively. The story was the same in March, with the average price increasing to Rs. 349.00, but the trading volumes dipped to 10,000 shares. By the time the merger announcement was made in April, the stock had reached stratosphere. When the merger was announced on April 19, 1996, the Bombay Stock Exchange had a trading holiday and the market had to wait until Monday before reacting. But even a couple of days before that, on April 18 1996, the price dropped marginally to Rs. 402.00 and the trading volume was 88,150 shares. And here comes the crucial part. When the market opened on April 22, after the formal announcement, the stock dropped sharply to Rs. 368.00, and, more important, volumes halved at 35,650 shares, displaying a clear waning of interest in stock. By the end of May 1996, the BBLIL stock had gone out of favour, with the average daily price for that month dropping to Rs. 338.00 and the trading volumes a mere 8,129 shares. Trading in the HLL stock too exhibited a similar pattern. The stock closed in January with an average price of Rs. 628.00 and average volumes of 9,291 shares. By the next month, interest had heightened and the stock closed in February with an average price of Rs. 696.00 and trading volumes of 25,085. March witnessed lower volumes at 12,458 but the price increased marginally to Rs. 698.00. As in the case of BBLIL, the HLL stock gathered momentum in April. A couple of days before the announcement, the stock price shot up to Rs. 795.00 and nothing less than one lakh shares were traded on that day compared to the average trading volumes of just around 15,000 till then. On April 18, the stock had declined to Rs. 780.00 while the volumes dropped steeply to 14,950 shares, possibly anticipating the formal announcement the next day. And once trading resumed after the merger announcement, on April 22, 1996 the stock dropped to Rs. 755.00 and the trading volume to just 9,400 shares. THE SEBI CHARGE: HLL is an insider, according to Section 2 (e) of the SEBI (Insider Trading) Regulations. It states "An insider means any person who is, or was, connected with
the company, and who is reasonably expected to have access, by virtue of such connection, to unpublished price-sensitive information." The SEBI has argued that both these conditions were met when HLL bought the BBLIL shares from the UTI. HLL and BBLIL had a common parentage--as subsidiaries of the London-based $33.52-billion Unilever--and were then under a common management. Thus, HLL and its directors had prior knowledge of the merger. THE HLL DEFENCE: No company can be an insider to itself. The transnational knowledge of the merger was because it was a primary party to the process, and not because BBLIL was an associate company. To buttress this point, HLL maintains that if it had purchased shares of Tata Oil Mills Co. (TOMCO) before the two merged in April, 1994, SEBI would not consider it a case of insider trading. Why? Because HLL was not associated with the Tata-owned TOMCO. HLL contends that it purchased the BBLIL shares so that its parent company, Unilever, could maintain a 51 per cent stake in the merged entity. Before the merger, Unilever had a 51 per cent stake in HLL, but only 50.27 per cent in BBLIL. According to the SEBI guidelines, HLL can be deemed an insider. But the SEBI's definition of an insider has to be fleshed out by it to provide a clearer picture. THE SEBI CHARGE: HLL purchased, the BBLIL shares on the basis of unpublished pricesensitive information which is prohibited under Section 3 of the Regulations. Section 2 (k) (v) states that unpublished, price-sensitive information relates to "the following matters (amalgamations, mergers, and takeovers), or is of concern to a company and is not generally known or published " According to the SEBI, there can be no dispute that the information of the overall fact of the merger falls under this definition. THE HLL DEFENCE: Only the information about the swap ratio is deemed price-sensitive. And this ratio was not known to HLL-or its directors-when the BBLIL shares were purchased in March, 1996. The two audit firms, S.S. Billimoria & Co. and M.N. Raiji & Co., recommended the ratio to the HLL board only in mid-April 1996. Moreover, HLL argues that the news of the merger was not price-sensitive, as it had been announced by the media before the companies' announcement, April 7, 1996). HLL also points out that it was a case of a
merger between two companies in the group, which had a common pool of management and similar distribution systems. Therefore, the merger information in itself had little relevance; the only thing that was price-sensitive was the swap ratio. HLL made a notional profit of Rs 4.37 crore on the transaction. THE SEBI CHARGE: Why did HLL not follow the route of issuing preferential shares to allow Unilever's stake to rise to 51 per cent in HLL? As per the SEBI chargesheet: "Such a step would have involved various compliances/clearances, and required Unilever to bring in substantial funds in foreign exchange." The implication: HLL depleted its reserves to ensure that Unilever did not have to bring in additional funds. THE HLL DEFENCE: Issuing of preferential shares would have, indeed, been a cheaper option to ensure that Unilever had a 51 per cent stake in HLL. Had HLL followed this route, it would have had to pay Rs 282.35, instead of Rs 350.35, per share. In other words, it would have made a profit of Rs 5.41 crore by doing so. HLL also states that while the preferential route would have been beneficial for itself, it would have been dilutory for other shareholders since it would have resulted in an expanded capital base, leading to a lower earnings per share in the future. HLL was probably worried that the clearances for a preferential allotment from the SEBI and the Reserve Bank of India (RBI) would take their time in coming-or may not be given at all. It had already faced a time-consuming and expensive run-in with the RBI during the HLLTOMCO merger in 1994. THE SEBI CHARGE: Levers cancelled the entire holding of HLL in BBLIL. THE HLL DEFENCE: HLL was upfront that its entire holding in BBLIL--1.60 per cent-including the lots purchased from the UTI would be cancelled after the merger in March, 1997. HLL maintains that this is perfectly legal. In addition, shareholders of both HLL and BBLIL approved of the cancellation of shares as part of the merger scheme. Says Iyer "By this process of cancellation, which normally happens in every amalgamation, the voting rights of Unilever have gone up. However, so have the voting rights of other shareholders. So, no exclusive benefit--profits or avoidance of loss--has accrued to HLL or Unilever."
By extinguishing the shares, HLL wanted to maintain Unilever's shareholding at 51 per cent and not realise any financial gains. However, Section 3 defines insider trading irrespective of whether profits are made or not. SEBI’S ORDER In the first-ever case of insider trading, SEBI has ordered HLL to compensate UTI by paying Rs. 3.04 crores and launched criminal prosecution proceedings against HLL and five of its directors, Mr. S.M. Datta, Mr. K.B Dadiseth, Mr. R. Gopalakrishnan, Mr. A. Lahiri and Mr. .M.K. Sharma. After detailed investigations, which included the recording of the statements of some of the directors of HLL, BBLIL and an officer of UTI, the findings of the investigation were communicated to HLL and its directors. According to these findings, prima facie, it appeared that HLL was an insider as it purchased eight lakh shares of BBLIL prior to the announcement of the merger of BBLIL with HLL on April 19, 1996 on the basis of unpublished price-sensitive information, and HLL had violated the regulations prohibiting insider trading. Subsequently, a personal hearing was given to HLL and its directors. Their written submissions were received. In view of this, SEBI had passed the order that HLL had a profit of Rs. 3.04 crores calculated on the basis of the difference between the market prices of the shares of BBLIL sold by UTI to HLL after the announcement of the merger and prior to the announcement of the merger (excluding premiums)”. Excluding a premium of around 10 per cent for jumbo deals in shares, the pre-merger market price was Rs. 318.00 plus 10 per cent premium and the post-merger price taken into calculation by SEBI was Rs. 356.00 plus 10 per cent as on December 1996, SEBI officials explained. Later, UTI filed an appeal with the appellate authority, claiming a higher compensation of Rs. 7.52 crores. It pleaded that it had to incur a notional loss, as it was not aware that a merger of the two Unilever group companies was on the cards. APPELLATE AUTHORITY REJECTS THE CASE The Appellate Authority in the Finance Ministry set aside the order of prosecution initiated by the SEBI against HLL and the five common directors in both HLL and BBLIL. The two member Authority, consisting of the Finance secretary. Mr. Montek Singh Ahluwallia and the
special secretary (Banking) Mr. C.H. Vasudev, in its judgment on July 14, 1998 said the SEBI was not justified in ordering prosecution against HLL and five of its directors. The Authority has also pointed out that SEBI has not chosen to use 15 G of the insider trading regulations for imposing a penalty but instead decided to use omnibus powers under section11 and 11B of the Act to adjudicate for awarding compensation. Use of omnibus powers for imposing a pecuniary burden cannot be the intent of laws. Therefore, it felt that the order of SEBI to award compensation to the UTI suffers from procedural deficiencies as well as locks in jurisdiction. Also, they expressed surprise to the fact that the UTI did not chose to approach SEBI in the first instance soon after it felt that the HLL, because of insider trading, had gained an unfair price advantage in the purchase of BBLIL shares from the UTI. Thus, the decision of the UTI to file an appeal on the quantum of compensation after SEBI has so motto accorded compensation to it, appears to be an afterthought. Therefore, given their finding with regard to jurisdictional competence of SEBI to award compensation, they did not consider it necessary to pass any separate order on the appeal filed by UTI. Further, the order said that there is persuasive evidence, which points towards market knowledge and undesired speculation about the possibility of the merger before the purchase of shares, in question by HLL from UTI. What weakens a crucial aspect the charge of insider trading that the information involved should not be generally known? On the information about the merger, the Authority has said that there was a case of merger of two healthy profit making companies, having a similar management culture. The Appellate Authority orders neither contest the fact that HLL is an insider nor that the merger’s information was price sensitive. HLL has been free from the charge of insider trading on the basis that merger of HLL and BBLIL was published in number of press reports. The appellate authority substantiated its order by giving a list of publications, which carried the news during that period. The authority was of opinion that on basis of press report and market speculation UTI could have acted more carefully. They were of the opinion that UTI was not market savvy.
SEBI MOVED THE COURT AGAINST ORDER SEBI moved to the court against the order of Appellate Authority on the HLL case. The case was pending in the metropolitan magistrate’s court for three years. Finally, SEBI approached Mumbai High Court complaining inordinate delay in September 2002. The Mumbai High Court directed the metropolitan magistrate to proceed on the case without delay. HLL defended its position by quoting the July 1998 order of Appellate Authority. “We hold that SEBI was most unjustified in ordering prosecution of the appellants (HLL)”. HLL made an application to magistrate, that summon should not be issued before the company is heard. However, Mumbai High Court quashed this application on the ground that the company could not be heard before the summon is issued. The case is still pending in the court. Winning and loosing the case is not significant in the whole incident. This case is important because it generated a detailed discussion on the legal and moral nature of insider trading and deep issues of corporate governance.
Hitech Drilling Services India (HDSI) Another, less clear-cut case, is that of Hitech Drilling Services India (HDSI). Aban Lloyd Chiles Offshore Limited made a bid to buy shares of HDSI from Tata, with the deal to be publicly announced on March 18, 2001. In the days leading up to March 18, SEBI observed unusually active trading of HDSI stock on the Bombay Stock Exchange and the price of HDSI stock rose from an average of Rs 35 in January and February to Rs 50.70 on March 16. So far, no action has been taken against anyone in this case. Similar patterns of price increases prior to a public announcement of a merger have been observed in the UTI Bank-Global Trust Bank merger. Therefore, despite the efforts of the Indian authorities to combat insider trading, the practice remains extremely common.
Profiting from disaster 9/11
In the wake of the terrorist attacks, which caused the destruction of the Twin Towers of New York's World Trade Center, damaged the Pentagon, and destroyed four large airliners with all aboard, securities-exchange investigators on three continents are poring over trading records to determine whether one or more parties profited by their advance knowledge of the disaster. An event as dramatic and large in scale as the Black Tuesday attacks had a severe and far-reaching effect on worldwide stock markets. This effect is somewhat like the impact of a stone thrown into a pond: There are certain specific companies which are strongly and immediately affected by the attacks; others which are affected more weakly and indirectly; some which decrease in value only because of a general feeling of pessimism rather than because of any direct impact on their bottom line; and some which may even increase in value because they are seen as a "safe haven" in uncertain times, or because they may gain business from an upcoming armed conflict.
Another way of looking at this "ripple" effect of insider trading is that the farther away a company is from the center of the impact the greater the odds that it would emerge unscathed had the attacks' impact been less horrendous than it was. The obvious members of the "first circle" of companies strongly affected by the attacks are American Airlines and United Airlines, the two companies whose planes were hijacked and used as flying bombs in the attacks on New York and Washington. These companies' stocks would have decreased in value as a result of any hijacking incident involving their planes, even one with a peaceful resolution. The same is true to a lesser extent of other airline companies, Boeing (the principal private manufacturer of airliners), and other companies that provide equipment and services to the air-transportation industry. The next circle includes companies that would weather a "normal" hijacking incident relatively unscathed, but would be significantly affected by a more violent attack. These include the insurance and reinsurance companies, which must cover the damage, as well as firms with a major presence in or near the Twin Towers. The general stock market -- the "third circle" in our analogy -- would not be strongly affected by a "peaceful" hijacking, but would be by a more violent one. It could be argued that even the Black Tuesday attacks as they occurred were not sufficient to cause a really bad "market break" -- while the decline of the Dow Jones Industrial Average on the first day of trading after the disaster was the largest on record in absolute terms, it was not one of the top ten historical declines in relative terms. Had the attacks been more completely successful -- for example, had the fourth plane preceded to Washington and crashed into the White House or the Capitol -- the overall market would surely have suffered a much worse crash. To understand what might have happened, it is worth comparing the market's performance immediately post-Black Tuesday, when the Dow Jones Industrials dropped by about seven percentage points, and the 1987 market crash, when the Dow dropped by over 22 percent in one day even though there was no obvious external reason for it to so.
Investigators will be looking at transactions starting with those that can be most easily identified as suspicious. Already enough has emerged to indicate that some trades were almost certainly made based upon advance knowledge of the Black Tuesday attacks:
•
Between September 6 and 7, the Chicago Board Options Exchange saw purchases of
4,744 put options on United Airlines, but only 396 call options. Although there was no news at that time to justify so much "left-handed" trading, United Airlines stock fell 42 percent, from $30.82 per share to $17.50, when the market reopened after the attacks. Assuming that 4,000 of the options were bought by people with advance knowledge of the imminent attacks, these "insiders" would have profited by almost $5 million. •
On September 10, 4,516 put options on American Airlines were bought on the Chicago
exchange, compared to only 748 calls. Again, there was no news at that point to justify this imbalance; but American Airlines stock fell 39 percent, from $29.70 to $18.00 per share, when the market reopened. Again, assuming that 4,000 of these options trades represent "insiders," they would represent a gain of about $4 million. •
No similar trading in other airlines occurred on the Chicago exchange in the days
immediately preceding Black Tuesday. •
Morgan Stanley Dean Witter & Co., which occupied 22 floors of the World Trade
Center, saw 2,157 of its October $45.00 put options bought in the three trading days before Black Tuesday; this compares to an average of 27 contracts per day before September 6. Morgan Stanley's share price fell from $48.90 to $42.50 in the aftermath of the attacks. Assuming that 2,000 of these options contracts were bought based upon knowledge of the approaching attacks, their purchasers could have profited by at least $1.2 million. •
Merrill Lynch & Co., with headquarters near the Twin Towers, saw 12,215 October
$45.00 put options bought in the four trading days before the attacks; the previous average volume in these options had been 252 contracts per day. When trading resumed, Merrill's shares fell from $46.88 to $41.50; assuming that 11,000 option contracts were bought by "insiders," their profit would have been about $5.5 million. •
European regulators are examing trades in Germany's Munich Re, Switzerland's Swiss
Re, and AXA of France, all major reinsurers with exposure to the Black Tuesday disaster. (Swiss Re estimates that its exposure will be $730 million; Munich Re expects to pay out as much as $903 million.) It is not clear if any trades in these stocks ring alarm bells; and some negative earnings news announced shortly before the attacks means that a certain amount of unusual selling may have been a normal market reaction and not anything more sinister.
•
Amsterdam traders have noted that there was unusual trading activity in KLM Royal
Dutch Airlines put options before the attacks. This is very much a developing story, and we can be sure that more and more accurate numbers will emerge soon. Investigators will be examining transactions starting with the few days immediately before the attack, and then working backwards; and similarly, they will be looking first at trades in the most obviously affected securities.
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Assuming that investigators are convinced that trades were made based upon advance knowledge of the attacks, they will obviously try to trace these trades back to determine who initiated them. Obviously, anyone who had detailed knowledge of the attacks before they happened was, at the very least, an accessory to their planning; and the overwhelming probability is that the trades could have been made only by the same people who masterminded the attacks themselves. The difficulty, of course, will be in tracing the transactions to their real source. The trading is sure to have been done under false names, behind shell corporations, and in general to have been thoroughly obfuscated. If in fact the Black Tuesday attacks -- and the associated securities transactions -- were made under orders from Osama bin Laden, then we are dealing with an expert in masking ownership of corporations and making covert deals. This does not mean that unraveling the threads of these transactions will be impossible, but it probably will not be quick or easy. The matter still is under investigation and none of the government investigating bodies -including the FBI, the Securities and Exchange Commission (SEC) and DOJ -are speaking to reporters about insider trading. Even so, suspicion of insider trading to profit from the Sept. 11 attacks is not limited to U.S. regulators. Investigations were initiated in a number of places including Japan, Germany, the United Kingdom, France, Luxembourg, Hong Kong, Switzerland and Spain. As in the United States, all are treating these inquiries as if they were state secrets.
BoM-ICICI Bank merger
In1999-2000 Bank of Madura and ICICI Bank merger was preceded by some interesting trading patterns that suggested the possibility of informed trading in the homestretch to the corporate action. The Bank of Madura's (BoM) stock had been hitting circuit-breaker for quite a few days and in a short period of time, it had appreciated more than 50 per cent. The news driving the price was the BoM's proposed merger with the ICICI Bank and the market expectation of a minimum swap ratio of around 1:1. These were the swing in the share prices of the BOM, ICICI bank which was showing high variation.
The ratio eventually turned out to be 2:1 (two shares of ICICI Bank every share of BoM). Considering BoM's small equity base of Rs 11.80 crore against ICICI Bank's Rs 196.80 crore, a swap ratio of 2:1 would have little impact on the ICICI Bank's equity, but it would considerably improve the bottomline. When the announcement of merger was made, the market had no clue about the swap ratio. After all, the merger of two banks is not unusual and the stock price responding to such news is also a sign of market efficiency. However, insiders and those connected with the merger play the game of insider trading on such occasions. Certain unusual trading before the formal announcement of the swap ratio, and the role of regulating agencies assumes importance in examining the issue in the context of insider trading, and develop public investors' confidence.
The Securities and Exchange Board of India (SEBI) had a regulation to prevent and punish insider trading. While efforts were made to fine-tune the regulation, as SEBI till the data did not book any major case on insider trading. Its earlier attempts on investigating insider trading in BBLIL and HLL merger, and Reliance Industries did not yielded any significant results. Using the available public information on stock price changes, the number of shares traded, the number of trades and the ratio of swap, it was pointed out the specific dates on which certain abnormal trading took place at a volume higher than average volume of the period. The Table gives the details of BSE trading statistics relating to the BoM stock.
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The analysis of Table showed a sudden spurt in volume per trade in September and October along with increased volume of shares for the month. A further analysis of the daily trading data shows the volume on two days (September 20 and October 6) increased suddenly. The BoM counter registered a volume of 44,650 shares on these two trading days on the BSE at an average price of around Rs 74. The issue was who were the investors taking sudden interest on BoM's stock on those two days. If these investors had known the swap ratio of two
ICICI shares for one BoM share, which the banks would announce on next Monday, the profit potential would be more than Rs 200 per share. In other words, the net gain available out of these trades would be Rs 89.30 lakh. Another important date was December 6, two days before the formal announcement on the merger. On this day, on the BSE, 58,7970 shares were traded in just 67 trades at an average price of Rs 98.18. The average volume per trade was 8,775 shares against the normal volume of 100 per trade. The total volume traded on the BSE from July to November was 90,230 stocks against the 5,87,970 stocks traded on December 6. There was abnormal trading on the NSE too that day. What was the motive behind such a trade on the BSE? Who were the buyers and, more particularly, the sellers? Was there any party, which knew of the merger deal and the swap ratio and influenced a PSU bank or a mutual fund to sell the shares at the current market price for such a block deal? These were all the questions that lead SEBI to investigate the case. With the current price of ICICI Bank's share, the profit from this deal is Rs 13.52 crore. Insider trading did not stop with the formal announcement of the proposal of a merger. For, there emerge two sets of investors in the market. The first has only the information in the public domain about BoM and ICICI Bank. The other has information about the swap ratio,The profitability due to price differential between the two stocks is known to the second set. The investor’s privy to the swap ratio can continue to do such deals. Though SEBI's attention was particularly drawn to investigate the trades of those periods, no public report is available if SEBI investigated the deals to examine the insider-trading issue. SEBI action: It is high time SEBI signaled strongly to the capital market regarding insiders' trading. ---It asked the stock exchange members to furnish the names of investors on whose behalf the buying took place on days when the volume was higher than the average during a period. ---It investigate these investors' connections with the top management of ICICI Bank/BoM, advisors to the merger scheme, the independent valuer of the swap ratio and all others specified by SEBI's insider-trading regulation.
However, SEBI put its hand on this case as early as possible but as and now no outcome has come and the case is still pending in the court.
Insider Trading at Texas Gulf Sulphur Company Insider trading not only concerns scholars and regulators but also attracts the attention of the general public. To get a practical idea of insider trading, consider the famous Texas Gulf Sulphur Company case .Texas Gulf Sulphur Company was established in 1909.In 1959 its exploratory prospecting with magnetic surveying equipment produced some evidence that valuable deposits of copper, zinc, and silver might exist in an area of Ontario. In 1963, the first drilling confirmed the possibility, and the commercial value of the find proved to be enormous. The company instituted tight control of the drilling project so as not to leak the information to outsiders .Meanwhile, various officers, directors, and employees of the company, knowing this information and the fact that it was not released to the public, bought shares of, and call options of, Texas Gulf Sulphur Company or were given stock options by the company and tipped other people to purchase the stock or options of the company. These activities happened between November 12, 1963, and April 16, 1964, a period when the stock prices of Texas Gulf Sulphur Company were relatively low due to its lackluster performance in business. Rumors about the company’s discovery surfaced and became rife in mid-April 1964. By then the stock price had risen to $29.375 from $17.375 on November 10, 1963. On April 12, 1964, the company made an announcement, which the Security Exchange Commission (SEC) later accused of misleading the public, that the company’s drilling had “not been conclusive” and “the rumors about the discovery were unreliable premature and possibly misleading,” and originated with speculators not connected with the company. Four days later, on April 16, 1964, however, the company announced “a major ore discovery” of about 25 million tons of copper, zinc, and silver. The stock price jumped to $71 on April 19, 1964. Those who had purchased or acquired stocks and options before this date reaped substantial financial gains.
In April 1965, the SEC filed a suit in the United States District Court against a number of individual defendants who were directors, managers, and employees of Texas Gulf Sulphur Company. The charges were based on the defendants’ violation of Rule 10(b)-5 of the Securities Exchange Act of 1934 for” engaging in the purchase and sale of securities on the basis of information with respect to material facts relating to Texas Gulf acquired by said defendants in the course of their corporate duties or employment with Texas Gulf which information had not been made available to Texas Gulf, its stockholders and other public investors; (b) making available such information, directly or indirectly, to other persons for the purpose of permitting or allowing such other persons to benefit from the receipt of such information through the purchase and sale of securities; and (c) engaging in other conduct of similar purport and object.” The SEC won the case.
Infosys fines its CEO for violating insider trading rules Infosys is not only an IT bellwether; it is also an ethical bellwether. The company, in perhaps the first instance in India, has fined its CEO Kris Gopalakrishnan for a technical violation of its insider trading rules. The fine, Rs 5 lakh, would be donated to charity. Besides the CEO, an independent director, Jeffrey Lehman, also has been fined $2,000 for the same violation. This is the third time that Infosys has punished a member of its top brass. Earlier, it had imposed a penalty on its director Srinath Batni. In a notice to the US SEC, Infosys said Mr. Gopalakrishnan had inherited 12,800 equity shares from his mother on December 24, 2007 but had inadvertently failed to notify the company within one business day after the change in his shareholding. This, according to the company, constituted a violation of its insider trading rules. . But Infosys’ audit committee believed that Mr. Gopalakrishnan had no intention of contravening the rules and imposed the penalty of Rs 5 lakh and directed him to donate the amount to a charitable organisation of his choice. Mr. Gopalakrishnan has made the donation.
Mr. Lehman was also imposed a penalty of $2,000 for failure to correctly follow the procedure on sale of shares and that amount, too, has been given to charity.
Finding and Analysis On the basis of the experts opinion survey and case study a various world Famous insider Trading Cases and other source the following are the finding:•
On paper, India's laws on insider trading are more stringent than international
ones. From merely barring insiders from trading on the basis of unpublished pricesensitive information, the laws have moved on to prohibiting anyone in the possession of such information from trading. And proof that the information was not shared is no longer acceptable defense against charges of insider trading; today, an accused needs to prove that such information could have never been shared. This shifts the focus on to the accused to prove that there has been no insider trading •
"Insider Trading is victimless Crime" the following quote here in suggested that
this crime is not done with an intention to effect the financial position of the General Investor. But without any intention, the general investor comes into this trap and is effected largely. •
The "Close window Scheme before 24 hr. of SEBI also seems as a failure
because all the parties that trade on the basis of inside information buy or sell the securities well before 24 hrs. The window is closed for them to trade. •
Despite the control and regulation restriction imposed on insider trading at stock
exchange in India or all over the world, these laws have not been effective to curb these kinds of activities within the stock exchange. •
"SEBI" website is also not properly constructed. As insider trading directly,
come under the control of SEBI. Therefore, any person seeking information on this topic will explore the SEBI's website but will not get any information. With almost full exploration of website, you will get the law on insider trading which will be an exaustic process and will require lot of time. The website also does not give any information on
the no. of case that are charged under insider Trading and any of the other default about this topic. •
The "Insider Trading Regulation 2002" is also not properly formed. Most of the
terms and expressions used under this law are incomplete and on this basis, only some of the Companies escape the charges of insider trading. HLL insider Trading, BOM ICICI Merger Case are still pending on these ground. •
Based on survey and people contacted for insider Trading Questioner shows that
there are very few sub-broker and educated people, who are just acquitted with the word insider trading. When they are just acquitted with the word then the knowledge about laws, regulation and its effect on shareholder are doubtful. •
There has been a silent battle going on between the various group of people as
some set of researcher wants to legalize the insider trading and so that all the punishment are curbed. The researcher who wants to legalize this kind of activities also do not have strong reasons on which basis they want to give insider Trading this plat form. •
It is very difficult to distinguish which information is price sensitive and which
is not. Because even a very small information can bring large no. of upswing and down swing in the pries of share. •
Round the Globe various cases related to insider Trading has been seen. But
nowhere including SEBI has not been successful to investigate the case before it has occurred. All the cases reported for insider trading have come to knowledge of SEBI well after the trading operations have been performed. •
Though SEBI keep's the eye on each and every trading activity of people
connected with the Companies but of no use. As the insider Trader are smarter and they perform their operations so cleanly that even SEBI cannot notice happening of such events in the stock market. •
SEBI's Insider Trading Act and Companies policies and procedures for the
insider trading are not adequate enough to prevent insider trading. Because generally
top level executive frame the policies and they can manipulate or misuse a slight clause according to them so as to gain the profit. •
In recent amendments, the SEBI is including insider trading under "Prevention
of Money laundering of Act” (PMLA) so that the punishment for the inside Trader are sever and they are afraid to indulge in such kind of trading activity. •
Insider trading such an activity where to prove the charge against the insider is
an arduous task. •
In this type of trading generally, the individual investor is the most affected
because the big broker, institutional investor keeps a trap on the market and buy & sell accordingly. Therefore general investor is most affected and they are not aware of this slap on there face. •
India's first, and most high-profile case of alleged insider trading involved
Hindustan Lever Limited (HLL) and five of its directors just ahead of the company's merger with Brooke Bond Lipton India. SEBI asked HLL to pay Rs 3.04 crore as penalty, but the Appellate Authority in the Finance Ministry set aside its order. So is the case with all the other cases, which are under SEBI. •
Every body in the share market be it the primary insider, secondary insider,
broker, auditors, general investor would like to take the advantage of the price sensitive information to make gain in market though they may consider trading on inside information as illegal. The picture below gives that how the judge who have no link with the share market and rarely deals in the shares. But when there is a chance of getting a inside information than the judge also wants to make unfair amount of profits.
Suggestions and Recommendation With the knowledge gained various source and on the basis of finding and analysis of the various aspect of insider trading some of the suggestion are stated here below. •
There should be China's wall constructed between the department having price
sensitive information and other departments of companies and outsider's who deal with the Company. So that they do not take advantage of price sensitive information and a proper list of all information, which are "Price Sensitive" should be maintained so that such information is taken extra care when dealing with such information. •
The Companies should disseminate price sensitive information to stock
exchange on continuous and immediate basis and should also improve investor & access to their public announcements. •
SEBI should make a law/or appoint an Committee that can bring in cases of
insider Trading well before such trading take place in the stock market so that interest of general investor is safe guarded.
•
SEBI should disallow the directors/officer, designated employees of the
companies to buy or sell the shares well before some important announcements are to be made and which effect the share market. •
SEBI should strictly observe that when some price sensitive information
declarations are made, the trading window should be closed so that company member does not take advantage of such declarations before they are made public. •
The Companies should also clearly give details of probable disciplinary the
code. Such as wage freeze, suspension, ineligibility for before participation in employee stock option plans with holding of promotion. •
It is SEBI's responsibility to bring out the cases and investigate charges of
insider Trading but at last power to convict the person lie with the Court which is a long process The Government should give in the power for the decision to the SEBI so that convict is punished on time before it is to late. •
SEBI should property construct the website where in the general investor can
get all the available information about the insider trading. A Forum should be established where the general investor can give their views, any complaints, suggestion to stop the riding horse of insider to make money. •
To facilitate compliance with the new reporting of transactions, issuers should either designate a single broker through whom all transactions in issuer stock by insiders must be completed or require insiders to use only brokers who will agree to the procedures set out by the company. A designated broker can help ensure compliance with the company’s preclearance procedures and reporting obligations by monitoring all transactions and reporting them promptly to the issuer. If designating a single broker is not feasible, issuers should require insiders to obtain a certification from their broker that the broker will: 1) Verify with the issuer that each transaction entered on behalf of the insider was pre cleared. 2) Report immediately to the issuer the details of each of the insider’s
transaction
In issuer’s securities. •
The stock exchanges should take up at least a substantial burden of filing action against persons violating the regulations. Since the Rules and regulations of the stock exchanges are considered ‘enactment’, and court judgments13 have found exchange regulations to have the force of law – they could easily enforce the requirements of the listing terms or the rules and regulations by seeking civil action in courts against persons or companies who violate such regulations. The exchanges should also better coordinate monitoring and surveillance of listed companies to track unusual activity in the stock of a company across markets for traces of insider dealings or manipulation.
Briefly, the good governance regulations provide for: a) Officer, director and substantial shareholder to disclose their holding on certain events or at certain intervals. b) Appointment of a compliance officer. c) Setting forth policies and procedure to restrict the possibility of abuse of insider trading. d) Monitoring and pre-clearance of trades by the designated persons. e) Restrict trading by such insiders within a certain period of time i.e. before corporate announcements, buybacks etc. are made. f) The company has to convey all the significant insider activity and corporate disclosure in a uniform publicly accessible means to the public – and to the stock exchange. g) Chinese walls within a firm to prevent one part of the firm, which deals in sensitive information from going to other parts of the firm, which have an inherent conflict of interest with such other parts. h) Minimum holding period of securities by insiders. i) No selective disclosure to analysts. Wide dissemination of information.
Conclusion According to the recent survey India is the largest hub of insider trading, which has determent the interest of individual investors and their confidence in the capital market because of the non-availability of proper monitoring authority to investigate and prosecute insiders. If such activities continue the basic function of stock exchange i.e. capital formation will be reduced as general investors trust will be lost on functioning of stock exchange. "Complaining about insider trading without finding a workable solution is like crying that the government should do something about smoking as it causes cancer, but doing nothing."
Quote By Trading Guru Same is the situation with the Indian Government and SEBI both have not been successful to curb insider trading. Though SEBI is now making some efforts to prevent insider to trade in stock exchange and disturb the main functioning of it. Efforts made by SEBI are on a slow pace which needs to be fasten up otherwise this kind of activities will loses the trust of general investors. It is also important to curb the insider trading other wise it will not show the correct and fair prices of shares of each companies. Insider trading is a victimless crime, which effect large number of general investors, and they do not even come to know this effect at once. In conclusion it can be said that. "It is difficult to prescribe remedies to each one of the trading malpractice in Indian Stock Market. But the problem of insider trading and secret take over bids could be tackled to a large extent by appropriate regulatory measures by authority”. Abid Hussain Member of Development Capital Market Committee It is therefore important for there to be markets free from all types of fraud and in particular insider trading which disenchants the common investor from the workings of the markets as if he is being invited to play a game of crap with loaded dice. Unfortunately, with the
unearthing of large frauds, even though India is not unique in this, the concept of corporate good governance has been lost in the war cry for blood. As a result, the government has gotten into overregulation and micromanagement by converting good governance into statutory provisions. We tend to forget that micromanagement cannot stamp out fraudulent action, it can only be reduced by effective enforcement of the laws, which should prohibit obvious illegalities. It should not be forgotten that what is sought to be caught is crime and treating all insiders as inherently tending towards a presumption of unfair dealing should be avoided. Standards of corporate governance should be left at the helm of the managers of the company. The regulator should specify in the Schedule to the regulations a list of optional procedure for limiting the possibilities of insider trading. What should be mandated instead should be a statement in the annual report of the degree of compliance with the standards of set forth in the Schedule. Thus companies, which do not follow corporate governance guidelines in substance, should be penalized by its shareholders. Introduction of corporate governance ratings, similar to debt ratings, which would pressure management to comply with such measures. This could be the missing link providing a simple number which can be appreciated and understood by the masses and would indicate the processes a company has put in place for the benefit of their non-insider shareholders.
Bibliography “Security market in India” by S.J. Lalwani
“Securities laws and regulation of financial markets” by ICSI “Study of financial market” by Roger.D.Agris “Swing Trading” by Jyoti Basu www.businesstoday.com www.sebi.com www.sec.com www.indiaenews.com www.infosys.com www.hllindia.com www.brookebond.com www.9/11trading.com
