Role of SEBI in Capital Market: Developments and Challenges

Role of SEBI in regulating Insider Trading

Mr. Arthur Levitt, a former Chairman of the Securities and Exchange Commission of the USA has expressed that insider trading has utterly no place in any fair-minded law abiding economy.^[24] There has been an increasing recognition that in order to maintain the confidence of investors in the public securities market, it is essential that some economic agents who possess an informational advantage over the others do not exploit the same to derive pecuniary gains for themselves.

U.S Securities and Exchange Commission describes “Insider trading” as a term which includes both legal and illegal conduct, the legal version is when corporate insiders”officers, directors, and employees”buy and sell stock in their own companies.^[25] Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include “tipping” such information, securities trading by the person “tipped,” and securities trading by those who misappropriate such information.^[26]

˜Company insiders have information unavailable to the public. These individuals have firsthand knowledge of what the company is doing and better information concerning what the future might hold. If there are likely problems for the company in the future, such as poor earnings, slow growth, or lawsuits, then insiders can sell their stock before these events happen. When this information becomes public, the stock™s price should decrease. However, this price decrease occurs after the insider has sold his or her shares, thus avoiding the loss. In this case the insider beat the market. On the other hand, insiders know when their company has a bright future, high potential earnings, innovative products being developed, etc. When the future looks bright, insiders can buy shares before the public becomes aware of these facts. The price, later, fully increases to represent the positive information. In both cases, insiders use private information to beat the market.™^[27]

Earlier, the concept of insider trading was limited to the aspect of a company insider tipping of an outsider and the outsider using the tip and trading in the company™s shares, this constitutes a breach of fiduciary duty owed by the insider to the company™s shareholders; it was called the classical theory of insider trading.^[28] Later US Supreme Court in the case US v. O™Hagan^[29] in 1997 extended the scope of insider trading by including the misappropriation theory which said that a person commits insider trading when he obtains material confidential information and uses it in securities transactions in breach of fiduciary duty or similar relationship of confidence to the source of information but not necessarily to the shareholders of the company whose stocks are traded.^[30]

It is said that the information captured by insider trading modifies the responsiveness of returns to annual unexpected earnings and also the information captured by insider training differs from that captured by annual unexpected earnings.^[31]

Insider trading weakens the confidence of the investor in the fairness and honesty of the securities markets and this is reason SEBI has treated the recognition and suit of insider trading violation as one of its main concern. SEBI™s first enactment to restrain insider trading, namely, SEBI (Prohibition of Insider Trading) Regulations, 1992 did not make much advancement due to poor enforcement. These regulations, again, have been amended substantially over time. SEBI™s current approach centers around prevention of insider trading by requiring listed companies, intermediaries, and advisors to set up internal systems for preventing insider trading and reporting on compliance or otherwise to SEBI. The insider trading regulations provide for disclosure of smaller amounts and provides for disclosure on selling shares (something which the takeover code does not mandate).

Regulation 2(e) of SEBI (Prohibition of Insider Trading) Regulations defines an ˜insider™ as a person connected or deemed to be connected and who is reasonably expected to have access to any unpublished price sensitive information in respect of securities [i.e. shares, debentures etc.] of a company, or who has received or has had access to such unpublished information.^[32] The directors, officer, employers of the company, & persons involving a professional or business relationship [like CA™s lawyers etc.] are connected person as per regulations 2 (c).^[33] The insider trading Regulations provide for disclosure of smaller amounts and provides for disclosure on selling shares (something which the takeover code does not mandate).^[34] Regulation 3 & 3A enumerates the various acts that an insider and company are prohibited to do, these regulations prohibit an insider and a company to ˜deal™ in certain circumstances; the term ˜deal™ is defined under regulation 2(d) which describe dealing in securities to mean an act of subscribing, buying, selling or agreeing to do so by any person either as principal or agent.[35]

The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations 1992 requires that a person who is connected with a listed company and is in possession of any unpublished price sensitive information likely to materially affect the price of securities of company, shall not

(i) On his behalf or on behalf of any other person deal in securities or

(ii) Communicate such information to any other person, who while in possession of such information shall not deal in securities.^[36]

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 to be 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;

(vii) and significant changes in policies, plans or operations of the company;^[37]

Apart from this chapter II of the same regulation gives guidelines regarding prohibition on dealing, communicating or counseling on matters relating to insider trading. Chapter III talks about power given to the board to make inquiries and inspection. Chapter IV talks about code of internal procedures and conduct for listed companies and other entities mainly it focuses upon disclosure requirement and internal procedures which is quite evident from the head note i.e.  ˜Policy on disclosure and internal procedure for prevention of insider trading™^[38].schedule I and schedule II talks about different model code for the prevention of insider trading for listed companies well as for other entities; the latter schedule although talks about code of corporate disclosure practices for prevention of insider trading.