lawyers in India

SEBI on Insider Trading

Written by: Robin George - I am currently pursuing B.A.LL.B(Hons.) 5th year from Jamia Millia Islamia University. I am also pursuing PGD in International Trade Law from Indian Law Institute
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  • Forces of demand and supply regulate the prices of shares as well. When people buy the shares of a particular company from the stock market (i.e. the demand for the share increases), the price of the shares of that company increases. Similarly, it decreases when people sell the shares (supply increases than demand).

    By investing in a company's share, an investor (share holder) becomes an owner of that particular company to the extent of the value of the shares held by him. He therefore is entitled to a share in the profits earned by the company. This share in profits that is distributed to a shareholder is known as dividends. Apart from the ownership, it is the dividend or the anticipation thereof that lures an investor into buying the shares of a particular company.

    The performance of a company is of primary importance to the investors and the general public who might invest in the company. The Indian company law provides that a company should prepare an annual account showing the company's trading results during the relevant arrear (section210, Companies Act, 1956).It also makes it mandatory that the company publishes its assets and liabilities at the end of the period along with the financial results. This has been provided to ensure transparency in the functioning of the company which the shareholders also have a right to know. Also, action 166 provides that the company calls at least one meeting of its shareholders each year.

    This meeting is known as the Annual General Body Meeting (AGM) and is kept with a view to ensure that the shareholders come together once in a year to ensure and review the working of the company. The information released in Annual Reports and Annual General Body Meetings relate to the performance of the company and hence play a valuable role in shaping the minds of existing and prospective shareholders.

    The General public and shareholders get knowledge of this information only during AGM or Annual Reports or when the company announces it in a press conference etc. However persons in the company itself or otherwise concerned to the company are in possession of such information before it is actually made public. For example, a Chartered Accountant auditing the accounts of the company, a lawyer giving the company any advice on its future endeavors, directors of the company taking decisions etc. come into possession of knowledge on the company's performances.

    The knowledge of this unpublished price sensitive information in hands of persons connected to the companies puts them in an advantageous position over others who lack it. Such information can be used to make gains by buying shares a cheaper rate anticipating that it might rise. Similarly, it can be used to insulate themselves against losses by selling shares before the prices fall down. Such transaction entered into by persons having access to any unpublished information is called Insider Trading. Such trading is not based on a level playing field and can prove detrimental to the interests of the shareholders of the company. Consequently, SEBI banned insider trading and laid down the SEBI (Prohibition of Insider Trading) Regulation 1992.

    Regulation 2(e) 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. 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). The definition of person would include a company, association or body of individuals whether incorporated or not. Apart from connected persons, the regulation also provides for 'deemed to be connected persons' who generally include intermediaries like an investment company, Trustee Company etc. Also included in the list is subsidiary of a company and relatives of connected persons etc.

    It is important to note here that an employee, director or officer of a company does not become a connected person solely by virtue of his position in the company. To be considered as a connected person, it is important to prove that they have indulged in insider trading. Regulation 2(ha) defines price sensitive information as any information which relates directly or indirectly to a company, and if published, would substantially affect the price of securities of the company.

    It also provides a list of information that it deems to be price sensitive information which includes:-
    Periodical financial result of the company.
    Intended declaration of dividends.
    Issue or buy–back of securities.
    Any major expansion plans or execution of new projects.
    Amalgamation, mergers or takeovers,
    Disposal of the whole or substantial part of the undertaking
    Any significant change in policies, plans or operation of the company

    A mere perusal of the list gives an impression that a price sensitive information would be any information that has direct nexus with the performances of the company in present and future time.

    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.

    Regulation 3 prohibits an insider to deal either on his behalf or on behalf of any other person in the securities of a company listed on a stock exchange when in possession of unpublished price sensitive information. It also prohibits the communication, procurement, counseling of such information directly or indirectly in writing or verbally unless such communication has been made in the ordinary course of business, profession, employment or under any law. Regulation 3A puts a similar prohibition on companies to deal in securities of another company or an associate of that company when in possession of unpublished price sensitive information. However, Regulation 3B provides that if the company proves that though the transaction was entered by an officer on its behalf, he was not aware of any such information. In such a case the company will not be held guilty of insider trading. It also provides with some other defenses which a company may advance in a proceeding for an offence under Regulation 3A.

    Thus, Regulation 3 & 3A provides the acts that an insider or company is prohibited to enter into. Contravention of this provision shall amount to insiders trading and is punishable as per section 24 of SEBI Act, 1992. The section provides for a punishment of imprisonment for a term up to 10 years or a fine up to Rs. 25 Crores or both.

    The SEBI (Prohibition of Insider Trading Regulation), 1992 also provides for certain measures that every listed company and other entities need to incorporate to facilitate prevention of insider trading.

    Regulation 13 provides that any person holding more than 5% shares or voting right in any listed company shall disclose to the company the number of shares or voting rights held by him. It also requires a director to inform the company about the number of shares or voting rights held by him within 4 days of his appointment. It also requires such shareholders and directors to make continuous declaration of any change in their share holding or voting rights to the company. The company in return is required to disclose such information received to all stock exchanges where the company is listed.

    Regulation 12 requires all listed companies and organizations associated with securities to frame a code of internal procedure. The regulation also provides a models code to which the internal procedure should be in consonance. The model code provides that a listed company shall appoint compliance officer who shall set forth policies, procedures and also monitor adherence to the rules for preservation of price sensitive information. It also lays down certain trading restrictions that all directors, officers and designated employees are subject to. Designated employees are officers comprising the top three tiers of the company's management or the employers designated by the company to whom the restrictions shall be applicable.

     It provides that such directors, officer and employees shall be eligible to deal in securities only during a trading period known as Trading windows, which shall be close at the time of:-
    Declaration of financial results.
    Declaration of dividends.
    Issue of securities by way of public/right/bonus etc.
    Major expansion plans or execution of new projects.
    Amalgamation, mergers, takeovers and buy back.
    Disposal of whole or substantial part of the undertaking.
    Any changes in plans, policies or operation of the company.

    The directors, employees or officers of a company shall only be eligible to deal in securities when the trading windows are open.

    It also provides that the directors etc. wanting to deal in the securities of the company beyond a threshold limit, which shall be decided by the company, a pre clearance of the same must be taken from the compliance officer. The deal should be affected within 7 days of pre-clearance failing which a fresh clearance is required.

    The model code also provides for prevention of insider trading in other entities that may come in possession of unpublished price sensitive information due to their nexus to a listed company. It provides that such entities should adopt the 'Chinese Wall' policy which demarcates the area of the organization having access to confidential information- known as 'Inside area'- from other areas of the organization – known as 'public area'. The employees in inside area shall not communicate any information to an employee in public area. It provides that in order to monitor Chinese wall policy and trading in client securities based on insider information, the organization / firm shall restrict trading in certain securities and designate such list as restricted / grey list. Trading in any security on the restricted list by designated employees, directors etc. may be blocked or disallowed during pre- clearance.

    The SEBI 'has been indeed circumspect in formulating this regulation. It covers all possible incidences of insider trading and also provides for measures that facilitates its prevention. Thus it will not be wrong to say that SEBI has ensured a level playing field for all shareholders of a company who otherwise would have been at a loss in the absence of such regulations. These regulations have also ensured that insider does not undermine the interests of small shareholders in his endeavor to make profits or insulating himself against a prospective loss.

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