Definition of 'Insider Trading'

The buying or selling of a security by someone who has access to material, nonpublic information about the security.

Meaning in simple terms The illegal practice of trading on the stock exchange to one's own advantage through having access to confidential information.

Insider trading is a term that most investors have heard and usually associate with illegal conduct. But the term actually includes both legal and illegal conduct. The legal version is when corporate insidersofficers, directors, and employeesbuy and sell stock in their own companies. When corporate insiders trade in their own securities, they must report their trades to the SEBI. 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.
Insider According to the Regulations "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or is deemed to have been connected with the company, and who is reasonably expected to have access, connection, to unpublished price sensitive information in respect of securities of a company, or who has received or has had access to such unpublished price sensitive information

Examples of insider trading cases that have been brought by the SEBI are cases against: Corporate officers, directors, and employees who traded the corporations securities after learning of significant, confidential corporate developments; Friends, business associates, family members, and other tippees of such officers, directors, and employees, who traded the securities after receiving such information; Employees of law, banking, brokerage and printing firms who were given such information to provide services to the corporation whose securities they traded; Government employees who learned of such information because of their employment by the government; and Other persons who misappropriated, and took advantage of, confidential information from their employers. Because insider trading undermines investor confidence in the fairness and integrity of the securities markets, the SEBI has treated the detection and prosecution of insider trading violations as one of its enforcement priorities

Why forbid insider trading?

The prevention of insider trading is widely treated as an important function of securities regulation. In the United States, which has the most--studied financial markets of the world, regulators appear to devote significant resources to combat insider trading. This has led

many observers in India to mechanically accept the notion that the prohibition of insider trading is an important function of SEBI. In most countries other than the US, government actions against insider trading are much more limited. Many countries pay lip service to the idea that insider trading must be prevented, while doing little by way of enforcement. In order to make sense of insider trading, we must go back to a basic understanding of markets, prices and the role of markets in the economy. The ideal securities market is one which does a good job of allocating capital in the economy. This function is enabled by market efficiency, the situation where the market price of each security accurately reflects the risk and return in its future. The primary function of regulation and policy is to foster market efficiency, hence we must evaluate the impact of insider trading upon market efficiency.. Insider trading appears unfair, especially to speculators outside a company who face difficult competition in the form of inside traders. Individual speculators and fund managers alike face inferior returns when markets are more efficient owing to the actions of inside traders. This does not, in itself, imply that insider trading is harmful. Insider trading clearly hurts individual and institutional speculators, but the interests of the economy and the interests of these professional traders are not congruent. Indeed, inside traders competing with professional traders is not unlike foreign goods competing on the domestic market -the economy at large benefits even though one class of economic agents suffers
the history th e first case

The first 'insider trader' case was reported in the US way back in 1792. William Duer, the then Assistant Secretary in the US Department of Treasury used his official position to gather insider knowledge and involved in speculative trading in the newly issued debt of the US government. He was indicted and spent his days behind bars. In the early 1920s JP Morgan & Co., served as an unofficial central bank of the U.S and reportedly used its high influence with the Republican Party to make profits. Then the inevitable happened. In early 1929, there was an unprecedented boom in the New York Stock Exchange and in September the sell off started plunging the prices to new lows and triggering a panic among investors, and banks. The Great Depression began to set in. Following this the chaotic economic scenario in the 1920s that saw financial excesses made and the decade long Great Depression and the shift in public opinion and all these contributed to the introduction of tough laws on insider trading done to manipulate profits.

Even till a few decades of the 20th century, insider trading was not considered illegal. In fact in the 1960s the world followed the Massachusetts Supreme Court ruling in the Goodwin v Agassiz case that insider information is a 'perk.' However, in 1964 the Securities Act Amendments laid down disciplinary controls for brokers and dealers.

Charles R. Geisst, PhD Wall Street: A History from Its Beginnings to the Fall of Enron,2004

"The market first crashed in 1792, soon after the nation's birth, thanks to a merchant prince named William Duer. He was a man of wide-ranging business interests who had supported and made money off the Revolution and who then married into the upper reaches of New York society. He thought he could use his insider connections to Alexander Hamilton to make a killing by speculating in the newly issued debt of the infant government. As so many would after him, Duer overreached. Borrowing heavily to finance his illicit schemes, he went bankrupt when the bubble burst. The New York City economy crashed along with him, and Duer was nearly disemboweled by an enraged mob that chased him through the streets. He died in debtors' prison a few years later."

The first country to take action

The first country to tackle insider trading effectively however was the United States[1].In the USA, the Securities and Exchange Commission is empowered under the Insider Trading Sanctions Act, 1984 to impose civil penalties in addition to criminal proceedings. Most countries have in place suitable legislation to curb the menace of insider trading.

regulatory mechanism in India

Insider trading in India was unhindered in its 125 year old stock market till about 1970. It was in the late 1970s this practice was recognized as unfair. In 1979, the Sachar committee said in its report that company employees like directors, auditors, company secretaries etc. may have some price sensitive information that could be used to manipulate stock prices which may cause financial misfortunes to the investing public. The company recommended amendments to the Companies Act, 1956 to restrict or prohibit the dealings of employees / insiders. Penalties were also suggested to prevent the insider trading. In 1986 the Patel committee recommended that the securities contracts (Regulations) Act, 1956 may be amended to make exchanges curb insider trading and unfair stock deals. It suggested heavy fines including imprisonment apart from refunding the profit made or the losses averted to the stock exchanges. In 1989 the Abid Hussain Committee recommended that the insider trading activities may be penalized by civil and criminal proceedings and also suggested that the SEBI formulate the regulations and governing codes to prevent unfair dealings. Following the recommendations by the committees, India through Securities and Exchange Board of India (Insider Trading) Regulations 1992 has prohibited this fraudulent practice and a person convicted of this offence is punishable under Section 24 and Section 15G of the SEBI Act 1992. These regulations were drastically amended in 2002 and renamed as SEBI (Prohibition of Insider Trading) Regulations 1992. Both the Insider Trading Regulations are basically punitive in nature in the sense that they describe what constitutes insider trading and then seek to punish this act in various ways. More importantly, they have to be complied with by all listed companies; all market intermediaries (such as brokers) and all advisers (such as merchant bankers, professional firms, etc.).

rajat gupta case

Former Goldman Sachs director Rajat Gupta was on Wednesday sentenced to two years in prison and fined $5 million by a US judge, months after the Indian-American Wall Street titan was found guilty of leaking boardroom secrets to a hedge fund manager in the largest insider trading case in the country's history. What did Rajat Gupta gain from leaking insider information to Raj Rajaratnam? The irony is that he did not make any money. The jury took two weeks to convict Raj Rajaratnam, who profited from leaks. Yet they took only two days to convict Gupta who did not make any money.

.According to Gary Naftalis, Gupta's chief defence lawyer, Gupta has not made any money, but lost his entire investment with Rajaratnam, which was about $10 million. Friends said Gupta was toying with the idea of suing Rajaratnam, when federal authorities arrested him. The federal sentencing guidelines seek to differentiate between those who profit from insider trading and those who don't. But the prosecution noted that Gupta was responsible for the trading that resulted in an aggregate $16 million in profit for Galleon Group. Gupta, who had achieved a high-profile status as a corporate executive, was considered as one of the main pillars of Indian-American community for his work as well as charity and benevolence. . His fall from grace was an unbelievable shock for the community.. He was an orphan. He went to Harvard Business School on a scholarship. He rose to dizzying heights. The jury foreman called it a 'storybook life,' Levick noted. 'We were hoping he would walk out of this courthouse,' said another juror. Some jurors were crying when the verdict was read.

Naftalis pointed out that Gupta would not risk everything for money he neither made nor needed. Posttrial comments suggest that jurors felt Rajaratnam manipulated. Gupta Rajat K Gupta was appointed managing director worldwide of McKinsey & Company in 1994 Even after he retired from McKinsey in 2003 after 30 years of service and went on to serve as board member of top American companies and also advisor to the then United Nation secretary general Kofi Annan. Gupta was on the Advisory boards of Harvard Business School and the Northwestern University's Kellogg School of Management. He was instrumental in founding the Indian School of Business, Hyderabad, India in 2001. He is also Chair of The Global Fund to Fight AIDS, Tuberculosis and Malaria. He has many other professional and business affiliations, including: on the Board of Governors of the Lauder Institute of Management & International Studies, The Wharton School, University of Pennsylvania; Chairman of the Board of Associates of the Harvard Business School; and Dean's Advisory Council, MIT Sloan School of Management.

The founder of the Indian School of Business in Hyderabad has been charged with five counts of security fraud and one of conspiracy, which together could get him 105 years in jail, with millions in fine. Gupta has been accused of passing insider tips to founder of Galleon hedge fund Raj Rajaratnam, who has been jailed to 11 years for insider trading.

He served as corporate chairman, board director or strategic advisor to a variety of large and notable organizations, including Goldman Sachs, Procter and Gamble, American Airlines, The Gates Foundation, The Global Fund and the International Chamber of Commerce. Gupta was born in Kolkata to Pran Kumari and Ashwini Kumar. His father was a journalist for Ananda Publishers. His mother taught at a Montessori school. Gupta has three siblings. When Gupta was five the family moved to New Delhi, where his father started the newspaper Hindustan Standard. Gupta's father died when he was 16; his mother died two years later. Now an orphan, Gupta and his siblings "decided to live by ourselves. It was pretty unusual in those days". He was a student at Modern School in New Delhi. He received a bachelor of technology degree in Mechanical Engineering from the Indian Institute of Technology, Delhi, in 1971, and an MBA from Harvard Business School in 1973, where he was named a Baker Scholar. He served for nearly a decade as managing director of McKinsey and Company over a 34-year career at the management consultancy. He stepped down as managing director in 2003 and retired from active practice in 2007, becoming, like other retired senior partners, a "senior partner emeritus". Gupta maintained an office, executive assistant, email and phone at McKinsey after retiring in 2007. After McKinsey, Gupta also co-founded and chaired the private equity firm New Silk Route with Parag Saxena and Victor Menezes.

While he was managing director of mckinsey, Gupta co-founded the Indian School of Business with friend and fellow senior partner Anil Kumar.

Gupta and Kumar have both since resigned as chairman and executive board director respectively.

On April 15, 2010, the Wall Street Journal reported that federal prosecutors in the United States were investigating Gupta's involvement in providing insider information to Rajaratnam during the financial crisis, in particular the $5 billion Berkshire Hathaway investment in Goldman Sachs at the height of the financial crisis in September, 2008.

Coverage of the event noted that Kumar - who, like Gupta, had graduated from IIT, was a longtime highly-regarded senior partner at McKinsey, and had also co-founded the ISB - had already pleaded guilty to charges in the same case. Gupta, Kumar, and Rajaratnam were all close friends and business partners. When Goldman Sachs's CEO Lloyd Blankfein asked Gupta about his insider trading rumours breaking in the press, Gupta replied: "I wouldn't have had anything to do with that." On March 1, 2011, the SEC filed an administrative civil complaint against Gupta for insider trading. It is alleged that he illegally tipped Rajaratnam with insider information about Goldman Sachs and Procter and Gamble while serving on the boards of both companies.

Rajaratnam, it is alleged, "used the information from Gupta to illegally profit in hedge fund trades. ... The information on Goldman made Rajaratnam's funds $17 million richer. ... The Procter and Gamble data created illegal profits of more than $570,000 for Galleon funds managed by others," the SEC said. "After a (Goldman Sachs) board call ... Mr. Gupta is said to have hung up the phone and called Mr. Rajartnam 23 seconds later. The next morning, the SEC says, Galleon funds sold their Goldman holdings, avoiding losses of more than $3 million."

Gupta stepped down from the board of Procter and Gamble on March 1, 2011. On March 7, 2011, he resigned from the boards of AMR Corp, American Airlines, Harman International and Genpact Ltd. On March 10, 2011, Gupta stepped down as chair of the International Chamber of Commerce "until a satisfactory resolution of the case". On March 15, he stepped down as chairman of the Public Health Foundation of India. On March 20, he resigned as chairman of the Indian School of Business, after some controversy at the school and in India. On March 29, he stepped down as advisor to the Gates foundation.

By April 2011, he had resigned from every board chairmanship or membership. On October 26, 2011. the United States Attorney's Office filed charges against Gupta. He was arrested in New York City by the FBI and pleaded not guilty. He was released on $10 million bail (secured by his Connecticut house) on the same day.

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Friday, July 17, 1998

Hindustan Lever guilt goes beyond violations of insider trading law

Aparna Viswanathan

Its strength lies in its simplicity: "No person can be an insider to himself." This is the proposition of law relied upon by the defence for Hindustan Lever (HLL) in the case arising out of HLL's purchase of eight lakh shares in Brooke Bond Lipton India Ltd (BBLIL) before the public announcement of the merger between HLL and BBLIL. Sebi, however, disagreed, and on March 11, ordered the prosecution of HLL and five of its directors on charges of insider trading. On July 14, the appellate authority of the finance ministry dismissed the Sebi order and said the latter had no reason to conclude that the finding of insider trading was of a degree of seriousness warranting prosecution.However, the Sebi order was correctly based on a simple, but well-accepted, proposition of law: what cannot be done directly cannot be done indirectly. An "insider" is defined by law as a person who is "connected" with a company and is reasonably expected to have access, by virtue of such connection, to unpublished pricesensitiveinformation. HLL did not dispute that it was "connected" to BBLIL because of the fact that the two are affiliated companies in the same group. However, HLL argued that it did not access any

information by virtue of such connection. Instead, HLL claimed that it received its information independently because it was one of the principal parties to the merger. Therefore, it was not an insider. The appellate authority, too, rightly rejected this view. HLL claimed that the purpose of the purchase of eight lakh shares was to enable Unilever to acquire 51 per cent of the shares of BBLIL. However, only three lakh shares were required to raise Unilever's holding in BBLIL to 51 per cent prior to the merger. The fact that eight lakh shares were purchased indicates that the real purpose was to increase Unilever's holding to 51 per cent in the postacquisition entity, that is, the merged company formed by HLL and BBLIL. Furthermore, Unilever would have had to bring in Rs 45-50 crore in order to raise its stake in themerged company to 51 per cent. Instead, HLL depleted its reserves in order to purchase the eight lakh shares before the announcement of the merger. HLL thus enabled Unilever to raise its equity stake without making a fresh infusion of cash. The foregoing facts show that HLL was acting on behalf of Unilever and secured an advantage for its holding company. However, if Unilever had directly purchased shares in BBLIL, such a purchase would have clearly constituted insider trading, even according to HLL as Unilever was not a principal party to the merger. In fact, HLL acted on its behalf and accomplished indirectly what Unilever could not do directly. Such indirect acts attract the same liability as the prohibited direct acts. The Sebi insider trading regulations (ITR) cannot be interpreted in a manner which contradicts wellestablished propositions of law. A purchase of shares by HLL on behalf of Unilever cannot be viewed as legal while a direct purchase of shares by Unilever would clearly constituteinsider trading.

In addition, accepting the HLL defence would violate a fundamental concept of Company Law, which is that the management of a company may never act in the interests of only one group of shareholders. Instead, management must take decisions which protect the interests of the company as a whole. That is the basic underpinning of corporate democracy. All the shareholders' interests must be protected, not only a selected few. However, in this case, HLL's purchase of eight lakh shares in BBLIL by depleting its reserves was clearly an act which favoured Unilever's interests at the expense of the interests of its remaining shareholders. Third, the HLL defence seeks to conceal violations of the legal rules governing preferential allotment of shares contained in Section 81(1A) of the Companies Act. In essence, HLL's purchase of shares in BBLIL, intended to raise Unilever's holding in the merged company to 51 per cent, constitutes a backdoor preferential allotment of shares to Unilever. As aresult of HLL's share purchase, it was no longer necessary to make a preferential allotment of shares to Unilever at the time of the merger. In fact, notably absent from the HLL-BBLIL merger is any preferential allotment of shares to Unilever as part of the merger agreement in sharp contrast to the 1993 merger between HLL and Tomco. By disguising the preferential allotment of shares to Unilever as an ordinary purchase of shares by HLL, the company avoided the requirement of passing a special resolution of shareholders as required in Section 81(1A) of the Companies Act. Unilever also avoided having to comply with the pricing formula set forth in the RBI guidelines. Importantly, structuring the transaction as a share purchase by HLL instead of a preferential allotment of shares eliminated the need to obtain any governmental approvals for increasing Unilever's shareholding in the merged company. In sum, the proposition that no person can be an insider in his own case is not legally sustainable as

itcontradicts well-established propositions of law which say that what cannot be done directly cannot be done indirectly. The basic tenets of corporate law requiring management to take decisions in the interests of all shareholders and the legal rules governing preferential allotment of shares were given the go-by. Therefore, it is irrelevant that HLL obtained information regarding the merger because it was one of the parties being merged. Irrespective of the fact that it was a principal party in the transaction, HLL was required under the Sebi insider trading regulations to either publicly disclose the impending merger or refrain from trading. Accordingly, Sebi correctly dismissed the argument that no person can be an insider to himself and found HLL guilty of insider trading.
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Conclusion

Highlights of SEBI Regulation on insider trading:

In line with Regulators all over the world, SEBI has also tightened regulation on insiders trading. It has broadened the definition of deemed to be insiders. As per new regulation one can be in the ambit of deemed to be insiders if he or she has access to unpublished price sensitive information even if not connected directly to the company. Highlight of the policy is as below:1. No insider will trade either on his own behalf or on behalf of any other person into the securities of any listed company if he or she has any unpublished information pertaining to the company with him. 2. Insider should not communicate any price sensitive with anybody unless the same is required for ordinary course of business . 3. If a person acquires 5% shares or voting right of any listed company, the same has to be disclosed to SEBI and Stock Exchanges within a period of 4 days . 4. On appointment of a director or an officer of a listed company, the person need to disclose SEBI and Stock Exchange about number of share held by him within 4 days of appointment. 5. Whenever there is a change in the position of holding by a person who holds more than 5% shares or voting right of the company. 6. When the change in the holding position of any officer or director exceeds by Rs 5 lakhs in value or 5000 shares or 2% of voting rights.

7. No company shall deal in the securities of any other company while in possession of any unpublished price sensitive information. 8. Insiders such as, directors, officers and employees of the company are eligible to buy or sell the securities when Trading Windows are open. Pre clearance from compliance officer is required if deal is for beyond threshold limit. The deal should be completed within.7 days of the clearance from compliance officer. Trading Windows will be closed if any corporate action is expected. 9. SEBI has prescribed format A, B, C and D for various reporting and disclosure by the insiders.

Powers of the SEBI related to insider trading in brief

1. SEBI has power to investigate the charges of Insider trading against any person 2. SEBI has right to examine records, books of accounts, documents pertaining to any company. 3. SEBI is empowered to record the statement of concerned person. 4. It has right to impose a penalty of 25 crore or 3 times of the amount of profit made by the company if found guilty of insider trading
5.SEBI may initiate criminal prosecution 6. SEBI may issue orders declaring transactions in securities based on unpublished price sensitive information 7. SEBI may issue orders prohibiting an insider or refraining an insider from dealing in the securities of the company

Should Insider Trading be permitted ?

In the USA, there is a debate whether insider trading be legalized. Mr. Emeritus Henry Manne, Dean of George Mason University School of Law, who is also considered as a father of law and economics has long been arguing for deregularization of insider trading. In his opinion, insider trading will drive the price of the securities near to its real value. Insider information can be treated as compensation to the employees and company can save cost by paying lesser monetary compensation to them. This will reduce cost of the company and increase efficiency and ensure proper price discovery. Another Professor of Law Mr. Jonathan Macey of Yale Law School has the same opinion. In his view, it should be left to the company to have its own policy. Another school of thought favours legalization of insider trading on the ground that when share buyback is allowed, insider trading should also be allowed, because share buyback decision is based on insider information which is not available with the public and small investors. Therefore, it is harming the interest small investors. The view is supported by Mr.Andrea Buffa & Giovanna Nicodano. Despite selected support for legalization of insider trading, majority are in opinion that it is against the interest of fair market. Regulators from most of the countries have found it one of the most controversial issue but they considered it harmful for the growth of the financial market and has declared it illegal.