Insider Trading

A Case Study on Rajat Gupta

9/21/2011 IMT, Ghaziabad Davinder Singh (11EX-015) Maitreyee Ray ( 11EX-031) Prateek Wadhwa (11EX-040) Priyanka Tyagi (11EX-041) Sandip Sarkar (11EX-047)

LEGAL ASPECT OF BUSINESS Term Paper

Insider Trading A case study on Rajat Gupta

Contents Introduction Understanding the Insider Trading as per SEC(U.S. Securities and Exchange Commission) Insider Insider Trading- SEC Perspective The Division of Enforcement The Securities Exchange Act of 1934 and the Insider Trading Sanctions Act of 1984 Fiduciary Point of view on Insider Trading Breach of Fiduciary Duty Case Background SEC vs Gupta Allegations Gupta vs SEC Countersuit Mercer vs Gupta Shareholder Suit Understanding the Insider Trading as per SEBI (Securities and Exchange Board of India) Insider Connected Person Price Sensitive Information Insider Trading Role of SEBI relating Insider Trading Rajat Guptas case with SEBIs Perspective References

Insider Trading A case study on Rajat Gupta

Introduction

Fraud, lying, conspiracy... not terms that any individual generally wants to be associated with their history, nonetheless with their reputation and personality; especially if that individual happens to be Rajat Gupta. Rajat Gupta - a name which pronounces itself on the board of directors or advisors - often as chairman of the board for more than 40 organizations which include large public companies, International policy / industry institutions, educational institutions, charitable organizations, Health organizations. It now pronounces itself with yet another captivating theme accused of insider trading by the United States Securities and Exchange Commission. The high profile nature of the Rajat Gupta insider trading case led to abundant research and writing by academic and media professionals. In this paper we seek to discuss the central moral and ethical issues surrounding the case. In addition, the greater issue of insider trading will be examined and moral foundations for the issue will be established and discussed. Also, we will be discussing the case as per SEBI guidelines in India. Finally, the presentation will conclude with a suggestion for the most consistent ethical approach to insider trading.
Understanding the Insider Trading as per SEC(U.S. Securities and Exchange Commission)

Insider An insider is understood as a person having control over the management of affairs of the corporation. Thus the directors of the company, corporate officers, significant shareholders, key employees, etc would be the insiders of the company. However for the purposes of regulating insider trading, insider has been given a relatively specific definition. Insider Trading A SEC Perspective Insider trading takes place legally every day, when corporate insiders officers, directors or employees buy or sell stock in their own companies within the confines of company policy and the regulations governing this trading. 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, non-public 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. Examples of insider trading cases that have been brought by the SEC are cases against:

Corporate officers, directors, and employees who traded the corporation's 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
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Insider Trading A case study on Rajat Gupta

Other persons who misappropriated, and took advantage of, confidential information from their employers.

The Division of Enforcement was created in August 1972 to consolidate enforcement activities that previously had been handled by the various operating divisions at the Commission's headquarters in Washington. The Commission's enforcement staff conducts investigations into possible violations of the federal securities laws, and prosecutes the Commission's civil suits in the federal courts as well as its administrative proceedings. In civil suits, the Commission seeks injunctions, which are orders that prohibit future violations; a person who violates an injunction is subject to fines or imprisonment for contempt. In addition, the Commission often seeks civil money penalties and the disgorgement of illegal profits. The courts may also bar or suspend individuals from acting as corporate officers or directors. Insider trading is a high priority area for the SECs enforcement program. Many recent cases involved hedge fund managers, corporate insiders and government employees who unlawfully traded on material non-public information, undermining the level playing field that is fundamental to the integrity and fair functioning of the capital markets. Insider trading is an extraordinarily difficult crime to prove. Direct evidence of insider trading is rare. There is no physical evidence that can be scientifically linked to a perpetrator. It requires examining inherently innocuous events meetings in restaurants, telephone calls, relationships between people, trading patterns and drawing reasonable inferences based on their timing and surrounding circumstances to lead to the conclusion that the defendant bought or sold stock with the benefit of inside information wrongfully obtained. . The Securities Exchange Act of 1934 and the Insider Trading Sanctions Act of 1984 have provisions which forbid insider trading. One provision of the 1934 Act requires the disgorgement of short-swing profits by named insiders. The 1934 Acts general antifraud provision has been used many times to sanction insider trading. In addition, in 1984 Congress enacted legislation imposing up to treble damages upon one who engages in insider trading. Section 16 of the 1934 Act places sanctions upon insiders who use inside information in making short-swing profits. For purposes of this provision, an insider is defined as any person who is directly or indirectly the beneficial owner of more than 10 per centum of any class of any equity security, which is registered or who is a director or an officer of the issuer. Every such person must file a report with the Securities and Exchange Commission at the time of the registration of the security on a national securities exchange or by the effective date of a filed registration statement or within ten days after he becomes a beneficial owner, director, or officer and within ten days after the close of each calendar month if there has been a change in the ownership or if the person has purchased or sold a security-based swap agreement. To prevent the unfair use of inside information, section 16(b) permits the company or any security holder suing on behalf of the company to recover any profit which the person realizes from any purchase and sale or sale and purchase of any equity security of the company within a period of less than six months. Section 10(b) of the 1934 Act and SEC Rule 10b-5 has also been used in many cases of insider trading violations. Section 10(b) is the 1934 Acts general antifraud provision.
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Insider Trading A case study on Rajat Gupta

Although it does not refer to specific types of fraud or to specific types of insiders, one of its most frequent applications over the years has been to insider trading. The Insider Trading Sanctions Act of 1984 provides that, if the Commission believes that any person has bought or sold a security while in possession of material non-public information, the Commission may bring an action in United States district court to seek a civil penalty. The penalty may be up to three times the profit gained or loss avoided. After a number of hearings and considerable debate in the 100th Congress, the President signed the Insider Trading and Securities Fraud Enforcement Act of 1988. This Act expanded the scope of civil penalties to control persons who fail to take adequate steps to prevent insider trading; increased the maximum jail terms for criminal securities law violations from five to ten years, with maximum criminal fines for individuals to be increased from $100,000 to $1,000,000 and for non-natural persons from $500,000 to $2,500,000. Fiduciary Point of view on Insider Trading A fiduciary duty is an obligation to act in the best interest of another party. For instance, a corporation's board member has a fiduciary duty to the shareholders, a trustee has a fiduciary duty to the trust's beneficiaries, and an attorney has a fiduciary duty to a client. A fiduciary obligation exists whenever the relationship with the client involves a special trust, confidence, and reliance on the fiduciary to exercise his discretion or expertise in acting for the client. The fiduciary must knowingly accept that trust and confidence to exercise his expertise and discretion to act on the client's behalf. . One of the problems with illegal insider trading is that it undermines the publics confidence in the fairness and integrity of securities markets, the SEC says. It is illegal to trade on material, non-public information about a security and to breach a fiduciary duty . Breach of Fiduciary Duty Investment Company Act of 1940, SEC. 36.(a) The Commission is authorized to bring an action in the proper district court of the United States, or in the United States court of any territory or other place subject to the jurisdiction of the United States, alleging that a person who is, or at the time of the alleged misconduct was, serving or acting in one or more of the following capacities has engaged within five years the commencement of the action or is about to engage in any act or practice constituting a breach of fiduciary duty involving personal misconduct in respect of any registered investment company for which such person so serves or acts, or at the time of the alleged misconduct, so served or acted (1) as officer, director, member of any advisory board, investment adviser, or depositor; or (2) as principal underwriter, if such registered company is an open-end company, unit investment trust, or face-amount certificate company. If such allegations are established, the court may enjoin such persons from acting in any or all such capacities either permanently or temporarily and award such injunctive or other relief against such person as may be reasonable and appropriate in the circumstances, having due regard to the protection of investors and to the effectuation of the policies declared in section 1(b) of this title.
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Insider Trading A case study on Rajat Gupta

(b) For the purposes of this subsection, the investment adviser of a registered investment company shall be deemed to have a fiduciary duty with respect to the receipt of compensation for services, or of payments of a material nature, paid by such registered investment company, or by the security holders thereof, to such investment adviser or any affiliated person of such investment adviser. An action may be brought under this subsection by the Commission, or by a security holder of such registered investment company on behalf of such company, against such investment adviser, or any affiliated person of such investment adviser, or any other person enumerated in subsection (a) of this section who has a fiduciary duty concerning such compensation or payments, for breach of fiduciary duty in respect of such compensation or payments paid by such registered investment company or by the security holders thereof to such investment adviser or person. With respect to any such action the following provisions shall apply : (1) It shall not be necessary to allege or prove that any defendant engaged in personal misconduct, and the plaintiff shall have the burden of proving a breach of fiduciary duty. (2) In any such action approval by the board of directors of such investment company of such compensation or payments, or of contracts or other arrangements providing for such compensation or payments, and ratification or approval of such compensation or payments, or of contracts or other arrangements providing for such compensation or payments, by the shareholders of such investment company, shall be given such consideration by the court as is deemed appropriate under all the circumstances . (3) No such action shall be brought or maintained against any person other than the recipient of such compensation or payments, and no damages or other relief shall be granted against any person other than the recipient of such compensation or payments. No award of damages shall be recoverable for any period prior to one year before the action was instituted. Any award of damages against such recipient shall be limited to the actual damages resulting from the breach of fiduciary duty and shall in no event exceed the amount of compensation or payments received from such investment company, or the security holders thereof, by such recipient . (4) This subsection shall not apply to compensation or payments made in connection with transactions subject to section 17 of this title, or rules, regulations, or orders thereunder, or to sales loads for the acquisition of any security issued by a registered investment company. (5) Any action pursuant to this subsection may be brought only in an appropriate district court of the United States. (6) No finding by a court with respect to a breach of fiduciary duty under this subsection shall be made a basis (A) for a finding of a violation of this title for the purposes of sections 9 and 49 of this title, section 15 of the Securities Exchange Act of 1934, or section 203 of title II of this Act, or (B) for an in junction to prohibit any person from serving in any of the capacities enumerated in subsection (a) of this section. (c) For the purposes of subsections (a) and (b) of this section, the term investment adviser includes a corporate or other trustee performing the functions of an investment adviser.

Insider Trading A case study on Rajat Gupta

Case Background

Rajat Gupta had been a corporate officer, board director and strategic advisor to a variety of notable public- and private-sector institutions, most notably as managing director of McKinsey & Company from 1994 to 2003. He is the co-founder of four organizations:

The Indian School of Business with Anil Kumar, The American India Foundation with Victor Menezes and Lata Krishnan, New Silk Route with Parag Saxena and Victor Menezes, and Scandent with Ramesh Vangal.

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 Galleon hedge-fund founder Raj 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 Anil Kumar who, like Gupta, had graduated from IIT, was a long time 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. SEC v. Gupta allegations 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 & Gamble while serving, served 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 & Gamble data created illegal profits of more than $570,000 for Galleon funds managed by others," the SEC said. As per New York Times, "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". The SECs complaint charges each of the defendants with violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder Gupta vigorously denied the SEC accusations. He is being represented by respected white-collar criminal attorney Gary Naftalis of Kramer Levin Naftalis & Frankel LLP in connection with the charges. Few important aspects of denial Gupta is the first person ever charged by SEC in this type of proceeding who is not a brokerdealer or investment management employee. This is a key claim in his countersuit.
Another important aspect of insider trading is gain -- Gupta's lawyer Naftalis said on March 1

that "Gupta is not accused of receiving anything in exchange for information." Yet a week later in U.S. v Rajaratnam it emerged that "Mr Rajaratnam might pay Mr Gupta with a large stake in
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Insider Trading A case study on Rajat Gupta

the fund, and that Mr Rajaratnam loaned Mr Gupta money so he could increase his investment in a Galleon fund. It also emerged that Mr. Gupta was in talks to become chairman of Galleon International, and therefore also stood to profit Wiretaps in U.S. v Rajaratnam were later played of Gupta asking Rajaratnam, "I want ... us to keep having the dialog as to how I can be helpful in Galleon International [and] Galleon Group." After Rajaratnam's conviction and the revelations to Gupta in the Rajaratnam trial, the difficulty of SEC's proving even the civil charges against Gupta was still deemed considerable by observers. By April 2011 he had resigned from every board chairmanship or membership. May, 2011 Bloomberg report noted that, "remarkably, none of Gupta's alleged criminal tips to Rajaratnam appear to have been captured on the FBI's wiretaps." But the report also noted a March 2010 e-mail from Gupta to Ajit Rangnekar, dean of the Indian School of Business, with denials, assertions and, in the reporter's opinion, "obvious inaccuracies," leaving many questions about where the cases and story would yet go. August, 2011 Both the SEC administrative action and Gupta's countersuit were dropped by mutual agreement, though charges could be refiled by the SEC in federal court. Gupta v. SEC countersuit On March 18, 2011 Gupta countersued the SEC (SDNY 11 Cv. 1900). The court filing read, "Mr. Gupta denies all allegations of wrongdoing and stands ready to mount a defense against each and every one of the Commission's charges. Yet under current Commission rules, Mr. Gupta would be deprived of a jury trial, the right to use the discovery procedures of the federal court to shape his defense and the protections of the federal rules of evidence, which were crafted to bar unreliable evidence." The countersuit said the SEC action 'unfairly and unconstitutionally' singles him out, as he is to date the only person not employed by a broker-dealer ever charged by the SEC in administrative proceedings. It is not known whether the provisions of Dodd-Frank (the law allowing for SEC administrative proceedings in this instance) may be applied retroactively to before the laws existence, as the SEC has done in charging Gupta. The countersuit is likely to be heard by Judge Jed Rakoff, who was previously unwelcoming to an earlier high-profile SEC action and who commented that the SEC's decision to charge Gupta administratively (and not criminally) was sort of bizarre. Law professor and commentator Peter J. Henning wrote of the retroactivity argument in Gupta's countersuit: "The Supreme Court referred to the general presumption against retroactive application of laws unless Congress clearly wants the new rule applied to earlier cases." On the surface this works in Gupta's favour, though there were other factors (above) to consider. In July, 2011, Judge Rakoff refused to throw out the countersuit against the SEC and in August, Gupta and the SEC agreed to drop their respective actions against each other. The judge had drawn attention to the fact that all 28 other SEC actions stemming from the Galleon case had been filed in federal court. As part of the August agreement, the SEC agreed to file any future charges against Gupta in federal court in New York where it would be assigned to Rakoff. There was no comment on whether such charges would be filed.
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Insider Trading A case study on Rajat Gupta

Mercer v. Gupta shareholder suit Just over three months after the SEC allegations of insider trading, Goldman Sachs shareholder James Mercer filed suit against Gupta "seeking to recover any "short-swing" profits on Goldman's behalf

Understanding the Insider Trading as per SEBI (Securities and Exchange Board of India)

Insider The SEBI (insider trading) regulations, 1992 define an insider to mean: An insider, as defined by the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 under Regulation 2(e) that: 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 has had access to such unpublished price sensitive information. Connected Person means any person who(i) Is a director, as defined in clause (13) of section 2 Companies Act, 1956 of a company, or is deemed to be a director of that company by virtue of sub-clause (10) of session 307 of that Act or; (ii) Occupies the position as an officer or an employee of the company or holds a position involving a professional or business relationship between himself and the company whether temporary or permanent and who may reasonably be expected to have an access to unpublished price sensitive information in relation to that company. A 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 sub-section (1B) of section 370, or sub-section (11) of section 372, of the Companies Act, 1956, or sub-clause (g) of section 2 of the Monopolies and Restrictive Trade Practices Act, 1969, as the case may be; . (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; . (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 Trustees of a mutual fund or a member of the Board of Directors of the Asset management Company of a mutual fund or is an employee thereof who has a fiduciary relationship with the company; . (iv) is a Member of the Board of Directors, or an employee, of a public financial institution as defined in section 4A of the Companies Act, 1956; . (v) is an official or an employee of a Self-regulatory Organisation recognised or authorised by the Board of a regulatory body; . (vi) is a relative of any of the aforementioned persons; . (vii) is a banker of the company; .
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Insider Trading A case study on Rajat Gupta

(viii) relatives of the connected person; or (ix) is a concern, firm, trust, Hindu undivided family, company or association of persons wherein any of the connected persons mentioned in sub-clause (i) of clause (c), of this regulation or any of the persons mentioned in sub-clause (vi), (vii) or (viii) of this clause have more than 10 per cent of the holding or interest 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. Reg. 2(ha) of SEBI (Insider Trading) (Amendment) Regulations, 1992, deals with 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. Examples: The following shall be deemed to be price sensitive information Death/ Imprisonment of promoter Family dispute over ownership Accident and loss of contracts Court decisions and Judgments Insider Trading The knowledge of 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. Role of SEBI relating Insider Trading To appoint a senior level employee generally the Company Secretary, as the Compliance Officers; To set up an appropriate mechanism and to frame and enforce a code of conduct for internal procedures, To abide by the Code of Corporate Disclosure practices as specified in Schedule II to the SEBI (Prohibition of Insider Trading) Regulations, 1992 To initiate the information received under the initial and continual disclosures to the Stock Exchange within 5 days of their receipts; To specify the close period; To identify the price sensitive information To ensure adequate data security of confidential information stored on the computer; To ensure adequate data security of confidential information stored on the computer; To prescribe the procedure for the pre-clearance of trade and entrusted the Compliance Officers with the responsibility of strict adherence of the same.
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Insider Trading A case study on Rajat Gupta

The penalties/ punishments can be imposed in case of violation of SEBI (Prohibition of Insider Trading) Regulations, 1992. 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 performance of the company in present and future time. The importance of policing insider trading has also assumed international significance as overseas regulators attempt to boost the confidence of domestic investors and attract the international investment community. So, SEBI now should take the role of a regulator only. Special courts should be set up for faster and efficiencies disposal of cases. Different countries have diverse enactments and codes of conduct to curb the ill practice of Insider Trading. While the US and the UK has comprehensive legislations and monitoring bodies in this regard, countries like Germany reply on a voluntary code of conduct. In India, SEBI (Insider Trading) Regulations 1992, amended in 2002, 2003, and 2007 and recently in 2008, framed under Section 11 of the SEBI Act, 1992, are intended to prevent and curb the menace of insider trading in securities. 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 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.

Rajat Guptas case with SEBIs Perspective

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Insider Trading A case study on Rajat Gupta

If the same case would have happened in India instead of US, Rajat Gupta, if found guilty of insider trading, a criminal case would have been filed against him. As per SEBI (Prohibition of Insider Trading) Regulations, 1992, he would have been fined Rs25 Crore or three times the gains made from the insider trading. SEBI can also initiate criminal action against him, resulting in imprisonment up to 10 years. Proposed provisions in Insider Trading Regulation Indias stock market regulator Securities and Exchange Board of India (SEBI) plans to relax its regulations governing insider trading and will remove a provision that provides for criminal action against employees of a company who do not comply with a code of conduct specified in current insider trading laws. However, their companies may end up paying the price for this. That is because SEBI also plans to allow markets to punish the companies to which the insiders belong. It says imprisonment is a harsh punishment for something that has happened because of lack of processes in the companies concerned. Instead, it wants companies to disclose in their annual report details of their compliance or noncompliance with the code of conduct. This will allow the markets to decide whether to economically penalize companies which do not have these process oriented safeguards in place and will take us a step forward towards the efficient capital markets hypothesis, says a SEBIs circular titled Consultative Paper on Amendments to SEBI (prohibition of insider trading) Regulations 1992. Alternatively, there are some cases in which insider trading may involve a breach of contract and in these cases, the aggrieved party can pursue a civil action. However, many cases of insider trading involve no direct violation of trust or contract and therefore, they should not be considered a legal matter. Even when laws against insider trading exist, the facts stated above should cast serious doubt on the alleged necessity of the laws

References
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Insider Trading A case study on Rajat Gupta

http://www.sec.gov/index.htm http://www.sebi.gov.in/sebiweb/ http://ccsindia.org/ccsindia/policy/money/studies/wp0029.pdf http://www.cochinstockexchange.com/cse/Insider%20Trading.pdf http://legalserviceindia.com/article/l268-SEBI-on-Insider-Trading.html

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