Insider trading


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Insider trading

  1. 1. Insider trading is the trading of a corporations stock or other securities (e.g. bonds or stock options) byindividuals with potential access to non-public information about the company.Such a trade is motivated by the possibility of generating extraordinary gain with the helpof nonpublic information (information not yet made public). It gives the trader an unfairadvantage over other traders in the same security.insiders are defined as a companys officers, directors and any beneficial owners of more than tenpercent of a class of the companys equity securities------------------------------------------------------------2---------------------------------------------------------------------------It is important to distinguish between a STAKEHOLDER and a SHAREHOLDER. They sound the same –but the difference is crucial!Shareholders hold shares in the company – that is they own part of it.Stakeholders have an interest in the company but do not own it (unless they are shareholders).Often the aims and objectives of the stakeholders are not the same as shareholders and they come intoconflict.The conflict often arises because while shareholders want short-term profits, the other stakeholders’desires tend to cost money and reduce profits. The owners often have to balance their own wishesagainst those of the other stakeholders or risk losing their ability to generate future profits (e.g. theworkers may go on strike or the customers refuse to buy the company’s products).---------------------------------------------------------------3--------------------------------------------------------------------------Campaign finance refers to the fundraising and spending that political campaigns do in their electioncampaigns. As campaigns have many expenditures, ranging from the cost of travel for the candidate andothers might include the purchasing of air time for TV advertisements, however in some countries, suchas Britain TV advertising is free. Candidates often devote substantial time and effort raising money tofinance campaigns.Although the political science literature indicates that most contributors give to support candidates with [1]whom they are already in agreement, there is wide public perception that donors expect illegitimate [2]government favors in return (such as specific legislation being enacted or defeated), so some have [citation needed]come to equate campaign finance with political corruption and bribery . These views have ledsome governments to reform fundraising sources and techniques in the hope of eliminating perceivedundue influence being given to monied interests. Another tactic is for the government, rather than privateindividuals and organizations, to provide funding for campaigns.Democratic countries have differing regulations on what types of donations to political parties andcampaigns are acceptable.--------------------------------------------------------end-------------------------------------------------------
  2. 2. Time for tighter norms to protect stakeholders’ interestAmit MitraDebate over prevailing standards of corporate governance in India gained stridency in the last couple of months inthe wake of the un-spooling of the sordid Satyam fiasco.Apart from temporarily staining the image of corporate India, Satyamgate, described as a home-grown replica of theinfamous Enron saga, did pick holes in the prevailing standards of corporate governance in India.More importantly, it brought into sharper focus the need and scope for tightening corporate governance norms tobenefit the growing population of Indian investors in the share bazaar.It was on the chilly evening of September 22, 2008 in London, when Satyam Computer Services was awarded thecoveted Golden Peacock Global Award for Excellence in Corporate Governance for 2008 by the World Council forCorporate Governance, with Dr Ola Ullsten, the former Prime Minister of Sweden, serving as the lead judge.And weeks later, the same Satyam got enmeshed in the squalid trappings of deliberate fraud, misleading ofshareholders and poor corporate governance.Under pressure from mutual funds and minority stakeholders, Satyam did finally call off the decision to purchase 51per cent stake in Maytas Infrastructure and 100 per cent in Maytas Properties.But this left in its wake several issues related to corporate governance.Firstly, the decision was not announced taking into confidence all the stakeholders of the company. That the twinMaytas companies are run by the family members of the scam-tainted founder of Satyam, Mr Ramalinga Raju, isclearly a case of blatant jettisoning of healthy corporate governance practices.Nasscom, the premier trade body and the voice of the Indian IT/BPO industry, quickly reacted by announcing that itwill be forming a Corporate Governance and Ethics Committee, chaired by Mr N.R. Narayana Murthy, Chief Mentor ofInfosys. Stock market regulator SEBI also announced that it would examine if there was a need to tweak existingregulations to enhance, compliance, transparency and efficiency in the corporate system.Improving standardsThere is no gainsaying of the importance of corporate governance at a time when stock market interests haveclambered up on to a much higher perch as compared to some years ago. In fact, the turmoil in global financialmarkets can be partly traced to poor corporate governance, with many reputed global financial institutions keepingshareholders in the dark regarding their precise financial standing.Back home, there is no denying that the Government, share market regulator, SEBI, and corporate India have beenpushing themselves hard to raise the bar for corporate governance. But the question is has corporate governancestandards have improved to the desired levels.What is corporate governance? Broadly, it refers to the set of systems, principles and processes by which a companyis governed. It can be defined as the relationship of a company to its shareholders, going beyond just legalcompliance.In other words, corporate governance encompasses a broad spectrum of elements, ranging from the role and powersof the Board, legislation, Board independence, code of conduct to financial and operational reporting, auditcommittees and risk management.Comprehensive laws
  3. 3. India, indeed, has an elaborate system of laws governing corporate governance. To start with, the Companies Act,1956 covers corporate governance widely through a string of provisions such as constitution of audit committee,fixing of a ceiling on remuneration for directors and directors‘ responsibility statement.It was the Confederation of Indian Industry (CII) that came out with the first comprehensive code on corporategovernance in 1998, which was followed by the recommendations of the Kumar Mangalam Birla Committee onCorporate Governance, appointed by SEBI.The recommendations were embedded into the Clause 49 of the Listing Agreement on Indian stock exchanges.At that time, the issue of corporate guidelines had come into focus in the wake of huge foreign investments flowinginto the country — these investors wanted assurance that the companies they were investing in will be managed well.And to further enhance their confidence and to safeguard retail investors, SEBI had revised Clause 49 of its ―listingagreement‖, which stipulated that at least one-third of the directors on the boards of the companies should beindependent professionals.These directors should in no way be connected to the interests of promoters. The revised Clause 49 was madeeffective from January 1, 2006.Major changes were also made to the definition of ‗independent directors‘, strengthening of the responsibilities ofaudit committee and improving the quality of financial disclosure.The board, as a whole, was assigned the task of adoption of a formal code of conduct for senior management andthe certification of financial statements issued by the CEO/CFO.It is, however, no secret that many companies are yet to fully comply with the Clause 49 norms. It is thus time forSEBI to get stricter with such companies to protect shareholders interests.Pledging of sharesMore recently, SEBI, in an attempt to further enhance transparency in corporate corridors, had made it mandatory forpromoters to announce their pledged shares for the public.Pledging of promoters shares has been commonplace in the history of corporate India and, as it was not earliermandatory on them to disclose the amount of shares pledged, shareholders were left guessing.Now that this disclosure has been made mandatory, shareholders will have a better idea of the financial stability andownership status of the companies they invested in.Weak linksHowever, despite these measures, there still exists some weak links in the system.For example, experts say, the Satyam episode did bring to the fore once again the role of independent directors, whoare supposed to protect shareholder interests.―Independent directors should also be held accountable for board decisions and audit-related compliance practices,‖said an analyst on corporate governance.Auditors‘ roleApart from independent directors, the role of auditors also came into focus.
  4. 4. The question that began to do the rounds in investors‘ circles in the immediate aftermath of the Satyam scandal waswhether shareholders and other stakeholders could take any action against the auditors.Ms Namrata Mehta, Corporate Lawyer, Economic Laws Practice (ELP), a law firm that advises and litigates in areasof Direct and Indirect Tax, says ―how an Indian Court will view the liability of the auditors of Satyam will depend uponthe extent to which the Court is convinced about a claim for negligence.‖She further points out that regardless of the final outcome, auditors must be ―reading their professional indemnityinsurance contracts with a microscope and wishing that the Limited Liability Partnership Act was passed a fewmonths earlier.‖Institutional investorsExperts feel that institutional investors can play a greater role in ensuring effective corporate governance standards,as they have a clout to extract information and play an activist role. This was best exemplified in the Satyam scam.As for retail investors, it is important that they take all possible precautions before making investments.Whatever may be the denouement of the Satyam fiasco, it is pertinent that corporate houses take this black chapterof India‘s corporate history as a lesson in poor corporate governance practices and collectively map out a stricterstructure that will protect the interests of all stakeholders.nsider trading is a term subject to many definitions and connotations and it encompasses both legal andprohibited activity. Insider trading takes place legally every day, when corporate insiders – officers, directorsor employees – buy or sell stock in their own companies within the confines of company policy and theregulations governing this trading. In simple terms ‗insider trading‘ buying or selling a security, in breach of afiduciary duty or other relationship of trust , and confidence , while in possession of material , nonpublicinformation about the securityThus , in nutshell , insider trading is the buying , selling or dealing in securities of a listed company by adirector , member of management , employee of the company , or by any other person such as internalauditor , advisor , consultant , analyst etc, who has knowledge of material inside information which is not
  5. 5. available to general publicExamples of Insider Trading-Corporate officers -, directors and employees who , traded the company‘s securities after learning ofsignificant, confidentiality corporate developments;Employees of law, banking , brokerage and printing firms- who were given such information to provideservices to corporation whose securities they traded;Government employees – who learned of such information because of their employment by the government;Therefore, preventing such transactions is an important obligation for any capital market regulatorysystem,because insider trading undermines investor confidence in the fairness and integrity of the securitiesmarkets.For instance, prior knowledge of a bonus issue would result in the insider acquiring a significant exposure inparticular scrip, knowing that his holding would increase significantly after the bonus is announced.The first country to tackle insider trading effectively however was the United States[1].In the USA, theSecurities and Exchange Commission is empowered under the Insider Trading Sanctions Act, 1984 toimpose civil penalties in addition to criminal proceedings. Most countries have in place suitable legislation tocurb the menace of insider trading.In India, SEBI (Insider Trading) Regulations 1992, framed under Section 11 of the SEBI Act, 1992, areintended to prevent and curb the menace of insider trading in Securities. Now SEBI has with effect from 20thFebruary 2002 amended these Regulations and rechristened them as SEBI 9 Prohibition of Insider TradingRegulation , 1992 . These Regulation have been further amended in November 2002Rational Behind Prohibition of Insider TradingThe smooth operation of the securities market and its healthy growth and development depends on a largeextend on the quality and integrity of the market .Such a market can alone inspire confidence in investorsInsider trading leads to loose of confidence of investors in securities market as they feel that market is riggedand only the few, who have inside information get benefit and make profits from their investments . Thus,process of insider trading corrupts the ‗level playing field‘Hence the practice of insider trading is intended to be prohibited in order to sustain the investor‘s confidencein the integrity of the security market.In Samir C Arora Vs SEBI [2]It was observed that activities like insider trading fraudulent trade practices and professional misconduct areabsolutely detrimental to the interests of ordinary investors and are strongly deprecated under the SEBIAct,1992 and the Regulations made there under. No punishment is too severe for those indulging suchactivities.MEANING OF Insider & Insider Trading DefinedSecurities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992, does not directlydefine the term "insider trading".But it defines the terms-. insider" or who is an "insider;[3]. who is a "connected person[4]. What are "price sensitive information".[5]InsiderAccording to the Regulations "insider" means any person who, is or was connected with the company or isdeemed 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
  6. 6. received or has had access to such unpublished price sensitive information;The above definition in turn introduces a new term "connected person".Connected personThe Regulation defines that a "connected person" means any person who-(i) is a director, as defined in clause (13) of section 2 of the Companies Act, 1956 (1 of 1956) of a company,or is deemed to be a director of that company by virtue of sub-clause (10) of section 307 of that Act or(ii) occupies the position as an officer or an employee of the company or holds a position involving aprofessional or business relationship between himself and the company whether temporary or permanentand who may reasonably be expected to have an access to unpublished price sensitive information inrelation to that company;Price Sensitive Information means any information, which relates directly or indirectly to a company andwhich if published, is likely to materially affect the price of securities of company.American insider trading lawThe United States has been the leading country in prohibiting insider trading and the first country to tackleinsider trading effectively.Thus it is important to discuss insider trading in American perspective. While Congress gave us the mandateto protect investors and keep our markets free from fraud, it has been our jurists, albeit at the urging of theCommission and the United States Department of Justice, who have played the largest role in defining thelaw of insider trading.The market crash in 1929 due to prolonged lack of investors confidence in the securities market followed byGreat Depression of US Economy , led to the enactment of Securities Act of 1933 in which Section 17 of thecontained prohibitions of fraud in the sale of securities which were greatly strengthened by the SecuritiesExchange Act of 1934The 1934 Act addressed insider trading directly through Section 16(b) and indirectlythrough Section 10(b).Section 16(b) of the Securities Exchange Act of 1934 prohibits short-swing profits(from any purchases and sales within any six month period) made by corporate directors, officers, orstockholders owning more than 10% of a firm‘s shares. Under Section 10(b) of the 1934 Act, SEC Rule 10b-5, prohibits fraud related to securities trading. Further the Insider Trading Sanctions Act of 1984 and theInsider Trading and Securities Fraud Enforcement Act of 1988 provide for penalties for illegal insider tradingto be as high as three times the profit gained or the loss avoided from the illegal trading..[ Much of thedevelopment of insider trading law has resulted from court decisions. In SEC v. Texas Gulf Sulphur Co.[6], afederal circuit court stated that anyone in possession of inside information must either disclose theinformation or refrain from trading. (1966)In 1984, the Supreme Court of the United States ruled in the case of Dirks v. SEC that tippees (receivers ofsecond-hand information) are liable if they had reason to believe that the tipper had breached a fiduciaryduty in disclosing confidential information and the tipper received any personal benefit from the disclosure.(Since Dirks disclosed the information in order to expose a fraud, rather than for personal gain, nobody wasliable for insider trading violations in his case.)The Dirks case also defined the concept of "constructive insiders," who are lawyers, investment bankers andothers who receive confidential information from a corporation while providing services to the corporation.Constructive insiders are also liable for insider trading violations if the corporation expects the information toremain confidential, since they acquire the fiduciary duties of the true insider.In United States v. Carpenter (1986) the U.S. Supreme Court cited an earlier ruling while unanimouslyupholding mail and wire fraud convictions for a defendant who received his information from a journalistrather than from the company itself. The journalist R. Foster Winans was also convicted. [7]"It is well established, as a general proposition, that a person who acquires special knowledge or informationby virtue of a confidential or fiduciary relationship with another is not free to exploit that knowledge orinformation for his own personal benefit but must account to his principle for any profits derived therefrom."However, in upholding the securities fraud (insider trading) convictions, the justices were evenly split.In 1997 the U.S. Supreme Court adopted the misappropriation theory of insider trading in United States v.
  7. 7. OHagan, 521 U.S. 642, 655 (1997),. OHagan was a partner in a law firm representing Grand Met, while itwas considering a tender offer for Pillsbury Co. OHagan used this inside information by buying call optionson Pillsbury stock, resulting in profits of over $4 million. OHagan claimed that neither he nor his firm owed afiduciary duty to Pillsbury, so that he did not commit fraud by purchasing Pillsbury options.The Court rejected OHagans arguments and upheld his conviction.The "misappropriation theory" holds that a person commits fraud "in connection with" a securities transaction,and thereby violates 10(b) and Rule 10b-5, when he misappropriates confidential information for securitiestrading purposes, in breach of a duty owed to the source of the information. Under this theory, a fiduciarysundisclosed, self-serving use of a principals information to purchase or sell securities, in breach of a duty ofloyalty and confidentiality, defrauds the principal of the exclusive use of the information. In lieu of premisingliability on a fiduciary relationship between company insider and purchaser or seller of the companys stock,the misappropriation theory premises liability on a fiduciary-turned-traders deception of those who entrustedhim with access to confidential information.The Court specifically recognized that a corporation‘s information is its property: "A companys confidentialinformation...qualifies as property to which the company has a right of exclusive use. The undisclosedmisappropriation of such information in violation of a fiduciary duty...constitutes fraud akin to embezzlement –the fraudulent appropriation to ones own use of the money or goods entrusted to ones care by another."In 2000, the SEC enacted Rule 10b5-1, which defined trading "on the basis of" inside information as any timea person trades while aware of material nonpublic information — so that it is no defense for one to say thatshe would have made the trade anyway. This rule also created an affirmative defense for pre-planned trades.In May of 2007, representatives Brian Baird and Louise Slaughter introduced a bill entitled the "Stop Tradingon Congressional Knowledge Act, or STOCK Act." that would hold congressional and federal employeesliable for stock trades they made using information they gained through their jobs. The bill would also seek toregulate so called "Political Intelligence" firms that research government activities and sell the information tofinancial managers.Insider trading in IndiaIn India Regulation 3 of the SEBI Regulations seeks to prohibit dealing, communication and counseling onmatters relating to, insider trading. Regulation 3 provides that no insider shall either on his own behalf of anyother person deal in securities of a company when in possession of any unpublished price sensitiveinformation on communicate, counsel or procure , directly or indirectly any unpublished price sensitiveinformation to any person , who while in possession of such unpublished price sensitive information shall notdeal in securities. However, these restrictions are not applicable to any communication required ordinary,course of business or profession or employment or any law.Further 3 A prohibits any company from dealing in the securities of another company or associate of thatother company while in possession of any unpublished price sensitive information.Insider Trading Regulations have been tightened by SEBI during February 2002. New rules cover temporaryinsiders like lawyers, accountants, investment bankers etc.[8]Directors and substantial shareholders have to disclose their holding to the company periodically. The NewRegulations have added relatives of connected persons, as well as, the companies, firms, trust, whichrelatives of connected persons, bankers of the company and of persons deemed to be connected personshold more than 10% .The definition of relative[9]under the New regulations is in line with that of theCompanies Act, 1956, which ranges from parents and siblings to spouses of siblings and grandchildren. Theterm ―connected person‖ is defined to mean either i) a director or deemed to be a director, ii) occupies theposition as an officer or an employee or having professional or business relationship whether temporary orpermanent, with the company. Thus, there are two categories of insiders:Primary insiders, who are directly connected with the company and secondary insiders who are deemed tobe connected with the company since they are expected to have access to unpublished price sensitiveinformation.[10] The jurisprudential basis for the person-connected approach seems to be founded in the
  8. 8. equitable notions of fiduciary duty.The secondary insider, who would have traded with an unfair informational advantage, may escape frombeing caught simply because there can be no trace of how he derived this information in the first place.insider by reason of his connection with the company. In reality, much of the flow of the price-sensitiveinformation often does not operate by way of such established networks of relational links betweenindividuals. Very often, such price-sensitive information is communicated and spread out through veryloosely connected and informal networks of brokers, clients and even between friends and through electronicnetworks etc. or an elaborate nexus of company official, brokers, traders. These individuals are very oftenprivy to strategic policy decisions or developments that may influence the valuation of a company‘s scrip onthe bourses.Duties/ Obligations Of the companyEvery listed company has the following obligations under the SEBI(Prohibition of Insider Trading)Regulations, 1992To appoint a senior level employee generally the Company Scecretary , 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 ofInsider Trading)Regulations , 1992To initiate the information received under the initial and continual disclosures to the Stock Exchange within 5days of their receipts;To specify the close period;To identify the Price Sensitive InformationTo 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 theresponsibility of strict adherence of the samePenaltiesFollowing penalties /punishments can be imposed in case of violation of SEBI (Prohibition of InsiderTrading)Regulations , 1992SEBI may impose a penalty of not Rs 25 Crores or three times the amount of profit made out of insidertrading; whichever is higherSEBI may initiate criminal prosecutionSEBI may issue orders declaring transactions in securities based on unpublished price sensitive informationSEBI may issue orders prohibiting an insider or refraining an insider from dealing in the securities of thecompanyConclusionThe new 2002 regulations in India have further fortified the 1992 regulations and have increased the list ofpersons that are deemed to be connected to Insiders. Listed companies and other entities are now requiredto frame internal policies and guidelines to preclude insider trading by directors, employees, partners, etc. Inthe past, it has been observed that insider trading legislation is ineffective and difficult to enforce and haslittle impact on securities markets. Low enforcement rates and few convictions against insiders have beencited as evidence of this ineffectiveness. Irrespective of whether or not the SEBI was bestowed with wideranging powers, it has been a clear failure when it came to the task of administering the law.The importance of policing insider trading has also assumed international significance as overseas regulatorsattempt 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 could be set up for faster andefficacious disposal of cases.References1. Where an insider discloses the inside information to another person, otherwise than in the properperformance of the functions of his employment, office or profession. (Section 52(2) (b)).2. 83 /20043. SEBI (Insider Trading) Regulations 1992[Reg2(e)]4. [Reg 2(c)]5. Reg 2(ha)]6. (1966)
  9. 9. 7. Christopher Cox, U.S. Securities and Exchange Commission Speech by SEC Chairman:Remarks at theAnnual Meeting of the Society of American Business Editors and Writers8. On September 15, 2002 the SEBI Board decided to relax the meaning of the term `relative in the InsiderTrading Regulations. Only direct relatives of those who are deemed to have price-sensitive insiderinformation on securities will now come under the ambit of the Securities and Exchange Board of India(Insider Trading) Regulations. SEBI officials pointed out that the decision to exclude the third category ofrelatives from the ambit of the insider trading regulations comes in the wake of a host of representationssaying that the existing definition of the term relative was too restrictive10. Regulation 2(h) identifies seven broad categories of secondary insiders within which these are a few sub-categories, such as (a) Companies under the same management;(b) Members and employees of Stockexchanges;(c) Market Intermediaries, Mutual Funds etc.;(d) Directors and employees of financialinstitutions;(e) Officers and employees of self-regulatory bodies;(f) Relatives;(g) Bankers--------------------------------------------------------------------------------[1]Where an insider discloses the inside information to another person, otherwise than in the properperformance of the functions of his employment, office or profession. (Section 52(2) (b)).[2] 83 /2004[3]SEBI (Insider Trading) Regulations 1992[Reg2(e)][4] [Reg 2(c)][5] Reg 2(ha)][6](1966),[7]Christopher Cox, U.S. Securities and Exchange Commission Speech by SEC Chairman:Remarks at theAnnual Meeting of the Society of American Business Editors and Writers[8][9]On September 15, 2002 the SEBI Board decided to relax the meaning of the term `relative in the InsiderTrading Regulations. Only direct relatives of those who are deemed to have price-sensitive insiderinformation on securities will now come under the ambit of the Securities and Exchange Board of India(Insider Trading) Regulations. SEBI officials pointed out that the decision to exclude the third category ofrelatives from the ambit of the insider trading regulations comes in the wake of a host of representationssaying that the existing definition of the term relative was too restrictiveAdded Date: 15 Jan 2008Lenght: 3022 wordsViews: 2479