Insider Trading : An Indian Perspective

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

Insider trading can be illegal or legal depending on when the insider makes the trade: it is illegal when the material information is still nonpublic--trading while having special knowledge is unfair to other investors who don't have access to such knowledge. Illegal insider trading therefore includes tipping others when you have any sort of nonpublic information. Directors are not the only ones who have the potential to be convicted of insider trading. People such as brokers and even family members can be guilty.

Insider trading is legal once the material information has been made public, at which time the insider has no direct advantage over other investors.

When insiders, e.g. key employees or executives who have access to the strategic information about the company, use the same for trading in the company's stocks or securities, it is called insider trading and is highly discouraged by the Securities and Exchange Board of India to promote fair trading in the market for the benefit of the common investor. 

Insider trading is an unfair practice, wherein the other stock holders are at a great disadvantage due to lack of important insider non-public information. However, in certain cases if the information has been made public, in a way that all concerned investors have access to it, that will not be a case of illegal insider trading. 

It was only about three decades back that insider trading was recognized in many developed countries as what it was - an injustice; in fact, a crime against shareholders and markets in general. At one time, not so far in the past, inside information and its use for personal profits was regarded as a perk of office and a benefit of having reached a high stage in life. It was the Sunday Times of UK that coined the classic phrase in 1973 to describe this sentiment - "the crime of being something in the city", meaning that insider trading was believed as legitimate at one time and a law against insider trading was like a law against high achievement. "Insider trading" is a term subject to many definitions and connotations and it encompasses both legal and prohibited activity. 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. It is the trading that takes place when those privileged with confidential information about important events use the special advantage of that knowledge to reap profits or avoid losses on the stock market, to the detriment of the source of the information and to the typical investors who buy or sell their stock without the advantage of "inside" information. Almost eight years ago, India's capital markets watchdog – the Securities and Exchange Board of India organised an international seminar on capital market regulations. Among others issues, it had invited senior officials of the Securities and Exchange Commission to tell us how it tackled the menace of insider trading.

Now we will refer to some cases of Insider Trading in India and world wide.

Former Goldman Sachs Indian-American board member Rajat Gupta, convicted of insider trading has been fined $13.9 million to settle related civil charges of feeding inside information to his friend, a billionaire hedge fund boss, Raj Rajaratnam.

The Securities and Exchange Commission announced the fine on Wednesday against Gupta, who was also permanently barred from serving as an officer or director of any public company. Gupta, a former chief of global consulting firm McKinsey & Co., was one of the biggest catches for the federal government in its five-year crackdown on insider trading that has brought about 70 criminal convictions.

Gupta was sentenced in October to two years in prison for passing confidential information gained from his position as a Goldman director to Raj Rajaratnam, founder of the Galleon group of 14 hedge funds. Gupta, who also had been a director of consumer products giant Procter & Gamble, was also ordered to pay a $5 million criminal fine.

Prosecutors said that Rajaratnam, who is serving an 11-year prison sentence, illegally reaped as much as $75 million through his trades, including about $11 million from the information provided by Gupta. The case revolving around Rajaratnam and the Galleon funds has been called the biggest insider trading prosecution in US history. Rajaratnam was fined $10 million in his criminal case and ordered to forfeit $53.8 million. He also paid a record $92.8 million civil penalty levied by the SEC.

Gupta's attorneys noted at his trial that he earned no profits from the scheme. Prosecutors accused Gupta of "above-the-law arrogance" in passing inside tips to Rajaratnam between March 2007 and January 2009. The advance information concerned a $5 billion investment by billionaire investor Warren Buffett's Berkshire Hathaway Inc. in Goldman and Goldman's financial results for the second and fourth quarters of 2008.

"The sanctions imposed today send a clear message to board members who are entrusted with protecting the confidences of the companies they serve," George Canellos, co-director of the SEC's enforcement division, said in a statement.

Gupta's conviction marked a spectacular fall from grace for the Harvard-educated businessman, who was born in Kolkata, India. More than 400 letters were written on his behalf to the federal judge hearing his case, including documents signed by Microsoft co-founder Bill Gates and former UN Secretary-General Kofi Annan.

Reliance Petro investments violated insider trading norms in the shares of erstwhile IPCL. 

The Securities and Exchange Board of India (Sebi) has fined Reliance Industries group entity Reliance Petroinvestments (RPIL) Rs 11 crore for violating insider trading norms in the shares of erstwhile IPCL before its merger with RIL.

"It may be concluded that by virtue of RPIL having control over IPCL, it was reasonably expected to have access to unpublished price sensitive information of IPCL. RPIL being the promoter having control over the company holding 46 per cent shares of IPCL is inherently expected to have access to price sensitive information. The company being in such a position it is unacceptable that it was not aware of such major/ important decisions of the company IPCL," the Sebi order said.

Share price of IPCL on March 5, 2007, declined by 8.13 per cent on the BSE when the Sensex declined by 3.79 per cent. However, in a divergence from the index, the scrip witnessed substantial price gain on March 8, 2007, and March 9, 2007, subsequent to the announcement of amalgamation of IPCL with Reliance Industries.

The findings of the investigation led to the allegation that RPIL was in the possession of unpublished price sensitive information while trading in the scrip of IPCL prior to announcement of declaration of interim dividend and amalgamation of IPCL with Reliance Industries which resulted in violation of regulation 3 of SEBI (Prohibition of Insider Trading) Regulations, 1992.

Worth Movies to  See on Insider Trading : Friends do once see the Following Movies ( Sequence Wise) on Insider Trading and Investment Banking and whole Financial Markets how it actually works by taking time from your busy Schedule.

1. Wall Street (1989 Movie)
2. Wall Street : Money Never Sleeps (2010 Movie)
3. Too Big To Fail (2011 Television Movie)
4. Inside Job (2010 Documentary Movie)

Did Tata Sons violate insider trading norms?

The fact that Tata Sons and its principal shareholder procured price-sensitive information ahead of others is, in itself, not something to get worked up about.

The Securities and Exchange Board of India (Sebi) is examining whether Tata Sons Ltd violated insider trading regulations in its interactions with group operating companies, according to The Economic Times. This isn’t surprising. A letter by Cyrus Mistry, former chairman of Tata Sons, to the company’s board had mentioned possible violations of insider trading regulations. In addition, people close to Mistry have spread the word that the relationships between operating companies, Tata Sons and Tata Trusts are nebulous. According to them, price-sensitive information often goes back and forth between these entities before the board of the operating company comes to a decision.

The charges, in one sense, implicate Mistry himself, since he was a key link between the operating companies and Tata Sons. Sebi’s insider trading regulations prohibit communication of unpublished price-sensitive information.

But a pertinent question here is if communication of price-sensitive information with a large shareholder should be seen as a violation, per se. If so, perhaps every Indian company would have violated Sebi’s regulations at one time or another. For instance, when a board nominee of the government or a bank or a private equity fund receives price-sensitive information, it doesn’t remain a closely guarded secret. That information is typically taken back to the team overseeing the investment at these entities.

It then depends on how you read Sebi’s insider trading laws. They state, “No insider shall communicate, provide, or allow access to any unpublished price sensitive information... to any person including other insiders except where such communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.” A bank’s or an investment firm’s nominee on a company’s board will argue that sharing the information with his team is in furtherance of legitimate purposes and performance of duties.

A Tata Sons nominee on the board of a Tata group company will make the same argument. Surely, it can’t be the regulator’s case that nominee directors keep all price-sensitive information close to their chests, and not take it back to the firm they represent. If it insists on doing so, it will throttle decision-making at the holding company level or at banks and investment firms, as the case may be. A former executive director at Sebi said that if such restrictions are imposed, taking normal business decisions will become impossible.

In fact, if Sebi starts examining all board nominees of large shareholders and how they handle price-sensitive information, it will clearly be a slippery slope. Where, then, does one draw the line?

Policymakers should accept the fact that large shareholders will rule the roost when it comes to decision-making at a company. A structure where the rights of large shareholders are curtailed will unduly empower the management of the company, which will result in negative outcomes.

JR Varma, professor of finance at Indian Institute of Management, Ahmedabad and a former Sebi board member says, “The central problem in Indian corporate governance is how to manage the conflicts between dominant shareholders and minority shareholders. We can’t improve corporate governance by limiting shareholder democracy, and therefore the ‘legitimate’ governance rights of the majority shareholder must be respected. In fact, the various obligations that regulators impose on dominant shareholders don’t make sense without the governance rights that underpin these obligations. That does not mean giving the majority shareholder a free hand to do whatever it likes. An important goal of corporate governance regulations is to ensure that dominant shareholders don’t abuse minority shareholders through unfair related party transactions or through insider trading.”

Sebi will surely have a case on its hands if it finds that any of the Tata Sons directors or any of trustees of Tata Trusts traded shares of operating companies, when the trading window was closed for insiders. The former Sebi official says that the operating word that should be kept in mind as far as insider trading violations go is ‘trading’. Besides, Sebi should devote its resources to areas where there is an abuse of power by dominant shareholders such as related party transactions that work against the interest of minority shareholders. The fact that Tata Sons and its principal shareholder procured price-sensitive information ahead of others is, in itself, not something to get worked up about. In fact, among other things, people close to Mistry complained how he had to hold multiple meetings with both trustees of Tata Trusts as well as directors of Tata Sons ahead of important decisions. These are matters that Tata Sons and Tata Trusts need to resolve.

Sebi has a model code of conduct as far as handling price-sensitive information by a listed company goes. The code doesn’t envisage sharing of information with a dominant shareholder. Even so, the Tata group can adapt best practices so that leakage of information is kept to the minimum.

Source:  Livemint.com