India: Insider Trading Laws In India Vis-À-Vis The US & The UK

4.1 The United States of America

According to the legal framework of the US, the fundamental provisions relating to insider trading are Security and Exchange Commission Rules (SEC) Rule 10 b-5 (anti-fraud rule)¹, Rule 14 e-3 (relating to tender offers) and Section 16 (b) (recovery of short-swing profits) of the Exchange Act.

4.1.1 Rule 10 b-5

Rule 10b-5 was etched in the light of Section 10(b)² of the Securities Exchange Act, 1934 which is also known as the anti-fraud rule and allows the Securities and Exchange Commission (SEC) to enforce the prohibition on insider trading. It is worth mentioning that neither Section 10(b) of the Securities Exchange Act, nor Rule 10b-5, expressly prevent insider trading. Rule 10b-5 prohibits the acts and business practices that amount to fraud or deceit on any person, in relation to the sale or purchase of securities. For the purpose of establishing fraud or deceit, the U.S. courts have laid their basis on the principle of fiduciary duty on the part of the person acting as an insider towards the company or the shareholders, i.e., only if the fiduciary duty existed for an insider and there was a breach of such fiduciary duty, such a person would be considered to be an insider liable for fraud under this Rule. The burden of proof that fiduciary duty existed was on the Regulator.

4.1.2 Rule 14 e-3³

Apart from Rule 10b-5, Rule 14e-3 of the Securities Exchange Act, specifies prohibition against insider trading during tender offer which prohibits any person who is in possession of material non-public information relating to the commencing of a tender offer, directly or indirectly, either of the bidder company or the target company, from trading in the securities of the target company. This provision provides a complete ban on insider trading and it differs from Rule 10b-5 as there is no need to prove existence of fiduciary duty. Nevertheless, the Rule has its exceptions. Sub-section (1) to Rule 14e-3 eliminates purchases by a broker or by an agent on behalf of an offering person. The Rule is so designed to allow bidders to utilize outside brokers to make open market purchases prior to the filing requirement.

4.1.3 Section 16(b)

Another important provision in relation to insider trading in the U.S. is Section 16(b) of the Securities Exchange Act, 1934, which permits the issuers of securities to recover short-swing profits from an insider. In the U.S., trading by corporate insiders is regulated by Section 16(b) of the Securities Exchange Act. As per this provision, the short swing profit (i.e. profits out of purchase and sale transactions within a period of six (6) months) made by insiders is restricted. It is immaterial as to whether the violator is in possession of non-public information. An issuer or a shareholder, under Section 16(b), has a right to recover any profits made by an officer, director, or controlling shareholder from purchases and sales that occur within six (6) months of each other. Liability is determined solely if the purchasesale transactions have taken place within the statutory period of six (6) months.

4.2 United Kingdom

4.2.1. The vital provisions related to insider trading or insider dealing are found in Section 52⁴ of the Criminal Justice Act, 1993 ( 'CJA') and the Financial Securities and Markets Act, 2000 ( 'FSMA'). The approach adopted in the CJA, 1993, follows the European Community Insider Dealing Directive, as per which insider dealing is an abuse of the market rather than breach of the insider's fiduciary obligations with the company. Insider trading in the U.K is regulated under securities legislation rather than the company law. The definition of 'insider dealing' under Section 52 of the CJA, 1993, covers the following three offences: (a) dealing offence; (b) encouragement offence; and (c) disclosure offence. This is similar to the Rule 10b-5 of the U.S. Securities and Exchange Act, which regulates manipulation cases as well as insider trading, under the single anti-fraud rule. Section 119⁵ of the FSMA requires the Financial Services Authority ('FSA') to issue a Code of Market Conduct (the 'Code') that provides guidance to determine what kind of behaviour amounts to market abuse. However, the Code is not exhaustive, and it has the effect of codifying the rules on market abuse.

4.3 India

4.3.1. Section 12A (d) & (e)⁶ of the SEBI Act, read with the Insider Regulations and Section 15G⁷ of the SEBI Act regulates insider trading in India. However, none of these provisions give a specific definition of 'insider trading'. Section 15G is an enabling provision for SEBI to impose penalty in insider trading cases and the SEBI relies on the nature of the violation and description of the prohibited activities under this provision for imposing such penalties. The cases of violation are defined within the provision itself. On the other hand, Section 12A of the SEBI Act lists prohibited activities that primarily include manipulative trades, insider trading activities and substantial acquisition of securities.

4.3.2. Although the term 'insider trading' has not been defined specifically, Regulation 4 of the Insider Regulations provides that contravention of Regulation 3 of Insider Regulations amounts to the offence of insider trading. Under Regulation 3 of the Insider Regulations, an insider who deals with the securities of a listed company, while in possession of any unpublished price sensitive information (UPSI) is said to be guilty of insider trading. It also prohibits an insider from procuring, counseling and communicating UPSI to any other person.

4.3.3. Therefore, the offence of 'insider trading' as provided under Regulation 3, read with Section 12A of the SEBI Act, requires any of the following activities: a. Dealing in securities, while in possession of UPSI; b. By encouraging another person to deal; c. By disclosing the UPSI to another person.

4.3.4. An analysis of the provisions governing the prohibition on insider trading (Regulation 3 and 4 of the Insider Regulations and Section 12 (d) and (e) and Section 15G of the SEBI Act) is imperative to understand the legal framework for prohibition of insider trading in India and to demonstrate the efficacy as well as deficiency of the provisions.

Footnotes

1 SEC rule 10b-5, 17 C.F.R § 240.10B-5 (1976) provides: "It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or, (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security."

2 Section 10(B) of Securities Exchange Act, 1934: "To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities based swap agreement any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors."

3 17 C.F.R. § 240.14E-3 (1981)

4 Section 52 - The offence - (1) An individual who has information as an insider is guilty of insider dealing if, in the circumstances mentioned in subsection (3), he deals in securities that are price-affected securities in relation to the information.

(2) An individual who has information as an insider is also guilty of insider dealing if—

(a) he encourages another person to deal in securities that are (whether or not that other knows it) price-affected securities in relation to the information, knowing or having reasonable cause to believe that the dealing would take place in the circumstances mentioned in subsection (3); or

(b) he discloses the information, otherwise than in the proper performance of the functions of his employment, office or profession, to another person.

(3) The circumstances referred to above are that the acquisition or disposal in question occurs on a regulated market, or that the person dealing relies on a professional intermediary or is himself acting as a professional intermediary.

(4) This section has effect subject to section 53.

5 Section 119 - (1) The Authority must prepare and issue a code containing such provisions as the Authority considers will give appropriate guidance to those determining whether or not behaviour amounts to market abuse.

(2) The code may among other things specify— (a) descriptions of behaviour that, in the opinion of the Authority, amount to market abuse;

(b) descriptions of behaviour that, in the opinion of the Authority, do not amount to market abuse; (c) factors that, in the opinion of the Authority, are to be taken into account in determining whether or not behaviour amounts to market abuse. (3) The code may make different provision in relation to persons, cases or circumstances of different descriptions. (4) The Authority may at any time alter or replace the code. (5) If the code is altered or replaced, the altered or replacement code must be issued by the Authority. (6) A code issued under this section must be published by the Authority in the way appearing to the Authority to be best calculated to bring it to the attention of the public. (7) The Authority must, without delay, give the Treasury a copy of any code published under this section. (8) The Authority may charge a reasonable fee for providing a person with a copy of the code.

6 Section 12A – "No person shall directly or indirectly –(d) engage in insider trading; (e) deal in securities while in possession of material or non-public information or communicate such material or non-public information to any other person, in a manner which is in contravention of the provisions of this Act or the rules or the regulations made thereunder;"

7 Section 15G- "Penalty for insider trading. - If any insider who,- (i) either on his own behalf or on behalf of any other person, deals in securities of a body corporate listed on any stock exchange on the basis of any unpublished price sensitive information; or (ii) communicates any unpublished price- sensitive information to any person, with or without his request for such information except as required in the ordinary course of business or under any law; or (iii) counsels, or procures for any other person to deal in any securities of anybody corporate on the basis of unpublished price-sensitive information, shall be liable to a penalty of twenty-five crore rupees or three times the amount of profits made out of insider trading, whichever is higher."

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