October 28, 2021

INSIDER TRADING LAW (SEBI Act, 1992)

Companies Act

What is Stock Trading?

Stock trading refers to the buying and selling of shares in a particular company from the Stock Market.

If you own the stock, you own a piece of the company and the number of shares you are holding or amount decides the percentage of your share holding in that company. It is Share Holding (Investment) if you hold the shares of the company for long and do not trade out on the same day or in short term high performance or fluctuation.

What is Insider trading?

Insider Trading or Insider Dealing is the illegal practice of trading on the stock exchange to one’s own advantage through having access to confidemtial information.

Insider trading is 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.

Illegal insider trading includes tipping others when you have any sort of nonpublic information. Legal insider trading happens when directors of the company purchase or sell shares, but they disclose their transactions legally.

Insider trading is defined as a malpractice wherein trade of a company’s securities is undertaken by people who by virtue of their work have access to the otherwise non public information which can be crucial for making investment decisions.

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 illegak insider trading. Because insider information gives an investor an advantage over others, it is illegal and punishable by law.

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. In simple terms ‘insider trading’ 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. So in nutshell , insider trading is the buying , selling or dealing in securities of a listed company bya director , member of management , employee of the company , or by any other person such as internal auditor , advisor , consultant , analyst etc, who has knowledge of material inside information which is not available to general public.

Example-

• prior knowledge of a bonus issue would result in the insider acquiring a significant exposure in particular scrip, knowing that his holding would increase significantly after the bonus is announced.

• officers , directors and employees who , traded the company’s securities after learning of significant, confidentiality corporate developments.

• Employees of law, banking , brokerage and printing firms- who were given such information to provide services to corporation whose securities they traded.

• Government employees – who learned of such information because of their employment by the govt.

Securities and Exchange Board of India

Insider trading in India is generally regulated by the SEBI Regulations on Prohibition of Insider Trading, 1992. Insider trading is defined in Section 2(e) of the act. However, the term insider trading is not defined anywhere in the Company’s Act, 1956. But, Section 195 of the Companys Act of 2013 prohibits insider trading by the director or the key managerial person. Section 458 of the Companys Act, 2013 delegates or confers the power to SEBI to prosecute both the listed and companies which are deemed to be listed of insider trading which is going on illegally inside any of these companies.

According to SEBI Prohibition of Insider Trading regulation 1992 which consists of IV chapters. There are the following provisions that are given under it:

Section 2(c) of the Act defines connected person.

  1. Who is the director of a company which is defined in Section 2(13) of the company’s activities or deemed to be a company?
  2. Either the employee or the officer of a company or any person or insider who has access to secret, unpublished information regarding the company’s securities or bonds.

So basically, a connected person can be any person who is directly or indirectly related to the affairs of the company. 

Section 2(h) defines the deemed to be a connected person. According to it, a ‘person deemed to be a connected’ can be any person who is directly or indirectly related to either an insider or a connected person.

Section 2(e) of this act defined the ‘insider’.An Insider can be any person who is connected to the company or has access to secret information that has not been publicly disclosed yet or any information related to the affairs of the company. Here, ‘price sensitive information’ is any kind of secret information that should be kept secret in order to protect the reputation of the company and by disclosing such information be likely to affect the price or securities of the company.

According to Section 3of SEBI regulations of Insider trading 1992, it is given that no insider or a connected person has the right to publicly disclose or display any secret information related to the affairs of the company if the made public can affect the price or securities of the company.

According to the Section 12 of the Act, all the listed companies with the SEBI, intermediaries, self-regulatory organizations, recognized stock exchanges, public finance institutions, corporate or professional firms should form the internal procedure code and moral ethics on the lines of rules given in the Schedule 1 of the act and should strictly follow them to prevent illegal insider trading in their companies.

One crucial thing to be noticed that according to this act, price-sensitive information must be disclosed to only those persons who need it in order to discharge their duties on the ‘need to know’ basis.

It’s the responsibility of the director or employee of the company to maintain the confidentiality of the price-sensitive information. Any person who is related to the company trades or discloses any secret information will be held liable in a criminal manner and strict action would be taken against them. Any person or employee/director/worker of the company who violates any rules or guidelines of code of conduct will be held liable for planetary action such as wage freeze, suspension of future participation in the company’s affairs, etc. These actions and guidelines and penalties are the same whether for listed companies or for corporate or professional firms.

Why Prohibition on Insider Trading

The smooth operation of the securities market and its healthy growth and development depends on a large extend on the quality and integrity of the market .Such a market can alone inspire confidence in investors.

Insider trading leads to loose of confidence of investors in securities market as they feel that market is rigged and only the few, who have inside information get benefit and make profits from their investments.Hence the practice of insider trading is intended to be prohibited in order to sustain the investor’s confidence in the integrity of the security market.

The first country to tackle insider trading effectively however was the United States. 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.

In India, SEBI (Insider Trading) Regulations 1992, framed under Section 11 of the SEBI Act,

1992, are intended to prevent and curb the menace of insider trading in Securities.

Now SEBI has with effect from 20th February 2002 amended these Regulations and rechristened them as SEBI 9 Prohibition of Insider Trading Regulation , 1992 . These Regulation have been further amended in November 2002.

Landmark cases

Hindustan Lever Limited v. SEBI

The facts of the case concerned the purchase by HLL of 8 lakh shares of BBLIL from the Unit Trust of India (UTI) on March 25, 1996. This purchase was made barely two weeks prior to a public announcement for a proposed merger of HLL with BBLIL.

 Upon investigation, SEBI by its Order dated March 11, 1998 (Order) found that, at the time of the purchase of shares of BBLIL from UTI, HLL was an “insider” as under Section 2(e) of the 1992 Regulations. The relevant extract of which describes an insider as any person who: “(i) is or was connected with the company or is deemed to have been connected with the company and is reasonably expected to have access by virtue of such connection to unpublished price sensitive information in respect of securities of the company, or (ii) has received or has had access to such unpublished price sensitive information.”

SEBI held that, since, HLL and BBLIL were subsidiaries of the same London based Unilever, and were effectively under the same management, HLL and its directors had prior knowledge of the merger. Thus HLL was covered under the definition of an insider as above defined.

Duties/ Obligations Of the company

Every listed company has the following obligations under the SEBI(Prohibition of Insider Trading) Regulations , 1992 :-

• To 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 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;

Penalties

Following penalties /punishments can be imposed in case of violation of SEBI (Prohibition of Insider Trading)Regulations , 1992 :-

• SEBI may impose a penalty of not Rs 25 Crores or three times the amount of profit made out of insider trading; whichever is higher

• SEBI may initiate criminal prosecution

•SEBI may issue orders declaring transactions in securities based on unpublished price sensitive information

• SEBI may issue orders prohibiting an insider or refraining an insider from dealing in the securities of the company

The prevention of insider trading is widely treated as an important function of securities regulation. Section11(2)(e) of companies act,1956 prohibits the insider trading but does not define it.

Conclusion

Since many litigations regarding Insider trading has been seen inspite of the prohibition act SEBI regulations and laws related to Trdaing are getting stricter after every amendment which I believe is good for continuation of fair and genuine practice of Trading. The new 2002 Regulations have further fortified the 1992 regulations and have increased the list of person that are connected to Insider Trading.

Author– Rachit Manchanda

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