A recent trend in insider trading investigations is that in the absence of direct evidence, the accused is acquitted by the Securities Appellate Tribunal (SAT). This is wrong. Although the market regulator may be unwilling to penalise anyone without direct evidence, it is well known that in insider trading — as the name itself suggests — direct evidence is hard to find.

The Securities and Exchange Board of India is considering revamping the two-decade-old insider trading regulations and inviting suggestions from the public. The ‘SEBI (Prohibition of Insider Trading) Regulations, 1992’ defines terms such as “insider”, “connected person” or “deemed to be connected person”, “dealing in securities” and “price-sensitive information”. These should be relooked and their scope widened in today’s context. For example, independent auditors, solicitors and legal consultants among others should also be expressly included in the definition of ‘connected persons’.

Under Regulation 3, no “insider” shall deal in securities or communicate, counsel or procure any unpublished price-sensitive information for any person who will deal with the securities with the advantage of such unpublished information. Similar restrictions apply to companies having unpublished public information.

The regulation provides the framework of initial and continual disclosure to the company which, in turn, shall report to the stock exchanges within specified timeframe. Provisions are required to make it mandatory for the person concerned to make public any price-sensitive information in the shortest possible time.

The immediate publication of such information by corporate houses would go a long way in avoiding insider trading deals in their securities. Accordingly, disclosure or intimation of unpublished information to the stock exchanges in electronic mode should be made mandatory.

Regulation 13 deals with initial disclosures where a promoter or promoter group or director or officer of a listed company or any person holding more than 5 per cent shares or voting rights in a listed company should disclose their holding within two working days. This will include continual disclosure if there is a change in holding, even if such changes bring the shareholding below 5 per cent. Investors have to continually disclose acquisition of additional shares every time it rises 2 per cent above the threshold limit of 5 per cent. However, the requirement of sending multiple disclosures to the stock exchanges on a single acquisition should be avoided. The acquirer must inform the stock exchanges and the company at one go, within a specific time period — say within two working days, so that such information can be promptly publicised.

With a view to toughen insider-trading norms, there was need for a code of internal procedures such as ‘Model Code of Conduct’. There are two types of ‘insider trading’ — permitted, which is possible when the window is open and relevant disclosures are made under regulation; and prohibited, which means illegal insider trading when the trading window is closed or without clearance or disclosure.

The model code of conduct provides a supplementary framework and acts as a preventive measure. It prescribes a “trading window”, which will be closed on days such as declaration of financial results, dividend and so on, and there can be no trade by the director and officer of the company.

The code also provides the concept of “pre-clearance of trade” beyond the threshold limit, requiring pre-clearance by the company. Part B of the code has a concept such as the “China Wall” policy, separating areas that have access to sensitive information. The concept of maintaining a “Restricted/ Grey list” of client companies is also mentioned as a prevention of insider trading.

On violation, SEBI has the power to impose higher penalties up to Rs 25 crore, or thrice the profit made from insider trading, whichever is higher. SEBI also has the power to punish with a fine up to Rs 25 crore and/ or imprisonment up to 10 years. An appeal against the SEBI order can be made to the Securities Appellate Tribunal. However, high penalties alone cannot be a deterrent and there should be other consequences including lifetime ban and/ or imprisonment.

Insider trading throws a shadow on the integrity of the capital market and, in turn, undermines investor confidence. SEBI should have a strong enforcement mechanism for detection and prosecution of violations.

Like in the UK, it should also be illegal if someone abstains from trading due to insider information. The principle is that it is illegal to trade on the basis of market-sensitive information that is not generally known and, for that matter, even no relationship to the issuer of the security is required. All that is required is that the guilty party traded (or caused trading) while having inside information.

SEBI should consider enhancing its technical capabilities for the inquiry process. Information technology-based surveillance mechanism is needed. Currently SEBI may appoint a qualified auditor to investigate the books of account or affairs of the insider or any other person. The eligibility and qualification of the auditor should be specified under the regulations.

Insider trading can happen across borders, and important evidence of domestic insider trading lies outside domestic borders. Accordingly, it is suggested that like the Securities and Exchange Commission in the US, SEBI should enter into MoUs or similar agreements with various countries for exchange of information and mutual cooperation. Successful investigations and prosecutions of cross-border cases require international cooperation.

Gajendra Singh, Associate Director contributed to the article

The author is Partner, Price Waterhouse

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