The Hindu Business Line : Curbing insider trading

SEBI has tightened insider trading regulations, but given the volume of fresh equity offerings, it is impossible for the regulator to track down the malaise in its entirety.

Girish Vanvari
Chirag Shah

“The most valuable commodity I know of is information.” This is one of the many famous quotes of the fictional character Gorden Gekko in the movie Wall Street. This statement has attained an evergreen status and is especially relevant in the current stock market context.

The stock market still lures the greedy who will go that extra mile to earn the special “tip” to beat the market. Some of the so-called “tips” more often than not originate from people who are privy to such information either within the company concerned or working closely with them. In simple terms, this information arbitrage is insider trading.

Insider trading is not a new concept but it shoots into prominence every once in a while where the stock market regulators apprehend someone guilty of this. The recent Galleon hedge fund case has everyone talking about insider trading. Like many countries, controversies surrounding insider trading form part of the Indian capital market history too.

Insider trading is carried out through different routes. It could range from a simple tip from your stock broker or it could be imbibed from a complex report. In a few instances, the people close to the sources openly disclose the information to all and sundry in the hope that it will lead to a snowballing effect in the market.

Some companies offer pre-deal shares as an added incentive to customers and when the deal is announced all parties ride on the stock market wave and multiply their profits. The common denominator in all these is to gain from participating in the stock market armed with the extra information.

SEBI MOVES

So what are the regulators doing about it in India? The insider trading regulations were introduced by the Securities and Exchange Board of India (SEBI) way back in 1992. Basically, the regulations prohibit any insider to deal in securities when in possession of unpublished price-sensitive information.

Further, there is a bar on insiders communicating such price-sensitive information to any person (other than in the course of business/profession/employment). The bar also applies to companies that deal in shares when in possession of unpublished price-sensitive information.

The regulations empower SEBI to initiate investigation proceedings where it prima facie forms a view that the insider regulations have been violated. Detailed actions, including criminal proceedings, against the guilty may be initiated by the Board after the investigation.

The regulations prescribe disclosure norms for any shareholding of directors/officers. Another requirement is the prescribing of a Code of Conduct to be observed by all internal personnel of the company. Such internal procedures are prescribed not only for companies but also for intermediaries, asset management companies, professional firms advising or liaising with the listed companies, etc.

The regulations have gone through multiple amendments since then, with the latest amendments made in 2008, wherein the Model Code of Conduct has been amended to prescribe that the directors/officers or certain employees who have bought/sold the shares cannot enter into an opposite transaction, that is, sell/buy shares within next six months.

This amendment has had far-reaching consequences on the markets as it attempts to curb insider speculation based on quarterly results and key events in the company. Further, participation in derivative transactions of shares by directors/officers or certain employees has also been restricted. In addition to curbing insider trading, these amendments further prevent the company personnel from participating in regular trading activities in their company shares to make short term gains. Often we see the companies and their officers disclose notices of their purchase and sale of shares under the insider trading regulations to the stock exchange. The stock exchanges also do their bit in identifying the information gaps apparent in the public domain.

Further, the penalty for insider trading is also quite steep — it is three times the profits made out of insider trading subject to a minimum of Rs 25 crore. Interestingly, this is one regulation wherein SEBI has been quite active by initiating suo motu enquiries to ensure that the spirit and substance of the same are complied with. Further, there are many orders issued by SEBI/SEBI Tribunal actually levying penalties.

This should ideally dissuade anyone from insider trading practices. The exchanges frequently monitor news reports on companies and write to the companies to confirm any unconfirmed/unauthorised news items that are published in the media. The aam aadmi may thus take solace from the fact that the regulators are keeping a keen eye to protect their interests.

MALAISE PERSISTS

Having said that, is enough being done? Considering that hundreds of companies make fresh offerings, the moot question is whether the powers and resources of SEBI are adequate to curb this growing malaise. Compare this with the masterminds at work in the stock market and one would appreciate the mountain that stands before the regulators.

Insider trading is sometimes carried out in such insignificant amounts that it is easy to escape the vigilant eye of the regulator. Further, even where cases are identified, proving that the persons involved are guilty is also a major challenge.

Further, the so-called ‘insiders’ are finding out more ingenious ways of filtering data to the stock market to see that bonus pay-day arrives quicker. Constant vigilance and strict reporting and monitoring rather than any significant tweak in the regulations are perhaps the need of the day. And it all starts in the ‘company’ itself. Accordingly, it is imperative that each company adopts watertight insider trading regulations in its governance framework and ensures strictest adherence to the same. Each ‘company’ needs to deal with sensitive information in the most mature manner to avoid infiltrations.

Do the markets recognise and reward vigilant companies and managements? Yes, they trade at a significant premium to their not-so-robust counterparts.

(The authors are Executive Director and Manager, respectively, KPMG.)

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