Get serious about insider trading

The decision by a New York court to sentence Rajat Gupta, former director of Goldman Sachs, to a two-year prison term for insider trading has drawn some strange reactions from India Inc.

Some of its leading members, including Kiran Mazumdar Shaw of Biocon and Rana Kapoor of Yes Bank, have joined voices with Bill Gates and others, to express the view that the sentence was very ‘extreme’.

One reaction, captured by Dow Jones, said: “They decided to make an example of a good man, who in a moment of weakness made an error of judgement”. Another said that even if Gupta committed “an error of judgement” he “deserved forgiveness”. Reactions such as these are more than a little disturbing. It reinforces the impression that informal sharing of material information by company insiders, despite stringent laws that forbid it, is quite the done thing in India.

Just a slip?

Now, the evidence put out by the US Securities Exchange Commission (SEC), which investigated Gupta, clearly shows that this case was not about him letting slip a few boardroom secrets in a social setting.

What SEC produced as proof was a record of a series of phone calls spread over many months, where Gupta called up his associate Raj Rajaratnam (of Galleon Funds) within minutes of receiving critical price-sensitive information, as he attended board meetings at Goldman Sachs and Procter & Gamble. The records show that Galleon lost no time in putting through trades in these stocks, resulting in large profits to the hedge fund. Even with all this information in the public domain, however, some market players ask why this is such a big deal. After all, boys will be boys, they argue, and insider trading is only an economic offence, not rape or murder.

It’s illegal

Well, for one, this ambivalent attitude towards insider trading is not shared by Indian lawmakers.

SEBI’s insider trading regulations, promulgated in 1992, expressly prohibit company insiders from sharing unpublished price-sensitive information with others. The Indian law in this regard is, in fact, far more stringent than the US law, where prosecutors have to prove that the insider derived benefit from trading on the information.

Not content with this, Indian regulations also have overt deterrents to prevent top company officials from indulging in any hanky-panky. Officials privy to price-sensitive information are required to make periodic disclosures to the compliance officer about their holdings in company stock. Transacting in this stock requires prior permission. Companies which are set to announce material events are required to completely bar transactions by insiders during and after the announcement.

Obvious infractions

Despite these strong deterrents, however, insider trading isn’t exactly uncommon in India.

Anecdotal evidence of this is available from the manner in which stock prices often respond to corporate actions such as mergers, stake sales and takeovers, much ahead of the public announcement. How often has one received the stock exchange announcement on the swap ratio for a merger, only to find that the shares concerned have already neatly adjusted to the ratio the previous week.

Then there are cases of shares tanking inexplicably for days without any apparent reason; investors are only later hit with the news that the top management has been dipping into the till.

The media is rife with leaks about companies being ‘on the prowl’ and ‘in talks’ for takeovers, with the companies in question not even bothering to make appropriate disclosures to the exchanges.

Then, there is the widely prevailing practice of company managements selectively sharing tidbits of material financial information with analysts through conference calls. In these calls, the media is often barred and the call transcript, if made public at all, is withheld for days, offering plenty of time for the coterie of brokers to trade on the information.

Making it stick

That these obvious infractions should happen at all, is testimony to the weak enforcement of the stringent laws on insider trading by companies and first-line regulators such as stock exchanges.

SEBI on its part has been initiating dozens of investigations into insider trading violations each year.

These investigations have involved some high profile names, from the Hindustan Lever-Brooke Bond case dating back to 1997, to the Samir Arora-Alliance Capital case in 2003 to more recent ones involving Reliance Industries and Polaris Software. But it has rarely been able to make these charges stick, mostly for want of convincing evidence. Where penalties are levied or the cases settled through a consent order, the verdict has come about several years after the violation. This makes the denouement quite irrelevant for the affected investors.

SEBI’s track record on prosecutions could certainly be improved through two immediate fixes. It should be allowed access to phone call records of possible suspects in market fraud investigations, without any further dilly-dallying. And SEBI’s plea that the government set up special courts to expedite trials for securities fraud needs quick consideration.

market integrity

Such empowerment may send out the signal to company promoters and market participants that regulators here do take a serious view of those who blithely ignore insider trading laws.

Those who argue that insider trading is not such a big deal do not recognise the simple fact that it strikes at the very root of market integrity.

When public investors or institutions which represent them put their money on a stock, they do so based on publicly available information on a company’s business, financials and prospects.

What ‘inside’ information on an impending merger, stake sale or financial performance does is to render such independent analysis completely meaningless.

If companies were to routinely leak out information about impending results, share swap ratios or corporate action to a favoured coterie, why have an elaborate system for reporting results, disclosure of material events or even substantial acquisition of shares?

Ultimately, every instance of insider trading strengthens the small investors’ conviction that the stock market is a gambling den, where he has no hope of scoring over the guy with deep pockets and an active old-boys network.

Restoring his faith in the system is crucial at a time when policymakers are trying every other trick in the book to convince the retail investor that equity investing is the best way to build wealth for the long term.

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