Insider trading is again in the spotlight with the US moving forcefully against it. More importantly, this has sparked off comparisons between the regulatory regimes in India and the US.

The term ‘insider trading’ is generally used derogatively, and refers to undue gains derived through access to privileged information. In common parlance, it refers to the trading of a company’s securities by people who have access to non-public, price-sensitive information about the company. The law prohibits an insider from trading in securities by misusing confidential and privileged information.

global regulatory regime

Globally, the US has been at the forefront, enacting comprehensive legislation to thwart insider trading. The economic depression of 1929 pushed the government to focus on investor protection. The Securities Exchange Act of 1934 contained several provisions to deal with insider trading. The Insider Trader and Securities Fraud Enforcement Act 1988, and Insider Trading Sanction Act 1984, followed by the Sarbanes-Oxley Act, further strengthened the US regulatory regime.

The UK was one of the first European countries to legislate against insider trading. The Financial Services and Markets Act 2000 prohibits insider trading through a broad scope of provisions. While most countries have framed regulations to curb the problem, there are variations in interpretation and application.

Indian scenario

The security market in India developed at the end of the 19th century through the establishment of the Bombay Stock Exchange. However, the first legislation on insider trading was formulated much later — with the Securities and Exchange Board of India (Insider Trading) Regulations 1992.

Over the years, regulations have been tightened to include the concept of deemed insider, and require promoters and officers of the company to make periodic disclosures of their transactions in securities. Insiders are prohibited from communicating unpublished, price-sensitive information or dealing in securities while in possession of such information. Listed companies are mandated to put in place an internal code of conduct providing for pre-clearance of trades, closure of trading window, and prompt dissemination of price-sensitive information to stock exchanges. They are also required to respond to queries or requests from exchanges for verification of market rumours. Contraventions are punishable with imprisonment or heavy fines.

The new Companies Bill (still in the works) contains provisions prohibiting insider trading, and spells out severe penal consequences.

There is a settlement scheme under which SEBI can either pass consent orders or compound offences related to contravention of securities laws. It is meant to achieve the twin objectives of appropriate sanction, and remedy and deterrence, without resorting to litigation and the consequent delays. Recently, offences related to insider trading have been excluded from the scheme, thereby giving a clear signal that there is no amnesty for such serious violations.

However, upgrading insider trading to the category of most serious offences has a downside. The level of evidence required is high, and guilt needs to be proven beyond reasonable doubt. Given the fundamental premise of treating a person as innocent until proven guilty — on which our judicial system operates — the conviction process is long and, expectedly, has a low success rate.

There is a perception that the low rate of conviction for insider trading contraventions in India is due to inadequacies in regulations. However, the reality is different: There is no paucity of regulations; it is their enforcement that needs scrutiny and reform.

Enforcement

In the US and other developed countries, wiretapping and phone records are critical investigative tools, which are admissible as evidence. In India, the regulatory and investigative agencies lack such technology to build their case. The capital market regulator, SEBI, has been seeking greater powers — to access phone records, as well as tape phone calls. Apart from the Government’s nod, this would also require an amendment in the Telegraph Act. Clearly, there is need to arm the regulator with the right set of tools.

Conclusion

It is vital to tackle the menace of insider trading in order to bolster India’s image as a safe investment destination. Furthermore, it will boost public participation in the securities market, which is essential for capital formation. Pragmatically replicating global best practices in investigation and collection of evidence would provide regulators with the necessary ammunition and instil fear of consequences in the mind of potential wrongdoers. Most importantly, the code of conduct formulated by companies, if followed in letter as well as spirit, could go a long way in combating insider trading.

Pankaj Tewari is Senior Manager — Risk Advisory Services, PwC India

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