Trading on the inside

India’s two-decade old insider trading laws are crying out for an overhaul. Not only because SEBI’s 1992 regulations need to incorporate recent learning from global regulators, but also to remove ambiguity and inconsistencies introduced by half a dozen amendments. Given that trading on ‘inside’ information strikes at the very root of a fair market in securities, it is good that the Justice Sodhi committee has completely rewritten the old law both for clarity and by introducing more stringent provisions that make it easier for SEBI to nail perpetrators.

The new regulations clarify the concept of an ‘insider’ and widen its scope. Apart from promoters, directors and employees of a company who may have access to price-sensitive information, the proposed law sweeps into its ambit a wide range of ‘connected persons’. So, government officials, judges and lawyers, consultants and merchant bankers — anyone indeed who enjoys access to inside information by virtue of statutory or contractual dealings with a firm — is expressly prohibited from trading on the basis of it. This notion of ‘insider trading’ is far stricter than that prevailing in the US, where trading on unpublished information becomes illegal only if it involves a breach of trust or fiduciary duty. India’s new rules also impose very strong deterrents against insider trading through a presumption of guilt. So if a ‘connected person’ trades on a company’s shares while possessing price-sensitive information, he can be prosecuted; the onus rests on him to prove that his intentions weren’t mala fide . The other new rule mooted is that promoters, directors and employees should not trade at all in the company’s shares without submitting a ‘trading plan’ six months in advance. This provision strongly protects public investors, but will also make life extremely difficult for promoters making creeping acquisitions and employees seeking legitimate gains from stock options. Trading on derivatives is also recommended for prohibition along with cash market trades. ‘Due diligence’ exercises are required to be followed by immediate public disclosures.

Detractors may argue that the proposed rules are too restrictive. But given poor financial literacy as well as market liquidity and depth, the spoils of insider trading can be disproportionately large. Therefore, stronger deterrents are needed. However, even if the new recommendations are fully implemented, SEBI’s track record in securing convictions for this white-collar crime may not automatically improve. Despite weaker insider trading laws, the US Securities Exchange Commission (SEC) has identified far more instances of insider trading and won more high-profile cases than SEBI in the last three years. That is owed not just to a better-staffed regulator, but also to first-line regulators such as American stock exchanges and the National Association of Securities Dealers, which actively monitor trading patterns and generate live alerts and data feeds on unusual trades for the SEC to act upon. That’s a model that India must emulate to re-assure investors that the securities market is not a playground for the rich and the powerful armed with privileged information.

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