Insider Trading Project

75
A “TERM PAPER” ON “INSIDER TRADING IN INDIA” SUBMITTED IN PARTIAL FULFILLMENT OF DEGREE OF MASTER OF BUSINESS ADMINISTRATION DEPARTMENT OF MANAGEMENT STUDIES Faculty of Commerce and Management Studies J. N. V. University, Jodhpur

description

This term paper deals with the insider trading cases in india and abroad and it present the measure taken by sebi to crub insider traders

Transcript of Insider Trading Project

Page 1: Insider Trading Project

A

“TERM PAPER”

ON

“INSIDER TRADING IN INDIA”

SUBMITTED IN PARTIAL FULFILLMENT OF DEGREE OF

MASTER OF BUSINESS ADMINISTRATION

DEPARTMENT OF MANAGEMENT STUDIES

Faculty of Commerce and Management Studies

J. N. V. University, Jodhpur

Supervised by Submitted by

Dr. (Mrs.) Swapna Patawari Swati Surana

MBA, Ph.D. M.B.A. (Semester 2nd)

Page 2: Insider Trading Project

CERTIFICATE

FACULTY OF COMMERCE AND MANAGEMENT,JAI NARAIN VYAS UNIVERSITY,

JODHPUR.

This is certifying that Term Paper titled

“INSIDER TRADING IN INDIA”

Has been satisfactorily completed by

MISS SWATI SURANA

As a partial fulfillment of Term Paper work for

MASTER OF BUSINESS ADMINISTRATION

During academic year 2007-2009

Supervised by Submitted by

Dr. (Mrs.) Swapna Patawari Swati Surana

MBA, Ph.D. M.B.A. (Semester 2nd)

Page 3: Insider Trading Project

ACKNOWLEDGEMENT

It gives me immense pleasure in submitting this term paper “INSIDER TRADING

IN INDIA ”. I am grateful to Dr. (Mrs.) Swapna Patawari Professor, DMS

J.N.V.University, Jodhpur under whose guidance I have had privilege of doing this

dissertation work. She took an active interest in my work and had an encouraging influence

over me. She has been a ladder of inspiration with the concrete support and strength

without whom the term paper would not have been completed.

Miss.Swati Surana

M.B.A (SEM-2nd)

Page 4: Insider Trading Project

Chapter Scheme

Introduction

Who is insider?

What is Inside Information? When Information ceases to be inside?

Price sensitive information

How does Insider Trading Work?

Who does insider-trading affect?

Transactions, which gives indication of insider trading

SEBI’s efforts to curb insider trading

The Difficulty in framing insider trading Laws

Various case studies

Finding and Analysis

Recommendation and suggestions

Conclusion

Bibliography

Page 5: Insider Trading Project

INTRODUCTION:

Insider trading is one of the most violent crimes on the faith of fair dealing in a capital market.

The scope and stringency of the violation and penalties differ wildly from country to country.

Trading by an insider of a company in the shares of a company is not per se a violation of law.

For instance, a person (an investigative journalist for example may interview an insider and

thus become one) may come across insider information by his perseverance in uncovering a

corporate fraud and disclose the fraud. A person can create inside information by his future

actions, for instance a future tender offer bidder knows that the price of the target company will

go up by his actions. In fact trading by insiders, including directors, officers and employees of

the company in the shares of their own company is a positive feature, which companies should

encourage because it aligns its interests with those of the insiders. What is prohibited is the

trading by an insider in breach of a duty of trust or confidence in the stock of a company on the

basis of non-public information to the exclusion of others. Insider trading violations may also

include "tipping" such information and securities trading by the person "tipped". If insider

trading is allowed unchecked in the capital markets, persons with insider information will have

a consistent edge in trades executed with such information and those without the information

will be consistent losers on the market. The latter category of people, which includes the vast

majority of investors, would slowly realize the loser game they are playing in this ‘market for

lemons’ and would believe that all transactions are thus biased against them. Slowly the typical

investor would desert the market, retarding or destroying important functions of the stock

market like capital formation.

In layman's language, the term "Insider Trading" is about trading with the use of inside

information i.e. information that has not yet been disclosed to the public. In the fastest

growing capital market system, stock exchanges occupy a very crucial position by

enabling the corporate sector to mobilise capital from household savings and channelise

such savings into productive areas of investment. The growth of securities market has

brought the single most unfair and unhealthy practice viz, Insider Trading, by which

persons connected with companies use unpublished price sensitive information to deal

Page 6: Insider Trading Project

in the securities of a company with a view to make profits or avoid losses by use of

such information.

Although the precise explanation of Insider Trading is very difficult to define, the

following activities of an insider constitute insider trading:

1) Taking advantage of inside information with full knowledge of the facts by dealing

for his own account or for the account of a third party, either directly or indirectly, in

transferable securities to which the inside information relates;

2) Disclosing inside information to a third party unless such disclosure is made in the

normal course of the exercise of his employment, profession or duties.

Recommending or procuring a third party to deal in transferable securities.

Transferable securities include shares; debt securities; securities equivalent to shares

and debt securities; contracts or rights to subscribe for, acquire or dispose of such

securities index contracts (i.e. a contract the purpose of which is to secure a profit or

avoid any loss by reference to fluctuations in an index); future options and financial

futures in respect of such securities.

Who is An Insider?

The concept of 'Insider' is very important one, and on this concept only, the whole play

of insider trading rests. Broadly, there are two types of insiders—Primary Insiders and

Secondary Insiders, A primary insider is a person who has access to inside information

by virtue of his relationship to an issuer of securities. While a secondary insider is

person who acquires inside information from a primary insider.

The characterizations of an insider as any person who possesses inside format

ion because he has access to it by virtue of the exercise of his employment, profession

or duties, brings out two types of insiders. One is internal insider who obtains inside

information in the exercise of his duties as officer or employee of the company. The

other one is external insider who obtains information because his connection with the

company on account of his employment and profession.

Page 7: Insider Trading Project

Above explanations of an insider, bring a concluding definition of the insider and that is

what explained by Greek law, "a person becomes an insider if he acquires confidential

information as a result of offering services under any capacity on a permanent or

temporary basis to an issuer or for an issuer". The Securities Exchange Board of India

has given a very wide definition, which merely defines an insider as:

The term "insider" is defined in clause (e) of regulation 2 as: "insider means any person

who, is or was connected with the company or is deemed to have been connected with the

company, and who is reasonably expected to have access, by virtue of such connection, to

unpublished price sensitive information in respect of securities of the company, or who has

received or had access to such unpublished price sensitive information."

The definition has two limbs. The two limbs form the two essential ingredients of the

definition, both of which may be split and presented as follows:

Insider means any person -

Who, is or was connected with the company

Or

Page 8: Insider Trading Project

who is deemed to have been connected with the company,

And

Who is reasonably expected to have access, by virtue of such connection, to unpublished

price sensitive information in respect of securities of the company,

Or

Who has received or had access to such unpublished price sensitive information.

In order to brand a person an insider any one of the two tests stipulated in the first limb,

and one of the three tests stipulated in the second limb, of the definition must be

established.

Clause (c) of regulation 2 defines the expression "connected person" and the following

persons will be treated as connected persons:

a director or shadow director of a company,

an officer or employee of the company,

A person having professional or business relationship with a company, if he may

reasonably be expected to have access to unpublished price-sensitive information in

relation to that company.

Clause (h) of regulation (2) defines the phrase "deemed to have been connected", these

secondary insiders are connected persons, but they are not directly connected with the

companies. Person is deemed to be a connected person if such person —

(i) is a company under the same management or group or any subsidiary company

thereof within the meaning of section (1B) of section 370, or subsection (11) of section

372, of (he Companies Act, 1956 (1 of 1956) or sub-clause (g) of section 2 of the

Monopolies and Restrictive Trade Practices Act, 1969 (54 of 1969) as the case may be:

or

(ii) Is an intermediary as specified in section 12 of the Act. Investment Company,

Trustee Company, Asset Management Company or an employee or director thereof or an

official of a stock exchange or of clearing house or Corporation;

Or

Page 9: Insider Trading Project

(iii) is a merchant banker, share transfer agent, registrar to an issue, debenture trustee,

broker, portfolio manager, Investment Advisor, sub- broker, Investment Company or

an employee thereof, or is a member of the Board of Directors of the Asset Management

Company of a mutual fund or is an employee thereof who have a fiduciary relationship

with the company;

(iv) is a member of the Board of Directors, or an employee, or a public financial

institution as defined in Section 4A of the Companies Act, 1956; or

(v) is an official or an employee of a self regulatory organisation recognised or

authorised by the Board of a regulatory body; or

(vi) is a relative of any of the aforementioned persons;

(vii) is a banker of the company;

(viii) relatives of the connected person;

(ix) is a concern, firm, trust, Hindu Undivided Family, company or Association of

Persons wherein any of the connected persons mentioned in clause 3(1)above this

regulation or any of the person mentioned in sub-clause (5) ,(6),(7) here in above has

have more than 10% of the holding or interest.

Relatives of connected person shall be relative of another, if and only if,

(A) They are members of Hindu Undivided Family; or

(B) They are husband and wife; or

(C) The one is related to the other in the manner indicated below:

MALE FEMALE

Father Mother (Incl. step mother)

Son (including step-Son) Sons' Wife

Father's Father Daughter (Incl. step-daughter)

Mother's Father Father's Mother

Son's Son Mother's Mother

Son's Daughter husband Sons' Son's wife

Daughter's Son Son's Daughter

Daughter's Son Daughter's Sons' wife

Daughter's Daughter's husband Daughters 's Daughter

Page 10: Insider Trading Project

Brother (Incl.-step-Brother) Brother's wife

Sister's husband Sister (Incl. step-sister)

What is Inside Information? When Information ceases to be Inside?

These questions play a pivotal role in insider trading. The CS (ID) Act of UK uses the

term unpublished information as inside information, that is to say, the information

which is not generally known to those persons who are accustomed or would be likely

to deal in the relevant securities. French Law prohibits the exploitation of information

before the public has knowledge of it. The ECD defines inside information as,

"information which has not been made public of a precise nature relating to one or

several issuers of transferable securities which, if it were made public, would be likely

to have a significant effect on the price of the transferable security or securities in

question. This definition does not seem to be of a satisfactory nature because this

definition on the one hand restricts inside information to that 'which has not been made

public' and on the other hand it seems to be uncertain whether information ceases to be

inside when it is published or when it becomes generally available to investors. Here,

the 'information which has not been made public' must not be equated with information,

which is not yet published. Further, in this context, it was rightly said in the case of

Mitchell v. Taxes Gulf Sulpher Co. that (he information loses its insider status only

when a good faith investor acting with due care can obtain knowledge, a point in time

which may well be after publication is effected.

Materiality or non-materiality of the inside information is fundamental to the very

concept of Insider Trading. Information is material only when, if disclosed, its effect on

the market price would be likely to be significant. Here, it must be understood that not

all information unknown to the public is necessarily inside information, since otherwise

managers and employees of undertakings would never be permitted to trade in the

securities of their company, as they always possess unpublished information. It is,

therefore, not sufficient that the information would influence most investors in arriving

at a decision whether to sell or buy but must also be likely have a material effect on the

Page 11: Insider Trading Project

market price of the particular security. The concept of certainty and specificity is related

with the concept materiality. The information must be something more than a simple

rumor, and must have a minimum degree of certainly.

Price sensitive information

Price sensitive information” means any information, which relates directly or indirectly to a

company and which if published is likely to materially affect the price of securities of

company.

The following shall be deemed price sensitive information:—

(i) Periodical financial results of the company;

(ii) Intended declaration of dividends (both interim and final);

(iii) Issue of securities or buy-back of securities;

(iv) Any major expansion plans or execution of new projects;

(v) Amalgamation, mergers or takeovers;

(vi) Disposal of the whole or substantial part of the undertaking; and

(vii) Significant changes in policies, plans or operations of the company.

(b) Listing Agreement requires all listed companies to immediately inform Stock

Exchange(s) in respect of the following events, which are considered to be, price

sensitive:

— Change in the general character or nature of business

— Disruption of operations due to natural calamity

— Commencement of Commercial Production/ Commercial Operations

— Developments with respect to pricing/ realization arising out of change

in the regulatory framework

— Litigation/dispute with a material impact

— Revision in Ratings

— Any other information having bearing on the operation/performance of the company

as well as price sensitive information which includes but not restricted 10;

(a) issue of any class of securities;

Page 12: Insider Trading Project

(a) Acquisition, merger, de-merger, amalgamation, restructuring, scheme of arrangement,

spin off or setting division of the company, etc;

(b) Change in market lot of the company's shares, sub-divisions of

equity shares of the company;

(b) Voluntary delisting by the company from the stock exchange(s);

(c) Forfeiture of shares;

(f) Any action which will result in alteration in the terms regarding

redemption/cancellation/retirement in whole or in part of any securities issued by the

company;

(g)Information regarding opening, closing of status of ADR. GDR or any other class of

securities 1o be issued abroad;

h) Cancellation of dividend/rights/bonus, etc;

Price sensitive information is required to be disseminated to the stock exchange on an

immediate and continuous basis.

How does Insider Trading Work?

In an insider trading case in 1989, a former stockbroker was convicted of trading based on

insider information. He received the insider information about a company “after its president

told his sister, who told her daughter, who told her husband,” who in turn told the defendant

who traded on the information. This is an example of just how far removed insider information

can get.

It is very difficult to express opinion on the extent and magnitude of insider trading in

India. During the last five years or so, this practice has almost been perfected so well

by the regular players that today it is accepted as part and parcel of the day to day stock

exchange operations. Promoters of several new ventures admit, albeit off-1he-record,

that they are forced to play into the hands of big brokers by participating in modified

forms of insider trading to brighten the market prospects for their issues. Advance

knowledge "of an imminent take-over bid. Knowledge of a forthcoming placement of

new shares in combination with the implementation of financial recovery programmes,

Page 13: Insider Trading Project

and knowledge of a significant change in the investment policy of a unit trust are some

of the examples of insider trading.

There are many types of ways of insider trading. Let us take a simple case of

bonus issue vis-à-vis insider trading. Suppose A Ltd. is coming out with a bonus issue.

The share price of A Ltd. will definitely be affected by such an action of the company.

The management personnel who are privy to this information may contract to buy large

quantity of the company's shares directly in their own names or indirectly in the names

of their main family members or friends. After this, the information is 'leaked out' so

that the general public enters into the market, which will ensure the price to rise.

Moreover, advise of brokers, saying to their customers that one must buy the shares of

A Ltd., because management of the company is also buying. Such practices bring more

and more buy orders and thus lead to substantial increase in prices, and that is what the

original 'tip makers' wait for. When this happens, the insiders unload and depart with

the cream of appreciation safely. The early investors who had taken the plunge also

make some money but, most of the investors have entered the market rather late, they

are left in the lunch holding large chunks of shares purchased at high prices. Thus, the

majority of the new investors do not gain at all.

Motivated reports strategically published in newspapers and magazines are also one

form of insider trading. Several investors act on the motivated reports and suffer their

Page 14: Insider Trading Project

own fate, by the time they realise their mistake the insider has got away with the

benefits.

Insider trading also takes the form of manipulation. Under the listing agreements

entered into by the companies with the stock exchange concerned, the publication of

half yearly working results are mandatory. Now the normal practice of dressing the half

yearly results in such a manner so as to show a result contrary to the general trend is

very common feature of companies. Suppose, A Ltd. is expected to do reasonably well

at the year end, the management of A Ltd. shows almost a break picture for the half

year. The individuals close to the management will unload all their holdings a few days

before the publication of the results. The common investor of A Ltd. will be watching

the share prices coming down. Then the poor half yearly results will be published which

will further bring down the prices. After a few months, the insiders will slowly buy

back the holdings and spread the news that the company has started doing well and the

prospects of (he company are bright.

Yet another form of insider trading takes the form of market support provided by the

management by resorting to very heavy purchases of its company's shares through

various intermediaries. Such practice is particularly used when the company is coming

out with a big right issue and the management cannot afford the price to fall below a

specified minimum. Generally, after the issue is over subscribed the price comes down

and the investor who has subscribed for the new issue realise that the issue was not

worth the price paid by him. This aspect of insider trading has almost become a

permanent feature of the share market operations of today's corporate world.

Such unfair practices are more common and frequent during or near the time of

declaration of annual or half yearly profits, bonus or rights issue or issue of convertible

debentures, new profits schemes of amalgamations or takeovers etc. Sometimes, insider

trading is resorted to by connected persons through speculators or brokers under the

benami transactions. Whatever form insider trading may assume, it is obvious that the

common investors are the ones who always lose.

Page 15: Insider Trading Project

Who Does Insider Trading Affect?

For understanding the effects of insider trading, it is helpful to categorize the agents

involved or affected into several groups. Economic analysis of insider trading typically

considers the following parties: insiders, market professionals, liquidity traders, and

Investors, who are defined as follows. Insiders, as defined earlier, are the officers,

directors, and other key employees of a firm who, by the nature of their employment,

obtain or possess confidential information regarding the firm’s prospects. An example

of an insider is the chief executive officer or the chief engineer of the firm. Market

professionals are informed non-insiders, including securities analysts, brokers, or

arbitrageurs, who have acquired private information regarding the firm’s prospects by

spending their own resources and who do not have any fiduciary relationship with the

firm. For example, a security analyst may have called the firm’s major customers and

learned that they are not interested in buying its new product line. Liquidity traders,

sometimes referred to as “noise” traders, are short-term stock market participants who

have some, usually negligible, holdings of the firm’s shares and trade in order to hedge

risk or balance their portfolios without consideration of a firm’s prospects. An example

of a liquidity trader is a large pension fund that buys and sells the firm’s shares from

time to time in order to meet the investment and redemption needs of its clients.

Investors may be small or large shareholders who have a long-term investment

objective such that they “buy and hold.” While not privy to management’s private

information, investors have a significant beneficial interest in the firm’s actual

performance. For instance, the heir to a substantial holding of the firm’s stock who does

not take an active role in its daily management is an investor. Insider trading involves

and affects each of the above classes of agents. If insiders were allowed to trade on their

privileged information, they would of course reap trading profits. At the same time,

insiders who are professional managers may receive reduced compensation from

investors to reflect the profits managers can earn from trading. Insider trading also

Page 16: Insider Trading Project

affects liquidity traders, who face the prospects of incurring losses when trading with

agents possessing superior information.

On the other hand, if they avoid trading, they will lose the diversification/hedging

benefits that prompt them to trade in the first place. In addition, insider trading implies

that informed non insiders or market professionals face informed competitors in the

financial marketplace. The rivalry between informed insiders and informed noninsiders

may drive the latter out of the market, making prices less informative, or, by furthering

competition, increase the speed with which information is released to uninformed

traders. Insider trading has an impact on investors through its effects on both investors’

trading profits (when they buy and sell holdings for liquidity reasons) and managerial

incentives to create value. If insider trading were not prohibited by law, investors,

especially large shareholders, would need to decide their firm’s policy toward insider

trading. The legal and economic literature on insider trading attempts to weigh the

trade-offs discussed above to formulate optimal policies. Different authors focus on

different classes of actors and different types of effects. Given the number of classes of

actors involved in and affected by insider trading and the multiplicity of effects,

differences in focus have led to rather discordant assessments of insider trading and

conflicting policy recommendations.

Transactions, which gives indication of insider trading

Certain types of transaction can alert securities regulators that the investor who initiated them

must have been acting based upon inside knowledge -- in other words, knowing some

significant piece of news before the general public.  A transaction will be considered

suspicious based upon a combination of criteria:  

The timing is just a little too good.  Anyone can make an investment at any time, but

someone who buys soon-to-be profitable put options or sells a stock short in the few trading

days immediately before a major decline in the stock's price will seem to have been more than

Page 17: Insider Trading Project

ordinarily lucky.  This criterion is suggestive when present, but is not mandatory.  For

example, a short sale could have been made quite some time before it would turn out to be

profitable.  But the longer in advance a short sale or put-option purchase is made, the more

uncertainty there will be as to whether events will play out according to plan; so generally the

inside trader doesn't make illicit trades very long in advance. 

The transaction itself is too specific.  For example, if someone bought puts on United

Airlines and American Airlines but not on Delta Airlines, investigators will be sure that the

trader knew in advance that these two airlines were targets of the attack.  (On the other hand,

this works both ways:  If there were similar trades in a third airline but not in others,

investigators can conclude that one or more flights of that airline were supposed to have been

hijacked as well.)

 The transaction is too large.  One of the most reliable indicators of illegal insider

trading is that the perpetrator has traded at an abnormally high level.  In other words, someone

who normally makes trades of a few thousand dollars now and then, but suddenly begins to

make much bigger plays, may well be doing so because s/he has some form of inside

knowledge.  If inside-traders kept their trades to reasonable levels, they would seldom, if ever,

be caught -- since their trades would not seem especially abnormal and they could be explained

as part of their regular investment strategy.  However, people typically get caught up by their

own greed:  when they know for certain that something significant is going to happen to the

price of a stock, they cannot resist the temptation to make as much money as possible on their

knowledge.

Transactions deviate from normal trading levels.  In the options markets, there is

normally a reasonably even balance between call and put options on any given stock; and there

is normally a reasonably predictable level of activity in options on any particular stock.  When

the balance between puts and calls is grossly disrupted and the level of volume in options

trading is far beyond normal, investigators can be pretty sure that something is up.

The transaction is too speculative.  In other words, the transaction is one that would be

unreasonably risky -- if not out-and-out stupid -- were it not that the perpetrator was trading

based upon inside knowledge.  For example, a large purchase of stock options that were both

significantly "out of the money" and relatively close to their expiration date, but suddenly

Page 18: Insider Trading Project

turned out to be valuable based upon some news affecting the underlying stock, would seem to

represent an unreasonable degree of prescience.

SEBI, s efforts to curb insider trading

Close period/closed trading window

Close period means the prohibited period specified for trading and dealing in the

securities of the company. The Regulations require that dealing in securities of a

listed company be prohibited at the time of:-

(a)Declaration of Financial results (quarterly, half-yearly and annual)

(b)Declaration of dividends (interim and final)

(c)Issue of securities by way of public/rights/bonus etc.

(d)Any major expansion plans or execution of new projects

(e)Amalgamation, mergers, takeovers and buy-back

(f) Disposal of the whole or substantially whole of the undertaking

(g) Any change in policies, plans or operations of the company.

The 'Close period' should continue upto 24 hours after the information referred to

above is made public. The 'close period' could commence from the time of

announcement of the meeting of the Board of Directors of a company with respect

to all price sensitive information and end 24 hour after the decision of the Board is

made public. In case of matters which are not required to be dealt in the Board

meeting, the close period should be from the time the preliminary discussions in

respect of the matters commence and end 24 hours after the information is made

public.

Pre-clearance of trades

All directors/officers/designated employees of the company who intend to deal in the

securities of the company (above a minimum threshold limit to be decided by the

company) should pre-clear the transaction as per the pre-dealing procedure as described

hereunder.

An application may be made in such form as the company may notify in this regard,

Page 19: Insider Trading Project

to the Compliance Officer indicating the estimated number of securities that the

designated employee/officer/director intends to deal in, the details as to the depository

with which he has a security account, the details as to the securities in such depository

mode and such other details as may be required by any rule made by the company in

this behalf.

An undertaking shall be executed in favour of the company by such designated

employee/director/officer incorporating, inter alias, the following clauses, as may be

applicable :

(a) That the employee/director/officer does not have any access or has not received

“Price Sensitive Information” upto the time of signing the undertaking.

(b) That in case the employee/director/officer has access to or receives “Price Sensitive

Information” after the signing of the undertaking but before the execution of the

transaction he/she shall inform the Compliance Officer of the change in his position and

that he/she would completely refrain from dealing in the securities of the company till

the time such information becomes public.

(c) That he/she has not contravened the code of conduct for prevention of insider

trading as notified by the company from time to time.

(d) That he/she has made a full and true disclosure in the matter.

Compliance Officer

The organisation/firm has a Compliance Officer (senior level employee) reporting to the

Managing Partner/Chief Executive Officer. The Compliance Officer shall be responsible

for setting forth policies and procedures and monitoring adherence to the rules for the

preservation of “Price Sensitive Information”, pre-clearing of all designated employees and

their dependents trades (directly or through respective department heads as decided by the

organisation/firm), monitoring of trades and the implementation of the code of conduct

under the overall supervision of the partners/proprietors.

The Compliance Officer shall also assist all the employees/directors/partners

in addressing any clarifications regarding SEBI (Prohibition of Insider Trading)

Regulations, 1992 and the organisation/firm’s code of conduct. The Compliance Officer

Page 20: Insider Trading Project

shall maintain a record of the designated employees and any changes made in the list of

designated employees.

Other restrictions

All directors/officers/designated employees shall execute their order in respect of

securities of the company within one week after the approval of pre-clearance is given.

If the order is not executed within one week after the approval is given, the

employee/director must pre-clear the transaction again.

All directors/officers/designated employees shall hold their investments in securities

for a minimum period of 30 days in order to be considered as being held for

investment purposes. The holding period shall also apply to subscription in the primary

market (IPO’s). In the case of IPO’s, the holding period would commence when the

securities are actually allotted.

In case the sale of securities is necessitated by personal emergency, the holding

period may be waived by the compliance officer after recording in writing his/her

reasons in this regard.

The Difficulty in framing insider trading Laws

Specific information v general information:

Generally, inside information is that which is likely to materially affect the price of securities if

it were public. The problem here is drawing the line between specific information and mere

hunches based on rumors or guesswork and research or fact-finding on commercial or

economic trends or businesses.

Sanctions:

Sanctions may be civil or criminal or both. Any form of sanction runs into the difficulty of

identifying the insider and obtaining the necessary discovery, especially if the insider arranged

the transactions from abroad through a bank that raises the bank secrecy defense against

foreign. A further problem with civil liability arises from the fact that there is no relationship

between the insider dealer and his counterpart in the market. It is not practicable to show which

Page 21: Insider Trading Project

counterpart dealt with the insider amongst the many transactions that may have taken place

between the time the insider dealt and the time the inside information became public. If the

insider were to be liable for losses to all counterparts in the market (e.g. the difference between

the price with and without the information) then the liability could be vast and disproportionate

to the offense. In the Texas Gulf Sulphur case it has been estimated (as opposed to an actual

award) that the liability to sellers of the shares was in the region of US $ 350 million - that is

US$ 150 million more than the net worth of the corporation.

Conflict of duties

Conflict of duties often arises when dealing in securities. When directors told a broker that the

dividend would be cut. If the broker sold the company’s stock for his client’s price sensitive

information, there may be a conflict between his duty not to trade and his duty to act in the best

interests of his customer. The prohibition on insider trading is usually overriding. The broker

was liable notwithstanding that he had a conflicting duty to do his best for his clients.

Share price of XYZ co. Will go down because of bad financial results. Therefore, you sell the stock.

Page 22: Insider Trading Project

Negative profits

Generally, where an insider holding securities is influenced not to sell because of inside

information and thereby avoids a loss, it is impracticable to impose liability because of the

difficulty of proving intent to sell which was subsequently doused by the inside information. In

the US, the plaintiff must have purchased or sold a security. Thus, a counter party has no claim

where he refrains from doing anything but would have dealt if he had known. Therefore, a

defendant who suffers a loss when insiders sell on unfavorable news and the price falls as a

result may have no standing since he did not sell.

Intent

Intent is usually an important factor in establishing guilt. There must be actual knowledge by

the insider that he is an insider and that the information is inside information, i.e. the insider

dealing must be knowing and deliberate.

Exemption for stabilization:

Stabilization is essentially insider trading because the managers are dealing in bonds while in

the possession of insider information. As they knew the market’s reaction to the original

invitations. The main purpose of stabilization is to even out the market in the primary

distribution period so that it reflects the real value of the securities and not speculative

dealings.

Territoriality

A major problem for the control of insider dealing is the territorial scope of the prohibition. If

the prohibition is strictly territorial it is a simple matter for the insider to trade from abroad or

on a foreign stock exchange - through a dummy company if necessary. As regards the UK

position, the CJA applies (in the case of dealing) where the individual was in the UK when he

did an act constituting or forming part of the offense or where the regulated market or

professional intermediary is in the UK. In the case of offenses of disclosing inside information,

Page 23: Insider Trading Project

or encouraging insider dealing, the offense is committed if the individual or the recipient was

in the UK when the disclosure or encouragement took place. The US Rule applies where the

fraud is achieved “by the use of any means or instrumentality of interstate commerce, or of the

mails or of any facility of any national securities exchange”. Insider dealing abroad may be

subject to US jurisdiction if the fraud has an effect on the US securities markets.

HLL-BBLIL Merger versus SEBI

"...it can be conclusively said that while entering into the transaction for purchase of 8 lakh

shares of BBLIL from UTI, HLL was acting on the basis of the privileged information in its

possession, regarding the impending merger of BBLIL with HLL. It also may be stated that, by

its very nature, when it comes to motives and intentions, there may not always be any direct

evidence. However, the chain of circumstances, the timing of the transaction, and other related

factors, demonstrates beyond doubt that the transaction was founded upon and effected on the

basis of unpublished price sensitive information about the impending merger."

- Excerpt from SEBI order that tried to establish an insider trading case against HLL

management.

THE BACKGROUND

Page 24: Insider Trading Project

The HLL-BBLIL merger announcement was made on April 19 1996. But the two stocks

especially that of BBLIL, started seeing heightened activity from February itself. The BBLIL

stock was quoting at Rs. 242.00 in end January, with average daily volumes of around 16,000

shares. By the end of February, the stock had shot up to Rs. 341.00 and 45,250 shares were

traded on the last trading day of that month; the average price and trading volumes that month

were Rs. 304 and 30,315 shares respectively. The story was the same in March, with the

average price increasing to Rs. 349.00, but the trading volumes dipped to 10,000 shares. By the

time the merger announcement was made in April, the stock had reached stratosphere. When

the merger was announced on April 19, 1996, the Bombay Stock Exchange had a trading

holiday and the market had to wait until Monday before reacting. But even a couple of days

before that, on April 18 1996, the price dropped marginally to Rs. 402.00 and the trading

volume was 88,150 shares.

And here comes the crucial part. When the market opened on April 22, after the formal

announcement, the stock dropped sharply to Rs. 368.00, and, more important, volumes halved

at 35,650 shares, displaying a clear waning of interest in stock. By the end of May 1996, the

BBLIL stock had gone out of favour, with the average daily price for that month dropping to

Rs. 338.00 and the trading volumes a mere 8,129 shares.

Trading in the HLL stock too exhibited a similar pattern. The stock closed in January with an

average price of Rs. 628.00 and average volumes of 9,291 shares. By the next month, interest

had heightened and the stock closed in February with an average price of Rs. 696.00 and

trading volumes of 25,085. March witnessed lower volumes at 12,458 but the price increased

marginally to Rs. 698.00. As in the case of BBLIL, the HLL stock gathered momentum in

April.

A couple of days before the announcement, the stock price shot up to Rs. 795.00 and nothing

less than one lakh shares were traded on that day compared to the average trading volumes of

just around 15,000 till then. On April 18, the stock had declined to Rs. 780.00 while the

volumes dropped steeply to 14,950 shares, possibly anticipating the formal announcement the

Page 25: Insider Trading Project

next day. And once trading resumed after the merger announcement, on April 22, 1996 the

stock dropped to Rs. 755.00 and the trading volume to just 9,400 shares.

THE SEBI CHARGE: HLL is an insider, according to Section 2 (e) of the SEBI (Insider

Trading) Regulations. It states "An insider means any person who is, or was, connected with

the company, and who is reasonably expected to have access, by virtue of such connection, to

unpublished price-sensitive information." The SEBI has argued that both these conditions were

met when HLL bought the BBLIL shares from the UTI. HLL and BBLIL had a common

parentage--as subsidiaries of the London-based $33.52-billion Unilever--and were then under a

common management. Thus, HLL and its directors had prior knowledge of the merger.

THE HLL DEFENCE: No company can be an insider to itself. The transnational knowledge

of the merger was because it was a primary party to the process, and not because BBLIL was

an associate company. To buttress this point, HLL maintains that if it had purchased shares of

Tata Oil Mills Co. (TOMCO) before the two merged in April, 1994, SEBI would not consider

it a case of insider trading. Why? Because HLL was not associated with the Tata-owned

TOMCO.

HLL contends that it purchased the BBLIL shares so that its parent company, Unilever, could

maintain a 51 per cent stake in the merged entity. Before the merger, Unilever had a 51 per

cent stake in HLL, but only 50.27 per cent in BBLIL. According to the SEBI guidelines, HLL

can be deemed an insider. But the SEBI's definition of an insider has to be fleshed out by it to

provide a clearer picture.

THE SEBI CHARGE: HLL purchased, the BBLIL shares on the basis of unpublished price-

sensitive information which is prohibited under Section 3 of the Regulations. Section 2 (k) (v)

states that unpublished, price-sensitive information relates to "the following matters

(amalgamations, mergers, and takeovers), or is of concern to a company and is not generally

known or published " According to the SEBI, there can be no dispute that the information of

the overall fact of the merger falls under this definition.

THE HLL DEFENCE: Only the information about the swap ratio is deemed price-sensitive.

And this ratio was not known to HLL-or its directors-when the BBLIL shares were purchased

Page 26: Insider Trading Project

in March, 1996. The two audit firms, S.S. Billimoria & Co. and M.N. Raiji & Co.,

recommended the ratio to the HLL board only in mid-April 1996. Moreover, HLL argues that

the news of the merger was not price-sensitive, as it had been announced by the media before

the companies' announcement, April 7, 1996). HLL also points out that it was a case of a

merger between two companies in the group, which had a common pool of management and

similar distribution systems. Therefore, the merger information in itself had little relevance; the

only thing that was price-sensitive was the swap ratio. HLL made a notional profit of Rs 4.37

crore on the transaction.

THE SEBI CHARGE: Why did HLL not follow the route of issuing preferential shares to

allow Unilever's stake to rise to 51 per cent in HLL? As per the SEBI chargesheet: "Such a step

would have involved various compliances/clearances, and required Unilever to bring in

substantial funds in foreign exchange." The implication: HLL depleted its reserves to ensure

that Unilever did not have to bring in additional funds.

THE HLL DEFENCE: Issuing of preferential shares would have, indeed, been a cheaper

option to ensure that Unilever had a 51 per cent stake in HLL. Had HLL followed this route, it

would have had to pay Rs 282.35, instead of Rs 350.35, per share. In other words, it would

have made a profit of Rs 5.41 crore by doing so. HLL also states that while the preferential

route would have been beneficial for itself, it would have been dilutory for other shareholders

since it would have resulted in an expanded capital base, leading to a lower earnings per share

in the future.

HLL was probably worried that the clearances for a preferential allotment from the SEBI and

the Reserve Bank of India (RBI) would take their time in coming-or may not be given at all. It

had already faced a time-consuming and expensive run-in with the RBI during the HLL-

TOMCO merger in 1994.

THE SEBI CHARGE: Levers cancelled the entire holding of HLL in BBLIL.

THE HLL DEFENCE: HLL was upfront that its entire holding in BBLIL--1.60 per cent--

including the lots purchased from the UTI would be cancelled after the merger in March, 1997.

HLL maintains that this is perfectly legal. In addition, shareholders of both HLL and BBLIL

Page 27: Insider Trading Project

approved of the cancellation of shares as part of the merger scheme. Says Iyer "By this process

of cancellation, which normally happens in every amalgamation, the voting rights of Unilever

have gone up. However, so have the voting rights of other shareholders. So, no exclusive

benefit--profits or avoidance of loss--has accrued to HLL or Unilever."

By extinguishing the shares, HLL wanted to maintain Unilever's shareholding at 51 per cent

and not realise any financial gains. However, Section 3 defines insider trading irrespective of

whether profits are made or not.

SEBI’S ORDER

In the first-ever case of insider trading, SEBI has ordered HLL to compensate UTI by paying

Rs. 3.04 crores and launched criminal prosecution proceedings against HLL and five of its

directors, Mr. S.M. Datta, Mr. K.B Dadiseth, Mr. R. Gopalakrishnan, Mr. A. Lahiri and

Mr. .M.K. Sharma. After detailed investigations, which included the recording of the

statements of some of the directors of HLL, BBLIL and an officer of UTI, the findings of the

investigation were communicated to HLL and its directors. According to these findings, prima

facie, it appeared that HLL was an insider as it purchased eight lakh shares of BBLIL prior to

the announcement of the merger of BBLIL with HLL on April 19, 1996 on the basis of

unpublished price-sensitive information, and HLL had violated the regulations prohibiting

insider trading. Subsequently, a personal hearing was given to HLL and its directors. Their

written submissions were received.

In view of this, SEBI had passed the order that HLL had a profit of Rs. 3.04 crores calculated

on the basis of the difference between the market prices of the shares of BBLIL sold by UTI to

HLL after the announcement of the merger and prior to the announcement of the merger

(excluding premiums)”. Excluding a premium of around 10 per cent for jumbo deals in shares,

the pre-merger market price was Rs. 318.00 plus 10 per cent premium and the post-merger

price taken into calculation by SEBI was Rs. 356.00 plus 10 per cent as on December 1996,

SEBI officials explained. Later, UTI filed an appeal with the appellate authority, claiming a

higher compensation of Rs. 7.52 crores. It pleaded that it had to incur a notional loss, as it was

not aware that a merger of the two Unilever group companies was on the cards.

Page 28: Insider Trading Project

APPELLATE AUTHORITY REJECTS THE CASE

The Appellate Authority in the Finance Ministry set aside the order of prosecution initiated by

the SEBI against HLL and the five common directors in both HLL and BBLIL. The two

member Authority, consisting of the Finance secretary. Mr. Montek Singh Ahluwallia and the

special secretary (Banking) Mr. C.H. Vasudev, in its judgment on July 14, 1998 said the SEBI

was not justified in ordering prosecution against HLL and five of its directors.

The Authority has also pointed out that SEBI has not chosen to use 15 G of the insider trading

regulations for imposing a penalty but instead decided to use omnibus powers under section11

and 11B of the Act to adjudicate for awarding compensation. Use of omnibus powers for

imposing a pecuniary burden cannot be the intent of laws. Therefore, it felt that the order of

SEBI to award compensation to the UTI suffers from procedural deficiencies as well as locks

in jurisdiction.

Also, they expressed surprise to the fact that the UTI did not chose to approach SEBI in the

first instance soon after it felt that the HLL, because of insider trading, had gained an unfair

price advantage in the purchase of BBLIL shares from the UTI. Thus, the decision of the UTI

to file an appeal on the quantum of compensation after SEBI has so motto accorded

compensation to it, appears to be an afterthought. Therefore, given their finding with regard to

jurisdictional competence of SEBI to award compensation, they did not consider it necessary to

pass any separate order on the appeal filed by UTI. Further, the order said that there is

persuasive evidence, which points towards market knowledge and undesired speculation about

the possibility of the merger before the purchase of shares, in question by HLL from UTI.

What weakens a crucial aspect the charge of insider trading that the information involved

should not be generally known? On the information about the merger, the Authority has said

that there was a case of merger of two healthy profit making companies, having a similar

management culture.

The Appellate Authority orders neither contest the fact that HLL is an insider nor that the

merger’s information was price sensitive. HLL has been free from the charge of insider trading

on the basis that merger of HLL and BBLIL was published in number of press reports. The

Page 29: Insider Trading Project

appellate authority substantiated its order by giving a list of publications, which carried the

news during that period. The authority was of opinion that on basis of press report and market

speculation UTI could have acted more carefully. They were of the opinion that UTI was not

market savvy.

SEBI MOVED THE COURT AGAINST ORDER

SEBI moved to the court against the order of Appellate Authority on the HLL case. The case

was pending in the metropolitan magistrate’s court for three years. Finally, SEBI approached

Mumbai High Court complaining inordinate delay in September 2002. The Mumbai High

Court directed the metropolitan magistrate to proceed on the case without delay.

HLL defended its position by quoting the July 1998 order of Appellate Authority. “We hold

that SEBI was most unjustified in ordering prosecution of the appellants (HLL)”. HLL made an

application to magistrate, that summon should not be issued before the company is heard.

However, Mumbai High Court quashed this application on the ground that the company could

not be heard before the summon is issued. The case is still pending in the court. Winning and

loosing the case is not significant in the whole incident. This case is important because it

generated a detailed discussion on the legal and moral nature of insider trading and deep issues

of corporate governance.

Hitech Drilling Services India (HDSI)

Another, less clear-cut case, is that of Hitech Drilling Services India (HDSI). Aban Lloyd

Chiles Offshore Limited made a bid to buy shares of HDSI from Tata, with the deal to be

publicly announced on March 18, 2001. In the days leading up to March 18, SEBI observed

unusually active trading of HDSI stock on the Bombay Stock Exchange and the price of HDSI

stock rose from an average of Rs 35 in January and February to Rs 50.70 on March 16. So far,

no action has been taken against anyone in this case. Similar patterns of price increases prior to

a public announcement of a merger have been observed in the UTI Bank-Global Trust Bank

Page 30: Insider Trading Project

merger. Therefore, despite the efforts of the Indian authorities to combat insider trading, the

practice remains extremely common.

Profiting from disaster 9/11

In the wake of the terrorist attacks, which caused the destruction of the Twin Towers of New

York's World Trade Center, damaged the Pentagon, and destroyed four large airliners with all

aboard, securities-exchange investigators on three continents are poring over trading records to

determine whether one or more parties profited by their advance knowledge of the disaster.

An event as dramatic and large in scale as the Black Tuesday attacks had

a severe and far-reaching effect on worldwide stock markets. This effect is somewhat like the

impact of a stone thrown into a pond:  There are certain specific companies which are strongly

and immediately affected by the attacks; others which are affected more weakly and indirectly;

Page 31: Insider Trading Project

some which decrease in value only because of a general feeling of pessimism rather than

because of any direct impact on their bottom line; and some which may even increase in value

because they are seen as a "safe haven" in uncertain times, or because they may gain business

from an upcoming armed conflict.

Another way of looking at this "ripple" effect of insider trading is that the farther away a

company is from the center of the impact the greater the odds that it would emerge unscathed

had the attacks' impact been less horrendous than it was. The obvious members of the "first

circle" of companies strongly affected by the attacks are American Airlines and United

Airlines, the two companies whose planes were hijacked and used as flying bombs in the

attacks on New York and Washington.  These companies' stocks would have decreased in

value as a result of any hijacking incident involving their planes, even one with a peaceful

resolution.  The same is true to a lesser extent of other airline companies, Boeing (the principal

private manufacturer of airliners), and other companies that provide equipment and services to

the air-transportation industry. The next circle includes companies that would weather a

"normal" hijacking incident relatively unscathed, but would be significantly affected by a more

violent attack.  These include the insurance and reinsurance companies, which must cover the

damage, as well as firms with a major presence in or near the Twin Towers. The general stock

market -- the "third circle" in our analogy -- would not be strongly affected by a "peaceful"

hijacking, but would be by a more violent one.  It could be argued that even the Black Tuesday

attacks as they occurred were not sufficient to cause a really bad "market break" -- while the

decline of the Dow Jones Industrial Average on the first day of trading after the disaster was

the largest on record in absolute terms, it was not one of the top ten historical declines in

relative terms.  Had the attacks been more completely successful -- for example, had the fourth

plane preceded to Washington and crashed into the White House or the Capitol -- the overall

market would surely have suffered a much worse crash.  To understand what might have

happened, it is worth comparing the market's performance immediately post-Black Tuesday,

when the Dow Jones Industrials dropped by about seven percentage points, and the 1987

market crash, when the Dow dropped by over 22 percent in one day even though there was no

obvious external reason for it to so.

Page 32: Insider Trading Project

 Investigators will be looking at transactions starting with those that can be most easily

identified as suspicious.  Already enough has emerged to indicate that some trades were almost

certainly made based upon advance knowledge of the Black Tuesday attacks:  

Between September 6 and 7, the Chicago Board Options Exchange saw purchases of

4,744 put options on United Airlines, but only 396 call options.  Although there was no

news at that time to justify so much "left-handed" trading, United Airlines stock fell 42

percent, from $30.82 per share to $17.50, when the market reopened after the attacks. 

Assuming that 4,000 of the options were bought by people with advance knowledge of

the imminent attacks, these "insiders" would have profited by almost $5 million.  

On September 10, 4,516 put options on American Airlines were bought on the Chicago

exchange, compared to only 748 calls.  Again, there was no news at that point to justify

this imbalance; but American Airlines stock fell 39 percent, from $29.70 to $18.00 per

share, when the market reopened.  Again, assuming that 4,000 of these options trades

represent "insiders," they would represent a gain of about $4 million.  

No similar trading in other airlines occurred on the Chicago exchange in the days

immediately preceding Black Tuesday.  

Morgan Stanley Dean Witter & Co., which occupied 22 floors of the World Trade

Center, saw 2,157 of its October $45.00 put options bought in the three trading days

before Black Tuesday; this compares to an average of 27 contracts per day before

September 6.  Morgan Stanley's share price fell from $48.90 to $42.50 in the aftermath

of the attacks.  Assuming that 2,000 of these options contracts were bought based upon

knowledge of the approaching attacks, their purchasers could have profited by at least

$1.2 million.  

Merrill Lynch & Co., with headquarters near the Twin Towers, saw 12,215 October

$45.00 put options bought in the four trading days before the attacks; the previous

average volume in these options had been 252 contracts per day.  When trading

resumed, Merrill's shares fell from $46.88 to $41.50; assuming that 11,000 option

contracts were bought by "insiders," their profit would have been about $5.5 million.  

Page 33: Insider Trading Project

European regulators are examing trades in Germany's Munich Re, Switzerland's Swiss

Re, and AXA of France, all major reinsurers with exposure to the Black Tuesday

disaster.  (Swiss Re estimates that its exposure will be $730 million; Munich Re expects

to pay out as much as $903 million.)  It is not clear if any trades in these stocks ring

alarm bells; and some negative earnings news announced shortly before the attacks

means that a certain amount of unusual selling may have been a normal market reaction

and not anything more sinister.  

Amsterdam traders have noted that there was unusual trading activity in KLM Royal

Dutch Airlines put options before the attacks.

This is very much a developing story, and we can be sure that more and more accurate

numbers will emerge soon.  Investigators will be examining transactions starting with the few

days immediately before the attack, and then working backwards; and similarly, they will be

looking first at trades in the most obviously affected securities. .

 

Assuming that investigators are convinced that trades were made based upon advance

knowledge of the attacks, they will obviously try to trace these trades back to determine who

initiated them.  Obviously, anyone who had detailed knowledge of the attacks before they

happened was, at the very least, an accessory to their planning; and the overwhelming

probability is that the trades could have been made only by the same people who masterminded

the attacks themselves. The difficulty, of course, will be in tracing the transactions to their real

source.  The trading is sure to have been done under false names, behind shell corporations,

and in general to have been thoroughly obfuscated.  If in fact the Black Tuesday attacks -- and

the associated securities transactions -- were made under orders from Osama bin Laden, then

we are dealing with an expert in masking ownership of corporations and making covert deals. 

This does not mean that unraveling the threads of these transactions will be impossible, but it

probably will not be quick or easy.

The matter still is under investigation and none of the government investigating bodies -

including the FBI, the Securities and Exchange Commission (SEC) and DOJ -are speaking to

reporters about insider trading. Even so, suspicion of insider trading to profit from the Sept. 11

attacks is not limited to U.S. regulators. Investigations were initiated in a number of places

Page 34: Insider Trading Project

including Japan, Germany, the United Kingdom, France, Luxembourg, Hong Kong,

Switzerland and Spain. As in the United States, all are treating these inquiries as if they were

state secrets.

BoM-ICICI Bank merger

In1999-2000 Bank of Madura and ICICI Bank merger was preceded by some interesting

trading patterns that suggested the possibility of informed trading in the homestretch to the

corporate action.

The Bank of Madura's (BoM) stock had been hitting circuit-breaker for quite a few days and in

a short period of time, it had appreciated more than 50 per cent. The news driving the price was

the BoM's proposed merger with the ICICI Bank and the market expectation of a minimum

swap ratio of around 1:1. These were the swing in the share prices of the BOM, ICICI bank

which was showing high variation.

The ratio eventually turned out to be 2:1 (two shares of ICICI Bank every share of BoM).

Considering BoM's small equity base of Rs 11.80 crore against ICICI Bank's Rs 196.80 crore,

a swap ratio of 2:1 would have little impact on the ICICI Bank's equity, but it would

considerably improve the bottomline.

Page 35: Insider Trading Project

When the announcement of merger was made, the market had no clue about the swap ratio.

After all, the merger of two banks is not unusual and the stock price responding to such news is

also a sign of market efficiency. However, insiders and those connected with the merger play

the game of insider trading on such occasions. Certain unusual trading before the formal

announcement of the swap ratio, and the role of regulating agencies assumes importance in

examining the issue in the context of insider trading, and develop public investors' confidence.

The Securities and Exchange Board of India (SEBI) had a regulation to prevent and punish

insider trading. While efforts were made to fine-tune the regulation, as SEBI till the data did

not book any major case on insider trading. Its earlier attempts on investigating insider trading

in BBLIL and HLL merger, and Reliance Industries did not yielded any significant results.

Using the available public information on stock price changes, the number of shares traded, the

number of trades and the ratio of swap, it was pointed out the specific dates on which certain

abnormal trading took place at a volume higher than average volume of the period. The Table

gives the details of BSE trading statistics relating to the BoM stock. .

The analysis of Table showed a sudden spurt in volume per trade in September and October

along with increased volume of shares for the month. A further analysis of the daily trading

data shows the volume on two days (September 20 and October 6) increased suddenly.

Page 36: Insider Trading Project

The BoM counter registered a volume of 44,650 shares on these two trading days on the BSE

at an average price of around Rs 74. The issue was who were the investors taking sudden

interest on BoM's stock on those two days. If these investors had known the swap ratio of two

ICICI shares for one BoM share, which the banks would announce on next Monday, the profit

potential would be more than Rs 200 per share. In other words, the net gain available out of

these trades would be Rs 89.30 lakh.

Another important date was December 6, two days before the formal announcement on the

merger. On this day, on the BSE, 58,7970 shares were traded in just 67 trades at an average

price of Rs 98.18. The average volume per trade was 8,775 shares against the normal volume

of 100 per trade.

The total volume traded on the BSE from July to November was 90,230 stocks against the

5,87,970 stocks traded on December 6. There was abnormal trading on the NSE too that day.

What was the motive behind such a trade on the BSE? Who were the buyers and, more

particularly, the sellers? Was there any party, which knew of the merger deal and the swap

ratio and influenced a PSU bank or a mutual fund to sell the shares at the current market price

for such a block deal? These were all the questions that lead SEBI to investigate the case. With

the current price of ICICI Bank's share, the profit from this deal is Rs 13.52 crore.

Insider trading did not stop with the formal announcement of the proposal of a merger. For,

there emerge two sets of investors in the market. The first has only the information in the

public domain about BoM and ICICI Bank. The other has information about the swap ratio,The

profitability due to price differential between the two stocks is known to the second set. The

investor’s privy to the swap ratio can continue to do such deals. Though SEBI's attention was

particularly drawn to investigate the trades of those periods, no public report is available if

SEBI investigated the deals to examine the insider-trading issue.

SEBI action: It is high time SEBI signaled strongly to the capital market regarding insiders'

trading.

Page 37: Insider Trading Project

---It asked the stock exchange members to furnish the names of investors on whose behalf the

buying took place on days when the volume was higher than the average during a period.

---It investigate these investors' connections with the top management of ICICI Bank/BoM,

advisors to the merger scheme, the independent valuer of the swap ratio and all others specified

by SEBI's insider-trading regulation.

However, SEBI put its hand on this case as early as possible but as and now no outcome has

come and the case is still pending in the court.

Insider Trading at Texas Gulf Sulphur Company

Insider trading not only concerns scholars and regulators but also attracts the attention of the

general public. To get a practical idea of insider trading, consider the famous Texas Gulf

Sulphur Company case .Texas Gulf Sulphur Company was established in 1909.In 1959 its

exploratory prospecting with magnetic surveying equipment produced some evidence that

valuable deposits of copper, zinc, and silver might exist in an area of Ontario.

In 1963, the first drilling confirmed the possibility, and the commercial value of the find

proved to be enormous. The company instituted tight control of the drilling project so as not to

leak the information to outsiders .Meanwhile, various officers, directors, and employees of the

company, knowing this information and the fact that it was not released to the public, bought

shares of, and call options of, Texas Gulf Sulphur Company or were given stock options by the

company and tipped other people to purchase the stock or options of the company. These

activities happened between November 12, 1963, and April 16, 1964, a period when the stock

prices of Texas Gulf Sulphur Company were relatively low due to its lackluster performance in

business.

Rumors about the company’s discovery surfaced and became rife in mid-April 1964. By then

the stock price had risen to $29.375 from $17.375 on November 10, 1963. On April 12, 1964,

the company made an announcement, which the Security Exchange Commission (SEC) later

accused of misleading the public, that the company’s drilling had “not been conclusive” and

Page 38: Insider Trading Project

“the rumors about the discovery were unreliable premature and possibly misleading,” and

originated with speculators not connected with the company. Four days later, on April 16,

1964, however, the company announced “a major ore discovery” of about 25 million tons of

copper, zinc, and silver. The stock price jumped to $71 on April 19, 1964. Those who had

purchased or acquired stocks and options before this date reaped substantial financial gains.

In April 1965, the SEC filed a suit in the United States District Court against a number of

individual defendants who were directors, managers, and employees of Texas Gulf Sulphur

Company. The charges were based on the defendants’ violation of Rule 10(b)-5 of the

Securities Exchange Act of 1934 for” engaging in the purchase and sale of securities on the

basis of information with respect to material facts relating to Texas Gulf acquired by said

defendants in the course of their corporate duties or employment with Texas Gulf which

information had not been made available to Texas Gulf, its stockholders and other public

investors; (b) making available such information, directly or indirectly, to other persons for the

purpose of permitting or allowing such other persons to benefit from the receipt of such

information through the purchase and sale of securities; and (c) engaging in other conduct of

similar purport and object.” The SEC won the case.

Infosys fines its CEO for violating insider trading rules

Infosys is not only an IT bellwether; it is also an ethical bellwether. The company, in perhaps

the first instance in India, has fined its CEO Kris Gopalakrishnan for a technical violation of its

insider trading rules.

The fine, Rs 5 lakh, would be donated to charity. Besides the CEO, an independent director,

Jeffrey Lehman, also has been fined $2,000 for the same violation. This is the third time that

Infosys has punished a member of its top brass. Earlier, it had imposed a penalty on its director

Srinath Batni. In a notice to the US SEC, Infosys said Mr. Gopalakrishnan had inherited 12,800

equity shares from his mother on December 24, 2007 but had inadvertently failed to notify the

Page 39: Insider Trading Project

company within one business day after the change in his shareholding. This, according to the

company, constituted a violation of its insider trading rules.

.

But Infosys’ audit committee believed that Mr. Gopalakrishnan had no intention of

contravening the rules and imposed the penalty of Rs 5 lakh and directed him to donate the

amount to a charitable organisation of his choice. Mr. Gopalakrishnan has made the donation.

Mr. Lehman was also imposed a penalty of $2,000 for failure to correctly follow the procedure

on sale of shares and that amount, too, has been given to charity.

Finding and Analysis

On the basis of the experts opinion survey and case study a various world

Famous insider Trading Cases and other source the following are the finding:-

On paper, India's laws on insider trading are more stringent than international

ones. From merely barring insiders from trading on the basis of unpublished

price-sensitive information, the laws have moved on to prohibiting anyone in

the possession of such information from trading. And proof that the information

was not shared is no longer acceptable defense against charges of insider

trading; today, an accused needs to prove that such information could have

never been shared. This shifts the focus on to the accused to prove that there has

been no insider trading

"Insider Trading is victimless Crime" the following quote here in suggested that

this crime is not done with an intention to effect the financial position of the

General Investor. But without any intention, the general investor comes into this

trap and is effected largely.

The "Close window Scheme before 24 hr. of SEBI also seems as a failure

because all the parties that trade on the basis of inside information buy or sell

the securities well before 24 hrs. The window is closed for them to trade.

Page 40: Insider Trading Project

Despite the control and regulation restriction imposed on insider trading at stock

exchange in India or all over the world, these laws have not been effective to

curb these kinds of activities within the stock exchange.

"SEBI" website is also not properly constructed. As insider trading directly,

come under the control of SEBI. Therefore, any person seeking information on

this topic will explore the SEBI's website but will not get any information. With

almost full exploration of website, you will get the law on insider trading which

will be an exaustic process and will require lot of time. The website also does

not give any information on the no. of case that are charged under insider

Trading and any of the other default about this topic.

The "Insider Trading Regulation 2002" is also not properly formed. Most of the

terms and expressions used under this law are incomplete and on this basis, only

some of the Companies escape the charges of insider trading. HLL insider

Trading, BOM - ICICI Merger Case are still pending on these ground.

Based on survey and people contacted for insider Trading Questioner shows that

there are very few sub-broker and educated people, who are just acquitted with

the word insider trading. When they are just acquitted with the word then the

knowledge about laws, regulation and its effect on shareholder are doubtful.

There has been a silent battle going on between the various group of people as

some set of researcher wants to legalize the insider trading and so that all the

punishment are curbed. The researcher who wants to legalize this kind of

activities also do not have strong reasons on which basis they want to give

insider Trading this plat form.

It is very difficult to distinguish which information is price sensitive and which

is not. Because even a very small information can bring large no. of upswing

and down swing in the pries of share.

Round the Globe various cases related to insider Trading has been seen. But

nowhere including SEBI has not been successful to investigate the case before it

Page 41: Insider Trading Project

has occurred. All the cases reported for insider trading have come to knowledge

of SEBI well after the trading operations have been performed.

Though SEBI keep's the eye on each and every trading activity of people

connected with the Companies but of no use. As the insider Trader are smarter

and they perform their operations so cleanly that even SEBI cannot notice

happening of such events in the stock market.

SEBI's Insider Trading Act and Companies policies and procedures for the

insider trading are not adequate enough to prevent insider trading. Because

generally top level executive frame the policies and they can manipulate or

misuse a slight clause according to them so as to gain the profit.

In recent amendments, the SEBI is including insider trading under "Prevention

of Money laundering of Act” (PMLA) so that the punishment for the inside

Trader are sever and they are afraid to indulge in such kind of trading activity.

Insider trading such an activity where to prove the charge against the insider is

an arduous task.

In this type of trading generally, the individual investor is the most affected

because the big broker, institutional investor keeps a trap on the market and buy

& sell accordingly. Therefore general investor is most affected and they are not

aware of this slap on there face.

India's first, and most high-profile case of alleged insider trading involved

Hindustan Lever Limited (HLL) and five of its directors just ahead of the

company's merger with Brooke Bond Lipton India. SEBI asked HLL to pay Rs

3.04 crore as penalty, but the Appellate Authority in the Finance Ministry set

aside its order. So is the case with all the other cases, which are under SEBI.

Every body in the share market be it the primary insider, secondary insider,

broker, auditors, general investor would like to take the advantage of the price

sensitive information to make gain in market though they may consider trading

on inside information as illegal. The picture below gives that how the judge who

have no link with the share market and rarely deals in the shares. But when there

Page 42: Insider Trading Project

is a chance of getting a inside information than the judge also wants to make

unfair amount of profits.

Suggestions and Recommendation

With the knowledge gained various source and on the basis of finding and analysis of

the various aspect of insider trading some of the suggestion are stated here below.

There should be China's wall constructed between the department having price

sensitive information and other departments of companies and outsider's who

deal with the Company. So that they do not take advantage of price sensitive

information and a proper list of all information, which are "Price Sensitive"

should be maintained so that such information is taken extra care when dealing

with such information.

The Companies should disseminate price sensitive information to stock

exchange on continuous and immediate basis and should also improve investor

& access to their public announcements.

Page 43: Insider Trading Project

SEBI should make a law/or appoint an Committee that can bring in cases of

insider Trading well before such trading take place in the stock market so that

interest of general investor is safe guarded.

SEBI should disallow the directors/officer, designated employees of the

companies to buy or sell the shares well before some important announcements

are to be made and which effect the share market.

SEBI should strictly observe that when some price sensitive information

declarations are made, the trading window should be closed so that company

member does not take advantage of such declarations before they are made

public.

The Companies should also clearly give details of probable disciplinary the

code. Such as wage freeze, suspension, ineligibility for before participation in

employee stock option plans with holding of promotion.

It is SEBI's responsibility to bring out the cases and investigate charges of

insider Trading but at last power to convict the person lie with the Court which

is a long process The Government should give in the power for the decision to

the SEBI so that convict is punished on time before it is to late.

SEBI should property construct the website where in the general investor can

get all the available information about the insider trading. A Forum should be

established where the general investor can give their views, any complaints,

suggestion to stop the riding horse of insider to make money.

To facilitate compliance with the new reporting of transactions, issuers should

either designate a single broker through whom all transactions in issuer stock by

insiders must be completed or require insiders to use only brokers who will agree

to the procedures set out by the company. A designated broker can help ensure

compliance with the company’s preclearance procedures and reporting obligations

by monitoring all transactions and reporting them promptly to the issuer. If

designating a single broker is not feasible, issuers should require insiders to obtain

a certification from their broker that the broker will:

Page 44: Insider Trading Project

1) Verify with the issuer that each transaction entered on behalf of the insider

was pre cleared.

2) Report immediately to the issuer the details of each of the insider’s

transaction

In issuer’s securities.

The stock exchanges should take up at least a substantial burden of filing action

against persons violating the regulations. Since the Rules and regulations of the

stock exchanges are considered ‘enactment’, and court judgments13 have found

exchange regulations to have the force of law – they could easily enforce the

requirements of the listing terms or the rules and regulations by seeking civil action

in courts against persons or companies who violate such regulations. The exchanges

should also better coordinate monitoring and surveillance of listed companies to

track unusual activity in the stock of a company across markets for traces of insider

dealings or manipulation.

Briefly, the good governance regulations provide for:

a) Officer, director and substantial shareholder to disclose their holding on certain

events or at certain intervals.

b) Appointment of a compliance officer.

c) Setting forth policies and procedure to restrict the possibility of abuse of insider

trading.

d) Monitoring and pre-clearance of trades by the designated persons.

e) Restrict trading by such insiders within a certain period of time i.e. before

corporate announcements, buybacks etc. are made.

f) The company has to convey all the significant insider activity and corporate

disclosure in a uniform publicly accessible means to the public – and to the stock

exchange.

g) Chinese walls within a firm to prevent one part of the firm, which deals in

sensitive information from going to other parts of the firm, which have an inherent

conflict of interest with such other parts.

Page 45: Insider Trading Project

h) Minimum holding period of securities by insiders.

i) No selective disclosure to analysts. Wide dissemination of information.

Conclusion

According to the recent survey India is the largest hub of insider trading, which has determent

the interest of individual investors and their confidence in the capital market because of the

non-availability of proper monitoring authority to investigate and prosecute insiders. If such

activities continue the basic function of stock exchange i.e. capital formation will be reduced

as general investors trust will be lost on functioning of stock exchange.

"Complaining about insider trading without finding a workable solution is like crying

that the government should do something about smoking as it causes cancer, but doing

nothing."

Quote By Trading Guru

Same is the situation with the Indian Government and SEBI both have not been

successful to curb insider trading. Though SEBI is now making some efforts to

prevent insider to trade in stock exchange and disturb the main functioning of it.

Efforts made by SEBI are on a slow pace which needs to be fasten up otherwise this

kind of activities will loses the trust of general investors.

It is also important to curb the insider trading other wise it will not show the correct

and fair prices of shares of each companies.

Insider trading is a victimless crime, which effect large number of general investors,

and they do not even come to know this effect at once. In conclusion it can be said

that.

"It is difficult to prescribe remedies to each one of the trading malpractice in

Indian Stock Market. But the problem of insider trading and secret take over bids

could be tackled to a large extent by appropriate regulatory measures by authority”.

Abid Hussain

Member of Development Capital Market Committee

Page 46: Insider Trading Project

It is therefore important for there to be markets free from all types of fraud and in particular

insider trading which disenchants the common investor from the workings of the markets

as if he is being invited to play a game of crap with loaded dice. Unfortunately, with the

unearthing of large frauds, even though India is not unique in this, the concept of corporate

good governance has been lost in the war cry for blood. As a result, the government has

gotten into overregulation and micromanagement by converting good governance into

statutory provisions. We tend to forget that micromanagement cannot stamp out fraudulent

action, it can only be reduced by effective enforcement of the laws, which should prohibit

obvious illegalities.

It should not be forgotten that what is sought to be caught is crime and treating all insiders

as inherently tending towards a presumption of unfair dealing should be avoided. Standards

of corporate governance should be left at the helm of the managers of the company. The

regulator should specify in the Schedule to the regulations a list of optional procedure for

limiting the possibilities of insider trading. What should be mandated instead should be a

statement in the annual report of the degree of compliance with the standards of set forth in

the Schedule. Thus companies, which do not follow corporate governance guidelines in

substance, should be penalized by its shareholders.

Introduction of corporate governance ratings, similar to debt ratings, which would pressure

management to comply with such measures. This could be the missing link providing a

simple number which can be appreciated and understood by the masses and would indicate

the processes a company has put in place for the benefit of their non-insider shareholders.

Page 47: Insider Trading Project

Bibliography

“Security market in India” by S.J. Lalwani

“Securities laws and regulation of financial markets” by ICSI

“Study of financial market” by Roger.D.Agris

“Swing Trading” by Jyoti Basu

www.businesstoday.com

www.sebi.com

www.sec.com

www.indiaenews.com

www.infosys.com

www.hllindia.com

www.brookebond.com

www.9/11trading.com