Ethics Management Insider Trading-libre

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Insider trading – a menace to Corporate Governance

Corporate governance is founded on four pillars i.e. righteousness, truth, perseverance and social

justice. The companies which trade in securities are listed either in the NSE or the BSE which are the

registered stock exchanges in the country. They have to regulate their activities in stock exchanges in

accordance with the norms prescribed by SEBI, the stock market regulator in India.

In this chapter, the author brings home the importance of corporate governance of companies trading in

stock markets. A listed company has to deal with its investors in a righteous and just manner.

Definition of insider trading and insiders

Insider trading is the most heinous fraud being faced in the corporate sector nowadays. It is trading of

a public company's stock or other securities i.e. as bonds or stock options by individuals with access to

non-public information about the company. Normally, trading by corporate insiders such as officers, key

employees, directors, and large shareholders is permitted, if this trading is done in a way that does not

take advantage of non-public information. But, the term iside tadig is frequently referred to apractice in which an insider or a related party trades based on material non-public information obtained

during the performance of the insider's duties at the company, or otherwise in breach of a fiduciary or

other relationship of trust and confidence or where the non-public information was misappropriated

from the company fraudulently.

Insider Trading, in general, implies buying, selling and dealing in shares and securities of a listed

company by insiders such as directors, designated officers of management team, employees of the

company or any other connected persons such as auditors, consultants, lawyers, analysts who possess

material inside information which is not available to general investors.

According to the Indian stock market regulator, SEBI, "insider" means any person who, is or was

connected with the company or is deemed to have been connected with the company, and who isreasonably expected to have access, connection, to unpublished price sensitive information (UPSI) in

respect of securities of a company, or who has received or has had access to such unpublished price

sensitive information. Inside unpublished price sensitive fact is inside information which only a select

few persons know because of their closeness to the company and which has not been publicly

circulated.

Stock prices often respond to corporate actions such as mergers, stake sales and takeovers, much

ahead of the public announcement. Insider trading strikes at the very root of market integrity.

When public investors or institutions which represent them put their money on a stock, they do so

ased o pulil aailale ifoatio o a opas usiess, fiaials ad pospets. What iside

information on an impending merger, stake sale or financial performance does is to render suchindependent analysis completely meaningless.

If companies were to routinely leak out information about impending results, * share swap ratios or

corporate action to a favored coterie, then there is no need for formally reporting results, disclosure of

material events or even substantial acquisition of shares! Ultimately, every instance of insider trading

stegthes the sall iestos oitio that the stok aket is a galig de, hee he has o

hope of scoring over those with deep pockets.



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*(Share swap ratio means the ratio in which an acquiring company will offer its own shares in exchange

for the target company's shares during a merger or acquisition. To calculate the swap ratio, companies

analyze financial ratios such as book value, earnings per share, profits after tax and dividends paid, as

well as other factors, such as the reasons for the merger or acquisition. For example, if a company offers

a swap ratio of 1:1.5, it will provide one share of its own company for every 1.5 shares of the company

being acquired).

Indian Regulatory Law and SEBI

There are two categories of Insiders i.e. (I) Primary Insiders who are directly connected to the company.

(ii) Secondary Insiders are those who deemed to be connected with the company as they are expected

to have access to unpublished price sensitive information.

According to SEBI, the stock market regulator in India, Price Sensitive Information means any

information, which relates directly or indirectly to a listed company and which if published, is likely to

materially affect the price of securities of such company. Regulation 2(ha) of SEBI Act, defies pie

sesitie ifoatio as any information which relates directly or indirectly to a company and which if

published is likely to materially affect the price of securities of a company. The information relating to

periodical financial results of the company; intended declaration of dividend – interim and final; issue of

any class of securities; buy back of securities; any major expansion plans or execution of new

projects; amalgamation, mergers or takeovers; disposal of whole or substantial part of undertaking or

Any significant change in policies plans or operations of the company are considered as price sensitive

information.

Regulation 3 prohibits the insiders of listed companies either on his own behalf or on behalf of any other

person, on dealing, communicating or counseling matters relating to insider trading. Similarly Regulation

3A prohibits a company from dealing in securities of another company or associate of that other

company, while in possession of price sensitive information.

Regulation 4.1 requires that all directors, officers and designated employees and their dependents – asdefined by the company shall execute their order in respect of securities of the company within 7 days

after the approval of pre-clearance is given. If he does not clear within one week, he must pre-clear the

transaction again.

Regulation 4.2 was fully substituted in lieu of earlier provision. It mandates all directors, officers,

designated employees who buy or sell any number of shares of the company shall not enter into an

opposite transaction i.e. sell or buy any number of shares during the next 6 months following prior

transaction. They should not take position in derivative transactions in the share of the company at any

time. In the case of IPO, the aforementioned persons shall have to hold their investments for a minimum

period of 30 days. The period of 30 days must be reckoned from the date of actual allotment. (Prior

tasatio eas a opas deisio that ipats the pies of its shaes hih is ot ade puliand that is only known to the insiders).

Regulation 13 of SEBI Insider Trading Regulation, speaks about initial and continual disclosures of

holdings or interest of Director or officer and substantial shareholders in a listed company. It casts duty

on directors or officers holding specified percentage of shareholding in a listed company to disclose their

holdings to the company and the company in turn intimate to the stock exchange of those disclosed

information.



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Regulation 13(1) postulates that every person holding more than 5% shares/voting rights in any listed

company shall disclose to the Company, in Form – A, the number of shares or voting rights held by such

person on becoming such holder within 2 working days of the receipt of intimation of allotment of

shares or the acquisition of shares or voting rights as the case may be.

Regulation 13 (6) mandates the Company to inform the stock exchanges where the shares of the

company are listed, the information as received under initial disclosure and/or continual disclosure,

within 2 working days of receipt of the information from the aforementioned persons.

Officials privy to price-sensitive information are required to make periodic disclosures to the compliance

officer of the company about their holdings in company stock. Transacting in this stock requires prior

permission. Companies which are set to announce material events are required to completely bar

transactions by insiders during and after the announcement.

Powers of SEBI in case of violations

Regulation 14 was substituted by the amendments made on 19- November-2008. Apart from initiatingactions under Regulation 11, SEBI is empowered to invoke powers enshrined in Securities and Exchange

Board of India Act,1992 in sections – 11- general powers of SEBI to protect the interests of investors in

securities and to promote the development of and to regulate securities market, 11B – “EBIs poe to

issue directions to market intermediaries, 11D – power to pass orders requiring a person who violated

or is likely to violate the provisions of the Act to cease or desist from committing or causing such

violation and SEBI may award penalty and imprisonment to a violator of the regulations. A violator shall

be punishable with imprisonment for a term which may extend to 10 years or with fine which may

extend to Rs.25 Crores or with both.

Penalty for contravention of code of conduct

Any employee/partner/director who trades in securities or communicates any information or

Counsels any person trading in securities, in contravention of the code of conduct may be penalized

and appropriate action may be taken by the organization/firm.

Employees/partners/directors of the organization/firm who violate the code of conduct may also

be subject to disciplinary action by the company, which may include wage freeze, suspension, etc.

The action by the organization/firm shall not preclude SEBI from taking any action in case of

violation of SEBI (Prohibition of Insider Trading) Regulations, 1992.

Exception to illegal insider trading

Not all trading on information is illegal insider trading. For example, if while travelling in an airplane a

passenger A, seated near the seat of the CEO of a Company telling the CFO travelling with him that the

company's profits will sour very shortly and then passenger A buys the stock, one is not guilty of insider

trading unless there was some closer connection between passenger A, the company, or the company

officers. But, information about a tender offer, especially regarding a merger or acquisition, is



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considered very sensitive information. If this type of information is obtained (directly or indirectly) and

there is reason to believe it is nonpublic, there is a duty to disclose it or abstain from trading.

The following case studies would be a lesson to learn.

Mens rea and insider trading under Insider Trading Regulations 1992

While interpreting the provisions of the SEBI (Insider Trading) Regulations, 1992, the Securities Appellate

Tribunal has in the past held that if a person who had indulged in insider trading had no intention of

gaining any unfair advantage, then the charge of insider trading cannot be sustained (Rakesh Agrawal v.

Securities and Exchange Board of India, [2004] 49 SCL 351).

Section 24 of the Securities and Exchange Board of India (SEBI) Act 1992, read with the Securities and

Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 (the Insider Trading

Regulations), provides the basis for criminal liability for insider trading in India. Section 24 of the SEBI Act

poides fo puishet ith a fie o ipisoet of a peso ho contravenes or attempts to

otaee o aets the otaetio of the poisios of the At o the egulatios ade ude it.

The Insider Trading Regulations under the SEBI Act specifically prohibit dealing in securities of a listedpublic company while in possession of unpublished price-sensitive information, or communicating or

counseling such information to a person who is prohibited from dealing in securities while in possession

of the information. A iside ho deals i seuities i otaetio of these poisios is guilt of

insider trading. The SEBI is given the power to initiate criminal prosecution under s.24 of the SEBI Act as

well as issuing certain directions such as prohibition on the dealing in securities, declaring the

transaction in securities as null and void, or delivery of securities back to the seller, in order to protect

the interests of the investors and the securities market, and to ensure compliance with the SEBI Act.

The first landmark decision on criminal liability for insider trading, which influenced the 2002

Amendments to a great extent, was Hindustan Lever Ltd v SEBI.

Hindustan lever Ltd. v. Sebi

Hindustan Lever Ltd. (Herein after HLL) and Brooke Bond Lipton India Ltd (BBLIL) were companies

controlled by Unilever Inc. of U.K and were under the same management; HLL purchased 8 lacs shares of

Brooke Bond Lipton India Ltd (BBLIL) from U.T.I on the 25th March 1996 @ Rs. 350.35 per share; 25 days

after the said transaction viz. on the 19th April 1996, HLL announced its merger with BBLIL and notified

the Stock Exchanges. Afte the aoueet of the ege, BBLILs pie shot up to ‘s. ad ee

beyond that. SEBI after 15 months of investigation came to a conclusion that HLL, BBLIL and its common

directors were liable for Insider Trading and has violated the provisions of the SEBI (Prohibition of

Insider Trading) Regulations, 1992. This resulted in causing a huge loss to UTI. “EBIs hage as ased

on the following factors:

On the date of acquisition of shares HLL had full knowledge of the impending merger and this

knowledge was in fact unpublished price sensitive information under the Insider Trading Regulations

and hence was in an advantageous position as compared to public investors. HLL made misuse of this

unpublished price sensitive information since it did not disclose the fact of impending merger to UTI and

neither did it make the same public before the deal to acquire 8 lac shares of BBLIL. U.T.I suffered a loss

of Rs. 3.4 crore due to the concealment of the information since it sold the shares at a price of Rs.

350.35 per share, whereas after the public disclosure of the merger the share price of BBLIL shot up



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beyond Rs. 400. UTI could have got a better price for its shares had the disclosure been made by HLL.

SEBI the regulatory body directed HLL to compensate Unit Trust of India (UTI) to the extent of Rs 3.04

crore for the notional loss incurred by it and also ordered that prosecution proceedings should be

initiated against Hindustan Lever Limited and its five directors who were party to the decision of the

purchase of shares.

O appeal to the Appellate Authoit “EBIs hage as deolished on the ground that there was no

unpublished price sensitive information involved since prior to the announcement of the merger,

leading financial newspapers had reported the possibility of the merger and hence it was public

knowledge. UTI could not allege that the information was undisclosed since it had the best of market

analysts and experts who were fully familiar with the market trends. As a fall out of this case SEBI

amended its Regulations in 2002 to specifically provide that speculative reports in the media would not

be treated as publication of price sensitive information.

Dilip pendse v. Sebi

This was perhaps the simplest case of Insider Trading which was handled by SEBI and it had nodifficulties in punishing the offenders. The facts were that Nishkalpa was a wholly owned subsidiary of

TATA Finance Ltd (TFL), which was a listed company. D. P. was the MD of TFL. On 31/03/2001, Nishkalpa

had incurred a huge loss of Rs. 79.37 crore and this was bound to affect the profits of TFL. This was

basically the unpublished price sensitive information of which Pendse was aware. This information was

disclosed to the public only on 30/04/2001. Thus any transaction by an Insider between the period

31/03/2001 to 30/04/2001 was bound to fall within the scope of Insider Trading. DP passed o this

information to his wife who sold 2, 90,000 shares of TFL held in her own name as well as in the name of

companies controlled by her and her father-in-law. It was very easy for SEBI to prove Insider Trading in

this cake walk or vanilla case.

Case studies from US

Michael Van Gilder Indicted for Insider Trading (reported by New York Times)

Insurance executive Michael Van Gilder, age 45, of Denver, was indicted by a federal grand jury in

Denver on five counts of insider trading. The U.S. Securities and Exchange Commission, which filed a

complaint charging Van Gilder with civil insider trading violations, conducted a parallel civil investigation

and substantially contributed to the criminal investigation of the case as well. The defendant allegedly

traded based on inside information regarding a Denver oil and natural gas company called Delta

Petroleum Corp.

According to the indictment, Van Gilder was the chief executive officer and a member of the board ofdirectors of Van Gilder Insurae Copa, a isuae usiess oed the defedats fail. Va

Gilder was a close personal friend of an executive at Delta Petroleum. Delta Petroleum was a Denver-

based oil and gas exploration and Development Company whose core area of operations was in the Gulf

Coast ad ‘ok Moutai egios. The opas stok as taded o NA“DAQ ude the tike

sol DPT‘. Va Gilde at ties aaged fo ad poided isuae poliies oeig etai of

Deltas usiess operations.



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From November 5, 2007 and continuing until at least January 9, 2008, Van Gilder allegedly committed

securities fraud by trading in securities based on material, non-public information.

Specifically, on November 8, 2007, Delta publicly announced and filed with the U.S. Securities and

Exchange Commission (SEC) a quarterly report disclosing its operational performance, revenues,

earnings and other financial performance for its quarterly period which ended September 30, 2007.

Three days prior to the dislosue, the fiaial puliatio Baos disseiated a atile etitled

Da of ‘ekoig fousig o Delta, epessig pessiis aout the opa ad its stok. Folloig

the puliatio of the atile, the pie of Deltas oo stok dopp ed $1.49 per share. Van Gilder

was, at the time, a shareholder of Delta and held shares of its common stock and long-term call options

to purchase Delta common stock in a brokerage account with Merrill Lynch and Company. The Baos

article was brought to Va Gildes attetio. Based o the atile, the defedat alled his stokoke

and asked whether he should sell his shares of Delta. Later that day, Van Gilder spoke with a Delta

eeutie. Aodig to the iditets allegatios, the eeutie oeyed to the defendant that Delta

planned on announcing figures in its third quarter financial report that would not miss its third quarter

forecasts and projections for its financial and operational performance, a first in a number of quarters

that Delta would meet its projected numbers. At the time Van Gilder received this information; the

financial and operational performance had not yet been publicly released and was not generally knownto the investing public.

Based on this confidential material, Van Gilder decided not to sell his Delta investment but instead

instructed his stockbroker to buy more Delta common stock on his behalf. As a result, the stockbroker

purchased an additional 1,250 shares of Delta common stock at $15.55 per share. Several hours after he

puhased the additioal stok, Va Gilde eailed to fieds ad told the that the Baos atile

as ogus ad that the should u Delta stok eause Delta ill hit thei ues. I the

November 8, 2007 third quarter results Delta disclosed earnings and other financial figures that were in

line with or exceeding previous forecasts and predictions of its performance for the quarter.

In late November 2007, discussions also began for Delta to get large cash infusion from a privately held

investment company called Tracinda, owned by California resident Kirk Kerkorian, through a large equityinvestment by Tracinda in the oil and gas company. The indictment alleges that the Delta executive

shared confidential information about the possible investment with defendant Van Gilder, and that, on

November 26, 2007, following a series of calls and other communications, Van Gilder contacted his

stockbroker and purchased an additional 1,750 shares of Delta common stock at $13.87 and $13.88 per

share.

As the indictment further relates, the Delta Executive continued to share information about the

confidential discussions about the contemplated Tracinda equity investment in Delta with defendant

Van Gilder, as the confidential discussions progressed over the course of early December 2007. As

result, according to the indictment, on December 8, 2007, Van Gilder, in turn, emailed his stockbroker to

adise hi that he ated to puhase as uh Delta stok as possile ad to das late aaged

through the stockbroker to purchase an additional 4,000 shares of Delta common stock at $17.64 per

share. Within minutes of execution of these purchases, Van Gilder spoke by phone with a family

member, who, several minutes later, instructed his own stockbroker to purchase Delta common stock.

On December 17, 2007, the Delta executive advised its board of directors of his discussions with

Tracinda. The board authorized the executive to proceed with negotiations with Tracinda. That evening,

the executive exchanged a series of tet essages ith the defedat egadig the oads deisio.

Several hours later Van Gilder directed that $40,000 be wire transferred from a bank account to his

Merrill Lynch brokerage account.



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On December 19, 2007, a representative of Tracinda contacted the Delta Executive and made an offer

for Tracinda to purchase a one-thid iteest i Delta though a puhase of Deltas oo stok at

$ pe shae. At the tie, Deltas stok as tadig at appoiatel $. pe shae. Taidas

overture remained confidential. Van Gilder, knowing about the overture, purchased 200 call options,

entitling him to purchase up to 20,000 shares of Delta common stock at $20 per share. Delta continued

negotiations with Tracinda, and on December 22, 2007, Tracinda agreed to increase its stock purchase

to $19 per share. The indictment alleges that in a series of calls Van Gilder was informed of the progress

of the confidential negotiations. Immediately following one of these conversations between Van Gilder

and the Delta executive, Van Gilder sent an email to two of his family members, with the subject line

etitled Xas peset. I the eail, he adised the fail ees to puhase Delta stok eause

soethig sigifiat ill happe i the et - eeks.

On December 24, 2007, Van Gilder, through his stockbroker, purchased 3,000 more shares of Delta

common stock at prices ranging between $15.63 and $15.65 per share, and 90 more call options to

purchase up to 9,000 additional shares at $20 per share. On December 28, 2007, during the course of

working to finalize the Tracinda stock purchase, the Delta executive exchanged a series of cell phone

text messages with Van Gilder. As a result, the defendant caused $272,212 from a bank account to bewire transferred into his Merrill Lynch brokerage account. The following day Van Gilder emailed his

stokoke, euestig the oke to get it o Delta asp.

O Deee 9, , Deltas oad of dietos appoed a fialized stok puhase ageeet fo

Tracinda to puhase appoiatel % of Deltas oo stok fo $9 pe shae. O Moda,

Deee , , efoe the oeeet of NA“DAQs egula tadig hous, Delta ad Taida

issued a press release announcing the stock purchase agreement. Within an hour of the commencement

of egula tadig hous that da, Va Gildes stokoke puhased a additioal , shaes of Delta

common stock at prices ranging from $19.28 to $19.33 per share, and 114 additional call options. By the

close of regular hours tradig that da, Deltas oo stok pie had ise $. fo its peious

lose of $.. Oe the ouse of the et thee tadig das, Deltas stok pie otiued to ise,closing at $22.82 per share by January 4, 2008. On January 9, 2008, Van Gilder sold the 290 call options

that he had purchased between December 19 and December 24, 2007, realizing a profit of

approximately $86,100 on the transaction.

The indictment charges Van Gilder with five counts of securities fraud, reflecting five transactions

between November 6, 2007 and December 24, 2007 where Van Gilder purchased Delta common stock

based on confidential insider information. If convicted on all counts, the defendant faces up to 100 years

in federal prison, and up to $25 million in fines.

Tadig o iside ifoatio udeuts the faiess ad taspae of ou fiaial akets, said

U.“. Attoe Joh Walsh. This ase deostates that i the highl etoked old e o lie i,

insider trading knows no geographic boundaries. This offie, ad U.“. Attoes Offies aoud the

country, will continue to target insider trading wherever it may occur. Thanks to the hard work of this

offie, the U.“. Attoes Offie i the “outhe Distit of Ne Yok, the “EC, ad the FBI, a Dee

isuae eeutie has ee haged fo pofitig usig ofidetial ifoatio.



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KPMG Employee involved in insider trading case (Reported by Economic Times)

As investors Carl Icahn and William Ackman bickered loudly on TV earlier this year (2013) about their

opposing bets on Herbalife, two other men were discussing the company in a different context: getting

non-public information to trade ahead of the stock's next move.

Referring to Icahn's announcement that he had purchased a large stake in the nutritional products

company, one of the men said: "I wish you would've known that he was going to release that and we

could've made some money."

The other replied: "Yeah, that would've been nice." The conversation was part of a call

California jeweler Bryan Shaw recorded and later shared with the Federal Bureau of Investigation to

help in their investigation of his longtime golf partner, Scott London. At the time, London was a

senior KPMG auditor who had been leaking inside information about his corporate clients to Shaw.

U.S. authorities filed criminal and civil charges against London, who is accused of passing Shaw non-

public information about five of KPMG's clients.

Later, a federal judge in Los Angeles freed London on a $150,000 bond, ordered him to turn over his

passport, and directed the former KPMG auditor not to make contact with Shaw unless in the company

of attorneys.

London's attorney, Harland Braun, said his client intended to plead guilty when he is formally arraigned

on May 17.

"Had my client been asked to give information for cash, he would have said no," Braun told reporters in

the courthouse hallway after the proceeding. "This is that gray area, when you talk at the country club.

But once you take money, you're dead."

According to prosecutors, Shaw made about $1 million trading on the tips and gave London roughly 10

percent of his profits on each of the trades in the form of cash, jewelry, concert tickets and free meals.

One gift for London was a Rolex Daytona Cosmography watch valued in 2011 at $12,000. Another,

$10,000 wrapped into a bundle of $100 bills. Shaw told the FBI he believed he spent between $25,000

and $45,000 in concert tickets for the two of them, including a Bruce Springsteen event.

Braun disputed the amounts, saying his client only received about $35,000. London turned over $7,500

in cash and the Rolex at the courthouse.

"I can't understand why he took the money," the attorney said. "He didn't need it."

Prosecutors charged London, a Los Angeles-based auditor, with one count of conspiracy to commit

securities fraud for giving Shaw information about public companies, including, Herbalife Ltd, Skechers

USA Inc and Deckers Outdoor Corp.

Deckers did not respond to multiple calls and emails seeking comment. Herbalife and footwear maker

Skechers disclosed earlier this week that KPMG had quit as their auditors in response to the matter.



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According to the complaint filed in federal court in Los Angeles, London also advised Shaw on the best

ways to trade on the information.

For instance, he told Shaw about a merger between KPMG client RSC Holdings and United Rentals

Inc and reassured his friend about trading on the takeover because "regulators were not looking for

'small fish,'" according to the complaint.

Case of Rajat Gupta, Indian American business icon (reported by economic times)

On March 1, 2011, the SEC filed an administrative civil complaint against Gupta for insider trading with

billionaire and Galleon Grouphedge fund founder Raj Rajaratnam. Coverage of the event noted that Anil

Kumar — who, like Gupta, had graduated from IIT, was a highly regarded senior partner at McKinsey,

and had also co-founded the Indian School of Business — had already pleaded guilty to charges in the

same case. Gupta, Kumar, and Rajaratnam were all close friends and business partners. Gupta

countersued and both sides eventually dropped charges. Rajat Gupta, former Goldman Sachs director,

Anil Kumar a former McKinsey & Co. partner and Rajiv Goel, an executive at Intel, were charged for

tippig Galleo goups ‘aj ‘ajaata ith iside ifoatio oth illios i the iggest hedge fud

ases i the U“ histo. FBIs taped conversations between the four were played in the Manhattancourts and the witnesses questioned to bring out the whole story.

On October 26, 2011 the United States Attorney's Office filed criminal charges against Gupta. He was

arrested in New York City by the FBI and pleaded not guilty. He was released on $10 million bail on the

sae da. Gupta's lae ote, A allegatio that ‘ajat Gupta egaged i a ulaful odut is

totally baseless .... He did not trade in any securities, did not tip Mr. Rajaratnam so he could trade, and

did ot shae i a pofits as pat of a uid po uo. Guptas defese attoes said that othes at

that firm were responsible for feeding the information because Raj Rajaratham was a major customer of

Golda “ahs ad had other sources" at the firm. Sri Lankan born Rajaratnam, former head of the

Galleon hedge funds, was on trial on 14 counts of insider trading... The SEC accused Gupta of tipping

Rajaratnam on Goldman earnings and the $5 billion Berkshire Hathaway investment, as well as othermaterial, non-public information about the bank, which Rajaratnam then allegedly traded on.

It is notable that Rajaratnam was convicted of 14 counts of conspiracy and securities fraud last year and

is serving an 11-year prison sentence.

The SEC alleged, "The tips generated 'illicit profits and loss avoidance' of more than $23 million."

Manhattan U.S. Attorney Preet Bharara said, "Rajat Gupta was entrusted by some of the premier

institutions of American business to sit inside their boardrooms, among their executives and directors,

and receive their confidential information so that he could give advice and counsel."

Details of wiretap recordings and trading activity related to the charges were analyzed at length in the

media, assessing the strengths and weaknesses of the prosecution's and defense's cases.

This case focused on the relationship between Raj Rajaratnam, Anil Kumar and Gupta. Gupta,

Rajaratnam, and Kumar were all involved to varying degrees as founding partners of private-equity firms

Taj Capital and New Silk Route, though Rajaratnam and Kumar left before they began operation. Gupta

remained as chairman of New Silk Route, and Rajaratnam eventually invested $50 million in the fund.

http://en.wikipedia.org/wiki/Indian_Institutes_of_Technology

http://en.wikipedia.org/wiki/Preet_Bharara

http://en.wikipedia.org/wiki/Raj_Rajaratnam

http://en.wikipedia.org/wiki/Raj_Rajaratnam

http://en.wikipedia.org/wiki/Preet_Bharara

http://en.wikipedia.org/wiki/Indian_Institutes_of_Technology



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A federal jury finally convicted Rajat Gupta, the Indian-American business icon who strode the US

corporate world and moved with the country's high and mighty, of insider trading in a case that

illustrated greed, guts, and glory in America's most successful immigrant community.

Rajat Gupta, a former director of Goldman Sachs and Procter and Gamble among other storied

companies, was found guilty on four out of six counts—three for securities fraud and one for conspiracy.He could receive up to 25 years in prison. The maximum sentence for securities fraud is 20 years and the

maximum sentence for conspiracy is five years. But Gupta's defence team indicated that ten years was

the maximum he would get.

Case of Indian origin trader Martoma facing 45 years in US jail (as reported by the Hindustan Times)

A Manhattan jury in Feb.2013 convicted Indian American portfolio manager Mathew Martoma of

insider trading in a case described as the most lucrative scam ever busted.

His company, the once-iconicbut-now-defunct hedge fund SAC Capital, made approximately $275

million (`1,705 crore) in profits and avoided losses based on inside information obtained by him. Heearned a one-time bonus of $9 million (`55.8 crore).

Martoma, 39, was convicted of one count of conspiracy to commit a fraud and two counts of

securities fraud, which could in all get him a maximum jail term of 45 years, with fines.

I the shot u, heatig a hae ee pofitale fo Matoa, ut i the ed, it ade him a

oited felo said Mahatta U“ attoe Peet Bhaaa, the poseuto.

Martoma was bor n Ajai Mathew Mariamdani Thomas in Michigan to parents from Kerala.

Martoma — from Mar Thoma Syrian Church — is an adopted family name.

As a portfolio manager at SAC starting in 2006, Martoma cultivated two physicians connected with

a search for Alzheimer cure by Elan Corporation and Wyeth.

The doctors, who cooperated with investigators later, kept him updated with the latest on the drug

trial, passing on confidential information in clear contravention of rules.

The drug trials were closely watched not only by the industry but also the market, with the stocks

of the two companies closely tied to the outcome.

Starting later 2007, SAC Capital started buying huge amounts of Elan and Wyeth shares based on a

tip Martoma got from one of the doctors that the drugs were safe.

Around July, 2008, one of his two sources told him the drug had turned out to be a dud. Martoma

told SAC Capital to offload Elan and Wyeth shares.

Over the next seven day, SAC offloaded almost its entire stock of Elan and Wyeth shares, making

$275 million in profits and avoiding losses on the crash that followed.

That, however, proved to be his best deal ever. In September, 2010, Martoma was fired, as a

“one-trick pony”, according to Bloomberg. The father of three children now faces up to 45 years in jail and fines that will wipe out any

money he made from that deal, and others, if any.



11

Prevention of Insider Trading and Corporate Good Governance

One Prof. Sandeep Parekh in his working paper on Prevention of Insider Trading and Corporate Good

Governance submitted in January 2003 has made certain good suggestions under the sub-heading

Pophlatis ad opoate good goeae:

(The extract from the report begins)

The 2002 amendments to the Regulations provide extensive suggestions and also extensive regulations

couched in the language of corporate good governance. Most of the good governance provisions are

provided for as mandatory provisions.

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 insidertrading.

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.

h) Minimum holding period of securities by insiders.I) No selective disclosure to analysts. Wide dissemination of information.

Sarbanes-Oxley Act

The US legislature, witness to an unending line of scandals, recently passed amendments

to the securities/disclosure laws of the country – in effect codifying into law several corporate

governance suggestions previously made. The Sarbanes-Oxley Act of 2002 requires:

directors, executive officers and large shareholders of public issuers to report

Transactions i the issues euit securities within two business days of a transaction.

pre-leaae poedues fo tasatios i the issues euit seuities;

the responsibilities the company will take for completing filings;

the requirement (or encouragement) to use a specified broker for transactions in the

Issues securities or the certifications required from brokers if no specific broker is

required;

the applicability of the rules to persons with business or family relations to the insider;

and

sanctions for failure to make timely filings.



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We will see in the Indian context several of the good governance regulations for their

relevance and their reason to exist on the statute and further whether they need to be divorced

from the mandatory/penal consequences of the regulations.

A. Officer, director and substantial shareholder to disclose their holding on certain

events or at certain intervals.

There should be some coordination between the requirement of reporting at the 5% level with the

requirements of the takeover code. In fact the takeover reporting is broader in some respects since it

mandates reporting by any person over certain thresholds and also requires reporting by a group – a

concept not introduced in these regulations. However, the insider trading regulations provide for

disclosure of smaller amounts and even provide for disclosure on selling shares (something which the

takeover code does not mandate). It is suggested that a purchase disclosure made under either

regulations (with the same or higher level of disclosure) should be deemed to be good disclosure under

the other. Additionally, this author suggests the introduction of short swing profits.

Short Swing’ profits: There should be a regulation introduced in the Insider Trading regulations which

compels an insider to disgorge or turn in profits made by insiders to the company for any transaction ineuit ased seuities i the opas seuities iludig its paets o susidias shaes if oth

the buy and sell side of the transaction is entered into within six months of the other.

Such a liability should be imposed without any necessity for guilt or wrongfulness. This would be a

provision which would get automatically attracted as soon as two things are established. First, the fact

of being a designated insider. And second, the fact that the same securities were bought and sold within

six months of each other. Such a regulation would be relatively easy to administer, since intent of the

person is immaterial. Merely the fact of the trade is sufficient to take action. Thus the appearance of

impropriety is removed from the markets.

B. Restrict trading by insiders within a certain period of time i.e. before corporate announcements,buybacks etc. are made.

Unfortunately, the wordings of the regulations are so broad, that it would chill trading in sometimes

rather large windows. The regulation should not asphyxiate trading by insiders. As we have seen before

trading by insiders and employees aligns their interests with those of the company and should be

encouraged if there is no improper behavior. Let us study the restriction for its scope.

Trading window

The company shall specify a trading period, to be called "Trading Wido", fo tadig i the opas

securities. The trading window shall be closed during the time the information referred to in para 3.2.3

is unpublished.

When the trading window is closed, the employees / directors shall not trade in the company's

securities in such period.



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The trading window shall be, inter alia, closed 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 whole or substantially whole of the undertaking

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

Issuance of bonus/rights shares has no real effect on the price of the security and therefore there is no

need to have a restricted window for that purpose. (d) to (g) are too broad and could cause unnecessary

problems. To give an example, a company makes a large gas find, in one grid. It does not want to close

that fact so that it can buy the neighboring grids at a bargain price. It therefore, for a valid business

purpose keeps the find a secret for six months. Even though the directors who know about the find

would be expressly prohibited from trading in the securities under the substantive provisions of the

regulations, all employees (who do not know) too would be barred from trading for six months in the

shares of the company. This is obviously not an unusual hypothetical. An auto company comes out withseetie plas fo itoduig e age odels alost ee oth. “uh companies would never

allow employees to trade in their shares because there is a closed ido fo a eeutio of e

pojets. Let e laif, that this does ot i a a effect the substantive provisions which restrict

insider trading – which of course is prohibited.

C. Pre clearance of trades

Certain provisions are made for clearing of trades if certain officers/employees engage in shares of their

own company. 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 transactions 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, 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.

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 (IPOs). In the case of IPOs, the holding period

would commence when the securities are actually allotted.

Once securities are pre-cleared, there is no necessity of prescribing just one week for the trades to

occur. This would expose the employees / officers to unnecessary market risk. Personal experience from

the market seems to suggest that it is not uncommon in large institutions for officers to get their

approval for trading after weeks from the date of application. Given a one week window to execute



14

their orders would penalize employees with aket tiig isk hile tadig i thei o opas

stock. The company should be free to determine their own methodology and the window permitting

execution of trade should certainly be restrictive regarding the quantity and the time frame should be

far less material.

A suggestion is already made for very senior officers (CEO, CFO, CIO, Company Secretary Etc.) to come

under the short swing rule. The other employees should be subject to a holding period and it should be

specified that if they violate the term – they would need to disgorge any profits made in the period.

Even absent mens rea, such a strict liability would still pass muster in a court of law because it is not

truly penal in nature – more remedial and process oriented.

D. Reporting of process to CEO/MD

There is clause which requires the CEO/MD to consider all insider trades and accompanying documents.

The Compliance officer shall place before the Managing Director / Chief Executive Officer or a

committee specified by the company, on a monthly basis all the details of the dealing in the securities by

employees / director / officer of the company and the accompanying documents that such persons hadexecuted under the pre-dealing procedure as envisaged in this code.

This kind of time for such a routine process by an MD is wasteful and unworkable – it is a totally

unworkable clause for large companies and such micromanagement should not be part of corporate

governance, leave alone regulations. This provision ought to be scrapped.

Other entities having access to inside information

Intermediaries in the capital markets like underwriters, lawyers, auditors are also required to comply

with Part B of the first Schedule. The regulation of these other entities is overworked and overregulated

at times and operationally impossible at other times. For instance having a compliance officer whoinspects insider trades and grants pre-clearance for trades of securities of employees is absolutely

uncalled for. To give an example practically every law firm advices listed companies. To have a

compliance officer in every firm and monitoring of trades by each employee is completely unworkable –

and even partial compliance will never happen. The fact that it is coupled with penalties of 10 years in

jail, suspension, fines etc. should eate a poeful aguet fo eoal of these opoate

goeae pealties fo non corporate and in particular because adequate remedies are in place for

actual insider trading. Certain other provisions are made for the intermediaries which need to be

relooked at.

E. Confidential Files

Files otaiig ofidetial ifoatio shall e kept seue. Copute files ust have adequate

seuit of logi ad pass od et. To mandate passwords/logins for securing confidential files is

nonsensical, to say the least. It would create workings of entire organizations which are built on sharing

information of confidential files unworkable. To again use the law firm example, if confidential files are

not shared effectively between colleagues, effectively assisting a client may not be possible. It should be

the discretion of the company/firm to bar access to such information as it sees fit. Such

micromanagement should be frowned upon.



15

OTHER RECOMMENDATIONS

Some possible additions to the regulations:

There are a few further provisions the Indian legislature/regulator should consider adding to

the existing framework of regulations to reduce the occurrence of insider trading.

I. Designated or qualified brokers.

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 esue opliae ith the opas peleaae 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:

• Verify with the issuer that each transaction entered on behalf of the insider was

precleared; and

• Report immediately to the issuer the details of each of the isides tasatios i the

Issues seuities.

II.

Derivatives amendments

Pats of the egulatios efe to shaes fo the pupose of posiptio hile the should prohibit

seuities tadig. For instance, one could, using derivatives, economically sell the shares withoutphysically trading in those shares. Similarly, one can easily create synthetic securities with the same

economic impact as an equity share of a company. By reclassifying shares into securities, one can

eliminate the problem because securities are defined to include equity, quasi-equity, derivatives and any

combination of the three. Pure debt instruments can be excluded specifically from the regulations.

Similarly, under Regulation 13 the disclosure requirements should refer to not merely a 5% stake in the

euit ut also to a iiu stake i deiaties of the opas seuities. The minimum can be a

rupee amount of the market value of the derivative (since calculating 5% of the derivatives market is

neither possible nor if possible not meaningful)

III.

Civil private cause of action by contemporaneous traders

People trading in the market contemporaneously - not just the regulator or the counterparties to the

insider should also have specific powers to rescind trades and charge damages to the insiders during the

period when they traded. This will provide a broader remedy and will have many people exerting an

economic pressure on the violator to make his trades unviable.

IV.

Proactive Stock Exchanges



16

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

eatet, ad out judgets hae foud ehage egulatios to hae 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.

V. Rescission

One author has suggested that a contract of sale or purchase by an insider be declared void by the

counterparty to a trade under the Indian Contract Act (this is besides the powers SEBI has to annul the

trade under Regulation 11). Though legally feasible, it raises impossible burdens i todas ituall

anonymous capital markets. For instance if an investor had bought 100 shares of the company during

the period when the insider trading took place, it would be difficult to determine the counterparty to

the insider. And in any case even if the counterparty to the trade is identified, the insider has not only

hurt his trade counterparty but also the market as a whole.14 By buying (or selling) shares the insider

would have raised (or lowered) the price of the shares so bought (or sold) and thus would affect therights of every person who bought or sold contemporaneously.

VI. Tippee liability

The regulations prohibit persons from tipping people about inside information by insiders i.e. the tipper.

However, there seems to be no liability for a person who improperly receives a tip i.e. a tippee from

trading. There is a vague pohiitio agaist poueet of ifoatio. However, it does not clearly

prohibit a tippee from trading.

VII.

Bounty system

Section 21A (e) of the American Securities Exchange Act of 1934 authorizes the Securities and Exchange

Commission to award a bounty to a person who provides information leading to the recovery of a civil

penalty from an insider trader, from a person who "tipped" information to an insider trader, or from a

person who directly or indirectly controlled an insider trader. This could be a useful addition to cracking

into new cases of insider activity.

The mystery penal clause

In the schedule, clause 7.1 of Insider Trading Regulations penalizes violation of the regulations and

whistle blowing duties of senior officers. It is not clear whethe the opoate goeae shedule is

included in the duty to report a violation i.e. does it include a procedural violation as well. However, a

look at Section 14 clears all doubts that one can go to jail for 10 years for violating simple or

Minor process oriented details.

A person who violates provisions of regulation 12 shall be liable for action under Section 11 or 11 B

and/or Section 24 of the Act. This in a country where the penalty for rape could be as low as 7 years.

Maybe, this is overstating the case, because a minor violation would not really be referred criminally.

But then, why not make the entire Schedule optional. Let companies make a standardized disclosure in

their annual report as to how much of the Schedule they are in compliance with and what they are not.



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Conclusion

The core of securities regulations is the implementation of the purpose that all investors should have

equal access to the rewards of participation in securities transactions. In other words all members of the

investing public should be subject to identical market risks. Inequities based upon unequal access to

knowledge should not be shrugged off as inevitable in our way of life. 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. And as a result, the

government has gotten into overregulation and micromanagement by converting good governance into

statutory provisions. We tend to forget that fraudulent action cannot be stamped out by

micromanagement; 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 governanceshould 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 1limiting 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 would be penalized by its shareholders. An author has also

suggested 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.

(The extract from the report of Prof. Sandeep Parekh ends)

Loopholes in Indian law

The Indian laws, which govern it, are not sufficient enough regarding transnational operation. So, it is

felt in some quarters that it should be amended to incorporate such provisions to protect the interests

of the investors. And there should be both civil and criminal penalty. Though the SEBI (Prohibition of

Insider trading) Regulations 1992 provide mechanism to deal with this problem, yet this regulation is not

sufficient to tackle insider trading completely. As such, the need for establishing a separate authority

and a separate law are needed to tackle insider trading in India. The Satyam scam is the latest example

to show the lacunas in law and lack of effective machinery in India to prohibit insider trading in India

How to prevent insider trading in companies – Precautions to be taken

Ethics Officers of the company, in coordination with the designated compliance officer of the company

who has to enforce the provisions of Prevention of Insider Trading (PTI), have to educate the company

employees on the consequences of insider trading which would invite both disciplinary action and

criminal action. They have to ensure that sensitive information which is privy to the Board is not leaked

out by employees who are privy to such information. Board agenda, Board minutes, etc. pertaining to

price sensitive information or any company decision which would impact the prices of securities of the



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company in the share market should not be circulated amongst the Board members through emails, etc.

These communications should be sent in sealed covers with the inscription on the envelope To be

opened by addressee ol. Computer files have to be secured through passwords. For the window

closing and reopening, proper announcements have to be made to the employees through internal mike

system.

The designated compliance officer has to forward complaints about insider trading to the Ethics Officers

for detailed preliminary investigation before reporting the matter to the SEBI.

Ensure that there are provisions in the Code of Conduct and Disciplinary Rules for taking disciplinary

action against the employees who violate the provisions of Insider Trading Regulations.

Ensure that employees of outsider law firms like KPMG, etc. do not get access to any sensitive

information from insiders.

Ensure that the compliance officer being appointed by the company is a person of absolute integrity and

functions independently, reporting directly to the CEO.

Insider Trading Regulations are available at

http://www.sebi.gov.in/acts/insideregu.pdf

Ethics Management 2013 - Author T. Job Anbalagan Email: [email protected]




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