Indian Institute of Management, Bangalore

PGP 2012- 2014

Business Law
Report submitted to
Professor Anil B. Suraj

Analysis of the Term Insider

under Insider Trading Regulations
In India and USA

Aadit Devanand- 1211001

Dheeraj Kumar - 1211180
Hitesh Agarwal - 1211188
Raje Meenal Pravin - 1211215

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Table of Contents
A.

Insider Trading Regulations An introduction......................................................3

B.

Scope of the word Insider in India......................................................................4

I. Meaning of insider under SEBI (Prohibition of Insider Trading Regulations)
1992........................................................................................................................ 4
II.

Case of Hindustan Level Limited and Brook Bond India Lipton.........................5

C. Scope of the word Insider in the United States of America................................6

I.

Meaning of insider under Securities Exchange Act of 1934............................6

II.

Select judgments that influenced the meaning of the term Insider................7

D. Comparison of term insider under the Indian and American legal frameworks..8
E.

Conclusion............................................................................................................ 9

F.

References......................................................................................................... 11

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A. Insider Trading Regulations An Introduction

Insider trading refers to the malpractice of using unpublished price sensitive
information by insiders of a company to benefit from trading of securities.
Individuals or companies who are connected with a corporate in various capacities
or have access to sensitive information that is not publicly available use this
information to appropriate unfair gains for themselves or their associates in the
securities markets.
In recent years, insider trading trials have hogged a lot of media attention in the
India, United States of America and other countries in the world. Recent insider
trading trials in the US include high profile cases against Raj Rajaratnam (founder of
Galleon Hedge Fund), Rajat Gupta (formerly Director of Goldman Sachs) and the
lesser known cases of SAC Capital, Obus , Diamondback Capital Management etc.
Insider Trading in Indian securities markets
Insider trading continues to be rampant in the Indian markets. SEBI initiated 117
insider trading cases in the 10 years ended 2009. On January 3, 2013, SEBI issued a
list of 149 rejected consent applications related to Insider Trading. The applicants
include some of the most reputed names in the Indian industry such as India
Infoline Limited, HSBC InvestDirect Securities Limited, GMR Holdings Private
Limited, M/s Reliance Petroinvestments Limited etc.
SEBI introduced insider trading regulations for the first time in 1992 called the SEBI
(Insider Trading Regulations) 1992. However, the regulations proved largely
ineffective in curbing insider trading in the Indian stock markets. SEBI introduced a
drastically amended version of the regulation in 2002 termed SEBI (Prohibition of
Insider Trading) Regulations 1992 and further amendments in 2008. A committee
has been constituted in 2013 to suggest further refinement of the insider trading
regulations
Description of the Problem Focus on the term Insider
In the light of these interesting developments in insider trading regulations and
litigations in India and abroad, we seek to understand the nuances of the insider
trading regulations in India.
The term insider trading is based on 2 pillars

who is an insider and

what is unpublished price sensitive information.

In this report we shall delve into the depth of the term insider as defined in the
Indian regulations and calibrated by select judgments of High Courts and Supreme
Courts.
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We shall also compare the meaning and scope of the term insider with that laid out
under the US SEC regulations and further analyzed and refined by Department of
Justice in recent trials.

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B. Scope of the word Insider in India

I. Meaning of insider under SEBI (Prohibition of Insider
Trading Regulations) 1992
According to SEBI, an insider is someone, who (i) is or was connected with the
company or is deemed to have been connected with the company and is reasonably
expected to have access to unpublished price sensitive information in respect of
securities of company, or (ii) has received or has had access to such unpublished
price sensitive information.
Further dwelling on insider definition in SEBI act, A connected person means any
person who (i) is a director of a company, or is deemed to be a director of that
company or (ii) occupies the position as an officer or an employee of the company
or holds a position involving a professional or business relationship between himself
and the company [whether temporary or permanent] and who may reasonably be
expected to have an access to unpublished price sensitive information in relation to
that company.
Clause 2(h) of the Regulations states that a Person is deemed to be a connected
person, if such person
(i)
(ii)

(iii)

(iv)
(v)
(vi)
(vii)
(viii)
(ix)

is a company under the same management or group, or any subsidiary

company
is an intermediary, 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.
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 member of the Board of Trustees of a
mutual fund or 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;
is a Member of the Board of Directors or an employee of a public financial
institution
is an official or an employee of a Self-regulatory Organisation recognised or
authorised by the Board of a regulatory body
is a relative of any of the aforementioned persons;
is a banker of the company.
relatives of the connected person; or
is a concern, firm, trust, Hindu undivided family, company or association of
persons wherein any of the connected persons mentioned in sub-clause (i) of
clause (c), of this regulation or any of the persons mentioned in sub-clause (vi),
(vii) or (viii) of this clause have more than 10 per cent of the holding or
interest.

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Other relevant terms:

Designated Employees
Designated employees shall include officers comprising top three tiers of the
company management and employees designated by the Company to whom the
trading restrictions shall be applicable.
Dependents
SEBI has included the requirement for disclosure of holdings and transactions in
securities of person who are dependents of insiders under the regulations.
However, the term dependent has not been defined and reference shall have to be
made to Companies Act to determine the same.
Analysis of the Definition
This definition has evolved over a period of time by amendments introduced in 2002
and SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2008. These
amendments though simple, changed the definition of insider trading profoundly
with the following implications. For e.g.

By separating the clauses for reasonably expected to have access and

received or has had received with an or, the SEBI created a new class of
deemed insiders. These are persons who have access to unpublished price
sensitive information and hence are liable for prosecution under these
regulations even if they are not connected or deemed to be connected with the
company.
Dependents of insiders will also come under the ambit of the regulations.
Such persons will be prohibited from squaring of their transaction in the
securities of the company within six months of the original transaction. Such
persons are totally prohibited from taking positions in derivatives on securities
of the company.

The most significant case to influence the meaning of the term insider was the
HLL-Brook Bond Case

II. Case of Hindustan Level Limited and Brook Bond India

Lipton
Hindustan Level Limited (HLL) purchased 8 lakh shares in Brooke Bond Lipton
Limited(BBLIL) in 1998. Just weeks after this purchase, HLL publicly announced its
merger with BBLIL.
At the time of the case, an "insider" was defined as a person who is "connected"
with a company AND is reasonably expected to have access, by virtue of such
connection, to unpublished price-sensitive information. HLL admitted that it was
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connected to BBLIL because both belonged to the same group of companies.

However, HLL claimed that it acquired the information of the merger independently
because of its participation merger negotiations and not by virtue of being
connected to BBLIL as an associate company. Therefore, it was not a connected
party who had obtained access to information by virtue of its connection and hence
not an insider as defined under the regulation.
As a response to the HLL defense, following views/stands were taken by SEBI
1. SEBI held that even if a person actually receives the unpublished price sensitive
information and he is not connected with the company such person would still be
termed an Insider. Hence, the fact HLL obtained information regarding the merger
because it was one of the parties being merged was irrelevant. Under the
regulations, HLL should have abstained from using the knowledge of its own
merger to gain from trading in shares of BBLIL. Hence, Sebi dismissed the
argument that no person can be an insider to himself and found HLL guilty of
insider trading.
2. Further apart from the HLL case, SEBI had found it difficult to prove incidence of
insider trading in various cases because of the words by virtue of such
connection included in the definition. Accordingly, the phrase by virtue of such
connection was eliminated when the amended regulations were introduced in
2002. The amendment simplified SEBIs task of proving its cases against the
insiders significantly, as now SEBI did not have to establish the connection of the
insider with the company or how he acquired the unpublished price-sensitive
information.

C. Scope of the word Insider in the United States of

America
There are two aspects to insider trading under Securities and Exchange Commission
(SEC) in the USA.

I. Meaning of insider under Securities Exchange Act of 1934.

1. Prohibition on Short swing profits
Section 16(b) of the Securities Exchange Act of 1934 prohibits short-swing profits
(profits realized in any period less than six months) by corporate insiders in their
own corporation's stock.
As per the Act, an insider is an officer or director of a public company, or an
individual or entity owning 10% or more of any class of a company's shares.
2. Anti-fraud provisions

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The SEC adopted Rule 10b-5 of the Act which states It shall be unlawful for any
person, directly or indirectly, by the use of any means or instrumentality of
interstate commerce, or of the mails or of any facility of any national securities
exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material
fact necessary in order to make the statements made, in the light of the
circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would
operate as a fraud or deceit upon any person, in connection with the purchase or
sale of any security."
The above provisions are left open ended, not directly referring to insider trading,
Hence courts have applied their discretion from case to case, which has formed the
basis of insider trading laws in US. Thus anti-fraud regulation keeps the door open
for interpretation which in turn gives it ability to meet new connivances and
arrangements.
The term insider was further refined by SEC rulings and judgments of Supreme
Court leading to development of the following legal principles
3. Theory of Misappropriation
Liability under the misappropriation theory arises when a person who is not a
corporate insider misappropriates confidential information for securities trading
purposes in breach of a duty owed to the source of the information. The
misappropriation is held to defraud the principal of the exclusive use of the
information and to satisfy the "fraudulent" element of the Rule 10b-5 claim.
4. Disclose or Abstain rule
Under the disclose or abstain rule, insiders, and those who would come to be known
as "temporary" or "constructive" insiders, who possess material nonpublic
information, must disclose it before trading or abstain from trading until the
information is publicly disseminated.
5. New Rules 1010b5-1 and 10b5-2 of Securities Exchange Act 1934
In 2000, the SEC adopted new Rules 10b5-1 and 10b5-2 to resolve two insider
trading issues where the courts have disagreed. Rule 10b5-2 sets forth a nonexclusive list of three situations in which a person has a duty of trust or confidence
for purposes of the "misappropriation" theory of the Exchange Act and Rule 10b-5
thereunder. Accordingly, a duty of trust or confidence exists:
1. Whenever a person agrees to maintain information in confidence.
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2. When two people have a history, pattern, or practice of sharing confidences such
that the recipient of the information knows or reasonably should know that the
person communicating the material non-public information expects that the
recipient will maintain its confidentiality.
3. When a person receives or obtains material non-public information from certain
enumerated close family members: spouses, parents, children, and siblings.

II. Select judgments that influenced the meaning of the term

Insider
1. Cady Roberts and Co
In 1961, in the case of In re Cady Roberts & Co. the first case based on the
violation of anti fraud provisions was brought to courts. In this case, a stockbroker
had been informed by a board member about an imminent dividend cut by the
company, and the stockbroker sold the shares of the company.
While the provisions of anti-fraud rule are easily applied to corporate insiders, the
SEC held that the application of law should not be restrained due to rigid
interpretation. The SEC stated that it was their task to identify those persons
who are in a special relationship with a company and privy to its internal affairs,
and thereby suffer correlative duties in trading in its securities and hence SEC
also applied the law to corporate outsiders. Thus this judgment demonstrated
SECs intent to make a wider interpretation of the provisions depending on the
facts and circumstances of the cases, thus leading to more effective regulation.
This case also lead to development of misappropriation theory and rule of
disclose or abstain described above.
2. Chiarella vs United States
In the case of Vincent Chiarella, who was working in a printing company, Chiarella
obtained the names of the tender offer target companies from the documents
submitted to him for printing, and made transactions based on that information.
The courts decided that disclose or abstain rule is only applicable when the
person has a fiduciary duty to the stockholders. Since the printer owed no duty to
the target shareholders, he was not guilty of insider trading.
3. Dirks vs SEC
In the Dirks vs. SEC case, a financial analyst was informed about a fraud in the
Company but one of the Directors of the Company. He passed on this information
to the Wall Street Journal who chose to ignore the same. Consequently, the
analyst informed his clients to sell their shares. The US Supreme Court did not
find Dirks liable of insider trading since his tipper did not make a personal gain
out of providing the information.
4. US Vs OHagan case
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OHagan a partner in a law firm traded in shares of a company who he believed

was going into a mergers and acquisitions transaction and made gains from
trading. He claimed that he did not have a fiduciary duty towards the
shareholders of the company and hence was not liable to insider trading. In a
landmark ruling, the Supreme Court dismissed his defense and that he had
breached his fiduciary duty to the law firm and defrauded his principal by
preventing exclusive use of that information by the principal.
5. Other cases of insider trading.(6)
Examples of insider trading cases that have been brought by the SEC are cases
against:
Corporate officers, directors, and employees who traded the corporation's
securities after learning of significant, confidential corporate developments;
Friends, business associates, family members, and other "tippees" of such
officers, directors, and employees, who traded the securities after receiving
such information;
Employees of law, banking, brokerage and printing firms who were given such
information to provide services to the corporation whose securities they
traded;
Government employees who learned of such information because of their
employment by the government; and
Other persons who misappropriated, and took advantage of, confidential
information from their employers.

D.Comparison of term insider under the Indian and

American legal frameworks
In large part, Indian regulations on insider trading and the meaning of insider
specifically are comparable to the US. A comparison of the term insider reveals the
following facts:
1. Requirement of Fiduciary duty
Both frameworks diverge with regards to misappropriation theory and requirement
of fiduciary duty. Thus US regulations do not prohibit all insider trading but prohibits
only the trading where there is a fiduciary duty between the receiver and the source
of information. This fiduciary duty need not be owed only to target companys stock
holders but could also be towards the principal or employer of the offendant.
There is no such requirement of fiduciary duty under SEBI regulations.
2. Law on Tipper and Tipee
In the Dirk vs SEC case, the US Supreme Court addressed the liability of tipees. The
SC held that if receivers of information (tipee) knew or had reason to believe that
the tipper (insider who has provided information) had breached a fiduciary duty in
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disclosing the confidential information and the tipper received a direct or indirect
personal benefit from the disclosure, only then the tipee who had acted on such
information would be liable for criminal prosecution. Because the Director of the
Company (the original tipper) disclosed the information to expose the fraud and not
for personal gain, Dirk (his tippee) escaped liability.
The Indian regulations however are silent on the liability of tipee.
3. Requirement of Mens Rea
U.S. Supreme Court declared that an offender could be punished with criminal
liability in misappropriation cases only if there was proof of the defendants
willfulness to commit insider trading.
4. Regulations vs Case Precedents
It can be seen from the above discussion, that while India has regulations that are
based on insider trading and define the term insider explicitly. On the other hand,
the US has refrained from using the term insider or insider trading in the
regulations. Thus, the law has evolved more through judgments of various courts
rather through regulations. Yet, US has one of the most developed insider trading
regulations in the world

E. Conclusion
Based on our analysis of both the legal frameworks, we believe that SEBI definition
of insider and insider trading provisions are stricter than those in the USA.
Subsequent to the 2008 amendments, and insertion of the deemed insider clause
Indian regulations give sweeping powers to the regulator to deem any person with
access to unpublished price sensitive information as an insider, whether or not
connected to the company. They impose absolute ban on insider trading rather than
selective prohibition imposed in USA where trading in absence of intent and
fiduciary duty is not liable for criminal punishment.
The advantage of such laws implies that the provisions are clearly defined in law
and leave lesser scope to the courts for interpretation. This in turn would make it
possible to punish even a slight deviation. However it leaves room open to
prosecute market analysts/researchers who conclude at price-sensitive information
based on independent research, which would be unfair. For example, identifying
undervalued stocks which are potential takeover target.
Historically, identification of insider trading has been done post facto, meaning the
transaction identified first, where large gains have been made and then the
establishment of insider being involved. By enabling anyone to be termed as an
insider, whether or not connected to the company, large investors, making sound
investment decisions may be targeted, and to prove that they did not have access
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to unpublished price sensitive information, which is extremely difficult. This could

spell disaster for a country like India whose capital markets are still nascent and
trying to tap funds for investments.
At the same time there is a risk, that as financial markets, instruments and trading
practices evolve and become more complicated, the SEBI laws may not lend
themselves to complex situations. Consequently SEBI may find it difficult to prove
occurrence of insider trading in courts.
However we do recommend that SEBI should introduce both civil and criminal
liability under the regulations and require willful contravention or mens rea for
imposition of criminal liability. Insider trading in absence of such willful intent should
be punishable with civil liability only. This is because SEBI has found it extremely
difficult in the past to prove guilt beyond reasonable doubt as required for
imposition of criminal liability. However, disregarding the absence of intention and
punishing unknowing violation of the law with a criminal liability could lead to
prosecution of innocent persons.

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F. References
1. SEBI (Insider Trading Regulations) 1992
2. SEBI (Prohibition of Insider Trading Regulations) 1992
3. Securities and Exchange Board of india (Prohibition of Insider Trading) (Amendment)
Regulations, 2008
4. Clarifications on SEBI (Prohibition of Insider Trading) Regulations, 1992.
5. Report on Insider Trading Annual Review 2012 by Morrison Forrester
http://www.mofo.com/files/Uploads/Images/130116-Insider-Trading-Annual-Review.pdf
6. Insider Trading http://www.sec.gov/answers/insider.htm
7. Speech by SEC Staff: Insider Trading A U.S. Perspective
http://www.sec.gov/news/speech/speecharchive/1998/spch221.htm
8. M &A Hotline Amendment to the SEBI Insider Trading Regulations 2008dated Dec 8,
2008 retireved at http://www.nishithdesai.com/corporate-update/2008/CorpSec-HotlineDec-8-2008.html
9. M &A Hotline SEBI amends the Insider Trading Regulations: 'Promoters' fall within the net
dated Sep 16, 2011 retireved at http://www.nishithdesai.com/New_Hotline/Capital/CAPITAL
%20MARKETS%20HOTLINE_Sep1611.htm
10.
Article SEBI broadens definition of insider in new norms dated Dec 5, 2008 in the
Economic Times
http://articles.economictimes.indiatimes.com/2008-12-05/news/27699212_1_insider-pricesensitive-information-prohibition-on-such-persons
11.
Article Somasekhar Sundaresan: Truth about Indian insider trading law in The
Business Standard, dated June 25, 2012
http://www.business-standard.com/article/economy-policy/somasekhar-sundaresan-truthabout-indian-insider-trading-law-112062500010_1.html
12. Article The real price of insider trading by Kaushik Dutta and Kshama V. Kaushik in the
Hindu Business Line http://www.thehindubusinessline.com/features/mentor/the-real-priceof-insider-trading/article2333588.ece
13.
Article Insider Trading Regulations - Highlights to the amendments and some posers
dated December 3, 2008 retrieved at
http://indiacorplaw.blogspot.in/2008/12/amendments-to-insider-trading.html
14.
Article SAT on Scope of Insider Trading dated February 3, 2012, retrieved from
http://indiacorplaw.blogspot.in/2012/02/sat-on-scope-of-insider-trading.html
15.
Article How to tackle Insider Trading in INDIA: An Analysis of current laws and
Regulations through judicial decisions dated March 28, 2012 in Corporate Law Reporter
retrieved at http://corporatelawreporter.com/tackle-insider-trading-india-analysis-currentlaws-regulations-judicial-decissions-8603.html
16.
Article on Prevention of Insider Trading by Prof Sandeep Parekh on Manupatra
retrieved at http://www.manupatrafast.com/articles/PopOpenArticle.aspx?ID=318de23cf3ed-44a9-8346-159f9af8544d&txtsearch=Subject:%20Finance/Banking

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17.
Article on Insider Trading by Manthan Saxena on www.legalindia.in
http://www.legalindia.in/insider-trading-2
18.
Report Securities MarketsA Place to Get Rich Quick or a Quicksand Going Straight
to Jail? The Mens Rea Required for Insider Trading Criminal Liability by Leng-Chia Hung
http://www.law.ntu.edu.tw/ntulawreview/articles/5-2/01-Article-Leng-Chia%20Hung.pdf

(All specific provisions of law have been reproduced from the relevant Act or
Regulation)

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