Privileged Communication and Insider Trading

An essential component of corporate governance concerns insider trading. Because of the ensuing information asymmetry, people with access to and privileged knowledge of internal company information must not abuse their position to obtain unfair advantages. Companies are expected to make sure that insiders refrain from trading in securities until the information is made public and to efficiently communicate important, price-sensitive information to prevent such incidents. “Disclose or abstain” should be the guiding concept in this situation. As a result, businesses must set up internal policies that include sufficient and prompt disclosures, reporting guidelines, standards for confidentiality, a code of conduct, and particular guidelines dictating how directors, employees, and other insiders should behave. Although the market regulator has not defined insider trading precisely, it refers to trading securities with the benefit of knowing confidential information that, if disclosed, could affect the securities market price.

Insider Trading

Insider means any person who is connected or in possession of or has access to unpublished price-sensitive information.¹ The term “insider trading” has multiple meanings and connotations, encompassing both legal and prohibited activities. Legitimate instances of Insider Trading occur routinely, where corporate insiders such as officers, directors, or employees engage in the buying or selling of stock in their own companies, adhering to company policies and regulatory guidelines governing such transactions. When a person uses information that is not available to the general public to make an investment decision, it is known as insider trading. In some situations, this information helps them avoid possible losses, but in other situations, it helps them make money. To put it simply, 'insider trading' refers to the act of buying, selling, or dealing in securities in violation of a fiduciary duty or another relationship of trust and confidence. This happens when someone has significant, confidential knowledge regarding the security under consideration. The purchase, sale, or manipulation of securities of a publicly traded company by individuals such as directors, management, or staff members, as well as by others like internal auditors, advisors, consultants, or analysts, who have access to material inside information not available to the public, constitutes insider trading.

At the start of the 20th century, insider trading was not regarded as unlawful. After the excesses of the 1920s, the subsequent decade of depression, and the resulting shift in public opinion, it was banned, with serious penalties being imposed on those who engaged in the practice. The Thomas Committee Report in 1948 cited instances of directors, agents, officers, and auditors possessing strategic information regarding the economic conditions of the company regarding the size of the dividends to be declared, of the issue of bonus shares, or the awaiting conclusion of a favorable contract before public disclosure.² In practice, insider trading implies withholding relevant information from the shareholders or releasing it at such intervals to fully exploit its insider potential.³

Insider trading in India within the Indian context is addressed by Section 3 of the SEBI, which aims to prohibit activities such as dealing, communication, and advising on matters related to insider trading. This section stipulates that no individual with insider status shall engage, either for themselves or on behalf of others, in the trading of securities of a company when possessing unpublished price-sensitive information. Additionally, insiders are barred from directly or indirectly communicating, advising, or procuring such sensitive information for any person. Individuals in possession of this information are also prohibited from trading in securities. It is important to note that these restrictions do not apply to communications required in the ordinary course of business, profession, employment, or as mandated by any law. This form of siphoning of excess profits of the company by the insiders not only devalues the shares but also deprives rightful owners of their interests.⁴ Insider trading is perceived as a breach of the fiduciary relationship between the company and its investors, as it often hampers the attainment of a company's objective in the capital market.⁵

Regulation of Insider Trading

SEBI (Prohibition of Insider Trading) Regulations, 2015 regulation is quite explicative of the definitions upon which it considers to strengthen the regulations and make it an internationally standard one along with providing it the ability to be adept enough for issues which might crop up in the long run. The 2015 regulations were adopted on 15 January 2015 after following the recommendations provided by a High-Level Committee that was constituted under Justice N.K. Sodhi⁶ in 2013, which reviewed the lacunae present in the 1992 Regulations. Though the 2002 amendment in 1992 Regulation was aimed at making the substantive law more robust, it still could not address certain pertinent issues prevalent in trade behaviors concerning insider trading.⁷ Many of the prosecutions brought about by SEBI ended up getting either overruled or dismissed; the case of Hindustan Lever Ltd. v. SEBI⁸ is a prime example of this. More than having substantive leeway and ambiguities, it was the procedural aspect of the 1992 regulations and its subsequent amendments, such as lack of proper evidence and a higher standard on the part of the regulator to prove a violation, which led to its overhauling into the new 2015 regulations.⁹

2015 Regulations define an insider as any person who is¹⁰

1. a connected person,
2. in possession of or access to unpublished, sensitive information.

While the definition of insiders has not been greatly varied from the 1992 regulations, the ambit of connected persons has been significantly increased. Where the old definition defined a connected person as either a director as per Section 2(13) of the 1956 Companies Act or a person who is an officer/employee of the company.¹¹ Thus, it was limited to official or professional relationships that a person had with respect to the company. The 2015 regulations, besides recognising official relationships, go beyond them and acknowledge contractual and fiduciary relationships as well. Not only is the ambit limited to types of people directly listed under the definition, but it also includes “immediate relatives”. Immediate relatives include spouses, siblings, parents, financially dependent persons, or anybody who is consulted while making decisions related to trading securities.¹²

Similar to the 2002 amendment to the 1992 Regulations, the 2015 Regulations offer specific defences to an accused insider, thereby reducing their potential liability. The insider could prove its innocence,¹³ for instance, if it can show that the transaction in question happened off the market or if it can show that decision-makers within a company did not have access to price-sensitive information when they made a decision.¹⁴ While the Indian insider trading laws do not require the prosecution to prove the guilty state of mind (mens rea) to establish a charge of insider trading, which is inherently an offense involving intent, the regulations should have permitted the lack of mens rea as a valid basis for refuting the liability of the accused.¹⁵

Unpublished Price Sensitive Information

Unpublished Price Sensitive Information (UPSI) is essentially information that is material having an impact on market conditions and is non-public, which on becoming generally available would affect the price of the securities to which it relates.¹⁶ If a piece of information is to be publicly disseminated and considered generally available, it must be published on a platform that is widely accessible to the public, like the stock exchange or the website of the company.¹⁷ One of the new regulation’s most significant changes relates to UPSI communication. The regulations' Section 3(1) makes it very evident that simply disclosing the UPSI to someone is illegal, regardless of whether or not the recipient has used it.¹⁸ The 1992 regulations, which stated that a UPSI communication was offensive if it was sent to someone who only dealt in securities using that information, were less lax than this measure. It can be argued that the purpose of this stringency is to impose a duty of care on the parties regarding how they handle such information. Additionally, the need-to-know principle for handling information in possession of securities transactions in the Indian market has been strengthened by the imposition of this stringency.

Regarding UPSI trading, the 2015 regulations are clearer and more concise, accounting for the potential listing of shares on the stock market. Any trade made while in possession of UPSI will be deemed to have been driven by “knowledge and awareness” of such unpublished information, according to the provision note in the new regulations. Thus, as a result, the trader has the burden of proving the accusations false and the standard of presumption placed against the information possessor is very high. This has also entailed another major change in the new regulations, which is that it also affords the insider, and not only the company as per the 1992 regulations,¹⁹ an opportunity to rebut the charges leveled against him. The committee reasoned that this inclusion and broadening serve the additional goal of aligning the regulations with case law, in addition to giving the insider a chance to support his position.

Prohibition of insider trading in India consists of the following key components:

1. prohibition on communicating UPSI by an insider
2. prohibition on other persons on procurement of UPSI and
3. prohibition on trading by an insider while in possession of UPSI²⁰

Conclusion

In conclusion, the 2015 PIT Regulations have improved the way that insider trading is addressed. By taking into account current market conditions and cultural norms, as well as the most recent judicial interpretations by SEBI and higher courts concerning specific definitions and responsibilities of insiders, these regulations show a more pragmatic approach. The rules have also strengthened the rigor of both the substantive and procedural aspects, standardising insider trading laws to better align with those of other jurisdictions. Notably, regardless of whether they traded in the relevant security, the regulations now establish a presumption against insiders who trade after obtaining unpublished price-sensitive information. The new regulations define insiders and connected persons in a broad, if not nearly universal, way, making the scope of person-based culpability still relatively narrow, particularly in comparison to the EU.²¹ India requires stricter criminal laws against insider trading in this area because such significant financial setbacks affect not only the party with access to the information but also the general public and the market.

This article is authored by Vishal Kumar, a Delhi based lawyer.