Case Study

INSIDER TRADING Regulations & Practices

Agenda for PresentationIntroduction

History behind insider trading

Regulatory Aspect of Insider Trading

Cases

Introduction

The Appellant is the Managing Director of ABS Industries Ltd., Vadodara (ABS) a company incorporated under the Companies Act 1956 (name of the company has been subsequently changed to Bayer ABS Ltd.) the main business of ABS is manufacture of resins and SAN , another polymer. Its shares are listed on few stock exchanges including Bombay Stock Exchange and National Stock Exchange. Bayer AG (Bayer) is a company registered in Germany having many subsidiaries in various parts of the world. Bayer took controlling stake in ABS in October 1996 by acquiring

Introduction Insider trading essentially denotes dealing in a company s securities on the basis of confidential information relating to the company which is not published or not known to the public used to make profit or loss. It is fairly a breach of fiduciary duties of officers of a company or connected persons as defined under the SEBI regulations,1992, towards the shareholders.

ContdInsider terms actually includes both legal and illegal conduct.

The legal version is when corporate insider officer, directors , and employees buy and sell stock in their own companies. when corporate insiders trade in their own securities , they must report their trades to SEBI.

Illegal insider trading refers generally to buying or selling a security , in breach of fiduciary duty or other relationship of trust and confidence, while in possession of material , non public information about the security.

Who are insider traders?Corporate officers, directors , and employees who traded the corporations securities after learning of significant , confidential corporate developments.

Friends , business associates, family members , and other types of such officers , directors , and employees, who traded the securities after receiving such information.

ContdEmployees of law, banking , brokerage and printing firms who were given such information to provide services to the corporation whose securities they traded.

Govt employees who learned of such information because of their employment by the govt .

Other persons who misappropriated ,and took advantage of, confidential information from their employers.

Why forbid insider trading?The prevention of insider trading is widely treated as an important function of securities regulation.

In order to make sense of insider trading , we must have basic understanding of markets, prices and role of markets in the economy.

Insider trading appears unfair, especially to speculators outside a company who face difficult competition in the form of insider trading.

History behind Insider Trading

History behind Insider Trading Regulation in IndiaInsider trading in India was unhindered in its 130 year old stock market till about 1970.

In 1979 , the Sachar committee recommended amendments to the companies Act,1956 to restrict prohibit the dealings of employees . Penalties were also suggested to prevent the insider trading.

In 1986 the Patel committee recommended that the securities contracts Act ,1956 may be amended to make exchange curb insider trading and unfair stock deals.

ContdIn 1989 the Abid Hussain committee recommended that the insider trading activities may be penalized by civil and criminal proceedings and also suggested the SEBI formulate the regulations and governing codes to prevent unfair dealings.

India through SEBI regulations 1992 has prohibited this fraudulent practice .

These regulations were drastically amended in 2002 and renamed as SEBI regulations 1992.

In India.Only 14 cases taken up by SEBI for insider trading in 2003-04 , which went down to only 7 in 2004-05.

In terms of cases completed, the no was only 9 and 5 respectively.

So does India has fewer incidence of insider trading or our systems/laws not geared enough to detect such cases?

Regulatory aspect of Insider Trading

Regulatory aspects of prohibition of Insider TradingSEBI prohibition of Insider Trading regulation 1995.

Section 11(2) E of companies act 1956 prohibits the Insider Trading

What is Insider Trading is not defined in the companies act -1956

Why there is need for the Prohibition of Insider Trading???As per SEBI the Prohibition of Insider Trading is required to make Securities Market:

Fair & Transparent

To have a level playing field for all the participants in the market

For free flow of information & avoid information asymmetry

Who is Insider??? Who is Insider is defined under the SEBI Prohibition of Insider Trading regulation 2 (e)

Insider is the person who is connected with the company , who could have the Unpublished price sensitive information or receive the information from somebody in the company .

For the purpose this definition, words connected person shall any person who is a connected person six months prior to an act of insider trading

Who Can be a connected person???It could be director of the company ,or is deemed to be a director of the by virtue of sub-clause(10) of section 307 of the companies act 1956

He /She could be officer or professional of the company or holding a business relationship with the company.

Any person having UPPI from the any subsidiary or group company is also stated to be the connected person.

Connected person can also be from intermediarys like stock exchange , Merchant Bank , Transfer agent, debenture trustee, Bankers & relatives of promoter or of BOD.

Relatives are defined very extensively in the companies act 1956

1. Father2. Mother3. Son4. Sons wife5. Daughter6. Fathers father7. Fathers mother8. Mothers mother9. Mothers father10.Sons son11.Sons sons wife12.Sons daughter

11.Sons sons wife12.Sons daughter13.Sons daughters husband14.Daughters husband15.Daughters son16.Daughters sons wife17.Daughters daughter18.Daughters daughters husband19.Brother20.Brothers wife21.Sister22.Sisters husband

But several close relatives are excluded Like all in-laws (Brother-in-law, Father-in-law etc.)-Brothers wifes brother etc.

What is price sensitive information??? The Price sensitive information is defined in Regulation 2(h)(a) of the prohibition of Insider Trading.

It means any information which relates directly or indirectly with the company & which if published is likely to materially affect the prices of the securitys of the company.

The information which is deemed to be price sensitive are like.Periodical financial results

Intended declaration of the dividends(both Interim & Final)

Issue of securities or buy back of securities

Any major expansion plans or execution of new projects.

Amalgamation & mergers or takeovers.

Disposal of the whole or substantial part of the undertaking

Any significant changes in policies , plans or operations of the company.

Regulation 3 of the Prohibition of Insider trading

No Insider should deal insecurity , while in possession of UPPI.

He / She should not communicate or procure the UPPSI to others.

Regulation 3(B)This regulation states that there should be Chinese Wall With in the company & one department should not know about what other departments are doing.

Disclosures for prohibition of Insider TradingInitial Disclosure

Like buying the stake greater than the 5% of the paid up capital of the company ,the acquiring company should inform the Stock Exchange with in 2 days of acquiring the stake.The new director should disclose all its trade position in Equity or derivatives with in 2 days of its appointment.

Continuous Disclosure

If the director changes its holding by 2% .Investment of Rs 5 Lacs or 25000 shares or buying the 1% stake of the paid up capital which ever is the least should be disclosed.3 All holdings in securities of that company4 Periodic statements of all transactions5 Annual statement of all holdings6 Any other disclosure of the company to stock exchanges.

Model Code of Conduct for Prohibition A compliance officer is required to be appointed by the company.

There should be pre-clearance of trade by the officer of designated employees. Designated employees includes :

Employees from top 3 layers of Mgmt.All Employees in finance department irrespective of any designation & grade.Employee designated by BOD from time to time to whom the trading restriction shall be a applicable.

Trading window ,is closed 7 days prior & 24 hours post event for the connected persons during the UPPSI activities like RESULTS,IPO,CAPEX,BUY BACK , etc.

There are several forms in accordance with disclosures & code of conduct.Insider_Trading_Code_of_Conduct.pdf

Investigation of Insider Trading

Regulation 4(a) deals with the request for the enquiries.

SEBI can also appoint the outsider auditor for the enquiry & auditor would have the same power as the SEBI possess.

Before undertaking any investigation under regulation (5) SEBI shall give a reasonable notice to insider for that purpose.

Where SEBI is satisfied that in the interest of investors or in public interest no such notice should be given, it may by an order in writing direct that the investigation be taken up without such notice.

SEBIs Power to make inquiries and inspection Regulation 4A

If the SEBI suspects that any person has violated any provision of these regulations, it may make inquiries with such persons.

The SEBI may appoint officers to inspect the books and records of insider(s) for the purpose of inspection.

The SEBI can investigate and inspect the books of account, either records and documents of an insider on prima facie.

SEBI can investigate into the complaints received from investors, intermediaries or any other person on any matter having a bearing on the allegations of insider trading.

Case Studies HLL-BBLIL MERGER

RAKESH AGARWAL vs. SEBI

SAMIR ARORA vs. SEBI

HLL-BBLIL MERGER CASE

HLLBROOKBOND LIPTON INDIA LTDFocus on legal controversy involving BBLILs merger with HLL.

SEBI, suspecting insider trading, conducted enquiries.

In August 1997, SEBI charged HLL of insider trading by using Unpublished Price-Sensitive Information.

HLLBROOKBOND LIPTON INDIA LTDHLL bought 8 lakh shares of BBLIL from UTI at Rs 350.35 per share (At a premium of 9.5% of the ruling market price of Rs 320) just two weeks before the formal announcement knowing that the HLL and BBLIL were going to merge.

SEBI held that HLL was using unpublished, price-sensitive information to trade, and was therefore guilty of insider trading.

In March 1998, SEBI passes an executive order, which sent shock waves through the countrys corporate sector.

SEBI directed HLL to pay UTI Rs 3.4 Crore in compensation, and also initiated criminal proceedings against the five directors of HLL and BBLIL.

HLLBROOKBOND LIPTON INDIA LTDHLL appealed against the SEBI verdict to the Union Ministry of Finance.

HLL contended that before the transaction, the merger was the subject of wide speculation by the market and the media.

After the formal announcement, press articles mentioned that the merger was no surprise to anyone.

HLL pointed out that the share price of BBLIL moved up from Rs 242 to Rs 320 between January and March, before the transaction, indicating that the merger was generally known information.

HLLBROOKBOND LIPTON INDIA LTDHLL contended that to be considered as an insider, it should have received information by virtue of such connection to the other company.

According to HLL, it was an initiator and the transferee, and it was the primary party to the merger and no primary party to the merger can be considered an insider from the point of view of insider-trading.

HLL argued that only the information about the swap ratio could be deemed to be price-sensitive and that this ratio was not known to HLL or its directors before the purchase of shares from UTI.

HLL also argued that the news of merger was not price sensitive as it had already been announced by the media before the official announcement.

HLLBROOKBOND LIPTON INDIA LTDHLL claimed that the purpose of the purchase of shares was to enable Uniliver to acquire 51% shares of BBLIL.

In July 1998, the Appellate Authority of the Finance Ministry dismissed the SEBI order.

However, SEBI was correctly order was correctly based on a simple proposition of law : what can not be done directly can not be done indirectly.

RAKESH AGARWAL vs. SEBI

RAKESH AGARWAL vs. SEBIOne of the most famous case highlighting the vulnerability of the SEBIs 1992 regulations.

Rakesh Agarwal, MD of ABS Industries Ltd was involed in negotiations with Bayer A.G, regarding their intention to takeover ABS.

As per SEBI, Rakesh Agarwal had access to the Unpublished price-sensitive information.

SEBI alleged that prior to the announcement of acquisition, Rakesh Agarwal, through his brother-in-law, had purchased shares of ABS and tendered the said shares in the open offer made by Bayer.

RAKESH AGARWAL vs. SEBIRakesh Agarwal contended that he did this in the interests of the company.

Pursuant to Bayers condition to acquire at least 51% shares of ABS, he, through his brother-in law bought the shares and later sold them to Bayer.

The SEBI directed Rakesh agarwal to deposit Rs 34,00,000 with Investor Education & Protection Funds of Stock Exchange, Mumbai and NSE.

SAT held that the SEBI order directing Agarwal to pay Rs 34 lakh couldnt be sustained, on the grounds that Rakesh Agarwal did that in the interests of the company.

SAMIR ARORA vs. SEBI

SAMIR ARORA vs. SEBISameer Arora was star fund manager of Alliance Capital Mutual Fund (ACM) and the poster boy of the Indian Mutual Fund Industry.

He was managing Rs 2264 crores with ACAM invested in Indian equity and fixed income markets as of 31st August 2003.

Within a few years of its launch, ACMF became a darling among the investors.

The fund which was launched in 1995, had been generating a return of 2.463 % since inception under the growth option.

The CIO, Asian operations, Samir Arora was applauded by everyone for a good show.

SAMIR ARORA vs. SEBIIn April 2003, there were talks about the consolidation of Digital Global Soft LTD(DGL) with the Hewlett Packard Indian Software Operations(HPISO), a 100% subsidiary of HP.

On May 5, 2003 Arora, in an interview with Business Standard, proposed that merger was going to immensely help DGL due to the additional projects it is going to get from HP.

On May 8, 2003 an internal analyst of Alliance recommended reducing position in the stock.

ACMF sold 1.19 lakh shares and ACM sold 2.18 lakh shares.

On May 12, 2003 ACMF sold 3.35 lakh shares while ACM sold 2.5 lakh shares.

SAMIR ARORA vs. SEBIArora said, Even risk from tomorrows results is too high. Bipolar situation, but we do not like to take such risks post-very volatility in technology stocks around results/corporate issues.

May 13, 2003 DGL announced Q4 results in line with the expectations of the market. ACM sold 2.11 lakh shares.

June 7, 2003 DGL announced demerger ratio which was perceived as unfavorable by the market. Stock fell 26%.

SAMIR ARORA vs. SEBIIn August 2003, SEBI charged Samir Arora of insider trading under Section 11B and 11(4)(B) of the SEBI Act.

SEBI indicted Arora on many serious charges i.e - A. Trading DGL shares on the basis of Unpublished price sensitive information.B. Non-disclosure after crossing 5% limit in several companiesC. Causing panic in the market by making public his decision to quit Alliance Capital, leading to the redemption of Rs 1300 Crore.

SAMIR ARORA vs. SEBIIn April 2004, SEBI debarred Arora from dealing in securities directly or indirectly for five years.

SEBI charged the penalty of Rs 15 Crore on ACM and two associated Alliance entities.

October 2004, the Securities Appellate Tribunal set aside the order of SEBI on grounds of insufficient evidence to prove the charges of insider trading and professional misconduct against Mr. Arora.

OBSERVATIONInability of SEBI in proving its cases.

Wide definition of Insider Trader as defined in the 1992 Act.

Proving Insider Trading a bizarrely difficult task.

Lack of assistance from Central Economic Intelligence Bureau (CEIB) to investigate the cases.

Absence of an adequate remedy available to the investors at large.

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