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Insider trading — Making it tougher to nail the guilty

Krishnan Thiagarajan

It has to be proved whether the insider has derived an unfair advantage over other parties or had a profit motive while trading on the basis of unpublished price sensitive information.

THE Securities Appellate Tribunal's (SAT) verdict in the Mr Rakesh Agrawal case has serious implications for the future course of insider trading regulations in the country. Earlier this week, SAT partly overturned the Securities and Exchange Board of India's (SEBI) order by holding Mr Agrawal not guilty of insider trading and also setting aside the penalty imposed according to regulations. It is significant that while issuing this ruling, SAT has widened the ambit of when insider trading becomes punishable under the regulations.

The plain reading of the SEBI (Insider Trading) Regulations appears to indicate that two conditions need to be fulfilled to hold somebody guilty as an insider. One, the "insider" must be a connected person by virtue of his position in the company such as director, officer or employee with a professional or business relationship with access to unpublished price sensitive information. Otherwise, he is deemed to be a connected person such as company under the same management or subsidiary, member of stock exchange or merchant banker or others acting in a similar capacity. Two, he had traded in those securities on the basis of unpublished price sensitive information.

But, according to the Presiding Officer of SAT, Mr C. Achuthan, satisfying these two conditions alone are not sufficient to hold a person guilty of insider trading. He has introduced a second limb to the definition of insider trading by stating that it has to be proved that the insider had derived an unfair advantage over other parties or had a profit motive while trading on the basis of unpublished price sensitive information.

As things stand today, proving insider trading according to the current regulations itself is difficult. On top of these, if the additional conditions of the SAT ruling are imposed, it will be become virtually impossible to enforce the insider trading regulations. It is imperative for SEBI to appeal against the SAT ruling because these onerous conditions imposed by the ruling will render the insider trading regulations futile. Moreover, the precedent established by this case has implications for other pending cases such as Mr Samir Arora's alleged insider trading in the shares of Digital GlobalSoft, and Reliance Industries' alleged insider trading in the case of L&T shares.

Crux of the case

Mr Agrawal, Managing Director of ABS Industries (now Bayer ABS), had asked his brother-in-law, Mr I. P. Kedia, to buy 1,82,500 shares of ABS Industries from the secondary market during the period September 9, 1996 to October 1, 1996. These purchases were financed by Mr Agrawal. The instructions to purchase shares of ABS immediately followed Mr Agrawal's return from Germany after meeting Bayer officials on September 5 and 6, 1996. In this meeting, it was decided that if Bayer entered into a joint venture with ABS, it would require 51 per cent holding in the company. No decision had been taken about a final joint venture during that meeting, though there was a probability of the talks culminating into one. ABS Industries put its intention of a board meeting to consider a possible joint venture deal by notifying all the stock exchanges only on October 1, 1996.

Thrust of the ruling

In the course its ruling, SAT has clearly stated that Mr Agrawal was an insider who had used unpublished price sensitive information. Clearly, the objective of the Insider Trading Regulation, which aims to ensure that all persons in the market are placed on an equal footing, had been breached.

But SAT said that given the gravity of the charge and penal consequences, the intention or motive of gaining an unfair advantage from insider trading had also to be established. In this case, SAT held that as Mr Agrawal purchased shares through his brother-in-law only to help meet the stiff condition of 51 per cent equity to Bayer entering the joint venture deal. Hence, there was a personal gain but not an unfair one intended to cheat others.

Ball in SEBI's court

By partly overturning the SEBI order, SAT has hurt the regulator's case. And SEBI ought to challenge this order by taking it to a higher legal fora. In the meantime, it may have to consider two fundamental changes to the insider trading regulations.

First of all, it has to ensure that the SEBI Regulations on Insider Trading are a separate code by itself. Preferably, it must be made into a separate Act as a part of general law relating to frauds, as is the case in the US. This will ensure that SEBI does not have to draw concepts and principles from the US and the UK laws to strengthen its case. At the same time it must also avoid the impression that there is ambiguity or weakness in the Indian Insider Trading Regulations.

Second, there appears to be a compelling need to consider imposition of a two-staged penalty for insider trading violations. No insider should be allowed to go scot-free just because the intention or motive is difficult to prove under the regulations. In the first stage, when the integrity of the markets is affected by the use of unpublished price sensitive information, a penalty should be imposed on the insider. The penalty ought to be punitive. In the second stage, when the intention or motive of the parties are proved, then a stiff penalty and prosecution should be provided for.

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