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Insider trading: Sebi panel's proposals are futile and definitely not foolproof

The Justice Sodhi committee appointed by market regulator Sebi to make the extant insider trading regulations foolproof has ironically ended up making suggestions that could have the effect of letting insider off the hook.

One redeeming feature of the report however, is its attempt to cast the net wide so as to catch all connected persons and their close relatives including public servants. A judge hearing a merger petition would be as much liable for the guilt of insider trading as a secretary of a key economic ministry regulating the industry to which the company's shares belong. Thus the secretary or minister in the ministry of fertilisers and chemicals would be guilty of insider trading if he acquires shares of a fertiliser company before making the announcement as to decontrol of fertiliser industry from price fixation by the government because he has done it on the basis of Unpublished Price Sensitive information (UPSI)---the impending decontrol of the industry from government clutches.

There are quite a few defences available to a person charged with the vice of insider trading. Innocent receipt of UPSI is one such defence. This would be manna from the heaven for the one seeking an escape route. An example given in the report of the committee is a research report which otherwise is a UPSI but the one which the alleged insider did not read before buying or selling the shares of the company. This gives a huge wiggle room to insider traders which everyone would latch onto with alacrity especially if she/he was not in the thick of things while the research report was being prepared or discussed in the company.

The wife of the CEO of the company may stumble upon the report of the proposed launch of a new product in collaboration with a famous MNC or her husband may apprise her of such a proposal during pillow talk. She may go ahead and buy the shares of the company and make a killing a few days thereafter when the product launch is announced. Should she be believed when she says she bought the shares independent of the knowledge of such impending product launch? It would be nave to believe her.

 Insider trading: Sebi panels proposals are futile and definitely not foolproof

One wonders why the SEBI has not gone ahead with its proposal to call upon insiders holding more than 10% equity stake in a company to disgorge the profits made from short swing operations---sale of shares within six months of their purchase

The exemption given to scheduled purchases or sales made by employees of the company either may not be latched onto or may become a convenient alibi in retrospect i.e. a post facto explanation for insider trading. An insider should normally not be expected to tie himself into knots by agreeing to a pre-scheduled buying or selling arrangement especially when such a schedule cannot be deviated from. Indeed a pre-scheduled arrangement would cramp him and prevent him from taking advantage of the latest development.

But this explanation may come handy as a post facto explanation for an insider trading done given the fact that such an arrangement has to be entered into with the compliance officer who would be his colleague. There is no reason why the compliance officer would not play ball. In order to make this exemption foolproof, such pre-scheduled transaction arrangements must be put up on the company website as well as the SEBI website for everyone to see.

Incidentally one wonders why the SEBI has not gone ahead with its proposal to call upon insiders holding more than 10% equity stake in a company to disgorge the profits made from short swing operations---sale of shares within six months of their purchase. SEBI wanted to emulate the SEC of the USA but for strange reasons it buried the proposal as abruptly as it was mooted.

The Sodhi panel has conceded that insider trading is often difficult to prove but the short swing profit norm is very easy to operate and calls for very little proof. Insider trading i.e. making profits on the basis of UPSI is presumed if shares sold were bought less than six months earlier period. Of course, we can have insider trading regulation in addition to the short swing profit regime. While casting the insider net far and wide is not bad, insider trading is often indulged in by big ticket investors in a company. There is no reason why we cannot ask short swing profits by big ticket investors to be disgorged to the company given the fact that it is the most glaring and brazen form of insider trading. The presumption of insider trading is not far-fetched because a six month shelf life for insider information is certainly not outrageous.

It is another matter that in the face of such a peremptory regime no big ticket investor would indulge in such a transaction because it would be galling for anybody to disgorge the profits, all the more so knowing pretty well that he is likely to be caught easily with no subjectivity involved. But such a regime would have been a strong deterrent to insider trading, thus nipping the evil in the bud. It spares the authorities of the arduous and sometimes impossible task of proving insider trading at least with regard to an important facet of insider operations.

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Updated Date: Dec 21, 2014 00:52:32 IST