Into The Dark World of Insider Trading

By Cearet Sood

Edited  by Shambhavi Singh, Senior Editor, The Indian Economist

“The One Plus One”, by Jojo Moyes, deals with unconscious indulgence in insider trading. It shows that how one of the characters without his knowledge enters insider trading. As a result of he was fined £750,000, given a six month sentence and suspended for twelve months. It made me think about the cases in India, about how I’ve not heard of many trials being held here, of how our laws aren’t implemented, as usual. So, I thought to gain some insights into this corporate governance issue and look into the current situation in various countries.

We’ve been hearing about many cases, with their trials being held and some people convicted, some acquitted. The latest and perhaps the most famous one has been Rajat Gupta’s trial, who is a very well known Indian-American and the first foreign born Managing Director of McKinsey & Company. He was found guilty of sharing strategic information of Goldman Sachs and Procter & Gamble, where he served on the board of directors with Raj Rajaratnam, billionaire founder of Galleon Group, a hedge fund management firm. It has been reported that Rajaratnam earned $17 million from Goldman and $570,000 from P&G. Even Rajaratnam was ordered an 11 year prison sentence, forfeiture of $53.8 million and a fine of $10 million. Gupta got sentenced to two years in Federal Prison and a fine of $5 million. The criminal case also forced Mr. Gupta to withdraw from his positions on corporate boards and philanthropic groups.

Insider trading, in simple terms, means to buy or sell securities. It is carried out by people who have access to strategic and inside information of the company, which has not been made public. The person, who indulges in Insider Trading, usually does it for profit motive. Whilst mostly considered to be illegal, it can have either conducts. It is legal, when all the concerned investors have access to the non public information. Directors, key executives, business associates, brokers etc usually have access to such information. It is an unfair trade practice simply because it undermines investors’ confidence in the stock market. Few people tend to make a fortune, whereas many lose their earnings because of this unethical practice. The practice of Insider Trading is widely prevalent. Most of these cases get highlighted in developed economies such as the US and the UK, mainly because of the tough rules and effective regulations adopted by the U.S Securities and Exchange Commission (SEC) and Financial Services Authority (FSA) respectively. In India, reporting of these cases is a rarity, because of our weak laws. Securities and Exchange Board of India (SEBI), regulator of stock markets in India, has very limited powers in controlling insider trading. Recently, SEBI has been allowed to look at the phone records of investors, but it is still not allowed to use wire traps, through which most cases are exposed. Even though the Section 30 of the SEBI Act, grants it powers like directing the insider not to deal in the securities, prohibiting them to deal in securities, restraining him to communicate or counsel any person to deal in securities, declaring the transaction in securities null and void. A person caught in indulging in insider trading, can be fined with Rs. 5 lakhs and an imprisonment between one month and three years. Whereas, the US has been the leading country in prohibiting insider trading, it has a base offence level of 8, which means that first time offenders are eligible to receive probation. The Insider Trading Sanctions Act of 1984 place penalties for illegal insider trading as high as three times the profit gained or loss avoided. Moreover, according to a report by Reuters, U.S. judges are imposing increasingly long prison terms for this offence, partly due to bigger profits being earned through illegal schemes. Although, some of our laws are in place, they aren’t implemented. Our imprisonment sentence is too short and fine too less. People are’t afraid of the law and in a way they are encouraged to indulge in insider trading to earn potential profit. Insider traders are often able to stay a step ahead of investigators. SEBI uses software to aggregate all the trades connected to related companies, individuals and mailing addresses but insider traders just use dummy firms at different addresses. When SEBI started tracking trades using investors’ tax identification numbers called Personal Account Numbers, insider traders simply switched to the PAN numbers of relatives, friends or colleagues.

My recommendations would be:

1. More investigative powers to be given to SEBI. They should be allowed to use wire traps, which would be helpful in catching insider trading cases.
2. Harsher punishment should be given to those found guilty. There should be fast track courts, where these cases should be heard.
3. Implementation of the laws should be of utmost importance, so that we have effective regulations in place.