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Insider trading: where's the deterrent?

August 04, 2003

Till now it was not evident whether the Securities and Exchange Board of India had powers to issue guidelines or directions relating to the issue of shares, listings and so on.

Even if it had the powers, it was not clear whether the manner in which it was using it was in proper legal form.

The recently-amended Sebi Act specifically empowers Sebi to issue these guidelines and directions. However, the wording of the Act still leaves some doubts. For example, it is not clear whether several of the guidelines issued by Sebi would have legal force.

For not redressing investors' grievances, a company and any intermediary would be subject to a penalty for each day or Rs 1 crore (Rs 10 million), whichever is less. Sebi has also been entrusted with considerable powers relating to search and seizure.

However, there are problems in the new framework and drafting. While the amended Act provides for prohibition and punishment for price manipulation and so on, extensive regulations made by Sebi earlier exist.

Each of these groups of provisions has been differently worded, and thus, could mean different things. Taken together, they may help cover many loopholes, which is not possible independently. However, working against each other, they may create contradiction and cause confusion as to which would operate and how the terms stated therein would be interpreted.

A new provision that needs closer watch in implementation is related to the compounding of offences. By this provision, an offender can approach Sebi and compound his offence by paying a fine, and thus avoid prosecution. This is available only if the punishment for the offence is not solely imprisonment or fine and imprisonment.

The strange aspect is that not a single offence under the Sebi Act is punishable solely by imprisonment or by fine and imprisonment. In other words, all offences under the Act -- even the worst cases of price rigging and insider trading -- can be compounded. It is essential, to ensure transparency and fairness, that the orders compounding the offences are made public.

The provisions describing manipulative acts are quite broad, and thus, would help cover many forms of offences without being specific. For example, one provision states that this offence would include "any device, scheme or artifice to defraud".

At the same time, certain wordings may create problems in implementation. For example, the use of manipulative or deceptive devices in connection with the issue, purchase or sale of securities are prohibited.

However, there is a rider that this should be in contravention of the provisions of the Act, regulations and so on. Thus, the generality of the provisions is considerably narrowed by requiring specific additional provisions of law listing such devices and prohibiting their use.

If Sebi has not listed such devices, the provision would be null.

In reality, even if there is such a listing, the devices listed in such regulations may not coincide with the ones conceived under the Act.

Thus, for example, Sebi has already prescribed the regulations related to manipulation, unfair practices and so on, but the wordings therein are quite different from the wordings in the Act. Thus, the Act and regulations may work against each other.

This is also perhaps because the Act has been amended only with the objective of laying down some powers in the parent Act. However, the whole scheme of law, whether included in the Act or in the regulations, should have been revised together so that they make a cohesive whole. Penal provisions are interpreted strictly and offenders may likely fall through the gaps.

Yet another example of this overlap and possible contradiction is a provision that prohibits "insider trading". However, there are already regulations that specifically prohibit several types of acts without naming them as insider trading transactions.

Strangely, the Act has yet another provision which prohibits a person from dealing "in securities while in possession of material or non-public information".

In a case of alleged insider trading, it is doubtful which of these provisions or a combination of them will apply. An optimistic legal advisor might hope that none of them would apply.

In the case of insider trading, the regulations have also been extensively amended. The objective mainly is to ensure that systems are laid down at the level of the company as well as established insiders for the prevention of insider trading.

Thus, not only there is an overall control of Sebi in the matter, but also the companies themselves prevent and discipline insider trading. The flip side is that too many parties are required to install procedures that are too elaborate and unrealistic for this purpose.

These regulations are, thus, likely to be observed more in the breach.

To conclude, one cannot be confident that the set-up is adequate to deal with offenders in the capital markets. They will face actual punishment only if (i) the legal set-up is relatively clear and unambiguous and not the product of unrelated amendments, (ii) the judiciary continues to take a liberal approach in favour of Sebi and perhaps goes a little further, (iii) and most importantly, Sebi drastically upgrades its investigation gathering evidence that can stand up in the court.

Otherwise, we may see one more scandal that may lead from the investors to refrain from the stock markets.

(The writer is a chartered accountant)

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