INSIDER TRADING AND FRONT RUNNING
LAWS IN INDIA AND ROLE OF COMPLIANCE
OFFICERS
Ashish Ahuja
Managing Partner
Wadia Ghandy and Co.
ashish.ahuja@wadiaghandy.com
Insider trading – Brief introduction
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Insider trading is basically the buying or selling of the securities of a listed public company by a person
who has unpublished price sensitive information relating to that company.
Insider trading, as a securities crime in India, is defined as such and governed by the SEBI (Prohibition
of Insider Trading) Regulations, 1992 (“Insider Trading Regulations”). While we must analyze the law
relating to insider trading in the context of the Indian regulatory regime, we shall for the purpose of a
comparative analysis also refer to certain American regulations/ laws.
The important definitions to be taken note of in order to understand the ambit and scope of the Insider
Trading Regulations are the definitions of who is an “insider” and of what constitutes “price sensitive
information”.
Basically, when an “insider” is in possession of “ unpublished price sensitive information”, that insider is
prohibited under Regulation 3 from directly or indirectly dealing in the securities of the company in
respect of which the insider possesses “price sensitive information”.
The scheme of the Insider Trading Regulations contemplates that listed public companies and other
specified entities should create an internal governance code and procedure which is intended to ensure a
self governing mechanism to prevent instances of insider trading. For this purpose, SEBI has prescribed a
Model Code of Conduct for prevention of Insider Trading for other Entities (under Schedule I to the Insider
Trading Regulations) (“Model Code”) which is to be adopted by the listed companies/ entities
Insider trading – Brief introduction
• As per the Model Code, a compliance officer (“Compliance
Officer”) is to be appointed by the listed company/ entity.
This Compliance Officer is to be a senior level employee
and is to perform certain stated and defined functions. He
is, however to function under the overall supervision of the
Board.
• The role of the compliance officer under the Model code is
– Responsibility for setting forth policies, procedures, monitoring
adherence to the rules for the preservation of “Price Sensitive
Information”, pre-clearing of trades of designated employees
and their dependent relatives (directly or through respective
department heads as decided by the Company) monitoring of
trades and the implementation of the code of conduct under
the overall supervision of the Board of the listed company.
SEBI’s VIEW ON THE ROLE OF THE COMPLIANCE
OFFICER IN CASE OF INSIDER TRADING
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SEBI Adjudication Order dated 27th July 2012 in respect of Mr. G Jayaraman in the matter of Satyam
Computer Services Ltd. (“Satyam”)
Vide the aforesaid Order, SEBI has held the erstwhile compliance officer of Satyam Computer
Services Ltd, Mr. G Jayaraman, liable for not enforcing the safeguards under the Model Code during
the period of December 2008 – January 2009. It may be noted that Mr. G Jayaraman was the
Company Secretary of Satyam.
The particular safeguard which the said Compliance Officer had failed to enforce was to close the
trading window after becoming aware of certain “price sensitive information” relating to Satyam,
i.e. The potential merger of Maytas with Satyam, which was not yet confirmed by the Board of
Satyam.
In the context of the facts of the case, under paragraph 20 of the said Order, SEBI has stated that
despite the Compliance Officer being under the overall supervision of the board of directors of the
company, he should have closed the trading window even without obtaining prior approval of the
board.
At paragraph 29 of the said Order, SEBI summarised the role that a Compliance Officer is expected
to play in the securities market. An extract is given below:“For orderly and fair functioning of the securities market, it is essential for every market player to
fulfil the requirements mandated in the law. The duty weighs even more on a person like
Compliance Officer, who is conferred upon with key responsibilities in a company. Hence, the
violation by the Noticee needs to be viewed seriously.”
SEBI imposed a penalty of Rs.5,00,000/- (Rupees Five Lakhs only) on Mr. G Jayaraman.
Front Running - Meaning
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Front running as a securities malpractice/ crime is recognised and
regulated by SEBI under the SEBI (Prohibition of Fraudulent and Unfair
Trading Practices Relating to Securities Market) Regulations, 2003.
• Front Running has not been defined by SEBI in a uniform manner,
however, the concept has been elaborated upon vide various regulations,
circulars and judgments of SEBI.
• One such example is the SEBI Circular on Consent Orders as amended by
Circular CIR/EFD/1/2012) dated 25th May 2012 (“Consent Order Circular”)
which has defined “front running” as under:
• “Front running; for the purpose of this circular, means usage of non-public
information to directly or indirectly, buy or sell securities or enter into
options or futures contracts, in advance of a substantial order, on an
impending transaction, in the same or related securities or futures or
options contracts, in anticipation that when the information becomes
public; the price of such securities or contracts may change;”
Front Running - Meaning
• What does this mean? I want to buy 3000 kgs of Gold. The order being
substantial would mean that the prices of the metal would shoot up.
Someone who knows what I want to do, takes position in Gold or silver or
any other metal whose price may get impacted by the price movement in
gold before my order is placed and usually sells once the price moves up
• Goldman Sachs has 90% of its revenues in the US from trading in the prop
book. Merchant banking accounts only for 10% of its revenues. There
were allegations in the US that they were front running as they had non
public information based on which they were trading
• Front running can also be a situation where a broker releases a research
report, which would have an impact on the prices of a scrip, but has
directly or indirectly taken positions before that report is made public
• Front running can also happen when huge orders are placed by mutual
funds and FIIs with brokers. Brokers may directly or indirectly take
positions in the scrips before inputting the order in the system
Front Running - Meaning
• SEBI has taken a strong stand against front running in Re: Shri Sujit
Karkera, Shri Purushottam Karkera and Smt Shilpa Kotak and Trading
Activity of Sujit Karkera and Group (MANU/SB/0115/2012) (in paragraph
26) whereby it has considered the evils of front running on the investor
community and elaborated on the same as follows:
– “Front running is one of the most heinous crimes in the securities markets. It
has the potential of eroding the faith of the investors in the securities market.
It amounts to defrauding an innocent and unsuspecting investor who blindly
repose trust in the entity to transact on his behalf in the securities market.
Once this trust is played truant with, one would run the risk of losing the
investor, not only for the loss it would have suffered but also for the loss of
confidence. It is of utmost importance that a sense of fair play be maintained
in the market so that innocent investors do not find themselves at the receiving
end of irregular conduct by entities in the market. Thus, I have considered it
critical that the penalty in the matter should be seen not only disgorgement in
nature but also deterrent in effect. Given this consideration I am imposing a
penalty with a multiple of 3 of the profit made for deterrent effect. With
regard to repetitive nature, I find that the default was repetitive in nature.”
Front Running -Touchpoints
• The touch point for front running is the place
where non public information is confided and
shared.
• Employees in mutual fund organisations and FIIs
– consent orders in case of l and t mutual funds
and hdfc mutual fund
• Brokers with whom huge orders are placed. UTI
Securities and FMO matter in Ballapur Industries
matter
• Merchant bankers during potential transactions
Front Running – Role of Compliance
Officers
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In all touchpoint – intermediary regulations, including broker regulations, merchant banker
regulations,
“..shall appoint a compliance officer who shall be responsible for monitoring the compliance of the
Act, rules and regulations, notifications, guidelines, instructions, etc., issued by the Board or the
Central Government and for redressal of investors’ grievance.”
“The Compliance officer shall immediately and independently report to the Board any noncompliance observed by him.”
Under the Master Circular for Mutual Funds dated 31st March 2012, SEBI which makes reference to
the Circular for Investment/ Trading in Securities by Employees of Asset Management Companies
and Mutual Fund Trustee Companies- dated 08-05-2001 provides for a meaning of the term “front
running” as under:
“Any transaction of front running by any employee directly or indirectly is strictly prohibited. For this
purpose, ‘front running' means any transaction of purchase /sale of a security carried by any
employee whether for self or for any other person, knowing fully well that the AMC also intends to
purchase/sell the same security for its mutual fund operations. For the purpose of ascertaining that
the employee had no prior knowledge of the Mutual Fund's intended transactions, the Compliance
Officer may take a declaration in this regard from the employee. Such declaration may be included
in the application form itself.”
Onerous role of the Compliance
Officer
• To monitor the compliance
• That means to watch and check and conduct scrutinies
to see that nobody is front running
• Would that mean random listening to conversations?
• Would than mean checking relative trades every now
and then
• Would that mean watching the movement of prices
before big trades and executed in the market
• Would that mean conducting researches and ensuring
that heavy technology is implemented to ensure that
front running does not happen?
But who is the Compliance Officer?
• Always an employee, at times the company secretary, who may
have no knowledge of trades and markets, if it is a compliance
officer in a non intermediary.
• What does he do? If someone asks him to close the trading
window, he closes the trading window. If someone asks him to pre
clear trades, he pre clears trades. If nobody asks him anything, he
does nothing
• In intermediaries, the most feared man. Transactions are shot down
on the basis of the compliance officer not agreeing. We have even
seen merchant bankers refusing to lend their names to issues, if the
compliance officer does not agree.
• But has anyone seen any compliance officer complaining to the
regulator? Why? Because he is still after all an employee. If he
blows the whistle once, will he ever get a job with any other
corporate,?
US Protection to Whistle Blowers
• If anyone acts as a whistle blower in the US,
pursuant to the Dodd Frank Wall Street
Reforms Act in 2010, two key protections were
afforded to him
– You cant throw him out of his job
– You must incentivise him. 10% to 30% of the
penalty is shared with the Whistle Blower
SEBI’s inabilities
• Why does SEBI have to chase the compliance officer?
• SEBI is not yet recognised as an organisation that has
the power to tap phones. It is still seeking a notification
that empowers it to do so under the Indian Telegraph
laws.
• Surveillance systems are not sufficient to discover front
running except on a prima facie basis
• Even in HDFC Mutual Fund case, because information
was voluntarily shared with SEBI that SEBI was able to
investigate.
• How many mutual funds would keep or share records?
• Therefore the over reliance on compliance oficers
Need for removal of dependence on
Compliance Officers
• The Compliance officers of all organisations
are employees, who are doing their best
within what the contours of the organisation
permit
• Need to recognise this and remove the
onerous burden on compliance officers
• Every solution needs to be practical. SEBI cant
guarantee jobs for compliance officers in
India, neither can it reward them in India
What Solutions to the problem of
insider trading and front running
• SEBI gets notified for the purpose of phone tapping, which
the government ought to do
• SEBI has huge surveillance information and knows on a
prima facie basis where front running has occurred
• Shift the burden of proof in such cases on the organisation
to prove that there was no insider trading or front running.
Create a presumed guilty until proved innocent
• Create a separate whistle blower framework that ensures
secrecy and rewards. Of course how SEBI will ensure
secrecy in such a porous organisation is anybody’s guess.
Don’t mandate a compliance officer to act as a whistle
blower. Incentivise him.
In other words
• Battles are fought between equals
• SEBI should therefore not search for the
“bakra” to sacrifice when you cant catch the
kingpin
THANK YOU