Trading in inside information

The SEBI decision has opened a pandora’s box of controversies. Backed by a financial power of its own and its parent, the Anglo-Dutchmultinational, Unilever, HLL went on an offensive and called SEBI’s decision unfair and promised to take the case to the highest court of the land. Not only this, in the 120-year old history of the Bombay Stock Exchange there were several cases of insider trading where general investors were taken for a ride. “The culprits went scot-free in the absence of clear-cut regulations and laws. Sebi itself came into existence only ten years ago,” said a BSE director, adding, “there is a need to evolve proper corporate governance.”

As in any case, legal opinion in India is divided over the charges (in HLL’s case, Sebi said HLL did insider trading by buying the shares of Brooke Bond Lipton India before the latter merged with HLL. The beneficiary was Unilever which managed to retain the 51 per cent stake in HLL after the merger) and the subsequent penal action taken by the SEBI. While the former chief justice of India, P N Bhagwati hired by HLL itself gave a clean chit to HLL and its directors, other corporatelawyers say SEBI has finally taken a `watershed’ decision to regulate and discipline a market which was showing no signs of self-restraint. The SEBI verdict clearly identified HLL’s follies and gave a verdict which would be quoted extensively in the years to come, corporate lawyers said.

One of the most interesting aspect of this particular case is that both the SEBI and the US Securities and Exchange Commission (SEC) have defined insider as a person and not as a company. This is turning out to be the main defence of HLL. In a query made by HLL, Justice Bhagwati said that HLL could be said to be an insider within the meaning of the definition only if HLL being a person deemed to have been connected with BBLIL. According to him, HLL had access to the information as it was a party to the agreement and could hence not qualify as an insider.

With HLL’s aggressive outburst against the SEBI verdict, experts say this case would be finally settled only in the highest courts of the land. Says a Mumbai-basedcorporate lawyer: "As HLL is the first case in the country where action has been taken for insider trading, it will take years to really prosecute them, considering the slow legal process in the country."

According to the Sebi regulations, an insider is defined as "any person who is, or was connected with the company or is deemed to have been connected with the company, and who is reasonably expected to have access, by virtue of such connection, to unpublished price sensitive information in respect of securities of the company, or who has received or has had access to such unpublished price sensitive information".

Similarly, the US SEC defines insider trading as a fraud committed either by company officials, their relatives or by the government officials who may have inside information about a company because of the post they held. Nowhere SEBI or SEC define an insider as a company where HLL is taking its shield. The SEC has initiated prosecution in various federal courts against many `insiders’ and`tippers’ for fraud. "We have taken extensive help from US SEC and referred at least ten cases before we took any action against HLL… the company’s defence was extremely weak," said a top SEBI official involved in the investigation. "In the US by now they (the company officials) would have been in jail," said an international corporate lawyer.

“SEBI’s order is a quasi-judicial one and the facts are complicated. Only the courts can decided the fate of this case. However, the SEBI’s action in the HLL case reflects that the the regulatory body is serious in enforcing regulation, which is a very good sign,” said Ashok Pratap, senior corporate lawyer.

Company lawyers say the regulatory body has a strong case as the Section 11 of the Sebi regulations on insider trading is quite clear. It says: "On receipt of explanation from the insider, Sebi may give such directions to protect the interest of the investors and in the interest of the securities market and for due compliance with the provisions of the Act,as it deems fit for the following purposes:

These three directives in the present case are redundant as the securities in question, Brooke Bond Lipton India’s shares bought by HLL from UTI does not exist any more as the company has been merged with Hindustan Lever. Likewise, the directive of prohibiting the insider (HLL in this case) to dispose of securities is also not feasible any longer. It is for this reason, Sebi officials said, the verdict has had to depend on invoking section 11A and 11B of the Sebi Act.

Section 11 A of the Sebi Act gives powers to Sebi to frame regulations for the protection of investors on matters relating to issue of capital transfer of securities and other incidental matters and the manner inwhich such matters will be disclosed by the companies. Section 11B, on the other hand, outlines the power to issue directions.

Seeking more clarity in the insider trading rules, Bhagwati says the definition lacks in clarity and therefore it ultimately depends on the interpretation of the law to determine whether or not a company in its capacity as a principal party can be termed as an insider. This has raised questions on whether or not changes need to be brought into the regulations on the subject to make them more effective. Sebi officials say the regulator would at a later point of time suggest changes in the regulations so as to nab more efficiently the growing tribe of white collar criminals.

Sebi, on its part, seemed to have set a tough standard with its HLL verdict. There are hundreds cases of violation of laws by companies, promoters and market intermediaries. Investors, who always end up being short-changed, expect tough action from the Sebi in other violations as well. They also expectcompanies to evolve a code of ethics for governance, especially in financial matters.