59) Another step towards tracking the ‘insider’

SEBI’s latest proposal to deal with the problem of insider-trading is fair and refreshingly simple.

The Japanese, with their fierce sense of commitment and loyalty to the organisation they are associated with, were ironically blasé about insider trading as typified by the general response to the law brought in 1988 in Japan to tackle the menace — what is wrong in being smart?

Equally ironical is the assiduity with which insiders are pursued in the US. A journalist was hauled over the coals there for making a fast buck out of the information she garnered during the course of analysis of a company.

Thin dividing line

While the line between crookedness and smartness may be thin, insider-trading cannot be allowed to go through as it would often be at the expense of those who did not have the price-sensitive information the insiders had.

The Securities and Exchange Board of India (SEBI) in its consultative paper on the issue brought out on New Year’s day has proposed to deal with the problem of insider-trading in a refreshingly simple manner.

The designated insiders, which would include all directors and officers of the company, and those who hold more than 10 per cent of the equity of a company will have to disgorge the profits to the company arising out of sale of shares they have made within six months of acquiring them.

No mens rea needs to be established. The fact that they were insiders and made profits in a short swing operation gives rise to the obligation to disgorge, period.

Fair enough, given the fact that those with long-term outlook are expected to hold on to the shares for a longer term. That they have resorted to short-termism, as it were, is enough to pin them down.

It is not clear though how a 10 per cent shareholder ipso facto becomes an insider unless he gets a seat on the board of directors.

On this touchstone, many FIIs operating in India could be insiders and their activities hamstrung should the regulations go through as they are.

Unwittingly perhaps the regulations are going to force FIIs to have a longer term perspective on their investments in India and should this happen the stock market may become a quieter place.

A few glitches

While the proposed new dispensation seems to be fair, there are a few minutiae that need to be addressed. The consultative paper proposes to follow the Last in First out (LIFO) principle for finding out whether a share was sold within six months of its acquisition. Let us say 10,000 shares of a company were acquired by the designated insider on January 1 and another 10,000 shares of the same company were acquired by him on May 4 of the same year. On June 29 and July 2 respectively of the same year, he sells these two lots and profits from both.

Now, according to the proposed dispensation, the profit from the first sale would have to be disgorged, hit as it is by the LIFO principle and the profit from the second sale will not have to be disgorged as it is saved by the LIFO principle — separation of buy and sell by more than six months. Had FIFO been the norm, both would have been caught by the new SEBI pincer on the anvil.

It is noteworthy that SEBI sets store by the LIFO principle whereas its counterparts in the Ministry of Finance, while drafting Section 45(2A) of the Income-tax Act, have set store by the FIFO principle for calculating capital gains on shares held in the depository mode.

A case can be made that relatives of auditors (auditor himself can hold shares in his client company only at the risk of attracting disqualification under Section 226 of the Companies Act), officials of SEBI, banks and financial institutions are also brought within the purview of the definition of ‘designated insiders’ irrespective of the quantum of shares held by them as they are also privy to price-sensitive information.

There is a view that the designated insiders would bide their time — let six months pass — before booking their profits a la investors who wait for a year to pass before selling so as to clothe their profits with the long-term capital gains tag in order to escape tax.

But this misses the point — while other investors can afford to wait for a year, an insider brooks no delay. Quick disposal is of essence to him as making a fast buck is what insider trading is all about.

Benamis roped in

The regulator however, may have a challenging job on hand. It has to keep an eagle eye on the designated insiders because there would always be temptation to make a fast buck based on inside information through the services of benamis.

To the credit of the draft regulations, it must be said that benamis are also being roped in — both independent operations and operations in concert with others on the part of the insiders would come under the regulations’ purview.

But then benami has always been the bane of this country and successive governments have shied away from taking a call on implementing the law on the issue gathering dust for about two decades now perhaps for the fear of stirring the hornet’s nest or out of the depressing realisation that the governmental machinery is not strong enough to establish benami ownership.

It remains to be seen how SEBI implements this law. The institution of benami could well frustrate it.

S. Murlidharan

(The author is a Delhi-based chartered accountant.)