Insider trading laws should not become a booby trap

I have written a piece in today's Economic Times on the new insider trading regulations. It hasn't appeared in all editions (at least in the Ahd edition), so here it is in full:

Insider trading laws should not become a booby trap
8 Dec 2008
The recent amendments to insider trading laws—brought about by SEBI—turn the law on its head.
The two key amendments are an expansion of the definition of insider trading, to convert insider trading to outsider trading. The other amendment creates a bar for insiders from trading in their companies’ shares for six months after the first leg of the buy/sell trade. Both are extreme measures, nearly unrivalled in their scope anywhere in the world.

The first is the modification of the essence of insider trading. Insider trading as existed last month penalised the misuse of non-public price-sensitive information by fiduciaries of the company, who have access to such information, and, in breach of their trust owed to the company, use it for private gain— of course at the cost of other shareholders. Fancy economists call this ‘exploitation of information asymmetry’. This breach continues if the insider gives the inside information to friends or relatives in what is known popularly as tipping of information to ‘tippees’.

The amendment extends the insider trading regulations, with a shift of some commas and clause repositioning, to include ‘any person who has received or has had access to such unpublished price-sensitive information’. Previously, this class of persons was only limited to those connected with the company.

So, now anyone who chances across price-sensitive information can be liable for insider trading. Thus a person who recycles paper from the trash of a listed company, or a journalist who actively attempts to uncover fraud, also becomes an insider as opposed to only officer/directors/fiduciaries and their tippees as previously existed.

If you think these cases are hypothetical and very unlikely to be prosecuted by SEBI, just look at the shameful example of Dirks in the US. Dirks, an analyst and an (temporary) investigative journalist who actively uncovered a massive fraud in a company and communicated this fact to his clients, was hauled up by the SEC for insider trading. The US Supreme Court had to finally rescue Dirks in a landmark case of Dirks vs SEC.

Even on first principles, to equate an outside-person—who chances upon inside information—with an insider (or tippee) is wrong. It is analogous to equating a bank robber with a person who chances across a hundred-rupee note on the street. While picking up that note may be unfair and morally wrong, it is certainly not deserving of the same penalty as that given to a bank robber. It is also wrong because it causes honest people to be caught in the web of the regulations even though they are acting in the interest of society in uncovering fraud.

To be sure, some odd jurisdictions have this kind of liability imposed on outsiders, commonly called the ‘possession theory’ of insider trading, though for the reasons cited, I find the regulation wholly unacceptable.

All aside, this amendment was brought without consulting the public and experts through a paper exposed for comments. I recall, as head of the legal affairs department of SEBI, I took relatively minor amendments, ironically to the insider trading regulations, to the Board, and was told in no uncertain terms that they would like the changes first to be exposed to public comments howsoever minor they may be. In any case, I guess, this is a law which we’ll have to now live with.

(The author is a faculty at IIM, Ahmedabad and was an ED at SEBI previously)

Link to article.

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