04 December 2008

Insider trading becomes outsider trading

The Securities and Exchange Board of India (SEBI) has recently amended the insider trading regulations. The two key amendments are:

1. Broadening of the definition of the term 'insider' to include anyone who has 'received' inside information.

2. Prohibition of trades by a designated insider within a 'swing period' of 6 months. In other words, corporate directors and officers cannot sell shares for a period of 6 months after buying. There is also an absolute prohibition on such persons from entering trades in the derivatives segment in the company's shares.

Both provisions are overly broad. I will write a detailed post on the first point later as the change marks a shift in the entire philosophy of insider trading in India and converts insider trading into insider and outsider trading.

The second amendment is an extreme version of the 'short swing profit' rule which I had advocated. The short swing profit rule, in existence in the US markets makes designated insiders like directors and senior officers hand over any profit they make to the company if the buy/sell occurs within a six month period. This and several other amendments to the regulations were proposed by me based on my IIM, A working paper written in 2003 available here. It imposes a strict liability on insiders without any need for proof of guilt. Conversely, the payment does not imply a guilt as the rule is a strict liability clause and only requires a designated insider to hand over profits to the company whether he/she was in fact in possession of price sensitive information or not. Based on the working paper, SEBI had put out a draft for public comments for short swing profits and other amendments.

The amendment carried out takes this principle to absurdity (and a wholesale departure from the papers for public comments) and wholly prohibits all trades by insiders for six months after purchase. I'm fairly sure no other jurisdiction goes to such extreme lengths to wholly outlaw officers from trading in such a large window. Clearly, this is a poorly thought out regulation, hazy in philosophy and extreme in execution.

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