Why SEBI is Failing at Regulating Insider Trading in India

[Bhavya Bhandari is currently pursuing an LLM. in Corporation Law at NYU School of Law. She can be reached at [email protected].

The Indian securities market regulator has been criticized in the last two decades for its failure to investigate and prosecute perpetrators of insider trading. Even when the perpetrators are caught and punished, the penalty is often so low that the regulations have lost any deterrent effect they might possess. This post highlights some of the reasons behind the low rates of investigation and prosecution of insider trading offences in India]

The SEBI (Prohibition of Insider Trading) Regulations, 2015 (like the erstwhile 1992 versions of the regulations) intends to regulate the rights of insiders to trade in the stocks of their company, not to banish them completely from holding and selling any stocks in their companies. This seems logical – barring them would be too harsh, and will also promote devious practices at the expense of outside shareholders. Whether this approach has worked is questionable however; insider trading continues to be rampant in India, much to the chagrin of Indian and foreign investors.

The Securities and Exchange Board of India (SEBI)e has investigated a number of insider trading cases in the last two decades, but has achieved a low rate of successful convictions. The process of investigation is also often too slow. The table below sets out the number of insider trading investigations SEBI initiated and completed between 2010-15:

Recently, a new scandal emerged to the limelight: Reuters reported that WhatsApp group chats had been used to circulate (surprisingly accurate) unpublished price sensitive information (UPSI) relating to the quarterly numbers of at least 12 companies, just a few days before the public announcements of the numbers. These leaks pertained to the financials of big companies – such as Dr. Reddy’s Laboratories Ltd., a pharma company with a large market cap. SEBI is now investigating the matter, but this has led to renewed criticism about the regulator’s laxity in investigating and prosecuting insider trading matters in the last two and a half decades. Reportedly, SEBI has used its search and seizure operations (which it seldom does) at around 34 locations in its efforts to investigate the WhatsApp leak.

So, what are the solutions? Should the law be amended to prohibit an insider from trading in the stocks of a company altogether? Or do the problems lie not with the regulations, but their implementation? Has SEBI been too soft in investigating and prosecuting insider trading offences, thus causing companies to take the regulations too lightly? Or does it lack the necessary powers and tools to catch the offenders?

SEBI’s low rates of successful investigation and conviction of insider trading cases could be due to a combination of these factors:

1. SEBI was only recently granted the power to call for phone records of suspects under investigation:

Insider trading is tough to detect and punish in any jurisdiction as it is, but the fact that SEBI has not been empowered with some basic investigative powers and tools is a major reason behind the low prosecution of insider trading cases even while it is widely acknowledged that insider trading is ‘deeply rooted’ in the Indian stock markets. SEBI even lacked the basic power to call for phone records until recently. A huge Ponzi scam (Saradha scam) in 2013 resulted in the Indian government urgently passing the Securities Laws (Amendment) Second Ordinance, 2013 permitting SEBI to call for the phone records of persons under investigation.[1] The Ordinance was formally adopted by the Parliament through the Securities Laws (Amendment) Act, 2014 (with retrospective effect from the date of the Ordinance) in 2014.

Up until the Ordinance in 2013, call records could not be obtained by SEBI under any circumstances. It is unfortunate that the Government waited until a huge scandal like Saradha, where around USD 6 billion was illegally mobilized from investors, to take this step. Without having had the ability to call for the phone records of suspects until recently, the regulator may have had its hands tied at the time of investigation in collection of evidence. The only way SEBI could go after suspected offenders then was by analyzing their trade patterns on the stock market, but many offenders found a way out of this by trading in the name of dummy companies. Many of them continue to trade in the accounts of their relatives and friends as well. The new power of SEBI to call for phone records was challenged (on the grounds of violation of right to privacy) before the Bombay High Court in 2014, but the Court ruled that SEBI has the power to call for phone records under the SEBI Act, so long as it is called as a part of a genuine investigation and not a ‘fishing’ enquiry. Hopefully, SEBI will now utilize this newly granted power to the fullest.

2. SEBI lacks the power to wiretap phone calls:

SEBI does not have the power to wiretap phone calls, a crucial tool used by other jurisdictions such as U.S. in obtaining evidence against insider trading suspects for the purposes of investigation and successful conviction. This power was denied to SEBI on the grounds of ‘misuse’. Currently, the Indian Telegraph Act, 1885, governs wiretapping. On the other hand, the U.S. Securities and Exchange Commission (SEC) unearthed crucial evidence by wiretapping the conversations between Raj Rajaratnam and Rajat Gupta, which ultimately led to their conviction.

3. SEBI has not utilized its existing powers and penal provisions to their fullest capacity:

In some ways SEBI has more powers than the SEC, but it has failed to utilize it to the fullest. While it is fair that SEBI has demanded additional powers from the Government to conduct searches and seizures, obtain call records, wiretap suspects, etc., a look at the existing cases reveal that SEBI has failed to utilize its existing powers to the fullest. Take for instance, SEBI’s powers to levy a penalty. As discussed, SEBI has the power under section 15G of the SEBI Act to impose a penalty of up to INR 25,00,00,000 (approximately USD 3,905,000) or three times the amount of profits made, whichever is higher. However, the maximum penalty SEBI has ever imposed is only INR 60,00,000 (approximately USD 94,000). There is no reasonable explanation for this. Also, SEBI has the power to petition before a criminal court and institute criminal proceedings against a person. If convicted, the person can be imprisoned for a period of up to 10 years. However, no one has ever been sent to prison for insider trading, even in the fairly big cases.

4. SEBI does not have the human resources to conduct a thorough investigation:

It has been a long-held belief that SEBI with its 780 odd employees has too much on its plate to handle. That is one employee for every six companies listed on the Indian exchange, while the SEC has fifteen times the number of employees (and one for every company listed on an American exchange). That, coupled with the fact that insider-trading cases are tougher to investigate, and its offenders harder to convict, especially without technologies such as wiretapping to aid, may have caused SEBI to prioritize other investigations over insider trading investigations. SEBI has recently stated that it will hire more staff to address these issues.

In conclusion, it appears that while SEBI does not have some powers (or only received them recently) that are vital to investigate insider-trading violations, SEBI has also failed to utilize all of its powers. In addition, the Government must consider granting wiretapping powers to SEBI. SEBI must also utilize the powers it has received recently, such as its power to review any phone records, and its widened search and seizure powers, etc. to improve its rate of investigation and successful conviction.

– Bhavya Bhandari

^[1] SEBI Act, Sec. 11(2)(ia).