A quarter century ago, when the capital market watchdog had just come into existence but there were no insider trading regulations, we used to joke that 90% of all trading in the stock market is based only on inside information. Even the last guy getting a hot tip on a long train commute to the Bombay Stock Exchange (BSE) thought he knew something that others didn’t. Even after the Securities & Exchange Board of India (SEBI) got its statutory teeth, I used to hear about this secretive group of chief financial officers (CFOs) of companies who met regularly at a Mumbai five-star hotel to exchange inside information.
In the past two decades, the rich and powerful have occasionally been nailed for insider trading; but, more often than not, they get away. During the many excesses of the United Progressive Alliance (UPA), a political columnist wrote a snippet about a Cabinet minister texting key government decisions to a television journalist even while the meeting was going on.
The Intelligence Bureau (IB) reported the matter to government when it noticed that the channel was breaking news on decisions even before the Cabinet meeting had ended. According to the column, the minister was so powerful that nobody dared to confront him; instead, it was decided to install jammers outside the Cabinet meeting rooms to prevent information leaking out. I later learnt that the minister’s cohorts tracked the channel in the knowledge that reports from that particular journalist were authentic and probably traded on the information.
In more recent times, Dilip Pendse, managing director of Tata Finance, was found guilty of insider trading in 2014, after a long legal battle. The company secretary of Jagran Prakashan and his wife were found guilty of profiting to the tune of Rs10.4 crore from inside information, in 2009. Even the venerable HDFC Mutual Fund was ordered to pay crores of rupees as fine, in two cases of front-running.
These anecdotes come to mind in the context a recent query by HDFC Bank to SEBI. The Bank wanted to know whether its employees, who are in possession of unpublished price sensitive information (UPSI) of the Bank or its clients and, hence, restricted from trading in the securities of these entities, could invest their money in the stock market through discretionary portfolio management schemes (PMS) where the client does not dictate the fund manager’s investment decisions.
Essentially, the Bank wanted to know whether its executives could avoid allegations of violative insider trading, if the portfolio manager bought or sold securities of companies where they had UPSI at a time when the trading window was closed for insiders. These executives, it said, would furnish declarations that they have no influence on the stock selection of the portfolio manager.
SEBI’s informal guidance was an unambiguously negative. It, correctly, quoted SEBI’s insider trading regulation (4)(1) to say that bankers could not escape the application of insider trading regulations even if they were clients of a portfolio management scheme. SEBI should be congratulated for such an unambiguous guidance and probably seeing through the nice big loophole that would open up in the difficult-to-prove insider trading regulations.
It must be noted that a SEBI committee, set up to update the insider trading regulations, had managed to insert precisely such an exception to exclude discretionary portfolio managers’ decisions, if they were made without reference to the client (unless circumstantial evidence proved a nexus between the portfolio manager and investor). SEBI seems to have shown rare wisdom by dropping this exception even while announcing the new insider trading rules. Hence, HDFC Bank’s subsequent request for clarity.
Now, consider what would happen if SEBI had accepted the draft regulations or offered a different guidance to HDFC Bank’s query. Insider trading is already extremely difficult to prove anywhere in the world, including countries where regulators can deploy money and technology and have the power to conduct wiretaps and to offer plea-bargains that allow them to let off the small fish to go after the big insider traders. Moreover, all the examples cited above, and scores of other cases investigated by SEBI, show that those in powerful and privileged positions, who have access to UPSI, are not above misusing it for some illegal profiteering.
Had SEBI allowed discretionary portfolio management to remain out of the purview of insider trading rules, it would inflict a nearly impossible burden on itself of proving insider trading through circumstantial evidence alone. Even if it were to cobble together a reasonable case, everyone accused of insider trading would quote SEBI’s informal guidance, to ensure that the watchdog is held to extremely strict proof that the accused had influenced the portfolio manager’s investment decision.
Knowing how hard that will be, any exception to SEBI’s insider trading regulations, or any guidance other than the one it gave HDFC Bank, would open the doors for misuse of PMS by all unscrupulous insiders. This is not an imaginary situation. One of the most famous insider trading cases is that of Robert Moffat, a former IBM executive who admitted to providing inside information to Danielle Chiesi, a consultant of Newcastle Funds with whom he reportedly had an intimate relationship. That is the case which also implicated Raj Rajarathnam of Galleon Funds, who is serving out a long prison sentence.
SEBI’s own investigations have also shown that some foreign ‘institutional’ investors are individual portfolios for the super-rich brought in disguised as an institution. What would stop a group of executives from ensuring that a discretionary PMS is actually limited to a buddy-group? The possibilities of misuse are endless and SEBI hardly has the capability, or the manpower, to track it.
Let us also not forget that the PMS business in India is run by bankers, brokers or mutual funds, who operate in a fairly incestuous set-up. They have constant dealings with one another (socially and professionally), making it even more difficult to prove any charge of insider trading, unless there is a sting operation of sorts.
SEBI’s guidance has put the burden of following the letter and spirit of its regulations squarely on corporate insiders. This is how it should be. Yes, it is possible that senior corporate executives and top bankers will not be able to avail the services of a discretionary portfolio manager; but so what? These are financially savvy individuals (minimum investment in a PMS is Rs25 lakh) who are more than capable of managing their own portfolio. Most of them are people who earn eight-figure salaries and, probably, have stock options whose value runs into nine and ten digits. They are smarter than the average portfolio manager and the small restriction on their investment options is not something that should make our hearts bleed in sympathy, given the enormous scope of misuse.
At a time when retail investors are slowly regaining confidence in the capital market mainly by routing investments through mutual funds, SEBI needs to ensure that it provides a fair and level playing field to investors, not one which allows powerful corporate insiders to get a near carte blanche by routing trades through a portfolio manager.