Author: Ria R Nair
Emerging capital markets need an effective and flexible regulatory mechanism that is capable of dealing with financial innovations and systemic risks thereby balancing financial development and broader financial inclusion. For such financial stability and economic growth, direct control by the regulatory authority backed by the letter of regulation has been the way forward in most of the countries. The development of securities market in various countries was struck by similar impediments which led the evolution of legal framework to mitigate these issues and to safeguard the interests of the players. This blog deals with the analysis of the structure of the legal system developed by India and USA to alleviate the systemic problems in the securities laws. It also chalks out the differences between the implementation of the established legal mechanisms.
The Need for Securities Regulation
The economic scenarios in the developing countries faced the brunt of financial malpractices due to lack of regulatory framework to deal with such issues and their impacts. The 1929 stock market crash witnessed by USA was believed to be caused due to irresponsible financial practices and in response to diminish the effect and resolve the unrest amongst the people the Securities Exchange Act 1934 (hereafter mentioned as “SEA 1934”) was enacted by the President Franklin D. Roosevelt’s administration. The Act was created to govern securities’ transactions on the secondary market, after issue, with an aim to ensure greater financial transparency and accuracy and less fraud or manipulation. To boost fairness and investor’ confidence, the Act also established the Securities and Exchange Commission (SEC), giving it broad powers to regulate various aspects of the secondary market, including powers to impose civil penalties such as fines and injunctions, and initiate criminal action against the market participants who have defrauded them. The Indian securities regulations also resorted to the formation of a regulatory body to overlook the various activities of the securities market. However, its regulatory body is watchdog for both, the primary and the secondary markets in India, unlike the USA framework.
The financial market in India was highly segmented until the initiation of reforms in 1992-93 on account of a variety of regulations and administered prices including barriers to entry. The reform process was initiated with the establishment of Securities and Exchange Board of India (hereinafter “SEBI”) by the Union Government promulgating the Securities and Exchange Board of India Act 1992 (hereafter mentioned as “SEBI Act 1992”), forming an autonomous body with statutory powers. Prior to the establishment of SEBI stock exchanges were under the administrative control of the Stock Exchange Division of DEA. The stock exchange division was responsible for the administration of the Securities Contract Regulation Act, 1956 which governed the business of buying, selling and dealing in securities. The mobilization or issuance of capital through the public securities market or otherwise was controlled by the Controller of Capital Issues (CCI). The net result of the CCI regime was that it (i) impeded resource mobilization (ii) led to unhealthy administrative practices (iii) resulted in the inability of the system to cope with the increasing resource mobilization load (iv) led to the development of a “grey” market and consequent unhealthy developments in the capital market and (v) paid little or no attention to development of market institutions. Hence, necessitating the formation of an autonomous body to overlook the emerging issues concerning the securities market.
Challenges faced by the Capital Market
The issues looming over the developing securities market were the risk of insider trading, selling unregistered stocks, stealing consumer funds, manipulating stock prices, disclosing false financial information, breaching broker-customer integrity and other practices that hamper the financial stability and faith in the securities market. Therefore, regulation mandating all listed companies to adhere to the stipulated guidelines was imperative to monitor and regulate the securities market while ensuring to protect the interests of the investors. While discussing the impacts of these enactments we will primarily look into the extent of the legislations with regards to these issues and later assess their influence on them.
The SEA 1934 has specific sections for conferring liability on traders for insider trading and initiation of civil penalties against them. It also explicitly prohibits the manipulation of security prices and imposes liability for publishing misleading statements. The Act also makes it obligatory on the listed companies to publish all the information regarding the securities and highly restricts any use of manipulative or deceptive means under the Act. The SEBI Act 1992 however speaks directly regarding the prohibition of manipulative and deceptive devices and does not have separate section for the other practices as mentioned in the SEA 1934. It includes provisions regarding insider trading and substantial acquisition of securities or their control and penalizes insider trading by imposes penalty for fraudulent and unfair trade practices but has proved to have had strikingly low rate successful convictions for the same.
The SEBI (Prohibition of Insider Trading) Regulations, 2015 (hereafter called “the Regulation”) was proposed as a systematic law which intended to effectively regulate the right of insiders to trade in stocks and shares of their own company and to rectify the inefficiency that exists. The Regulation clearly defines the act of communication of unpublished price sensitive information (UPSI) would amount to insider trading as “illegal”, however it has not been direct while imposing liability on the persons concerned. The mere textual reading of Regulation 3 and 4 clearly indicated that communication of UPSI would amount to insider trading. However the SEBI 2015 Regulations, categorize such communication to be “illegal”, they have not been acted upon by the regulator to impose liability on any person. Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, lay down the law regarding insider trading, where a corporate insider possessing “material non-public information” trades in securities. The above provision has also been understood in such a way that even an “insider” who “tips” someone else to either buy or sell some shares shall be guilty of the offence of insider trading. Hence, the “tipper” and the “tippee” both may be held guilty of insider trading. The tipper and tippee relationship is more often than not based out of pecuniary/personal benefits that the tipper would receive for providing the UPSI, yet the United States has also forgone this requirement of a pecuniary/personal benefit to the tipper in order to have stricter restrictions on the mere exchange of material non-public information. The case of Salman v. U.S. the U.S. Supreme Court put to rest the above pecuniary benefit requirement which was put forth in Dirks v. SEC, and held that gifting of personal benefit to relatives shall impute a personal benefit and that does not necessarily mean it must be monetary. If such interpretation was to be applied in the Indian scenario not only would it be the complete realization of powers by SEBI but also the effective mitigate the problem of insider trading. The SEBI has effectively diluted the application of insider trading norms and set a much higher prerequisite to be met before any actionable claim be brought forth against any offenders by keeping a window open for interpretation of the statutes.
In letter the SEBI has more powers than the SEC, but its inability to investigate and impose penalties to limit of its potential has lead low prosecution even though it is widely acknowledged that major financial systemic issues are deep rooted in the Indian stock market. The SEBI has demanded additional powers from the Government to conduct searches and seizures, obtain call records, wiretap suspects, etc., however it has not used the powers conferred upon it, such as to impose penalty up to INR 25,00,00,000 (approximately USD 3,905,000) or three times the amount of profits made, whichever is higher by limiting its maximum imposition till date to INR 60,00,000 (approximately USD 94,000). 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. This clearly shows the laxity on the enforcement of the powers vested with the regulatory authorities in India to restrain the use of unfair trade practices and maintain financial clarity to all the players. The US enactment invites both civil and criminal penalties to prevent the unfair use of inside information, depending on what statutes a trader is found guilty of violating. The penalty can be up to three times the profit gained or loss avoided, however, willful violations of other provisions, such as Section 10(b), the general antifraud securities statute, may result in other significant penalties which include fines up to $5 million and/or imprisonment up to 20 years; a business may be fined up to $25 million. This shows that the investigation regime of the SEC exercises its powers in the rightful manner so as to initiate action and impose significant fines in its quest to discipline the actions of the players involved in their financial market.
Author: Ria R Nair is student of Amity University, Mumbai. Currently she is researcher at the Indian Society for the Legal Research. She can be followed on LinkedIn.
 The necessary paradigms are still evolving, although there appears to be a general consensus on some key principles that will be central to a major redesign of financial regulation. Financial Market Regulation and Reforms in Emerging Markets, Masahiro Kawai, Eswar S. Prasad ISBN 978-0-8157-0489-8.
This aspect have been primarily governed through the Disclosure and Investor Protection Guidelines, 2000 (DIPG).The current version DIPG 2000 has also been amended a large number of times, making the DIPG one of the most dynamic pieces of SEBI’s regulations.
Section 20A of the Securities Exchange Act, 1934.
Section 21A of the Securities Exchange Act, 1934.
Section 12A of the Securities Exchange Board of India Act 1992.
Section 15G of the Securities Exchange Board of India Act 1992.
Section 15HA of the Securities Exchange Board of India Act 1992.
Salman v. U.S., 137 S.Ct. 420, 196 L.Ed.2d 351 (2016).
Dirks v. SEC, 463 U.S. 646 (1983).
The SEC typically seeks the civil penalties, and the Department of Justice typically seeks the criminal penalties.