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CATCH ME IF YOU CAN!

Floating like a butterfly and stinging like a bee habitual punters with the right dose of guile and guts slip information and trespass insider trading norms with impunity and rob the investing public.  
Insider trading has suddenly become headlines news in India not because SEBI unearthed and prosecuted high profile perpetrators, but the new case of Galleon that SEC is relentlessly pursuing has a few high profile Indians as defendants in that case. 
Insider trading of a prohibited variety is a financial crime. Yes there is a permitted variety which is legal where corporate insiders like officers, directors and employees buy or sell stocks of their own companies within the regulatory framework for such trades. According to SEC one must follow the "disclose or abstain rule". Therefore, insiders who are in possession of material non-public information must disclose before trading or refrain from trading until the information is publicly circulated.
The simple principle of prohibited insider trading is that it is detrimental to market integrity. The rule enunciated by Courts in the US is that “no one should be allowed to trade with the benefit of inside information because it operates as a fraud on all other buyers and sellers in the market” 
The court further laid down that "the undisclosed misappropriation of confidential information in violation of a fiduciary duty...constitutes fraud akin to embezzlement “ 
Many of the insider trading prosecutions by SEC also included directors, auditors, in-house counsel and audit committee members. Prosecution included allegations that a board member who was privy to a potential acquisition erred, an attorney who was involved in the due diligence of the deal slipped vital information, an audit committee member tipped his close friend on earnings shortfall of the company, a general counsel of the company traded on insider information, two former auditors were caught for trading in shares of audit clients and the list goes on. 
The Oscar winning movie “Wall Street” was modelled after Ivan Boesky, the world’s most (in) famous arbitrageur who was on the cover page of the Time magazine in 1986. He illegally obtained tips about mergers on the horizon through a network of contacts and began trading before mergers became public knowledge. He made several hundreds of millions most of which he lost as fine to SEC and then spent a prison term for about two years. Who knows twenty three years later the TIME magazine may put the Galleon fellows on their cover. (For the Time Magazine cover and the story check http://www.time.com/time/covers/0,16641,19861201,00.html)

In an interesting case Chiarella v. United States, a financial printer’s conviction that he misappropriated non-public information on a certain merger from documents given to him for printing and used it for his gain was reversed by the Supreme Court. In response to this decision, the SEC plugged the rules. Printers who are privy to such non public information could well be soft targets by the operators who are sly and have the nerve. I am not aware if any printer has been caught again for insider trading. I mean in the US.

In India, the Securities Exchange Board of India (SEBI) has the power to prosecute offenders who violate the provisions relating to insider trading and who deal in securities in contravention of the provisions of the regulation. It is interesting to note that the Board has the right to investigate suo motu upon its own knowledge or information in its possession to protect the interest of investors in securities against breach of these regulations. Schedules I & II of these regulations have certain model code of conduct and disclosure practices that are required to be followed by a number of specified parties and that list includes all the professional firms such as auditors, accountancy firms, law firms, analysts, consultants, etc., assisting or advising listed companies.  
Professional firms that do legal services, due diligence work, internal audit, statutory audits, consulting work for mergers and acquisitions, valuations etc. all have potentially price sensitive information and it is naive to assume that there are no punters or their friends in and around these entities who scavenge for sensitive information from willing employees. 
 
The SEBI regulations make a mention of the so called Chinese wall (it is considered a legal flotsam and now a day’s the term is ethical wall or screening devices). This wall has pores and is farcical in today’s world of high tech communications and loose data protection laws in the developing world. The decision in the famous case of Chinese wall in Brunei – Prince Jefri Bolkiah Vs KPMG gives an interesting insight into the world of conflicts of interest and confidentiality. 
 
The prevention of insider trading is widely treated as an important function of securities regulation. It is one thing to have a set of regulations in place yet another to have the skill, will and the means to implement them to protect investors. 
 
Unlike anywhere else in the world, the US regulations on insider trading and their knack to prosecute offenders by peeling layer after layer of evidence are remarkable. It is reported that in 2008 alone there were more than 600 enforcement actions by SEC. It dedicates over 60 percent of its resources each year to the enforcement and examination programs. Last year its enforcement complaint centre handled over 600,000 tips sent by individuals. In spite of all these persistent efforts, SEC is still under fire for many scandals in the US including the Madoff Ponzi Scheme. With dwindling workforce (it has some 3500 staff!)and surging work load, SEC is demanding more budget allocation from some $900 million now to about 1.2 billion dollars annually.  
Compare this to what SEBI has, just 615 staff ( about 25% of which are secretaries and other staff) to deal with multifarious activities that it does with stock exchanges, stock brokers and sub-brokers, mutual funds, venture capital funds, portfolio managers, not to speak of dealing with a vibrant investing population that relies more on tips and tippers than anything else. Its 2008-09 annual report is yet to be published on its website and for 2007-08 it recorded a fee income of just under Rs.400 Crores that is some $ 85 Million.
 
As on 31st July 2009, as per SEBI’s website, the list of prosecutions launched across the country since December 1994 is a meagre twelve violations on insider trading.  This is dismal performance and all those who get away with slipping insider information and those who merrily use them will laugh at this. It is time SEBI got some serious funding to acquire appropriate technologies and talents. It must enhance its monitoring mechanisms to garner its own intelligence to initiate suo moto action as proclaimed in regulation 5(2)(b). Simply updating these rules and regulations now and then may be of no use. It should get high tech and partner with professionals to use appropriate data mining, analytics and surveillance tools to detect and prosecute operators that are suspected to be involved in insider trading. With a whopping 25 crores penalty that it can impose, the investment in skill and technology will pay handsome dividends.
 
As an ounce of prevention to start with can SEBI simply ask all the entities it has listed in regulation 12(1) to publish in newspapers on the last of February every year that such entities are in full compliance of these codes? Let the intermediaries, asset management companies, trustees of mutual funds, the self regulatory bodies, the recognised stock exchanges and clearing house or corporations, the public financial institutions and the professional firms such as auditors, accountancy firms, law firms, analysts and consultants do a self assessment and state publicly that they are in fact compliant with the regulations and then let SEBI do a random audit. This will ensure that such firms take these codes seriously and monitor violations. Perhaps some punters are not sufficiently afraid as yet. 

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