Blowing The Whistle On Insider Trading

A robust insider trading law that is effectively enforced constitutes an essential precondition for the preservation of market integrity. India’s market regulator, the Securities and Exchange Board of India has taken giant strides in bolstering the substantive regulations on insider trading. However, it has enjoyed mixed success in enforcing these regulations. One can attribute such a disposition to, among other things, the lack of effective enforcement tools in the regulator’s hand. The fact that direct evidence in insider trading cases is rather elusive compounds the problem, and reliance entirely on circumstantial evidence can often be inadequate in successfully bringing insider trading cases before the Indian courts and tribunals.

Precisely with a view to vitalise its enforcement apparatus, SEBI has initiated a public consultation on the need to establish an informant mechanism. This would encourage individuals with information regarding potential violation of the insider trading regime to report such instances to the regulator in a “timely, safe and open” manner that would guard against victimisation of the messenger. Through this, SEBI hopes to achieve early detection of insider trading cases and greater enforceability of its regulations. While SEBI’s intentions are laudable, its success with such a mechanism would depend upon a number of institutional and practical factors.

To begin with, while the concept of such a whistleblowing set-up is not new to the Indian securities markets, the present informant mechanism introduces significant shifts in approach.

Take The Matter To SEBI

First, the whistleblower regimes prescribed under the Companies Act, 2013, and SEBI’s listing regulations provide for an internal mechanism for receipt of information regarding unethical behaviour or violations of the law by a company’s management or employees. Typically, the audit committee and its chairperson bear responsibility for receiving and appropriately dealing with such information provided by informants. Accordingly, companies have the obligation to establish and communicate appropriate internal mechanisms to deal with whistleblowing. SEBI’s new proposal extends matters further.

Whistleblowers must pass on information regarding wrongdoing to SEBI by effectively bypassing the company’s management. This is beneficial as it limits possible victimisation of the informant, but it also reduces the opportunity for companies to take on board early warnings to prevent further wrongdoing.

Whistleblower Bounty: Double-Edged Sword

Second, the whistleblowing mechanism currently in vogue does not stipulate financial incentives to the informant when the whistleblowing results in successful actions against a wrongdoer. Thus far, SEBI has steered clear of a reward or bounty system that is prominent in other jurisdictions. Now, however, SEBI appears to have capitulated, as the discussion paper recommends a monetary reward of 10 percent of the monies that SEBI collects through disgorgement, subject to a maximum of Rs 1 crore. Moreover, the rewards are available only for significant actions that result in disgorgement of at least Rs 5 crore, and not for actions below that limit. Clearly, the reasoning is that financial incentives will motivate individuals within or outside companies with the relevant information regarding insider trading to pass on that information to the regulator.

Although SEBI’s approach in using a bounty system will likely augment its enforcement initiatives, its success lies in the regulator’s ability to weed out genuine and useful information from the inane and futile.

Leaf Out Of U.S. SEC’s Playbook

This leads to the third factor, namely regulatory capacity. SEBI proposes to set up an independent Office of Information Protection, which will be independent of the investigation and inspections arms of the regulator. The OIP is said to “serve as a medium of exchange” between the informants or their legal representative on the one hand and the SEBI board on the other. The purpose of creating such an independent body is to not only properly channel the flow of information, but also protect the identity and interest of the whistleblower. The reasoning is noteworthy, but its success ultimately lies in how SEBI supports the OIP through appropriate resourcing measures.

In proposing the informant mechanism as well as the establishment of the OIP, SEBI has clearly taken a leaf out of the book of the U.S. Securities and Exchange Commission. Nearly a decade ago, after calls for greater regulation besieged U.S. lawmakers in the wake of the global financial crisis, the Dodd-Frank Act of 2010 introduced a bounty program under which a whistleblower became entitled to an award of between 10 percent and 30 percent of monetary sanctions. This applies when the SEC recovers amounts from wrongdoers that are in excess of $1 million. Interestingly, the U.S. approach encompasses not just insider trading, but also to various other securities offences such as market manipulation, ponzi schemes, fraudulent or unregistered securities offerings, false or misleading statements about a company, and the like. In that sense, SEBI’s approach is unfathomable in that it circumscribes the informant mechanism only to insider trading matters, whereas its utility may very well extend to the entire gamut of securities market offences.

If SEBI is seeking to emulate the SEC, it has a tough act to follow. The SEC administers its Whistleblower Program through its Office of the Whistleblower, an arm established within SEC’s enforcement division. The OWB has enjoyed tremendous success in its decade of existence. The number of tips the SEC received has grown appreciably, although these relate to various types of securities offences and not only insider trading:

Whistleblowers have financially benefited as well in the process. The 2018 report by the SEC indicates that it “has awarded over $326 million to 59 individuals” during the existence of the Whistleblower Program, of which in the financial year 2018 alone it “awarded more than $168 million in whistleblower awards to 13 individuals”, as the information they provided aided the SEC in bringing successful actions.

Moving back to India, SEBI’s proposal on the informant mechanism represents its focus on the process-oriented and evidentiary aspects of insider trading rather than substantive legal principles, which it has hitherto placed emphasis on. Whether the informant mechanism would result in more optimal enforcement of insider trading regulations would depend upon the ultimate shape the mechanism takes and the extent to which SEBI is able to commit resources to the OIP, which is the lynchpin in the operation of the mechanism. When established, the OIP has to discharge its unenviable burden of encouraging whistleblowing by filtering the genuine cases from the frivolous ones and, more importantly, by adopting adequate measures to prevent victimisation of the whistleblowers.

Umakanth Varottil is an Associate Professor of Law at the National University of Singapore. He specialises in company law, corporate governance and mergers and acquisitions.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.