THE US STOCK ACT: CRITICAL LESSONS FOR THE INDIAN INSIDER TRADING REGIME

This post is authored by Pavitra Khaitan and Aakriti Tewari, Penultimate year law students at Jindal Global Law School.

Introduction

A robust legal framework on insider trading is one of the most pertinent issues to tackle in an efficient corporate governance regime. Unfortunately, there often exists a gaping lacuna between theory and practice – further reinstating the need for reliable and effective regulations pertaining to insider trading. These issues transcend physical borders and find themselves present across jurisdictions, however, allow for certain lessons to be inculcated within regimes through learning from the failure of legislation. One such gap lies in the effectiveness of The Stop Trading on Congressional Knowledge Act of 2012 (hereinafter “STOCK”), which was originally introduced to ensure that members of Congress in the United States did not indulge in insider trading. This paper will seek to explore the effectiveness of the same and highlight gaps in its enforcement, to uncover lessons that can be applied in an Indian context. It will fundamentally argue against the effectiveness of the STOCK Act, and prove that it is not needed in the Indian context owing to a pre-existing foundational basis in Indian law that prohibits political figures from executing trades on insider information. However, it will also draw from certain arguments present in response to the failures of the US STOCK Act to devise a potential solution to ensure that such breaches do not take place in the Indian model, which, owing to high degrees of political corruption, lies at risk of suffering from such infirmities.

The Application of the STOCK Act in the United States

The exigency for the STOCK Act was created by repeated instances of media reports taking note of insider trading by members of the United States Congress, especially during the wake of the 2008 financial crisis. Though there existed legislation prior to the STOCK Act in order to prohibit insider trading, their lack of enforceability required immediate attention, especially when it came to government officials. The key takeaways of the Act are two-fold in nature. Firstly, the disclosure requirements for securities transactions for members of the Congress was expanded. In compliance with the Act, members of the Congress, their immediate family as well as their senior staff are mandated to disclose any trades over a thousand dollars within forty-five days of the transaction.[1] Secondly, the STOCK Act brings members of the Congress within the ambit of Rule 10-b of the Insider Trading Prohibitions which already existed in the United States. The act also establishes a fiduciary relationship by stating that the members of Congress are not exempt from insider trading, as highlighted by Section 4 of the Act. However, in spite of the creation of such a legal framework, instances of congressional insider trading are still extremely common in the nation, with 2021 identifying more than twenty nine members of congress violating insider trading law.[2]

Discrepancy between Theory and Practice: Implementation of the Act

The inability of the STOCK Act to successfully prosecute even a single member of the Congress is fundamentally premised upon the requirements laid down by the Act to prove that such insider trading has taken place.[3] The essential element in order to prove a breach of the STOCK Act by a Congress member, is to prove that the non-public information dependent upon which the trade was made was obtained from the position of the member. However, the Speech and Debate Clause embedded in Section 6 of the United States Constitution provides immunity to the members of Congress for acts performed in the capacity of their duties, as well as for acts undertaken by their staff members, as established in U.S. v Brewster.[4] In this context, the information used by the members of the Congress for insider trading will be protected by this clause, since it will be information obtained in the pursuance of legislative activities.[5] Access to these legislative discussions and meetings is impossible owing to the protection of the clause and thus determining whether the information was relied upon to trade is unfeasible. This problem of the STOCK Act can be seen manifested in the failure of the Justice Department to be able to hold Senator Richard Burr responsible for his insider trading transactions.[6] In his defence, he merely stated that he relied only on news reports publicly available in order to make his decision.[7] It seems paradoxical and almost intentional that the Congress passed such legislation knowing the existence of the Speech and Debate clause. The STOCK act, in this regard, merely seems like a mechanism to prove to the public that the Congress is taking measures to subject themselves to the same laws as others.[8]

Second, the Act does not address within its ambit hedge fund managers. Trading using inside governmental information is not illegal in the United States. Owing to the unregulated nature of hedge funds, hedge fund managers promise a much higher return than what is the existing benchmark. This automatically means that information about imminent legislations are extremely valuable to hedge fund managers.[9] The United States capital markets assimilate publicly available information instantaneously, which raises the value of inside information.[10] Though the initial draft of the legislation had a requirement to disclose governmental information passed by the workers to hedge funds, this clause was deleted by the House. However, as stated by many critics, it was irresponsible for the government leaders to have “dropped the ball” on requiring the registration of political intelligence agents. The flow of secret information between Washington and Wall Street could have otherwise been expose.[11]

Additionally, the STOCK Act does not mandate the disclosure of profit made during the trading process. This essentially means that the members of Congress merely have to report the number of shares which they have bought or sold, and of which company. This, unfortunately, does not help to reveal the possibility of using inside information in order to make such decisions. The time period for reporting and disclosing such a transaction is also a large one when the capital markets work at a nimble rate, especially during flash trading where transactions are made in seconds.

Potential Solutions to Combat the Inefficiency of the STOCK Act

The STOCK Act, though seemingly a boon for the public, is extremely limited in scope with regard to the Congress. Owing to the ineffective framework which exists merely as a façade for the public eye, a strong legislative responsive sought to completely ban individual trading by members of the United States Congress.[12] The ban would call for the prohibiting of selling, purchasing of individual stock as well as any other type of investments by all sitting members of the Congress and their senior staff. Recent years have also seen members of the Congress themselves stating that they are not comfortable owning individual stock,[13] especially following the political consequences which are resultant of being suspected of insider trading.[14] Therefore, through instances like the Friends of Angelo VIP program[15] and Senator Burr’s trading decisions, it is clear that the STOCK Act has not been and will possibly not continue to be sufficient in order to supress insider trading by the United States Congress. With no sure shot mechanism to curb insider trading, the question remains as to whether the Congress will ever advance legislations in order to encourage and grow their own individual financial interests.[16] It seems that the only advantage of the STOCK Act is that of establishing that the Congress owes a fiduciary duty with regard to trading. It thus becomes essential to find a solution in order to restore the trust of the public in the officials they have elected.

Lessons for the Indian Insider Trading Regime

This paper has, borrowing from American jurisprudence and legislation, made an attempt to critically analyse the efficiency and scope of the STOCK Act in prohibiting members of Congress from making trades based upon insider information. Academic attempts at discerning lessons from one jurisdiction and transplanting them into the framework of another have often been premised on some form of uniformity in how these legal systems function. In other words, for a law to be transplanted into the framework of another jurisdiction, certain aspects of the law and how it functions must be analogous.

It is argued that while the STOCK Act’s inefficiency is a warning for India to veer away from merely performative legislation, an additional reason for not warranting such a legislation in the Indian context is owing to the fact that the insider trading regimes of both nations are starkly different to one another structurally. While a similar gap in addressing such issues may exist, the lessons to be gained from India do not culminate in a push for introducing a similar legislation. Contrarily, it is argued that India’s existing legislation is broadly inclusive of government officials and leaves them at a possibility of facing legal consequences, if they choose to engage in insider trading. This is a deviation from a similar conception in the American context, where, as discussed, the STOCK Act was introduced to fill a lacuna that was not inclusive of government officials.

The NK Sodhi Committee Report[17] served as one of the most significant developments in introducing the SEBI (Prohibition of Insider Trading) Regulations, 2015[18] (hereinafter “PIT”). Most significantly to the topic at hand, however, the Report made explicit mention of the role of public servants and the high likelihood of Unpublished Price Sensitive Information (hereinafter “UPSI”) being accessible to them. Sourcing from the Report, the Committee made the clear and unequivocal recommendation that public servants are often at the receiving end of information that can be understood to be UPSI. Hence, it recommended that the definitions of terms such as “insider” and “connected person” be suitably amended to include the broader issue of members of Parliament being immune from being prosecuted when making insider trades. The Report relied on examples such as public servants who displayed “active involvement” in any policy that impacted the price of securities, as well as judges hearing and ruling on matters that adversely or materially impacted the price of securities.[19]

The cognizance taken of this issue can be reflected in the provisions of the PIT Regulations themselves. For example, under Regulation 2 (1) (g)[20], an insider may be defined broadly as any person with any form of knowledge of UPSI, along with any person deemed to be a connected person. This is entrenched with the definition of a connected person, elucidated under Regulation 2 (1) (d)[21], which can be summarized to be any individual with any form of access of UPSI, or who is associated in any form with the company in question. This may be direct or indirect in nature, giving a wide berth for scrutiny into the trades of government officials.

As per Regulation 3[22] and subsequent provisions of the Regulations, the scope remains fairly wide, both by way of defining who might perpetrate insider trading, but also by way of establishing what constitutes the crime as per law. For instance, in Regulation 3, it is laid out that no insider may provide, and no person may procure, any such information that may be construed to be UPSI. It does not stress on establishing any such class of individuals, nor does it attempt to narrow down the definitions provided in Regulation 2. It can be summarily understood, given that the scope is broad of the Regulations, that any individual in possession of UPSI is an insider. No such explicit or implicit exemption exists for government employees, who would have to seek recourse only if it were proven that the information would warrant legitimate usage. Therefore, structurally, India appears to not require any specific law, such as an Indian version of the STOCK Act, that would aid in ensuring public servants do not partake in insider trading. The special legislative cover and privilege that was awarded to lawmakers in the United States, therefore does not apply to India.

That being said, this does not necessarily mandate that the lessons learned from the US’s experience with the STOCK Act may not apply to India. The perusal of the NK Sodhi Report[23] reveals that not only can the exposure of public servants to insider trading be a severe threat to India’s corporate governance regime, but also that there is a clear need for laws that adequately address the possibility of corruption and insider trading by members of Parliament in India. Unfortunately, owing to a lack of reports of such cases, judicial precedent is not as helpful in discerning how such cases may be handled, and cannot be incorporated adequately in this analysis. As Courts themselves are silent on this matter, and judicial precedent on insider trading broadly cannot be adequately extrapolated to this case, a clear picture is not painted of how prevalent such an issue is. This lends a slightly incomplete picture as to whether such information is regularly traded on, and if so, what can be done to remedy it.

Where India and the US may find significant common ground, and where the US’s experience with the STOCK Act may serve as particularly significant guidance, lies in the fact that despite inclusive laws in theory, there is insufficient basis in practice to adequately thwart attempts to engage in insider trading. As explored, despite the presence of a specialized law, American lawmakers remain undeterred in their pursuit for financial gain.

One such example is that of Nancy Pelosi, whose husband executed trades that showed clear influence from her role as Speaker of the House.[24] Being a key influential member in terms of the introduction of legislation that would negatively impact a stock she had significant investment in, it was with little surprise that the legislation failed. As per American law, she had insightful insider information pertaining to her holdings solely as a Speaker of the House, and not as a corporate insider, which would put her at risk of being found guilty of insider trading. Such loopholes in legislation ensure that in practice, the purpose and reason for such laws are entirely bifurcated.[25]

In the Indian context, in a hypothetical situation, it is clear that a member of Parliament would not have had the fortune of being able to execute such a strategy, as per the PIT Regulations. However, given the lack of any such cases, it is surprising that no parliamentary figures appear to have engaged in insider trading. While this would normally be positive, India being the 85th least corrupt nation in a list of 180 countries[26] draws suspicion as to whether the law is truly working for government individuals. Additionally, though the Securities and Exchange Board of India (hereinafter “SEBI”) is seemingly an independent regulator, its lack of financial independence takes away from this freedom.[27] Relying heavily on government grants, SEBI’s lack of autonomy when it comes to the government makes the lack of investigation into insider trading by government officials increasingly suspicious. In this context, hypothetically, investigation by the SEBI into the government would be almost equivalent to the government being investigated by its own arm.

Burgeoning attention on a global scale towards bans on the trading of securities by government official yields a need for a possible solution in the Indian context, to ensure that such activities are thwarted entirely – a particularly necessary step given India’s notoriety with political corruption.

Therefore, this paper, using the STOCK Act and scholarship surrounding it, proposes a model that attempts to solve this issue, drawing from Fritz’s proposal of the use of index funds as a tangible solution in the American context.[28] The essential proposal, though suggesting banning as a perhaps cleaner alternative, ensures that politicians may continue to trade, but not in individual stocks. This would be permissible using indexes such as NIFTY50 and SENSEX, ensuring that members of Parliament and public servants may only invest in index funds – which would be dependent on the state of the Indian economic condition. By investing solely in market indexes, this entirely solves the potential misuse of law and privileges accorded to government employees. Furthermore, concurring with Fritz, the market regulator, in the Indian context, SEBI, would be responsible for overseeing such investments. Therefore, while banning individual trades is certainly advocated for, this paper proposes using the US experience with the STOCK Act to instead propose a much more creative and beneficial solution for all stakeholders, eliminating the possibility of using insider information on a company for any form of personal gain. SEBI’s role, and potential conflict of interest does not apply as no individual stocks are being invested in – and only an amalgamation of stocks that adequately represent the state of the economy may be accessed.

Fritz’s proposal serves as a response to the inefficiency of the STOCK Act, yielding him to make a similar proposal in the American context. This approach establishes a middle ground while simultaneously making a strong argument for the possibility of politicians to continue to invest in securities – while bypassing any need for insider information to be misused.[29] Other explorations, as seen in other forms on scholarship, are predominantly concerned with stringent bans on any form of trading for politicians. While these are valid, effective, and credible mechanisms to achieve workable solutions, they are devoid of incentives for politicians that may result in further encouragement of illegal wealth acquiring mechanisms. Furthermore, politicians’ ability to invest in equity markets may further show avid participation in the nation’s economy – largely tying their personal interests with the interests of economic growth.[30] Such a move may spur on greater confidence not only in politicians themselves, but in citizens’ faith in the economy as a whole. Therefore, this proposal is extended to the Indian context as a strong potential deterrent to insider trading by politicians.

Conclusion

Through the course of this paper, thus, an attempt has been made to draw from the existing framework- the STOCK Act- lessons which can be implemented in the Indian insider trading regime. The analysis aims to bring into the forefront how even if the multitude of fallacies existing withing the STOCK Act are modified, such an Act would not find its ground in India.

Although at the face of it introducing such legislation in India might seem beneficial, we have distinguished between the structure of the trading regimes in both countries and concluded that there exists no requirement for an Act in India to solely govern government officials. There is a dearth of cases revolving around governmental officials committing insider trading in India.

In arguendo, even if in the future there exists a requirement for the courts to preside over a case of such nature in India, the PIT provides an outline of possible consequences for such actions, owing to the inclusive nature of its insider clause.

[1] STOCK Act, Pub. L. No. 112-105, 126 Stat. 291, 292 (2012). [2] “29 Members of Congress Caught Violating a Federal Law on Their Stock Trades in 2021” (Business InsiderSeptember 24, 2021) <https://www.businessinsider.in/investment/news/29-members-of-congress-caught-violating-a-federal-law-on-their-stock-trades-in-2021/slidelist/86496614.cms> accessed May 9, 2022. [3] Nocera J (Bloomberg.com) <https://www.bloomberg.com/opinion/articles/2020-12-04/-stop-trading-act-for-congress-isn-t-stopping-much-trading> accessed May 11, 2022. [4] U.S. Const. art. I, § 6, cl. 1. ; U.S. v. Brewster, 408 U.S. 501(1972). [5] Seaquist G, Bramhandkar A and Barken M, “CONGRESSIONAL INSIDER TRADING RUNS DEEP WILL THE STOCK ACT ONLY SKIM THE SURFACE?” (2013) 29 North East Journal of Legal Studies. [6] Robert Faturechi DW, “Senator Dumped up to $1.7 Million of Stock after Reassuring Public about Coronavirus Preparedness” (ProPublica) <https://www.propublica.org/article/senator-dumped-up-to-1-7-million-of-stock-after-reassuring-public-about-coronavirus-preparedness> accessed May 8, 2022. [7] “Sen. Burr: I Sold off Stocks Because of TV Reports, Not inside Info about Coronavirus” (NBCNews.comMarch 20, 2020) <https://www.nbcnews.com/politics/congress/sen-burr-i- sold-stocks-because-tv-reports-not-inside-n1165036> accessed May 11, 2022. [8] Zeiler D, “Stock Act: Latest Political Flimflam Won't Stop Worst Abuses” (Money Morning - We Make Investing ProfitableOctober 16, 2014) <https://moneymorning.com/2012/04/04/stock-act-latest-political-flimflam-wont-stop-worst-abuses/> accessed May 9, 2022. [9] Supra (n 5). [10] Supra (n 5). [11] Supra (n 8). [12] “Members of Congress Introduce Bipartisan Legislation to Stop Government Officials from Profiting off of Insider Information” (Congressman Raja KrishnamoorthiMarch 3, 2021) <https://krishnamoorthi.house.gov/media/press-releases/members-congress-introduce-bipartisan-legislation-stop-government-officials> accessed May 9, 2022. [13] Fandos N, “To Gain Public's Trust, Should Members of Congress Stop Trading Stock?” (The New York TimesJune 15, 2020) <https://www.nytimes.com/2020/06/15/us/politics/congress-trading-stock-loeffler-burr.html> accessed May 11, 2022. [14] “Georgia Senate Runoff Results” (PBS) <https://www.pbs.org/newshour/elections-2020/georgia-senate-runoff> accessed May 11, 2022. [15] Emshwiller JR, “Panel Split on Need to Probe VIP Loans” (The Wall Street JournalOctober 2, 2009) <https://www.wsj.com/articles/SB125444130726157831> accessed May 8, 2022. [16] Supra (n 5). [17] Report of the High Level Committee to Review the SEBI (Protection of Insider Trading) Regulations, 1992. [18] SEBI (Prohibition of Insider Trading) Regulations, 2015. [19] Ibid. [20] Regulation 2 (1) (g), SEBI (Prohibition of Insider Trading) Regulations 2015. [21] Regulation 2 (1) (d), SEBI (Prohibition of Insider Trading) Regulations 2015. [22] Regulation 3, SEBI (Prohibition of Insider Trading) Regulations 2015. [23] Supra (n 17). [24] Kevin W. Fritz, 'The Stock Act Is Inadequate: U.S. Index Funds are the Solution to Political Insider Trading' (2013) 7 Liberty U L Rev 275. [25] Ibid. [26] “India Corruption RANK2021 Data - 2022 Forecast - 1995-2020 Historical - Chart” (India Corruption Rank - 2021 Data - 2022 Forecast - 1995-2020 Historical - Chart) <https://tradingeconomics.com/india/corruption-rank>; accessed May 11, 2022. [27] “Regulators Should Not Depend on Government Grant, Must Have Own Income Source: Ex-Sebi Chief” (The Indian Express January 7, 2020) <https://indianexpress.com/article/business/market/regulators-should-not-depend-on-government-grant-must-have-own-income-source-ex-sebi-chief-6204673/> accessed May 11, 2022. [28] Supra (n 24) [29] Ibid. [30] Ibid.