Thursday, May 31, 2012



                                                                                                              By Dr TPadma.,
LLM., Ph D (Law)
LLD Scholar
                                                                                                                       (A P Law University)


I   Introduction

 Pendency of cases in courts across the country has turned out to be a "gigantic problem" with about three crore cases waiting for redressal and the undue delay making people to shy away from justice delivery system.

Despite an increased disposal rate of cases, the apex court failed to reduce the pendency as it could not cope with the rising number of cases filed every year. The dockets swelled and the pendency by January 2008 was within striking distance of the 50,000-mark, standing at 46,926. By January 2009, pendency rose to 49,819, before finally breaching the 50,000-mark in March.

A similar trend was seen at the level of high courts and trial courts. The 21 high courts, working with a strength of 635 judges as against a sanctioned strength of 886, reported a pendency of 38.7 lakh cases as of January 1, 2009, against 37.4 lakh cases on January 1, 2008.

Trial courts, having a judge strength of 13,556 against a sanctioned strength of 16,685, were burdened with an additional pendency of nearly 10 lakh cases by January 2009, when the pendency figure was 2.64 crore. It stood at 2.54 crore cases in January 2008[1]

The huge backlog of cases and the interminable delays in adjudication of cases has come to assume critical proportions in Indian Judicial System. Apart from an infrastructural mismatch, the lower judge strength of around 10.5 per a million population is broadly considered an endemic cause for this problem.  In All India Judges’ Association & Ors. V. Union of India & Ors[2]. the Supreme Court analyzed the reasons underlying the huge backlog of cases and observed that additional posts of judicial officers and the complementary infrastructure would have to be created and directed that an increase in the judge strength to achieve the level of 50 judges per a million population should be implemented in a phased manner and within a period of five years from the date of judgment apart from taking expeditious steps for  filling up existing vacancies.

Globalization has been a great stimulation in the process of integration of economies and  societies of different countries across the globe.  It has been a great tool for  breaking  economic barrier and envisioning world as a market for trade. In the modern techniques of dispute resolution of commercial conflicts, emphasis has drifted from litigation to arbitration.  As things are never static, emphasis   is further   sliding from arbitration to alternate dispute resolution procedures.  Mediation or conciliation is one of the most important procedures of ADR (Alternate Dispute Resolution).   Regulation of arbitration laws by conciliation or mediation is a novelty of the modern arbitration law. The drift from arbitration towards conciliation started with the  appearance of conciliation legislation, which of late has been   increasingly  attracting the attention of the international business community. Conciliation may play a pivotal  role, particularly   in settling   commercial disputes.  It is  more economic convenient, speedy, and less formal mode of dispute resolution.  

 II  The key elements of ADR

      There is no fixed  form of ADR. There  may be  many  variants  of the ADR themes.  However  basically, ADR comprises  of the following five elements.

i)                The parties must be willing to seek informal resolution and they must  trust  the intermediary  and the procedure, however  they are   free to walk  away  at any time.

ii)             There is no fixed procedure and there are no rules of disclosures of documents and anything which is said or produced is on a “without” prejudice” basis   and cannot be relied upon should there  be later  judicial  or arbitral proceedings.

iii)           The entire process is very  speedy  and comparatively cheap;

iv)           The intermediary has no power to produce a binding result; and indeed his intervention in pronouncing a recommendation may be unwelcome.

v)              The purpose of the procedure is to produce a compromise result under which neither party loses face (win-win) and which   gets away from the remedies  open to a court.

III.  Judicial approach to ADR

    The only field  where the Courts in India  have recognized ADR is in the field of arbitration.  The arbitration was originally governed by the provisions of the Indian Arbitration Act, 1940.  The Courts were very much concerned over the supervision of Arbitral Tribunals and they were very keen to see whether the arbitrator has exceeded his jurisdiction while deciding the issue, which has been referred to him for arbitration. 

     The scope of Interference of the award passed by an arbitration was dealt with by the Apex Court in the decision reported in Food corporation of India Vs.  Jogindarial Mohindarpal[3] as follows: “Arbitration as a mode for settlement of disputes between the parties has a tradition in India.  It has a social purpose to fulfill today.  It has a great urgency today when there has been an explosion of litigation in the Courts of law established by the sovereign power.  However in proceedings of arbitration, there must be adherence to justice, equality of law and fair play in action.  The proceedings of arbitration must adhere to the principles of natural justice and must be in consonance with such practice and procedure, which will lead to a proper resolution of the dispute and create confidence of the people, for whose benefit these procedures are resorted to.  It is therefore, the function of the Court of law to oversee that the arbitrator acts within the norms of justice.  Once they do so and the award is clear, just and fair, compel to adhere and obey the decision of their chosen adjudicator.  It is in this perspective that one should view the scope and limit of corrections by the Court on an award made by the arbitrator.  The law of arbitration must be made simple, less technical and more responsible to the actual realities of the situation but must be responsible to the canon of justice and fair play.  The arbitrator should be made to adhere to such process and norms which will create confidence not only doing justice between parties but by creating a sense that justice appears to have been done”.

      The Courts were anxious to see whether there was any jurisdiction to the  arbitrator to decide such dispute or not while interpreting the arbitration clause in the agreement.  The power to decide such dispute or not while interpreting the arbitration clause in the agreement.  The power to decide the jurisdiction of the arbitrator to decide a particular issue or not was vested with the Law Courts.  There was much delay in settlement of disputes between the parties in law Courts which prevented investment of money in India by other countries.  Further there was no provision in the Indian Arbitration Act 1940 to resolve a dispute between an Indian and a non-Indian as the law-relating contract between the parties were different which caused difficulties to refer such matter for arbitration.  In order to avoid such a difficulty, India has undertaken major reforms in its arbitration law in the recent year as part of economic reforms Initially in 1991.  simultaneously many steps have been taken to bring judicial reforms in the country, the thrust being on the minimization of Courts intervention in the arbitration process by adoption of the United Nations Commission on International trade Law (UNCITRAL). With this in mind, the Government has given birth to a new legislation called.  “The Arbitration and conciliation Act 1996”.  There are distinctive features in this Act compared to 1940 Act.  India judiciary has played a substantial role in up gradation of ADR mechanism.  The Apex court has recognized the alternate forum in its various decisions. In Guru Nanak Foundation V.  Rattan & Sons[4] Court observed that “Interminable, time consuming, complex and expensive court procedures impelled jurists to search for an alternative forum, less formal, more effective and speedy for resolution of disputes avoiding procedure claptrap”. The realization of concepts like speedy trial and free legal aid by apex Court in various cases has also helped in the up gradation of Alternate dispute redressal mechanism. 

 Another major step in the growth of ADR services in India is the establishment of  (1) Indian Institute of Arbitration and mediation (IIAM) (2) Indian council for Arbitration  (ICA) and (3) International Centre for Alternate Dispute Resolution (ICADR) for alternate dispute resolution. These institutions provide services of negotiation, mediation, conciliation, arbitration, settlement conferences etc.  They also help in finding lacunae in existing ADR laws and recommended reforms to overcome them.

IV. Global perspective

The history of Alternate dispute resolution forum at international level can be traced back from the period of Renaissance, when Catholic popes acted as arbitrators in conflicts between European countries. One of the successful examples of the said mechanism is the international mediation conducted by former U.S. President Jimmy Carter in Bosnia. ADR has given fruitful results not only in international political arena but also in International business world in setting commercial disputes among many corporate houses for e.g. settlement of a long standing commercial dispute between General Motors Co. and Johnson Matthey Inc., which was pending in US district court since past few years. The biggest stepping stone in the field of International ADR is the adoption of UNCITRAL (United Nation Commission on International Trade Law) model on International commercial arbitration. An important feature of the said model is that it has harmonized the concept of arbitration and conciliation in order to designate it for universal application.  General Assembly of UN also recommended its member countries to adopt this model in view to have uniform laws for ADR mechanism. Other important international conventions on arbitration are: (1) The Geneva Protocol on Arbitration clauses of 1923. (2) The Geneva convention on the execution of foreign arbitral Award, 1927 (3) The New York convention of 1958 on the recognition and enforcement of Foreign Arbitral Award.

V. Online Dispute Resolution

Online dispute resolution (ODR) is a branch of dispute resolution which uses technology to facilitate the resolution of disputes between parties. It primarily involves negotiation, mediation or arbitration, or a combination of all three. Online dispute resolution (“ODR”) is conceived as a means to achieve some of the most powerful legal ideals of the Western legal tradition, which include:

      (1) Legal Certainty:

In making individual plans, decisions, and choices everyone is entitled to know what the law is in advance.

(2) Access to Justice:

Everyone involved in a dispute shall be entitled to an easily accessible redress mechanism that provides for a timely resolution and effective remedies at reasonable cost.

ODR is concerned with the civilized (i.e. peaceful) resolution of disputes between private parties, and, secondly, with the prevention of such conflicts through the provision of legal certainty. National legal systems fulfill the former function by offering plaintiffs to litigate disputes before state courts which exercise mandatory jurisdiction over defendants, and the latter by making the litigation process public, thus allowing for the proliferation of precedent, as well as by the enactment of codifications of rules of law.

Regarding the dispute resolution function of private law, there are a variety of functional equivalents to litigation available, which are collectively referred to as alternative dispute resolution (ADR). On the one hand ODR relates to the resolution of disputes that result from online conduct, i.e. from communications and transactions which come about through the use of the Internet Domain name disputes are a prominent example as are disputes related to e-commerce. On the other hand, ODR relates to the use of online communication technology in the resolution process, even if the dispute itself has an offline origin. The provision of alternative dispute resolution (ADR) services on the Internet has become quite popular[5]. Online dispute resolution (ODR) in India is in its infancy stage and it is gaining prominence day by day. With the enactment of Information Technology Act, 2000, e-commerce and e-governance have been given a formal and legal recognition.[6]

VI. Indian Scenario

In India Part III of Arbitration and Conciliation Act, 1996 provides for      International Commercial Arbitration.

 In common parlance, there is some difference between conciliation and mediation. This is evident from these two statutes of the parliament. (i) In the year 1996, the Arbitration and  Conciliation Act, 1996 was passed and sec.30  of that Act, provides   that an  arbitral tribunal  may try to have the dispute settled  by use  of  ‘mediation’ or conciliation’ and sub-section (1) of sec.30 permits the arbitral tribunal to “use mediation, conciliation or other procedures”,  for the purpose of reaching settlement (ii) The Civil Procedure Code (Amendment) Act, 1999 which introduced  sec.89, too speaks of conciliation and mediation as different concepts. Order 10 Rules 1A, 1B,1C of  the Code  also  go along with sec.89.

      A.  Conciliation

   In order to understand what Parliament meant by ‘Conciliation, we have necessarily to refer to the functions of a ‘conciliator’ as   visualized   by part III of the `1996 Act.  It is  true, sec.62  of the said  Act deals with reference to conciliation by agreement of parties  but sec.89 permits the  court to refer  a dispute  for conciliation  even where  parties do not consent, provided the Court thinks that the case is one fit for  conciliation.  This makes no difference as to the meaning of ‘conciliation under sec.89 because, it says that once a reference is made to a ‘conciliator’ the 1996 Act would apply. Thus the meaning of ‘conciliation’ as can be gathered from the 1996 Act has to be read into sec. 89 of the Code of Civil Procedure. The 1996 Act is, it may be noted, based on the UNCITRAL Rules for conciliation.

Now under section 65 of the 1996 Act, the ‘conciliator’ may request each party to submit to him a brief written statement describing the “general nature of the dispute and the points at issue”. He can ask for supplementary statements and documents. Section 67 describes the role of a conciliator. Subsection (1) states that he shall assist parties in an independent and impartial manner. Subsection (2) states that he shall be guided by principles of objectivity, fairness and justice, giving consideration, among other things, to the rights and obligations of the parties, the usages of the trade concerned and the circumstances surrounding the dispute, including any previous business practices between the parties. Subsection (3) states that he shall take into account “the circumstances of the case, the wishes the parties may express, including a request for oral statements”. Subsection (4) is important and permits the ‘conciliator’ to make proposals for a settlement. It states as follows:

“Section 67(4). The conciliator may, at any stage of the conciliation proceeding, make proposals for a settlement of the dispute. Such proposals need not be in writing and need not be accompanied by a statement of the reasons therefor.”

 Section 69 states that the conciliator may invite parties to meet him. Sec. 70 deals with disclosure by the conciliator of information given to him by one party, to the other party. Sec. 71 deals with cooperation of parties with the conciliator, sec. 72 deals with suggestions being submitted to the conciliator by each party for the purpose of settlement. Sec. 73, which is important, states that the conciliator can formulate terms of a possible settlement if he feels there exist elements of a settlement. He is also entitled to ‘reformulate the terms’ after receiving the observations of the parties. Subsection (1) of sec. 73 reads thus:

“Sec. 73(1) settlement agreement. (1) When it appears to the Conciliator that there exist elements of a settlement which may be acceptable to the parties, he shall formulate the terms of a possible settlement and submit them to the parties for their observations. After receiving the observations of the parties, the Conciliator may reformulate the terms of a possible settlement in the light of such observations.”

The above provisions in the 1996 Act, make it clear that the ‘Conciliator’ under the said Act, apart from assisting the parties to reach a settlement, is also permitted to make “proposals for a settlement” and “formulate the terms of a possible settlement” or “reformulate the terms”. This is indeed the UNCITRAL concept.

B. Mediation

          If the role of the ‘conciliator’ in India is pro-active and interventionist as stated above, the role of the ‘mediator’ must necessarily be restricted to that of a ‘facilitator’.

          Meditation is a facilitative process in which disputing   parties engage the assistance of an impartial third party, the mediator who helps them to try to arrive  at an agreed  resolution of their dispute.  The mediator has no authority to make any decisions  that are  binding on them, but  uses certain procedures techniques and skills  to help them to negotiate an agreed resolution of their dispute without  adjudication[7].

 Prof. Robert Baruch Bush and Prof.  Joseph Folgen say:

          “In a transformative approach to mediation, mediating persons consciously try to avoid shaping issues, proposals or terms of settlement, or even pushing for the achievement of settlement at all.  In stead, they encourage parties to define problems and find solutions for themselves and they endorse and support the parties” own efforts to do so”.

          The meaning of these words as understood in India appears to be similar to the way they are understood in UK.  In the recent Discussion Paper by the lord Chancellor’s Department on alternative Dispute Resolution. While defining “Mediation” and “Conciliation”, it is stated that ‘Mediation’ is a way of settling disputes by a third party who helps both sides to come to an agreement, which each considers acceptable Mediation can be evaluative or ‘facilitative’. ‘Conciliation’, it is said, is a procedure like mediation but the third party, the conciliator, takes a more interventionist role in bringing the two parties together and in suggesting possible solutions to help achieve a settlement.  But it is also stated that the term ‘conciliation’ is gradually falling into disuse and a process which is pro-active is also being regarded as a form of Mediation. This has already happened in USA.

           The above discussion shows that the ‘mediator’ is a facilitator and does not have a pro-active rule.  But, as shown below, these words are differently understood in US.

 A statement by John F. Kennedy, former US President which is relevant in this context is reproduced below:

 Let us not negotiate with fear but let us not fear to negotiate”.

 None can deny that our cultural heritage is no different.  Mahatma Gandhi advocated conciliation and mediations as a practicing lawyer in South Africa and said that it was the duty of lawyers to make efforts to settle disputes and that by doing so, lawyers would not be losers.  He said that he, in fact, built up a reputation that he would always appear for the party whose case was invariably the just one.  Therefore, the systems of conciliation and mediation are as much part of our cultural heritage as they are in any other country. But what is that has stood in the way ? where was the need to usher in, by force of statute, something which was part of our culture?  It is not difficult to answer this question. Over the years, more cases have accumulated in our courts than our courts can decide within reasonable time.  The litigant whose case is not worth a contest has developed a mind-set that there is nothing wrong in delaying justice, either by compelling the other party to go to a court of law or by himself moving the Court and keeping the issue sub-judice. The litigant is today fairly sure that justice to his opponent even if it cannot be denied ultimately, can be delayed as long as possible, may be for years. Unfortunately, successive governments have neglected the judiciary. The number of courts have not increased at least up to a basic minimum requirement and everybody finds it easy to blame the judiciary for the backlog. The judiciary is no doubt accountable, but there are other players who control the purse.  It has been rightly said that the judiciary has neither the purse nor the sword.

In India, we do not have a separate system of federal courts and state courts.  The Courts established by the State Governments in India administer both Central and State laws,  In  particular they administer laws relatable mostly to the Concurrent List (List III) (such as the Contract Act, the Indian Penal Code, the Code of Civil Procedure, the Code of Criminal Procedure) and to the Union List (List I) in the VII Schedule of the constitution. This creates an obligation on the Central Government, in my view, to meet at least more than fifty percent of the expense of the State Courts.  Added to this, whenever a Bill is introduced in Parliament or the State Legislatures, there is no ‘Judicial impact assessment’ made, as done in other countries like the USA setting out in the financial Memorandum attached to the bill, how many civil and criminal cases will be generated out of the new rights and offences created by the Bill if it becomes law.

The Constitution Review Committee has made a recommendation that the central Government must bear a substantial part of the expenditure on Courts and that sufficient allocation must be made by the Finance Commission and the Planning Commission in this behalf.

It is obvious however that the Government of India will not be able to establish all the needed Courts in a short time. Alternative methods must therefore be necessarily found, even otherwise.

“As a consequence of observations by the Constitution Bench of the Supreme Court in P. Ramachandra Rao v. State of Karnataka[8] as to the  critical judge – population ratio in the country, the Executive at the Federal level was energized and consequent on the recommendations of the XI Finance Commission evolved a scheme of ‘Fast Track Courts’. The operationalization of the scheme was however differently managed in several States.”

The problem of overcrowding of dockets is not peculiar to out country nor is peculiar to our times.  Such problems have been and are faced by almost every country in the world.  Necessity became the mother of invention in several countries. Alternative Dispute Mechanisms were evolved and adopted.  The United States of America is a more litigious country than ours. It has introduced Federal and State Legislations /Rules of Court to enable parties to resort to mediation voluntarily or by compulsion  (by what is called Court-annexed mediation). So Australia, New Zealand, Canada and the United Kingdom. There are various Reports of the Law Commissions or Reports of Royal Commissions or other committees on the ADR, mediation and conciliation.  In every country, initially, there has been some resistance from the Bar.  Judges, known for their conservatism, as usual, were also somewhat lukewarm in their approach to ADRs in the beginning.  But, gradually, once the systems were implemented, the Bar and the Bench found that litigants did benefit enormously in terms of time and ``money Conciliation or mediation became very popular.  In USA, in twenty years, surprisingly the settlement rate rose up to 94%.  There are similar success stories in other countries[9].

Let us take the case of Lok Adalats.  When the institution of Lok Adalats was started over fifteen to twenty years ago, there was tremendous skepticism and opposition both at the Bar and in the Judiciary.  Soon, it was discovered that certain special types of cases- particularly those relating to claim for damages in motor accidents and compensation in land acquisition cases and others and also some criminal cases where the offences were compoundable, were best suited for settlement through Lok Adalats.  These settlement centers were presided by retired Judicial Officers or those in office but not attached to the cases.  As of today, millions of cases have been dealt with in Lok Adalats and millions of rupees have been distributed through Lok Adalats in these types of cases.  Ultimately, Lok Adalats have today come to stay and have been accepted.

Lok Adalats can, however, deal only with cases where the settlement process is not long.  But cases involving commercial disputes, property disputes, partition disputes, matrimonial disputes and the like, it is obvious, cannot be listed in a Lok Adalat and disposed of the same day by applying a multiplier formula as in accident cases.  These are more serious cases where parties have to be brought to the negotiating table and the conciliator/mediator has to have separate as well as joint sessions with the parties in a good number of sittings.  These may extend to six, or even ten such sessions.  Lot of facts may have to be ascertained, documents may have to be called for, matters of equity may have to taken into account and what is more, a lot of effort is to be made to make the rival parties cool down their tempers.  In a Lok Adalat, in motor accident cases, the rivals are either the State or the Insurance companies and there is absent the emotional part that is invariably involved during negotiation in other types of cases.  This is because there is no such long standing rivalry or enmity in Lok Adalat cases.  It is, therefore, essential that in more serious cases, parties must be cajoled, nay, even be persuasively compelled, to talk to each other through a conciliation/mediation process so that they may first cool down, come to reason and start thinking of settling their disputes.  Once that is done, then conciliation or mediation is held, and settlement reached, they can still remain friends.  There is no longer any acrimony. In addition, both sides have saved time and money.

Now that the Indian Parliament, which saw that conciliation and mediation processes have led to a new revolution in judicial administration in other countries, has, in its wisdom accepted that conciliation/mediation should be a regular process in every case which comes to Court.  Even if parties do not agree for conciliation or mediation, the Court may, if it thinks the case to be a fit case, make a reference to conciliation or mediation.  Courts and lawyers have therefore a paramount obligation to enforce the legislative mandate.  We, therefore, have necessarily to make an effort to see how, by peaceful means, rather than by the adversarial process,  we can wipe out the tears of those suffering prolonged agony caused by delay and expense. If Lok Adalats, regarding which there was initial opposition, have come to stay and have become acceptable because of the spectacular results achieved, there is no reason why the conciliation/mediation processes should not be given a fair trial in civil litigation, where a mediator/conciliator brings down the tensions, make parties see reason, and helps in settling their disputes.  Unlike other systems of ADR like ‘compulsory or court-annexed non-binding arbitration’, there is here no compulsion.  There is only persuasion so far as the terms of settlement are concerned. Compulsion is only persuasion so far as the terms of settlement are concerned.  Compulsion is only to the extent of compelling parties to go to the negotiating table, discuss through the medium of an experienced conciliator/mediator.  Such a process was always part of our Indian culture, even long before any system of Courts was established.

Now the trend is to treat the Court not only as a seat for regular adjudication but also as a Centre for settlement, established by Parliament.  In every High Court and in every District Court, to start with, separate accommodation must be provided for a conciliation/mediation centre to function.  The Courts have a dual function – one as an adjudicator and the other as a facilitator for settlement.  As done in the Gujarat High Court, every High Court and district Court must straightaway set apart specific accommodation for a “Conciliation and Mediation Centre”.  After Court hours every day, and during weekends and holidays, the centre must function regularly.  Such Centers are sure to attract a lot of response.

Apart from the direct advantages to the litigants  in each of such cases which is settled, there are other indirect advantages to the judicial administration as a whole on account of this new effort?  This new process of settlement through conciliation and mediation will reduce the civil dispute dockets and bring the pendency to a tolerable level.  The greater advantage, in fact, is the one that will indirectly accrue to the criminal justice system.  If civil cases are reduced substantially or to some extent, the time so saved can be utilized for disposal of a larger number of criminal cases.  In that branch, there cannot be settlements except where they relate to compoundable offences.  Plea bargaining has not yet become part of our system.

In our country, there is one great advantage, as compared to other countries, in that we are not burdened, both terms of time and expense, by a jury system in civil cases.  That would have delayed our trials more, with that advantage in our procedural system, there is need to go for conciliation/mediation in a big way as ordained by statute and take it seriously. The new concepts introduced in sec. 89 as regards conciliation and mediation are sure to result in bringing about a silent revolution in our judicial system.

 The Chief Justice of India, at a conference on alternative dispute resolution – conciliation and mediation, organized by the International Centre for alternative dispute Resolution said there was an urgent need to increase the number of subordinate courts in the country from 16,000 to 35,000. He further stated that there were only 14,000 judges for 16,000 subordinate courts and he had requested State governments to recruit presiding officers. The States were not recruiting judicial officers every year and this was leading to vacancies not being filled in time.

Human beings, when it comes to disputes relating to money or status, are all the same, everywhere round the globe. Selfishness, strength of money-power for protracting litigation or ego are common features.  If the conciliation /mediation solutions have been successful in other countries, they must and will succeed here also.  Where the problems are same, the solutions could be similar, though there may be differences in degree or the methodology adopted. The procedure for conciliation/mediation are today part of the systems of almost every judicial administration both in common law countries as well as in countries governed by civil law systems.  The fact that we have woken up in 1999 and have started to enforce sec. 89 of the Code of Civil Procedure only from 1st July 2002, should not matter.  Better late than never. Every Bar council, every Bar Association and every lawyer to give conciliation/mediation higher priority than adjudication and give the litigant a reasonably good chance of settling the disputes so as to save time, money-leaving more complicated and tougher cases and the criminal cases to pass through the adjudicatory process.

[ This article was published in the Supreme Court Journal]
Note: The Author is a member of A P State Higher Judiciary. The views expressed in   this article are purely personal.

[1] Source : Supreme Court News Jan-Mar, 2009
[2] JT 2002 (3) SC 503
[3]  1989(2) SCC 347
[4]  AIR 1981 SC 2075
[5] German Law Journal
[6] Wikipedia
[7] ADR Principles and Practice by Henry J. Brown and Arthur L. Marriot 1997
[8] JT 2002 (4) SC 92
[9] Law Commission of India (papers presented in international conference on ADR)

Tuesday, May 29, 2012




By K P C Rao., 

"A company's confidential information qualifies as property to which the company has a right of exclusive use. The undisclosed misappropriation of such information in violation of a fiduciary duty constitutes fraud akin to embezzlement – the fraudulent appropriation to one's own use of the money or goods entrusted to one's care by another[1]."

-U S Supreme Court


The World economy has been experiencing a progressive international economic integration for the last half a century. There has been a marked acceleration in this process of globalization and also liberalization during the last three decades. Every modern economy is based on a sound financial system which helps in production, capital and economic growth by encouraging savings habits, mobilizing savings from households and other segments and allocating savings into productive usage such as trade, commerce, manufacture etc.

A financial system is a set of institutional arrangements through which financial surpluses are mobilized from the units generating surplus income and transferring them to the others in needs of them. The main factors influence the capital market and its growth are level of savings in the household sector, taxation levels, health of economy, corporate performance, industrial trends and common patterns of   living.

Meaning and Segments of Financial Markets

What are the financial markets? If you are confused, there is a good reason. That’s because financial markets go by many terms, including capital markets, money market, securities market even the markets. Some experts even simply refer to it as the stock market, even though they are referring to stocks, bonds and commodities.

In economics, a financial market is a mechanism that allows people to buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), and other fungible items of value at low transaction costs and at prices that reflect the efficient-market hypothesis.

Quite simply, that is what the financial markets are - any type of financial transaction that you can think of that helps businesses grow and investors make money.  The financial markets have two major components, (1) the money market and (2) the capital market. The money market refers to the market where borrowers and lenders exchange short-term funds to solve their liquidity needs. The Capital Market is a market for financial investments that are direct or indirect claims to capital. It is wider than the Securities Market and embraces all forms of lending and borrowing, whether or not evidenced by the creation of a negotiable financial instrument. The money market possesses different operational features as compared to capital market. It deals with raising and deployment of funds for short duration while the capital market deals with long-term funding. The money market provides the institutional source for providing working capital to the industry, while the capital market offers long-term capital for financing fixed assets.

The Securities Market, however, refers to the markets for those financial instruments/claims/obligations that are commonly and readily transferable by sale. The Securities Market has two ‘inter-dependent’ and ‘inseparable segments’, viz., (1) the primary market (new issues)   and (2) the secondary market (stock).

History of India Financial Market

The history of Indian capital markets spans back 200 years, around the end of the 18th century. It was at this time that India was under the rule of the East India Company. The capital market of India initially developed around Mumbai with around 200 to 250 securities brokers participating in active trade during the second half of the 19th century.

Indian Financial market comprise of primary market, Foreign Direct Investments (FDIs) alternative investment options, banking and insurance and the pension sectors, asset management segment as well. With all these elements in the India Financial market, it happens to be one of the oldest across the globe and is definitely the fastest growing and best among all the financial markets of the emerging economies.

The financial market in India at present is more advanced than many other sectors as it became organized as early as the 19th century with the securities exchanges in Mumbai, Ahmedabad and Kolkata. In the early 1960s, the number of securities exchanges in India became eight - including Mumbai, Ahmedabad and Kolkata. Apart from these three exchanges, there was the Madras, Kanpur, Delhi, Bangalore and Pune exchanges as well. Today there are 21 regional securities exchanges in India which are in operational out of 25 exchanges. (Recognition of 4 stock exchanges have been withdrawn by SEBI[2] on different grounds)

Though, the Indian stock markets have remained stagnant till 1990 due to the rigid economic controls,  it was only in 1991, after the liberalization process that the Indian stock  market witnessed a flurry of IPOs[3] serially. The market saw many new companies spanning across different industry segments and business began to flourish.

The launch of the NSE (National Stock Exchange) and the OTCEI (Over the Counter Exchange of India) in the mid 1990s helped in regulating a smooth and transparent form of securities trading.

The regulatory body for the Indian capital markets was the SEBI (Securities and Exchange Board of India). The capital markets in India experienced turbulence after which the SEBI came into prominence. The market loopholes had to be bridged by taking drastic measures.

Indian Financial Market helps in promoting the savings of the economy and helping to adopt an effective channel to transmit various financial policies. The Indian financial sector is well-developed, competitive, efficient and integrated to face all shocks. In the India financial market there are various types of financial products whose prices are determined by the numerous buyers and sellers in the market. The other determinant factor of the prices of the financial products is the market forces of demand and supply. The various other types of Indian markets help in the functioning of the wide India financial sector.

Securities Market Reforms and Development

The development of the securities market what we are seeing today did not happen overnight. Though the historical records relating to securities market in India is meager and obscure, there is evidence to indicate that the loan securities of the East Indian Company used to be traded towards close of the 18th century. By 1830’s, the trading in shares of banks started. The trader by the name of broker emerged in 1830 when 6 persons called themselves as share brokers. This number grew gradually. Till 1850, they traded in shares of banks and securities of the East India Company in Mumbai under a sprawling Banyan Tree in front of the Town Hall, which is now in the Horniman Circle Park. It is no surprise that the majestic Phiroze Jeejeebhoy Towers is located at the Horniman Circle. In 1850, the Companies Act introducing limited liability was enacted heralding the era of modern joint stock company which propelled trading volumes.

The American Civil War broke out in 1861 which cut off supply of cotton from the USA to Europe. This heightened the demand for cotton from India. Cotton prices increased. Exports of cotton grew, payments were received in bullion. The great and sudden spurt in wealth produced by cotton price propelled setting up companies for every conceivable purpose. Between 1863 and 1865, the new ventures raised nearly ` 30 crore in the form of paid up capital and nearly ` 38 crore of the premia. Rarely was a share which did not command a premium between 1861 and 1865. The Back Bay Reclamation share with `5,000 paid up was at ` 50,000 premium, the Port Canning share with ` 1,000 paid up was at ` 11,000 premium, etc. There was a share mania and everybody was after a piece of paper, variously called ‘allotments’, ‘scrips’ and ‘shares’. The people woke up only when the American Civil war ended. Then all rushed to sell their securities but there were no buyers. They were left with huge mass of un-saleable paper. This occurred then. This also occurs today at regular intervals. However, the bubbles and burst continue to be a perennial feature of the securities market world over.

The depression was so severe that it paved way for setting up of a formal market. The number of brokers, which had increased during the civil war to about 250, declined. During the civil war, they had become so influential and powerful that even the police had only salams for them. But after the end of the civil war, they were driven from pillar to post by the police. They moved from place to place till 1874 when they found a convenient place, which is now appropriately called Dalal Street[4] after their name. They organized an informal association on or about 9th July 1875 for protecting their interests. On 3rd December 1887, they established a stock exchange called ‘Native Share and Stock Brokers’ Association’. This laid the foundation of the oldest stock exchange in India. The word ‘native’ indicated that only natives of India could be brokers of the Exchange.

In 1880s a number textile mills came up in Ahmedabad. This created a need for trading of shares of these mills. In 1894, the brokers of Ahmedabad formed "The Ahmedabad Share and Stock Brokers' Association".

The 1870s saw a boom in jute prices, 1880s and 1890s saw boom in tea prices, then followed coal boom. When the booms ended, there were endless differences and disputes among brokers in eastern India which was home to production of jute, tea and coal. This provoked the establishment of "The Calcutta Stock Exchange Association" on June 15, 1908.

Then followed the proliferation of exchanges, many of them even do not exist today. The rest is history.

Legal Developments

Control of capital issues was introduced through the Defence of India Rules in 1943 under the Defence of India Act, 1939 to channel resources to support the war effort. The control was retained after the war with some modifications as a means of controlling the raising of capital by companies and to ensure that national resources were channeled to serve the goals and priorities of the government, and to protect the interests of investors. The relevant provisions in the Defence of India Rules were replaced by the Capital Issues (Continuance of Control) Act in April 1947.

Though the stock exchanges were in operation, there was no legislation for their regulation till the Bombay Securities Contracts Control Act was enacted in 1925. This was, however, deficient in many respects. Under the constitution which came into force on January 26, 1950, stock exchanges and forward markets came under the exclusive authority of the central government. Following the recommendations of the A. D. Gorwala Committee in 1951, the Securities Contracts (Regulation) Act, 1956 was enacted to provide for direct and indirect control of virtually all aspects of securities trading and the running of stock exchanges and to prevent undesirable transactions in securities.

March Forward to 1990s

In 1980s and 19990s, it was increasingly realized that an efficient and well developed securities market is essential for sustained economic growth. The securities market fosters economic growth to the extent it augments the quantities of real savings and capital formation from a given level of national income and it raises productivity of investment by improving allocation of investible funds. The extent depends on the quality of the securities market. In order to improve the quality of the market, that is, to improve market efficiency, enhance transparency, prevent unfair trade practices and bring the Indian market up to international standards, a package of reforms consisting of measures to liberalise, regulate and develop the securities market is being implemented since early 1990s. The package included liberalization, regulation and development:

i)    Liberalization

The more liberalised a securities market is, the better is its impact on economic growth. Interventions in the securities market were originally designed to help governments expropriate much of the seignior age and control and direct the flow of funds for favoured uses. These helped governments to tap savings on a low or even no-cost basis. Besides, government used to allocate funds from the securities market to competing enterprises and decide the terms of allocation. The result was channelisation of resources to favoured uses rather than sound projects. In such circumstances accumulation of capital per se meant little, where rate of return on some investments were negative while extremely remunerative investment opportunities were foregone. This kept the average rate of return from investment lower than it would otherwise have been and, given the cost of savings, the resulting investment was less than optimum. Hence, it was necessary to do away interventions hindering optimum allocation of resources.

ii)    Regulation

Our laws provide an inclusive definition of ‘securities’. It says that ‘securities’ include shares, bonds, debentures, units of CIS, etc. It does not define in terms of ingredients an instrument must have to be considered as ‘securities’. We hardly come across this   ‘ingredient type of’ definition’ of ‘securities’ in any other jurisdiction. It is precisely because ‘securities’ are most insecure instruments. The only ingredient common to all types of securities is its associated ‘insecurity’. If it is a market for such insecure instruments, market would collapse if somebody does not regulate away the insecurities.

We need regulations to correct for identified market imperfections which produce sub-optimal outcomes and to prevent market failures. In the absence of regulation by a specialized agency, each participant would do its own due diligence before undertaking any transaction in the market. This imposes huge social costs. Besides, regulations signal minimum standards of quality and hence enhance confidence in markets. With a known asymmetric information problem, risk averse investors may exit the market altogether if such minimum standards are not signaled. In its extreme form the market breaks down completely.

There is an apparent contradiction that the reforms aim at liberalization while regulations appear to restrict liberalization. Liberalisation does not mean scrapping of all codes and statutes, as some market participants may wish. It rather means replacement of one set by another set of more liberal code / statute, which allow full freedom to economic agents, but influence or prescribe the way they should carry out their activities, so that the liberalized markets operate in an efficient and fair manner and the risks of systemic failure are minimized. It is, however, desirable to keep in mind the contradiction to ensure that we do not resort to excessive regulation and regulations are designed and implemented properly. Otherwise the costs of regulation would exceed the benefits from regulation.


Unless you develop market, what do you regulate? Unless there is regulation, how does the market develop? It is a chicken and egg issue. Regulation is necessary to develop market and once the market develops, it needs to be regulated. That is why many of the reform initiatives combine the elements of regulation and development. Besides, some developmental measures are introduced as a part of general programme for economic and political development. The macroeconomic policies relating to interest rate, prices, etc can have salubrious effect on the growth and development of the securities market. Other developmental measures include provision of reliable payment system and clearing mechanism, standardized accounting procedure, good corporate governance, skilled manpower etc. which improve the efficiency and transparency of the market.

Although the reforms in true sense happened since early 1990s but the reforms in securities market in India have taken place after the establishment of the SEBI in 1992. These reforms have been designed and implemented jointly by all stakeholders, including the government, the regulator, and the regulated.

A few major reforms are furnished below:

a)     Control over Issue of Capital

A major initiative of liberalisation was the repeal of the Capital Issues (Control) Act, 1947 in May 1992. With this, Government’s control over issue of capital, pricing of the issues, fixing of premia and rates of interest on debentures etc. ceased and the market was allowed to allocate resources to competing uses. In the interest of investors, SEBI issued Disclosure and Investor Protection (DIP) guidelines. The guidelines allow issuers, complying with the eligibility criteria, to issue securities the securities at market determined rates. The market moved from merit based to disclosure based regulation.

b)     Establishment of Regulator

A major initiative of regulation was establishment of a statutory autonomous agency, called SEBI, to provide reassurance that it is safe to undertake transactions in securities. It was empowered adequately and assigned the responsibility to (a) protect the interests of investors in securities, (b) promote the development of the securities market, and (c) regulate the securities market. Its regulatory jurisdiction extends over corporate in the issuance of capital and transfer of securities, in addition to all intermediaries and persons associated with securities market. All market intermediaries are registered and regulated by SEBI. They are also required to appoint a compliance officer who is responsible for monitoring compliance with securities laws and for redressal of investor grievances.

c)     Screen Based Trading

A major developmental initiative was a nation-wide on-line fully-automated screen based trading system (SBTS) where a member can punch into the computer quantities of securities and the prices at which he likes to transact and the transaction is executed as soon as it finds a matching sale or buy order from a counter party. SBTS electronically matches orders on a strict price/time priority and hence cut down on time, cost and risk of error, as well as on fraud resulting in improved operational efficiency. It allowed faster incorporation of price sensitive information into prevailing prices, thus increasing the informational efficiency of markets. It enabled market participants to see the full market on real-time, making the market transparent. It allowed a large number of participants, irrespective of their geographical locations, to trade with one another simultaneously, improving the depth and liquidity of the market – over 10,000 terminals creating waves by clicks from over 400 towns / cities in India. It provided full anonymity by accepting orders, big or small, from members without revealing their identity, thus providing equal access to everybody. It also provided a perfect audit trail, which helps to resolve disputes by logging in the trade execution process in entirety.

The SBTS shifted the trading platform from the trading hall of an exchange to brokers’ premises. It was then shifted to the PCs in the residences of investors through the Internet and to hand-held devices through WAP for convenience of mobile investors. This made a huge difference in terms of equal access to investors in a geographically vast country like India.

d)     Risk management

A number of measures were taken to manage the risks in the market so that the participants are safe and market integrity is protected. These include:

i) Trading Cycle

The trading cycle varied from 14 days for specified securities to 30 days for others and settlement took another fortnight. Often this cycle was not adhered to. This was euphemistically often described as T+ anything. Many things could happen between entering into a trade and its performance providing incentives for either of the parties to go back on its promise. This had on several occasions led to defaults and risks in settlement. In order to reduce large open positions, the trading cycle was reduced over a period of time to a week initially. Rolling settlement on T+5 basis was introduced in phases. All scrips moved to rolling settlement from December 2001. T+5 gave way to T+3 from April 2002 and T+2 from April 2003.

ii)    Dematerialisation

Settlement system on Indian stock exchanges gave rise to settlement risk due to the time that elapsed before trades are settled. Trades were settled by physical movement of paper. This had two aspects. First, the settlement of trade in stock exchanges by delivery of shares by the seller and payment by the purchaser. The process of physically moving the securities from the seller to the ultimate buyer through the seller’s broker and buyer’s broker took time with the risk of delay somewhere along the chain. The second aspect related to transfer of shares in favour of the purchaser by the company. The system of transfer of ownership was grossly inefficient as every transfer involved physical movement of paper securities to the issuer for registration, with the change of ownership being evidenced by an endorsement on the security certificate. In many cases the process of transfer took much longer, and a significant proportion of transactions ended up as bad delivery due to faulty compliance of paper work. Theft, forgery, mutilation of certificates and other irregularities were rampant, and in addition the issuer had the right to refuse the transfer of a security. All this added to costs, and delays in settlement, restricted liquidity and made investor grievance redressal time consuming and at times intractable.

To obviate these problems, the Depositories Act, 1996 was passed to provide for the establishment of depositories in securities with the objective of ensuring free transferability of securities with speed, accuracy and security by (a) making securities of public limited companies freely transferable subject to certain exceptions; (b) dematerialising the securities in the depository mode; and (c) providing for maintenance of ownership records in a book entry form. In order to streamline both the stages of settlement process, the Act envisages transfer of ownership of securities electronically by book entry without making the securities move from person to person. Currently 99% of market capitalization is dematerialized and 99.9% of trades are settled by delivery.

iii)  Derivatives

To assist market participants to manage risks better through hedging, speculation and arbitrage, the Securities Contracts (Regulation) Act,1956, (SCRA) was amended in 1995 to lift the ban on options in securities. The SCRA was amended further in December 1999 to expand the definition of securities to include derivatives so that the whole regulatory framework governing trading of securities could apply to trading of derivatives also. A three-decade old ban on forward trading, better known as BADLA[5], which had lost its relevance and was hindering introduction of derivatives trading, was withdrawn. Derivative trading took off in June 2000 on two exchanges.

iv)  Settlement Guarantee

A variety of measures were taken to address the risk in the market. Clearing corporations emerged to assume counter party risk. Trade and settlement guarantee funds were set up to guarantee settlement of trades irrespective of default by brokers. These funds provide full novation and work as central counter party. The Exchanges /clearing corporations monitor the positions of the brokers on real time basis.

Various measures taken over last decade or so have yielded considerable benefits to the market, as evidenced by the growth in number of market participants, growth in volumes in securities transactions, increasing globalization of the Indian market, reduction in transaction costs, and compliance with international standards.

Insider trading

Insider trading is the trading of a corporation's stock or other securities (e.g. bonds or stock options) by individuals with potential access to non-public information about the company. In most countries, trading by corporate insiders such as officers, key employees, directors, and large shareholders may be legal, if this trading is done in a way that does not take advantage of non-public information. However, the term is frequently used to refer to a practice in which an insider or a related party trades based on material non-public information obtained during the performance of the insider's duties at the corporation, or otherwise in breach of a fiduciary or other relationship of trust and confidence or where the non-public information was misappropriated from the company[6].

It was the Sunday Times of UK that coined the classic phrase in 1973 to describe this sentiment - "the crime of being something in the city", meaning that insider trading was believed as legitimate at one time and a law against insider trading was like a law against high achievement. It is the trading that takes place when those privileged with confidential information about important events use the special advantage of that knowledge to reap profits or avoid losses on the stock market, to the detriment of the source of the information and to the typical investors who buy or sell their stock without the advantage of "inside" information. Almost eight years ago, India's capital markets watchdog – the Securities and Exchange Board of India organised an international seminar on capital market regulations. Among others issues, it had invited senior officials of the Securities and Exchange Commission to tell us how it tackled the ‘menace of insider trading’.


The following are the objectives of the study:-

1)     To find out the reasons for insider trading.
2)     To find out to what extent this evil permeated in the financial system   and the resultant consequences and overall impact on the society.
3)     To suggest suitable measures in the Indian regulatory framework to stop this menace.
4)     To give reasons for the suggestions based on empirical research.


It was only about three decades back that insider trading was recognized in many developed countries as what it was - an injustice; in fact, a crime against shareholders and markets in general. At one time, not so far in the past, inside information and its use for personal profits was regarded as a perk of office and a benefit of having reached a high stage in life.

In the United States and Germany, for mandatory reporting purposes, corporate insiders are defined as a company's officers, directors and any beneficial owners of more than ten percent of a class of the company's equity securities. Trades made by these types of insiders in the company's own stock, based on material non-public information, are considered to be fraudulent since the insiders are violating the fiduciary duty that they owe to the shareholders. The corporate insider, simply by accepting employment, has undertaken a legal obligation to the shareholders to put the shareholders' interests before their own, in matters related to the corporation. When the insider buys or sells based upon company owned information, he is violating his obligation to the shareholders.

For example, illegal insider trading would occur if the chief executive officer of Company X learned (prior to a public announcement) that Company X will be taken over, and bought shares in Company X knowing that the share price would likely rise.

In the United States and many other jurisdictions, however, "insiders" are not just limited to corporate officials and major shareholders where illegal insider trading is concerned, but can include any individual who trades shares based on material non-public information in violation of some duty of trust. This duty may be imputed; for example, in many jurisdictions, in cases of where a corporate insider "tips" a friend about non-public information likely to have an effect on the company's share price, the duty the corporate insider owes the company is now imputed to the friend and the friend violates a duty to the company if he or she trades on the basis of this information.

In the United States and several other jurisdictions, trading conducted by corporate officers, key employees, directors, or significant shareholders[7] must be reported to the Regulator or publicly disclosed, usually within a few business days of the trade. Many investors follow the summaries of these insider trades in the hope that mimicking these trades will be profitable. While "legal" insider trading cannot be based on material non-public information, some investors believe corporate insiders nonetheless may have better insights into the health of a corporation and that their trades otherwise convey important information.

But one of the main reasons that capital is available in such quantities in the markets is basically that the investor trusts the markets to be fair. Fairness is a major issue. Even though it sounds simplistic, it is a critical factor and one that is absent, really to a surprising degree in many of the sophisticated foreign markets. The common belief in Europe that certain investors have access to confidential information and regularly profit from that information may be the major reason why comparatively few Europeans actually own stock. Indeed, the European Economic Community has formally recognized the importance of insider trading prohibitions by passing a directive requiring its members to adopt insider trading legislation. The preamble to the directive stresses the economic importance of a healthy securities market, recognizes that maintaining healthy markets requires investor confidence and acknowledges that investor confidence depends on the "assurance afforded to investors that they are placed on an equal footing and that they will be protected against the improper use of inside information." These precepts echo around the world as reports of increased insider trading regulation and enforcement efforts are daily news.[8]

Insider Trading Law in the US

Rooted in the common law tradition of England, the US legal system has relied largely on the courts to develop the law prohibiting insider trading. The United States Department of Justice has played the largest role in defining the law of insider trading.

After the United States stock market crash of 1929, Congress enacted the Securities Act of 1933 and the Securities Exchange Act of 1934, aimed at controlling the abuses believed to have contributed to the crash. The 1934 Act addressed insider trading directly through Section 16(b) and indirectly through Section 10(b).

Section 16(b) prohibits short-swing profits (profits realized in any period less than six months) by corporate insiders in their own corporation's stock, except in very limited circumstance. It applies only to directors or officers of the corporation and those holding greater than 10% of the stock and is designed to prevent insider trading by those most likely to be privy to important corporate information.

Section 10(b) of the Securities and Exchange Act of 1934 makes it unlawful for any person "to use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC[9]] may prescribe." To implement Section 10(b), the SEC adopted Rule 10b-5, which provides, in relevant part:

It shall be unlawful for any person, directly or indirectly . . .,

(a)  to employ any device, scheme, or artifice to defraud,
(b)  to make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or
(c)  to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of a security.

Liability for insider trading

Liability for insider trading violations cannot be avoided by passing on the information in an "I scratch your back, you scratch mine" or quid pro quo arrangement, as long as the person receiving the information knew or should have known that the information was company property. It should be noted that when allegations of a potential inside deal occur, all parties that may have been involved are at risk of being found guilty.

For example, if Company A's CEO[10] did not trade on the undisclosed takeover news, but instead passed the information on to his brother-in-law who traded on it, illegal insider trading would still have occurred.

Insider Trading - Position in India

According to Regulation 2 (e) of the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992[11]  “insider” means any person who, is or was connected with the company or is deemed to have been connected with the company, and who is reasonably expected to have access to unpublished price sensitive information in respect of securities, or who has received or has had access to such unpublished price sensitive information;

 Price Sensitive Information

According to Regulation 2 (ha) of the Regulations, “price sensitive information” means any information which relates directly or indirectly to a company and which if published is likely to materially affect the price of securities of company.

According to the Explanation given in this Regulation — the following shall be deemed to be price sensitive information:—

(i)       periodical financial results of the company;
(ii)    intended declaration of dividends (both interim and final);
(iii)  issue of securities or buy-back of securities;
(iv)   any major expansion plans or execution of new projects;
(v)     amalgamation, mergers or takeovers;
(vi)      disposal of the whole or substantial part of the undertaking; and
(vii)   significant changes in policies, plans or operations of the company;

Prohibition on dealing, communicating or counseling on matters relating to insider trading (R.3& 3A)

No insider shall—

(i) either on his own behalf or on behalf of any other person, deal in securities of a company listed on any stock exchange [12][when in possession of] any unpublished price sensitive information; or

[[13](ii) communicate counsel or procure directly or indirectly any unpublished price sensitive information to any person who while in possession of such unpublished price sensitive information shall not deal in securities :

Provided that nothing contained above shall be applicable to any communication required in the ordinary course of business [14][or profession or employment] or under any law]

No company shall deal in the securities of another company or associate of that other company while in possession of any unpublished price sensitive information.

Violation of provisions relating to insider trading (R.4)

Any insider who deals in securities in contravention of the provisions of regulation 3 [or 3A] shall be guilty of insider trading.

Penalty for insider trading (Sec 15G)

 If any insider who,-

(i)       either on his own behalf or on behalf of any other person, deals in securities of a body corporate listed on any stock exchange on the basis of any unpublished price sensitive information; or
(ii)    communicates any unpublished price- sensitive information to any person, with or without his request for such information except as required in the ordinary course of business or under any law; or
(iii)  counsels, or procures for any other person to deal in any securities of anybody corporate on the basis of unpublished price-sensitive information,

Shall be liable to a penalty of twenty-five crore rupees or three times the amount of profits made out of insider trading whichever is higher.

Insider trading is considered to be a serious economic offence. The  enormity of the challenge posed by economic offenders’ calls for a professional and pro-active approach.  Despite regulations, several countries have found it difficult to frame insiders because of the nature of the offence. Identifying the insider and then proving the charge is an onerous task due to the heavy burden of proof involved in each case. Although SEBI has implemented laws on insider trading yet the number of offenders actually brought to book is dismal. In fact, many a time SEBI has been unable to detect instances of insider trading. SEBI Regulations do stipulate safeguards like initial and continual disclosures by insiders to companies, code of conduct to be followed by listed companies etc. but there is room for improvement.

It is important to remember that capital markets are a source of large pool of funds for all kinds of investors. Most Funds say that the systems and processes are proper but one individual can beat these systems by being unethical. The argument is unacceptable. If systems are proper that means front running should not be possible. There will always be some individuals who will try to beat the system. Process has to be continuously upgraded to catch these people. Hence, it becomes important that the regulator has to maintain its integrity and efficiency by following a consistent approach which is designed to provide a level playing field in enforcement securities laws of the land. Nobody is more equal than the others and, therefore, trading by ‘insiders’ to the detriment of ‘outsiders’ should be strictly dealt with. Therefore, fighting against Insider trading is a biggest challenge before the Indian Watch Dog, the "SEBI”

Therefore,  it is all the more important that the SEBI should strong enough to  play a proactive and vigilant role by introducing stringent measures designed to provide greater deterrence, detection and punishment of violations of insider trading law. It should introduce greater transparencies, keep a check on sudden abnormal trends in the market, provide adequate safeguards like prohibition of trading by insiders prior to corporate announcements viz. mergers, takeovers, monitor the trading patterns and undertake swift investigations in case of a spurt of buying or selling activity in the market, take stringent action against the guilty to act as deterrence for others. At the same time, it is the prerogative of companies to strictly adhere to the code of conduct prescribed by SEBI, and ensure good corporate governance in order to protect the overall interest of investors against unfair and inequitable practices of insider trading.


Insider trading has the dangerous potential of market manipulation and misuse of un published price sensitive information by a privileged few insiders who are in possession of such information. This kind of malpractice defeats the very principle of fair and ethical business practices, besides spelling a doom for the common and small investors. The Capital Markets in India have been victims of this malady for years and more particularly when liberalization attracted small investors to the markets. Instances of artificially jacking up prices of shares and thereby inducing gullible people to buy them are also common. People have lost heavily on account of frauds of this nature committed by unscrupulous market players.

Till the early nineties, the Indian economy functioned in an environment regimented by control and regulations. With the reforms initiated by the Government, the economy moved from controlled to market driven. The forces of globalization and liberalization compelled the corporate to restructure the business by adopting the tools, viz., mergers, amalgamations and takeovers. All these activities, in turn, impacted the functioning of the capital market, more particularly the movement of share prices.

In tune with these changes, certain developments have been brought into Legal frame work governing the Securities market in India. The four main legislations governing the securities market in India are (1) the Securities Contracts (Regulation) Act,1956, which provides for regulation of transactions in securities through control over stock exchanges; (2) the SEBI Act,1992 which establishes SEBI to protect investors and develop and regulate securities market; (3) the Depositories Act,1996 which provides for electronic maintenance and transfer of ownership of ‘demat’ securities and  (4) the Companies Act,1956, which sets out the code of conduct for the corporate sector in relation to issue, allotment and transfer of securities, and disclosures to be made in public issues.  

Recent changes

SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2011

Securities Exchange Board of India vide notification no LAD-NRO/GN/2011-12/16/26150, Dated 16-8-2011 has issued further regulations regarding ”Disclosure of interest or holding in listed companies by certain persons – Initial Disclosure.” through SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2011. These Regulations envisages:

“(2A) Any person who is a promoter or part of promoter group of a listed company shall disclose to the company in Form B the number of shares or voting rights held by such person, within two working days of becoming such promoter or person belonging to promoter group ;

“(4A) Any person who is a promoter or part of promoter group of a listed company, shall disclose to the company and the stock exchange where the securities are listed in Form D, the total number of shares or voting rights held and change in shareholding or voting rights, if there has been a change in such holdings of such person from the last disclosure made under Listing Agreement or under sub-regulation (2A) or under this sub-regulation, and the change exceeds INR 5 lakh in value or 25,000 shares or 1% of total shareholding or voting rights, whichever is lower.”

Change of Takeover threshold Limits (2011)

In order to open up India’s market for corporate control new takeover regulations are announced by markets regulator SEBI on 28th July, 2011. The Code has three major changes which are as follows: -

1)     The trigger point or threshold limit has been changed from 15% to 25%. This means that if the person/entity or persons acting in concert acquire shares of 25% of the company, the open offer would have to be made.

2)     The size of the open offer has been increased from 20% to 26%. The earlier limit of offer has been changed as the threshold limit has been changed and it makes sense that the size of the open offer should be bigger than the threshold limit.

3)     The contentious issue of non-compete fee has been abolished. This is a demand which has been made by minority shareholders and it has been finally accepted.

In other words, under the changed regulations, an acquirer has to make an open offer once he crosses the threshold holding of 25% in a company, rather than 15% as before, and the open offer has to be for 26% (20% earlier) and at the full price at which the threshold was crossed. No more sweet deals for promoter-sellers in the form of ‘non-compete fees’, an element of the share price that was denied to minority shareholders, while making the open offer. The acquirer would end up with a controlling stake, and shareholders, with a higher price than was likely in the previous regime. The raising of the open-offer trigger threshold has two effects. It makes it easier to fund enterprises -private equity player can hold a much larger stake, just a sliver lower than 25%, without getting into control mode. At the same time, the fact that someone can come so close to the 26% threshold that endows the holder with veto rights on special resolutions would put the promoters on their toes, even when that holding is below the 25% takeover threshold.

Efficient transfer of resources from those having idle resources to others who have pressing need for them is achieved through financial markets. Stated formally, financial markets provide channels for allocation of savings to investment. These provide a variety of assets to savers as well as various forms in which the investors can raise funds and thereby decouple the acts of saving and investment. The savers and investors are constrained not by their individual abilities, but by the economy’s ability, to invest and save respectively. The financial markets, thus, contribute to economic development to the extent that the latter depends on the rates of savings and investment.

An efficient and robust financial system acts as a powerful engine of economic development by mobilising resources and allocating the same to their productive uses. It reduces the transaction cost of the economy through provision of an efficient payment mechanism, helps in pooling of risks and making available long-term capital through maturity transformation. By making funds available for entrepreneurial activity and through its impact on economic efficiency and growth, a well functioning financial sector also helps alleviate poverty both directly and indirectly. In a developing country, however, financial sectors are usually incomplete in as much as they lack a full range of markets and institutions that meet all the financing needs of the economy.


The frame work of hypothesis is based on the following postulates:

1)     Efficient transfer of resources from those having idle resources to others who have pressing need for them is achieved through financial markets.
2)     Financial Markets provide channels for allocation of savings to investment.
3)     The Financial Markets contribute to economic development to the extent that the latter depends on the rates of savings and investment.
4)     As a natural corollary of the liberalization and globalization, the Indian Capital Market has undergone a sea change in terms of innovations, growth and deregulation.
5)     The securities market fosters economic growth to the extent that it:
a)       augments the quantities of real savings and capital formation from any given level of national income;
b)       increases net capital inflow from abroad;
c)       raises the productivity of investment by improving allocation of investable funds; and
d)       reduces the cost of capital.
6)     The securities market provides a fast-rate breeding ground for the skills and judgment need for entrepreneurship, risk bearing, port folio selection and management.
7)     An active securities market serves as an ‘engine’ of general financial development may, in particular, accelerate the integration of informal financial systems with the institutional financial sector. Securities directly displace traditional assets such as gold and stocks of produce or, indirectly, may provide port folio assets for unit trusts, pension funds and similar FIs that raise savings from the traditional sector.
8)     The existence of the securities market enhances the scope, and provides institutional mechanisms, for the operation of monetary and financial policy.
9)     The responsibility for regulating the securities market in India is shared by the Department of Economic Affairs (DEA), Ministry of Corporate Affairs (MCA), Reserve Bank of India (RBI) and SEBI.
10)The twin objectives of the regulator (SEBI) in India are:
a)     to protect the  interest of investors in securities;
b)     to promote the development of, and to regulate the securities market by taking appropriate measures.


As is well-known at the present day, a research scholar cannot depend upon any one particular method for the preparation of a thesis. A combination of different methods is required to achieve the best possible results. Thus a Historical-cum Analytical method has been applied mainly in the preparation of the present work. Where ever necessary, comparative and critical methods also are employed to have a detailed study of the subject under consideration.


The required materials for the thesis have been collected mainly by applying the Doctrinal Approach. This approach deals with formal sources of Law like Legislation, Case law, Text Books, Articles etc. It is basically textual in approach as contrasted to Non-Doctrinal Approach which is primarily contextual in nature. In the preparation of this thesis, by adopting the above-mentioned technique, data have been collected from various enactments including the SEBI Act, 1992; The Companies Act, 1956; The Securities Contracts (Regulation) Act, 1956 and The Depositories Act, 1996 and the rules  and regulations made under these enactments,  Reports of the Securities Exchange Commission (SEC) USA, and the reports of the Securities and Exchange Board of India (SEBI), judgments of the Securities Appellate Tribunal (SAT) / Company Law Board (CLB) / Supreme Court, High Courts etc.


The thesis is divided into 6 chapters as under:

Chapter – I
Emerging Financial Markets: In this chapter an outline of the scheme of research intended for the thesis is brought out.  The objectives of the study, methodology, sources of information are also discussed in this chapter.

Chapter – II
Capital Markets: In this chapter the Primary and Secondary Market functions, Capital Market Instruments like Prime Instruments, Hybrid Instruments, Derivatives, Mutual Funds, Venture Capital, Collective Investment Schemes and the importance of Credit Rating have elaborately brought out.

Chapter – III
Legal and Regulatory Frame Work: In this chapter, the relevant provisions of law under different enactments including the SEBI Act, 1992; The Companies Act, 1956; The Securities Contracts (Regulation) Act, 1956 and The Depositories Act, 1996and the rules  and regulations made under these enactments have been discussed elaborately.

Chapter – IV
Judicial Approach: In this chapter, the relevant case laws and the approach of the courts / quasi judicial authorities in interpreting the relevant provisions of the statutes and in imposing the penalties in case of violations of the prevailing laws have discussed elaborately.    

Chapter – V
Recent Trends and Reforms: A developed securities market enables all individuals, no matter how limited their means, to share the increased wealth provided by competitive private enterprises. The legal structure of society forms an important pillar in the fight against corrupt practices in the financial markets. To fight against these corrupt practices, there is a need for a strong legal framework. In India, the legal framework for curbing and controlling Insider Trading is primarily based on statutory and common law. Certain changes have taken place recently in the Indian regulatory framework, as the existing legislations and other regulations are not sufficient to tackle this menace; there still remain some areas that require change. In this chapter, the changes that have taken place recently in the regulatory frame work are brought out elaborately.

Chapter – VI
Conclusion & Recommendations: In the last chapter, a brief summary of the thesis together with observations and findings of the Researcher have been highlighted.

Every effort will made to make the thesis as exhaustive and as comprehensive as possible.

Further Readings:

I.       Books
1)           G.S. Batra : Financial Services and Market (Deep & Deep Publication)-2005
2)           L.M. Bhole : Financial Institutions and Markets (TA MC-Graw Hill)
3)           H.R. Machiraju; The Working of Stock Exchange in India.
4)           H.R. Machiraju : Indian Financial System (Vikas)
5)           V. A. Avadhani : Investment & Securities Market in India (Himalaya Publishing House)
6)           Young Patrick; Capital Market Revolution: The Future of Markets in an Online Word.
7)           Sanjeev Aggarwal; Guide to Indian Capital Market; Bharat Law House, 22, Tarun Enclave, Pitampura, New Delhi – 110034.
8)           V.L. Iyer; SEBI Practice Munual, Taxman Allied Service (P) Ltd., 59/32, New Rohtak Road, New Delhi – 110005.
9)           M.Y. Khan; Indian Financial Systems; Tata McGraw Hill, 4/12, Asaf Ali Road, New Delhi – 110002.

II.   Journals, Articles and Reports
1)     NSE (2009). Indian Securities Market: A Review, Mumbai: National Stock Exchange of India.
2)     Planning Commission (2008). A Hundred Small Steps-Report of the Committee on Financial Sector Reforms, New Delhi: Sage Publications India.
3)     SEBI: Various reports of the annual report from 1992-93 to 2008- 09.
4)     Corporate Law Adviser; Corporate Law Adviser, Post Bag No. 3, Vasant Vihar, New Delhi – 110052.
5)     Supreme Court Journal; 2011(7) SCJ; Article By Dr T. Padma  titled  ‘What is an insider trading?’ Need for stringent regulations to fight against this menace – an overview.
III.   Legislations, Orders and Regulations
1)     Securities Exchange Board of India Act, 1992
2)     The Securities Contracts (Regulation) Amendment Act, 2007
3)     Securities Contracts (Regulation) Act, 1956
4)     Depositories Act, 1996
5)     The Companies Act, 1956 (As Amended)

IV.    Newspapers and Magazines
1)           Chartered Accountant, Monthly Journal of ICAI.
2)           Chartered Secretary; Monthly Journal of ICSI.
3)           Management Accountant; Monthly Journal of ICWAI.

V.    Web-sites
5)           www.

[1]  In United States v. O'Hagan, 521 U.S. 642, 655 (1997)
[2] The Securities and Exchange Board of India
[3] Initial public offer
[4] Dalal street located in Mumbai, India
[5]  A carry-forward system in stock trading
[6] Information Page from U S Securities and Exchange Commission accessed on 20th September, 2011
[7] In the U.S., it is defined as beneficial owners of ten percent or more of the firm's equity securities
[8] Excerpts from Speech of SEC Staff on ‘Insider Trading – A U.S. Perspective’ at 16th International Symposium on Economic Crime, Jesus College, Cambridge, England
[9] The U.S. Securities and Exchange Commission (frequently abbreviated SEC) is a federal agency which holds primary responsibility for enforcing the federal securities laws and regulating the securities industry, the nation's stock and options exchanges, and other electronic securities markets in the United States. In addition to the 1934 Act that created it, the SEC enforces the Securities Act of 1933, the Trust Indenture Act of 1939, the Investment Company Act of 1940, the Investment Advisers Act of 1940, the Sarbanes-Oxley Act of 2002 and other statutes. The SEC was created by section 4 of the Securities Exchange Act of 1934 (now codified as 15 U.S.C. § 78d and commonly referred to as the 1934 Act).

[10] CEO is the highest ranking executive in a company whose main responsibilities include developing and implementing high-level strategies, making major corporate decisions, managing the overall operations and resources of a company, and acting as the main point of communication between the board of directors and the corporate operations. The CEO will often have a position on the board, and in some cases is even the chair. 
[11] Amended   by the SEBI (Insider Trading) (Amendment) Regulations, 2002, w.e.f. 20.02.2002.
[12] Substituted for “on the basis of”, ibid.
[13] Substituted by the SEBI (Insider Trading) (Amendment) Regulations, 2002, w.e.f.20.2.2002. Prior to substitution, clause (ii) read as under:
"(ii) communicate any unpublished price sensitive information to any person, with or without his request for such information, except as required in the ordinary course of business or under any law; or"
[14] Inserted by the SEBI (Prohibition of Insider Trading) (Second Amendment) Regulations, 2002, w.e.f. 29.11.2002.