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INSIDER TRADING LAWS IN

PAKISTAN: A CRITIQUE

1993

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PTCL, 1993 Jour. 42

INSIDER TRADING LAWS IN PAKISTAN

A CRITIQUE Prepared by:

Khozem A. Haidermota

Insider Trading Laws In Pakistan: A Critique

I. Introduction:-

Average investors act invariably on incomplete or inaccurate information, consequently there

are winners and losers; but for the development of and confidence in capital markets, it is

imperative that such losers do not perceive to have been defrauded. It is a well-established

principle in developed capital markets of the world that when “insiders” of a public company trade

in their own company stock with the knowledge of material non-public information, a fraud on

the market has been committed. This is based on the hypothesis that the price is an open and

developed securities market is determined by the available material information regarding the

company and its business. Misleading statements or material commissions distort the true value

of the securities and, therefore, defraud the market and consequently the shareholders at large.

The contention that insider trading must be curbed has, however, been controverted by

several scholars, through the views of such scholars have not been adopted by most capital market

regulators of developed and developing economics. To analyse the merits of such dissent is not

the purpose of this paper. The object is to examine the existing laws on insider trading and to

suggest amendments and clarification where appropriate.

In any event, very briefly, the two main arguments made by those who view insider trading as

acceptable practice are thus: -- First. It is argued that prohibition on insider trading cannot be

enforced under any reasonable commitment of administrative and judicial resources. This

argument has particular relevance in Pakistan because hard-to-detect evasion devices are

available to insiders, such as the use of factitious names or nominees, benamis etc. This problem

is compounded by our protracted and inefficient legal system. Second, unhampered insider

trading can be viewed as a necessary form of compensation for entrepreneurial activity. As

Professor Henry Manne contends, “insider trading is the means by which the incentives for

entrepreneurial activity in large corporations is effectively preserved: the individuals in the

corporation who are responsible for its successes must be able to appropriate the gains.” Manne,

Insider Trading and Law Professors, 23 Vanderbilt L. Rev. 547 (1970).

II. Overview of Legal Framework:-

The legal framework of insider trading laws in Pakistan are found in Sections, 223 and 224 of

the Companies Ordinance, 1984 (hereinafter, the “Companies, Ordinance”) and Section 17(e)(vi)

of the Securities and Exchange Ordinance, 1969 (hereinafter, the “Securities Ordinance”).

Sections 220 to 222 of the Companies Ordinance mandates inter alia that specified disclosures

made by insiders with respect to the beneficial ownership of their listed company’s securities. The

adequacy and timing of such disclosures, through intertwined with subject of insider trading laws,

will however be dealt with in a separate paper.

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Section 223 of the Companies Ordinance prohibits short selling by certain insiders. Section 224

of the Companies Ordinance requires that insiders report to the Corporate Law Authority

purchases and sales of their own company’s securities within a period of less than six months. Any

gains by such insiders within six months are made recoverable by the company. Section 17(e)(vi)

of the Securities Ordinance prohibits an insider from buying or selling its own securities when such

insider is in possession of material facts and omits to disclose such facts while buying or selling

securities. Section 23(3) of the Securities Ordinance allows a shareholder to bring an action for

damages against an insider for violation of insider trading laws under the Ordinance. This Section

clarifies that such an action for damages may be brought without having to establish a contractual

relationship between the shareholder and the insider. Finally, Section 24 of the Securities

Ordinance permits criminal sanctions against the offending insider.

Research revealed that there has been no prosecution in Pakistan under any of the foregoing

statutes. Therefore, to analyse the implications of these statutes similar laws as existing in the

United States will be examined. Admittedly the capital markets of Pakistan and the United States

cannot be compared. Nonetheless reference to U.S. laws is appropriate for the following two

reasons: (1) insider trading laws have been on the books in the U.S. since 1933 and their courts

and legislators alike have made several mistakes. We could avoid such mistakes by learning from

their experiences; and (ii) for better or for worse, Pakistani statutes in substantial part are

modelled after the U.S. statutes.

III. Prohibition on Buying or Selling Securities with Insider Information under the Securities and

Exchange Ordinance: -

The statute that directly prohibits trading of securities predicated on inside information is

found in Section 17 of the Securities and Exchange Ordinance, 1969 which is relevant part states:

No person shall, for the purpose of inducing, dissuading, effecting or preventing in any

manner influencing or turning to his advantage, the sale or purchase of any security, directly or

indirectly—

(a) to (d) omitted.

(e) do any act or practice or engage in a course of business, or omit to do any act which

operates or would operate as a fraud, deceit or manipulation upon any person, in

particular—

(i) To (v) omitted.

(vi) being a director or an officer of the issuer of a listed equity security or a

beneficial owner of not less than ten percent of such security who is in

possession of material facts omit to disclose any such facts while buying

or selling such security.

Unfortunately, the above statute has not been interpreted by the Courts in Pakistan. If,

however, the regulators are keen to combat insider trading activities, it is likely that they will rely

on the above statute, since it is the only statute found in either the Securities Ordinance or in the

Companies Ordinance where an insider is prohibited from using material non-public information

while buying or selling listed securities.

There are three fundamental concerns with the above statute. First, definition of

insider is a narrow one and under certain circumstances would not cover persons with important

policy making functions at a listed company. Second, if an insider tips off a friend with non-public

material inside information and the friend trades on such information, is the insider (the tipper)

and/or the friend (tippee) accountable? Third, absent guidelines, it would be very difficult to

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ascertain exactly what constitutes material non-public facts which must be disclosed prior to an

insider trading in the issuer’s securities.

III(a) Definition of insider under Securities and Exchange Ordinance:--

Presently, under the Securities Ordinance, insider trading is forbidden for a director or any officer

of the issuer of a listed equity security or a beneficial owner of not less than ten percent of such

security. The identification of a director is generally self-evident, but that of an officer is more

problematic. The definition of an officer found in Securities Ordinance states that “officer … in

relation to an issuer includes managing agents, manager, secretary, accountant or auditor of the

issue.” This definition is unsatisfactory since it makes no attempt to cover people likely to have

inside information, since a person’s title alone should not determine whether such person is an

insider. The proper focus should be on whether a person is “a corporate employee performing

important executive duties of such character that he would be likely, in discharging these duties,

to obtain confidential information about company’s affairs that would aid him if he engaged in

personal market transactions.” U.S. Securities Exchange Act Release No. 28869, May 1991. If title

were determinative, persons with significant executive functions could avoid responsibility by

foregoing title and persons with officer titles but no significant managerial or policy making duties

would be subject to harsh liabilities. Intriguingly, the definition of an officer in the Securities and

Exchange Rules is broader than the one found in the Ordinance. The definition in the Rules

addresses the concern that a person’s title should not be dispositive. It states: “An officer in

relation to an issuer include a managing agent, manager, secretary or accountant of the issuer and

other person who by virtue of his office may be in possession of any material information with

regard to the affairs of the issuer.” (Emphasis added) It is at, therefore, the very least suggested

that the definition of officer found in the Securities and Exchange Rules should be substituted for

the definition of an officer found in the Securities Ordinance.

The person who comes within the ambit of a ten percent beneficial holder of the issuer’s

securities and consequently an insider is also not specifically defined in the Securities Ordinance.

For purposes of consistency, it is suggested that the definition of beneficial owner found in Section

224 of the Companies Ordinance (elaborated in Part IV of this paper) be adopted in the Securities

Ordinance.

III(b). Liability of Tippees:-

The next question we have to address is whether the prohibition on insider dealings based on non-

public information should be extended beyond the insiders discussed above. For example, should

tippees (i.e. one to whom an insider has selectively disclosed information) be held accountable.

This problem of selective disclosure not only arises when friends engage in informal conversations

at parties but is also obtained frequently by market analysis who follow particular companies,

contacting company officials for information relating to their dividend payout plans, earnings

projections and the like.

Two competing views must be examined before extending the reach of insider trading statutes

to tippees. On the one hand, to hold tippees liable could have an inhibiting influence on the role

of market analysis – which is recognized for the preservation of healthy market analysis. Market

analysts plays a constructive role in making the market more efficient by ferreting out the

abundance of information about companies and selectively disclosing the relevant ones to their

clients. As such, those who want to give tippees a free ride argue that sanctions on them would

“hamper legitimate investigative securities analysis.” But, on the other hand, those who favour

regulation of tippees, argue that allowing tippees to go unfettered would be tantamount to

shifting the loss from such tippee, or such tippee’s clients, to the investing public. Moreover, they

argue that it appears to be a logical fallacy that whereas the tipper (i.e. generally, the insider)

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would not be able to trade on inside information, but the tippee or his clients would nevertheless

be able to trade without violating the laws.

After years of confusion and contradictory court decisions, the Supreme Court of the United

States in Dirks v. Securities & Exchange Commission, 103S, Ct. 3255 (1983) finally put some

semblance of order regarding the liability of tippees. Since the Dirks case takes a well-reasoned

middle ground between the above two competing views, I shall briefly elaborate the case here. In

Dirks, an employee of a mutual fund disclosed in Dirks, a security analyst, that a massive fraud

was about to be uncovered at the mutual fund. Dirks selectively disclosed this information to his

institutional clients who immediately disposed of their shares in the mutual fund. The U.S.

Securities and Exchange Commission found that Dirks had violated insider trading laws since it had

a duty to publicly disclose the information prior to disclosing the same to its clients.

The U.S. Supreme Court reversed the U.S. Securities and Exchange Commission’s decision and

found Dirks not guilty. The test the Court applied was “whether the insider personally will benefit

directly or indirectly from his disclosure. Absent some personal gain, there has been no breach of

duty to stockholders.” Thus, since the insider at the mutual fund who disclosed the non-public

information to Dirks did not do so for personal gain, there was no breach of fiduciary duty by the

in sider, and Dirks had no duty to refrain from using the information, even though it was within

his knowledge that material non-public information had come from an insider.

What did Dirks decision essentially does is to stimulate analysts particularly analysts who make

a business out of selective disclosure of their market investigations and use it for the benefit of

their clients, so long as they do not (a) reward the insider (tipper) financially or otherwise, or (b)

misappropriate or steal the information. See, Bloomenthal, Securities Law Handbook (Clark,

Boardman 1989-1990 Edition), p.390.

This indeed appears to be good public policy and the regulators may wish to clarify the law

accordingly. Pakistan’s capital markets are in its infancy and are relatively lenient stance towards

tippees, as indicated by the Dirks case, appears appropriate. Such tippees are frequently market

analysts or brokers and it is essential to encourage their market making capabilities to stimulate

the capital markets.

Brokers who also sit as directors on the boards of listed companies.(a scenario gaining fashion

in Pakistan), would not be able to avail of the protection afforded to tippees since they would be

deemed to be insiders.

III(c). Standard for Materiality:-

The third question that arises is to determine exactly what is the material information about the

issuer that must be disclosed to the public prior to permitting an insider to trade in the securities

of the issuer? In other words, what is the standard of materiality? Again, courts in Pakistan have

yet to examine the standard of materiality in the context of insider trading laws. In Pakistani

courts, the question of materiality frequently arises in the context of information to be included

in court pleadings. In this context, Prem’s Judicial Dictionary states that the “word material means

of such nature as to affect in any way, directly or indirectly, the probability of anything to be

determined by the proceeding, or the credit of any witness.” This standard of materiality if applied

in the context of insider trading laws may set too low a standard. A low standard could bury a

shareholder with an avalanche of irrelevant information about the issuer, a result that would

hardly be of any assistance to the investing public.

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Since materiality is essentially a question of fact and can generally only be determined on a

case by case bases, guidelines can only be suggested such that management is not burdened with

disclosing every trivial information about the company prior to trading in the company’s securities.

U.S. Supreme Court decisions and a Directive of the European Community on the subject is

illuminating in this regard. Both in the context of proxy solicitation and insider trading, the

standard of materiality set forth by the U.S. Supreme Court states that “there must be a substantial

likelihood that the disclosure of the omitted fact would have been viewed by a reasonable investor

as having significantly altered the total mix of information made available.” See TCS Industries v.

Northway, 426 U.S. 438 (1976); Basic v. Levinson, 485 U.S. 224 (1987).

In the U.S, leading legal commentators, however acknowledge that the appropriate standard

of materiality in the context of insider trading laws remains an elusive concept. They also

acknowledge that courts have applied standards of materiality laid down by the Supreme Court

on an inconsistent basis.

Perhaps a better standard of materiality may be found in European Community Directive on

Coordinating Regulations on insider Trading (89/592/EEC) (the “Directive”). The language focuses

on unpublished price sensitive information. The directive inter alia prohibits dealing by the insiders

in the issuers securities if they are in possession of unpublished price sensitive information. It

states that such information: (i) must be of a precise nature relating to one or more companies or

to one or more transferable securities, (ii) it must not have been made public and (iii) it must be

likely, if made public, to have a significant effect on the price of the security or the securities in

question.

The Directive appears to be a simpler framework to work with. It is, however, acknowledged

that a fact finder has a tough balancing act to play. By setting a low standard of materiality,

management would be overburdened with disclosure obligations, a result hardly conducive to

maximizing shareholder wealth. But at the same time, too high standard may legally permit

management/insiders to trade with knowledge of non-public information that is potentially very

price sensitive.

III(d) Claims by Shareholder against offending insider:-

It is permissible for a shareholder to bring a claim for monetary damages against an offending

insider. In the context of a shareholder successfully establishing damages against an offending

insider, sub-section 3 of Section 23 of the Securities Ordinance must be examined. This section

states:

“Any person who participates in any act or transaction in contravention of section 17 shall be

liable to any person who has purchased or sold a security in reliance on such act or transaction

for damages caused by such reliance, without regard to the presence or absence of any

contractual relationship between the two, unless the person so contravening proves that he

acted in good faith and had no knowledge or reasonable ground to believe that there was any

fraud, untruth or omission.”

Insider trading based on material non-public information can be viewed as a fraud committed

by the insider on the shareholder. The title of Section 17 “Prohibition of Fraudulent Acts, etc,”

makes it self-evident. However, as codified in Section 17 of our Contract Act, 1872, fraud may

only be committed because of breach of a contractual relationship. It is creditworthy that in

order to establish an insider trading fraud, the above sub-section, in essence, states that a

shareholder can have a claim against the insider without regard to the presence or absence of

any contractual relationship between the two. The justification for this is that stock market

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transactions are faceless in nature as literally several thousand shares change hands daily and

generally purchasers and sellers do not have contact, nor do they know each other. As such in

the great majority of stock exchange transactions, there would be no contract between the

insider and the stockholder.

The above sub-section also requires that an insider who violates Section 17 should be liable to

any person who has purchased or sold a security in reliance of such act or transaction for damages

caused by such a reliance. Absent contractual relationship, such reliance can be established on the

presumption that “an investor who trades stock at the price set by the impersonal market does

so in reliance of the integrity of that price.” Basic v. Levinson, supra (emphasis added). Because

most publicly available information is reflected in the market price, an investor’s reliance on any

public material misrepresentations may be presumed for purposes of liability under insider trading

laws.

III(e) Defences available to insider:-

An insider has two main defences when charged with violating insider trading laws under the

Securities Ordinance. First as stated in sub-section 3 or Section 23, an insider would be vindicated

if he can prove that “he acted in good faith and had no knowledge or reasonable ground to believe

that there was any fraud, untruth or omission.” This may, for example, be established if the insider

can prove that the traded on unpublished price sensitive information based on a good faith believe

that the information was already public.

The second line of defence would be that a reasonable investor would not have considered

the undisclosed information significant at the time of his trade, in other words, information was

not price sensitive. For example, the information of a speculative or contingent transaction that,

if consummated, would substantially affect the value of the shares may not be price sensitive

information because of the possibility that contemplated transaction would not be effectuated. It

also appears to be good public policy to allow management freedom to negotiate transactions,

prepare feasibility studies, etc. without having the burden of disclosing the same to the general

public until an agreement in principle has been reached. Premature disclosure of a contemplated

transaction (such as a merger) could itself mislead investors.

IV. Short Swing Profits:-

Section 224 of the Companies Ordinance imposes liability on director, chief executive,

managing agent, chief accountant, secretary or auditor of a listed company or any person directly

or indirectly beneficial owner of more than 10% of its listed equity securities, with respect of any

profit derived by them as a result of purchase and sale or sale and purchase occurring within a

period of six months.

The list of insiders in Section 224 is based on the presumption that if anyone has accurate

information about a listed company, it is these persons (See Part III(a) of this paper with respect

to enlarging the definition of an insider). The specified insiders must tender the amount of the

profit to the company and simultaneously send and intimation to this effect to the Registrar and

the Corporate Law Authority. If the insider neglects to tender or the company fails to recover any

such profits within a prescribed period, such profits shall vest in the Federal Government.

Before examining the statute, securities that must be aggregated to determine a person’s 10%

beneficial ownership needs elaboration. In substance, under Section 224, for determining whether

or not a person is a ten percent holder, the definition would include shares beneficial owner held

or controlled by him or his spouse or by any of his dependent lineal ascendants or descendants.

In the case where such person is a partner in a firm, beneficial ownership will be deemed to include

the securities beneficially held by such firm. And in the case where such person is a shareholder in

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a private company, beneficial ownership shall be deemed to include securities beneficially held by

such company.

At a theoretical level, Section 224 is a compromise between two competing and equally

forceful arguments. On the one hand, it is assumed that increased management investment in an

enterprise will benefit public investors and attract competent management personnel. On the

other hand, there is a fear that insiders may engage in speculative trading in their own company’s

stock based on non-public information. Section 224 by implication suggests that if any insider

purchases and sells or sells and purchases securities within six, it is presumed to be engaging in

speculative and manipulative trading (any profits so derived are commonly referred as “short

swing profits”.) Whereas if such purchases or sales take place with a gap of more than six months

it is presumed that the insider held or is holding the shares for investment purposes.

It is important to note that for the purposes of imposing liability under Section 224 of the

Companies Ordinance (unlike the insider trading laws under the Securities Ordinance), It is

immaterial whether an insider in fact traded on non-public information. It is assumed that such is

the case if a purchase-sale or sale-purchase sequence occur within a six-month period. Quite

obviously, in a particular case an insider who trades within six months may do so relying on any

inside information. Whereas an insider who trades with the gap of more than six months, has

based it on material information that is not in the public domain. However, because of the extreme

difficulty of establishing whether a trade is based on material non-public inside information, the

six-month bright line test appears to be on strong logical footing.

Courts in Pakistan have not yet been faced question of applying Section 224 to a particular

fact pattern. Unless certain modifications are incorporated in the statute, judicial interpretation

on a case by case basis could lead to undesirable results for the investing public and insiders alike.

For instance, Section 224 states that 10% beneficial holder is subject to liability under the

Section. However, for the purpose of determining the six-month span for a purchase and sale, or

vice versa. It is not clear from the statute whether the transaction by which a person becomes a

10% holder is deemed to be a purchase. In other words, if a person on day one purchases 10%

shareholding in Company A and on day ten sells the entire holding at a profit. Is this profit

recoverable by the Company A? Until 1976 in the United States, certain courts held that the profits

were recoverable. (This was based on the court’s interpretation of Section 16(b) of the U.S.

Securities Exchange Act, 1934 - the statute most analogous to our Section 224). In Foremost-

Mckesson v. Provident Securities, 423 U.S. 232 (1976), the U.S. Supreme Court reversed this

position and held that in a purchase - sale sequence, a 10% beneficial owner must account for

profits only if he was a beneficial owner before the purchase. In 1991, relevant U.S. statute was

appropriately published. The justification of the U.S. Supreme Court decision, which is a

compelling one, is that it cannot be assumed that prior to a person becoming 10% holder he would

have any opportunity to be privy to material non-public information of the company. Thus, it is

suggested, that Section 224 of the Companies Ordinance be modified to reflect the fact that

transaction by which a person becomes a 10% holder will not be deemed a purchase unless he is

otherwise an insider (i.e. a director, chief executive, etc) for purposes of disgorging profits under

Section 224.

By the same token the statute should be clarified to the effect that insiders (other than a 10%

holder) who engage in a transaction relating to issuer’s securities after they are no longer insiders

can be matched by an off-setting transaction which occurred while they were insiders. The

rationale for this is that the initial purchase or sale occurred while they were insiders and

consequently could have been privy to non-public information. Such insiders should not be

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allowed to quit their offices in order to reap the profits based on sale and purchase or a purchase

and sale of the company’s stock within a six-month period.

Even though derivative securities are not yet traded on stock exchange in Pakistan, stock

market experts believe that its introduction is likely in the foreseeable future. The application of

Section 224 can be complicated where trading by insiders involve the exercise or conversion of

derivate securities. For example, should conversion of Class B Stock into its underlying Class A

Stock be considered either a purchase of the Class A Stock or a sale of the Class B Stock? Due to

the lack of statutory clarification, questions such as these mystified judges in the United States for

several years. It was only in 1991 that it was statutorily promulgated that the exercise or

conversion of a derivative security was neither a purchase nor a sale. This is based on the rationale

that holding derivative securities in essence equivalent to holding the underlying equity securities.

For the purpose of short swing liability, the value of derivative securities is directly related to value

of the underlying security. A U.S. District Court, Seinfeld v. Hospital Cort, 685 F. Supp 1057 (N.D.

111. 1988), explains as follows:-

This judicial rule [treating exercise as a purchase under Section 16(b)] cannot withstand careful

analysis. A person who acquires a call option acquires the right to purchase the underlying stock

at a given price. If the price of the stock subsequently rises and the person exercises the option

and then sells the stock, the profit’ he earns represents the ‘swing’ in the price, not between the

date of exercise of the option and later sale of the stock, but rather between the time he originally

purchases the option and time he sells the stock …. The courts have strayed because they have

viewed the intervening event – the exercise of the option for stock – as an independent purchase.

This is incorrect. Because the option holder already owns the right to purchase the stock at a fixed

price, his decision to actually exercise the option does not provide him the ability to earn insider

profits and thus does not constitute a [Section 16(b)] ‘purchase’.

Consequently, it is suggested that Section 224 be modified to essentially reflect the fact that

the exercise or conversion of a derivative security is neither a purchase nor a sale. Since the

exercise/conversion represents neither the acquisition nor the disposition of a right affording the

opportunity to profit. Thus, it should not be an event that is matched against another transaction

in the underlying equity for the purpose of determining an insider’s short swing profit.

I appreciate that the foregoing discussion regarding derivative securities in the context of

Section 224 is rather technical and perhaps even confusing. Additionally, I must admit that I have

ignored several further technical aspects (such as complications that arise when

exercise/conversion prices are not pre-set) so as not to confuse matters even further. The basic

purpose of raising it is to highlight the issues that the regulators must consider if they are to

revamp the insider trading laws in Pakistan.

Due to vague statutes in the United States, considerable amount of litigation has taken place

in connection with short swing profits. The regulators in Pakistan would be well advised to

explicitly lay down the treatment of short swing profits so as to avoid loss and expenses that

investors may suffer due to litigation that may emerge as Pakistan’s capital markets become more

sophisticated. Unclear statutes are also a deterrent to entrepreneurial activity.

V. Short Selling:-

Short sale is a way that investors may profit from declining security prices. When people sell

a security they do not own, it is referred to as short selling and they do so with the hope of

purchasing the share in the future at a lower price. An illustration may help. Let’s say a short seller

places an order to short sell 1000 shares which such seller believes is overvalued. A broker will

find a willing buyer at, say Rs. 50 per share and execute the sale. Generally, the broker will lend

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the requisite shares to the short seller. The buyer receives the 1000 shares and pays the Rs. 50,000

purchase price. The broker, as the lender of shares, keeps the Rs. 50,000 as collateral. Now let us

say the share’s price actually does fall to, say Rs. 30 the short seller can cover the short position

by requesting the broker to buy the shares. The short seller pays the new sellers Rs. 30,000 and

the 1000 shares given up by the new seller are delivered to the broker. Thereafter, the broker

gives the Rs. 50,000 collateral back to the short seller who makes a profit of Rs. 20,000 on the

short sale.

Since it would be an unconscionable result to allow insiders to bet on falling security prices

(apart from its propensity to tempt insider dealings), Section 223 of the Companies Ordinance

prohibits short selling by insiders specified therein, i.e., director, chief executive, managing agent,

chief accountant, secretary or auditor of a listed company and no person who is directly or

indirectly the beneficial owner of not less than ten percent of the listed equity securities of such

company. This list of insiders is identical to the list found in Section 224.

It is further suggested that Section 223 be amended to forbid short sale be any person

(regardless of whether he or she is an insider) at the price below the last proceeding sale. This

would keep people from selling short a stock that is already moving downward, thereby increasing

selling pressure and causing further price decline. This was a common tactic of the so called “Bear-

Raiders” and consequently contributed to the Great Depression in the United States during the

1930s. Several investors would secretly agree to sell shares of a certain company short, pushing

the price very low levels. At a pre-set signal, they would cover their short positions, making a

substantial profit on the transactions. See, Widicus and Stitzel, personal Investing (c. Richard D.

Irwin, Inc 1980), p. 350. Following the Great Depression, the Securities and Exchange Commission

in the United States prohibited short sales at a price below the last preceding sale.

In Pakistan, the restriction on short selling applies only to specified insiders, but it is suggested

it should be extended to anyone short selling if such sale is at price below that of the immediately

preceding sale. This would avert downward spiral of prices caused by short selling.

VI. Penalties:-

With regard to the penalties imposed under Section 223 (short sales) and Section 224 (short

swing profits), if a person knowingly and wilfully contravenes the provisions of the foregoing

statutes, such person may be liable to fine up to Rs. 30,000 and in the case of a continuing

contravention, to a further fine of which may extend to Rs. 1,000 for every day during which

contravention continues. It is noteworthy that liability is imposed only if there is a specific intent

to violate the statute. A person who fails to comply with the statute because of negligence,

perhaps even gross negligence, may avoid penalties prescribed for violation of Sections 223 and

224. (It may be noted, however, that negligence would not bar disgorgement of short swing profits

by the insider under Section 224).

With regard to the penalties that may be imposed for violation of insider trading laws under

Section 17 of Securities and Exchange Ordinance, sub section 1 of Section 24 makes a violation of

insider trading laws, under the Ordinance a criminal offence and is punishable with imprisonment

for a term that may extend to three years or with a fine that may extend to Rs. 10,000 or with

both. Sub-section 2 of Section 24-unlike a typical fraud case where the onus is on the claimant to

prove the fraud-where a corporate body is guilty of insider trading laws, its directors, manager or

other officers shall also be presumed guilty unless they can rebut this presumption by proving that

exercised all diligence to prevent its commission.

It is suggested that through the monetary fines may be raised to increase its deterrent effect,

imposition of jail terms at the present time appears inappropriate. Jail terms may be more suitable

10


only after regulators – by imposing monetary fines and tougher enforcement – have made insiders

sensitive in the fact that insider trading is a criminal offence and will be penalized. At present,

there does not even appear to be prevalent belief that insider trading is a forbidden practice.

VII. Benamis:-

Before concluding this paper, a word about benami transactions may be in order. The simple

meaning of such a transaction is that a purchaser desires to buy property (such as shares of a listed

company) but does not desire to buy in his own name and therefore buys in the name of someone

else.

Benami transactions are very common in the Sub-continent and their validity has been upheld

by numerous pronouncements of the highest validity has been upheld by numerous judicial

pronouncements of the highest courts. Even the Federal Shariah Court in Khan Imtiaz v The Islamic

Republic of Pakistan, PLD 1983 F.S.C. 28, where benami transactions were challenged on the

grounds of being un-Islamic and repugnant to Quran and Sunnah, the Court dismissed the Petition

and observed that it is for the Legislature to make benami transactional illegal.

The prevalence of benami transactions not only makes the detection and enforcement of

illegal insider trading, to say the least, a difficult task, but also there are weighty social and revenue

reasons to make such transactions illegal. India has recently enacted a statute, Benami

Transactions (Prohibition) Act (XLV of 1988), which prohibits benami transactions.

VIII. Concluding Remarks:-

The purpose of this paper has not been to make a case for or against more vigorous

enforcement/regulation of insider trading laws in Pakistan. It is, however, submitted that this issue

needs to be debated. We must consider whether in light of the condition prevailing in our capital

markets, regulations prohibiting insider trading laws are desirable and enforceable in practice.

In this paper an attempt has been made to analyse the existing insider trading laws in Pakistan.

In suggesting amendments and clarifications to the laws, I have been cognizant of the fact that

incentives for entrepreneurship activity must be balanced against the interests of the average

investor. Clarifications and amendments to the insider trading laws are required not only to strike

this balance but also to avoid loss and expenses that investors may suffer due to litigation that

may emerge as Pakistan’s capital markets become more sophisticated but are yet dictated by

rather obscure and vague statutes.

Author(s)

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Khozem A. Haidermota HaiderMotaBNR

Senior Partner,

[email protected]

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