Understanding sense behind introducing amendments in SEBI Insider Trading Regulations
Greed is the driving influence behind all irregularities in the securities market and one of the biggest irregularities in the securities market is Insider Trading. There is a popular saying in Dalal Street that insider trading is as old as trading itself. In order to promote healthy growth of the securities market in India and to protect common investor in India, the SEBI vide SEBI (Prohibition of Insider Trading) Amendment Regulations, 2018 notified certain amendments to the SEBI (Prohibition of Insider Trading) Regulations 2015 (“PIT Regulations”).
It is imperative to understand the sense behind introducing these new amendments and this write-up is an analysis of some specific gamut of new requirement that is applicable to listed companies. This article does not comprehensively set out all the amendments to the PIT Regulations introduced by the SEBI but merely seeks to highlight the important ones with the implementation plan. Before reaching to the amendments, lets’ analysis some recent cases pertain to Insider trading.
Case Study 1:- In the matter of Axis Bank /HDFC Bank (Source: www.sebi.gov.in)
In the matter of Axis Bank/ HDFC bank, it was observed that the financial figures pertaining to the quarterly results of Axis Bank/ HDFC Bank were either identical or matched closely with the figures that were in circulation in various wats app groups prior to its official announcement by Axis Bank/ HDFC Bank. The same could not have been possible without leakage of information from the persons, who were privy to the information relating to financials prior to submission it with the exchanges.
During investigation by SEBI, the origin of the leakage of unpublished price sensitive information (“UPSI”) could not be ascertained and in the Direction to this matter, SEBI stated that such leakage is prima facie attributable to the inadequacy of the processes / controls / systems that Bank(s) as a listed company had put in place. Accordingly, in the interest of the Security Market, the SEBI issued the following direction to both the banks:
1) To strengthen its processes/systems/controls forthwith to ensure that such instances of leakage of UPSI do not recur in future;
2) To give name of the officials of the Company, who are responsible for monitoring such systems and the periodicity of monitoring?
3) To place the list of persons involved in generation and sharing of UPSI, etc.
4) To conduct an internal inquiry into the leakage of unpublished price sensitive information relating and take appropriate action against those responsible for the same.
5) The inquiry directed above shall be completed within a period of 3 months from the direction and within 7 days from the completion thereof, the Bank would have to file a report to SEBI.
Similar intense were also occurred in other listed company like Tata Motors etc., after which SEBI passed several directions against various companies, including Axis Bank, HDFC Bank, Tata Motors to ascertain leakage of UPSI/ confidential information ahead of their official announcement. In the aforesaid matters, the SEBI was neither able to identify the person who could be made responsible for such leakage nor it could pin down the source of information as the UPSI was available with many senior officials of the Company including board members. After it passed several directions against various companies, including Axis Bank, Tata Motors and HDFC Bank, the SEBI, the markets regulator, decided to amend PIT Regulations and induce the following amendments:
1) To place adequate and effective system of internal controls for identifying inside information and maintain lists of employees and other persons with whom such information is shared.
2) CEO/ MD shall build adequate and effective system of internal control and the Audit Committee of a listed company shall verify that the systems for internal control are adequate and are operating effectively.
3) To build and maintain the list of persons (with structural digital database) who are involved in generation of UPSI and with whom such UPSI is shared. The structured digital database shall be maintained with adequate internal controls and checks such as time stamping and audit trails to ensure non-tampering of the database.
4) To build an internal process for internal inquiry into leakage of UPSI and to take appropriate action against the responsible person.
5) To protect the whistle blower in the matter of leakage of UPSI.
If we analysis the direction/order of SEBI as given in the matters of Axis Bank/ HDFC Bank with the new requirement as aforesaid, we find that SEBI has copied it form its own order and inserted in the SEBI Insider Trading amendments Regulations 2018.
Promoters will have to be more cautious in dealing with UPSI.
Management and Promoters will have to be more cautious in dealing with UPSI, as SEBI’s new insider-trading norms will hold them responsible if they hold on to UPSI without any ‘legitimate purpose’. There have been many cases (like Tata Motor and ADF Foods) in the recent past wherein information given to promoter groups have come under spotlight. Recently, Cyrus Mistry, the former Chairman of Tata Sons, had alleged that information related to Tata group companies was being shared with Ratan Tata. However, the Tata group has maintained that it has complied with all rules in this matter.
Case Study: (2) In the matter of ADF Foods Limited (Source: www.sebi.gov.in)
SEBI ordered impounding of alleged illegal gains worth over Rs 1.02 crore from ADF Foods’ promoters Bhavesh Thakkar and Priyanka Thakkar and four others in an insider trading case. Relationship of the Bhavesh Thakkar (acting as Promoter, Executive Director and CFO of the Company) with the entities charged for Insider Trading were as below.
Pallavi Mehta and Shefali Mehta (who was neither covered under promoters group nor its relative ist), had traded in the scrip of ADF Foods on the basis of UPSI which they obtain from Promoters without any legitimate purpose. Pallavi Mehta and Shefali Mehta were neither covered under promoters’ group nor involved in day to day functions of the Company due to which it took more than two years to SEBI in identifying them as Insiders. Following factors were considered which assisted SEBI to identify them as Insider and connected person under the definition of SEBI Insider Regulations.
1) Bhavesh Thakkar and other Insiders were communicating frequently (call records) and would therefore, lead SEBI to believe that UPSI was communicated to such Insiders by Bhavesh Thakkar, promoter of ADF Foods.
Here, it is pertinent to note that frequently communication can also be treated as circumstantial evidence like it also happened in the matter of Rajat Gupta, where, insider trading cases have been prosecuted primarily on the basis of circumstantial evidence.
2) Communication of UPSI by an ‘Insider’ to other ‘Insiders’ is not allowed except where such communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.
3) From the authorization letters related to the trading account of Pallavi Mehta and Shefali Mehta (as received by SEBI from Lalkar Securities), it was observed that while Navin Mehta and Bhavesh Thakkar were authorized to place orders on behalf of Pallavi Mehta, whereas, Abhishek Mehta and Navin Mehta were authorized to place orders on behalf of Shefali Mehta.
4) The bank account of Priyanka Thakkar was also used for transferring funds to Pallavi Mehta and Shefali Mehta for their trades in the scrip of ADF Foods. – Deemed Trading.
Here, it is pertinent to note that transferring of fund is not the trading, but it is an activity based on UPSI and comes under the preview of dealing in securities. The PIT Regulations employ the term ‘dealing in securities’, where, it is intended to widely define the term “trading” to include dealing. Such a construction is intended to curb the activities based on UPSI which are strictly not buying, selling or subscribing, such as pledging etc. when in possession of UPSI.”
Thus, the activities of the aforesaid persons are considered as insider trading and accordingly SEBI impound the alleged unlawful gains of a sum of ₹1,02,63,169.81 (alleged gains of ₹77,23,637.73 + interest of ₹25,39,532.08,) jointly and severally.
Insider trading investigation is a challenging task:
Insider trading investigation is a challenging task and it is not possible to easily establish links between insiders that have access to UPSI and the persons who traded on it. The amendment is primarily based on building a database of people who are connected to the designated persons and Insider, so that the chain of connections can be traced quickly. Here is what SEBI introduced in the PIT Regulations by adding the following statutory compliance requirement to induce the listed companies to build a digital database.
1) Annual Disclosure by Designated Persons (Designated Person includes the Promoter, whether hold majority shares or not) with the following details
(a) Immediate relatives
(b) Details of person with whom such designated persons share a material financial relationship.
(c) Phone, mobile and cell numbers which are used by them
(d) the names of educational institutions from which designated persons have graduated and names of their past employers shall also be disclosed on a one-time basis.
Material financial relationship is one in which a person is a recipient of any kind of payment, such as by way of a loan or gift during the preceding 12 months, equivalent to at least 25% of the payer’s annual income, excluding transactions on an arm’s length basis.
Considering the matter of ADF Foods, amendment for including material financial relationship is relevant from a SEBI investigation perspective, especially for trading done through third-party accounts.
2) All information shall be handled within the organisation on a need-to-know basis and no unpublished price sensitive information shall be communicated to any person except in furtherance of legitimate purposes.
3) The board of directors shall ensure that a structured digital database is maintained containing the names of such persons or entities as the case may be with whom information is shared.
4) person in receipt of unpublished price sensitive information pursuant to a “legitimate purpose” shall be considered an “insider” for purposes of these regulations and due notice shall be given to such persons to maintain confidentiality of such unpublished price sensitive information in compliance with these regulations.
5) The board of directors of a listed company shall make a policy for determination of “legitimate purposes”.
Onus to prove now been shifted from SEBI to the Insider:
It is now specifically provided under the amended regulations that the Insider who executes the trade in shares while having possession of USPI would be presumed to have been motivated by the knowledge and awareness of such UPSI. Thus, onus to prove that trades were executed otherwise is shifted on the Insider who did such trade and SEBI is not under the obligation to prove beyond doubt that trades were executed with UPSI. This is one of the most important shifts, Earlier, it was SEBI’s responsibility to prove the guilt of an insider trading accused.
Perpetual insiders (those in continuous possession of unpublished price-sensitive information) will have to frame their trading plans in advance. However, asking an insider to submit a trading plan is similar as asking a commitment that an act will be performed irrespective of evolving conditions.
CEO/ MD should revisit Internal Control Mechanism of the Company.
The SEBI has always been vigilant in restriction the practice of insider trading; however, this move of SEBI certainly signifies its Zero Tolerance approach towards insider trading and heightened focus on imposing strict accountability on the Corporate Chiefs to adopt appropriate measures to curb the malpractice and restore the faith of bonafide investors in securities market.
1. It is the responsibility of Chief Executive Officer/ Managing Director of a listed company to put in place an adequate and effective system of internal controls to ensure compliance with the requirements given in these regulations to prevent insider trading.
2. It is the board of directors of every listed company, who shall ensure that the Chief Executive Officer or the Managing Director compliance of the aforesaid requirement.
3. The Audit Committee of a listed company shall review compliance with the provisions of this requirement at least once in a financial year and shall verify that the systems for internal control are adequate and are operating effectively.
SEBI has a clear intention that in case of any leakage of UPSI it would be CEO / MD to whom SEBI will issue summon for inquiry, and if it is found that the Internal Control System is not adequate and effective, the CEO/MD and the members of Audit Committee shall jointly be liable for such incident. Every CEO/ MD and the Audit Committee of the listed Company must revisit their Internal Control Mechanism and ensure the adequacy and effectiveness. Internal Control Mechanism must be drafted with all care and the same should be finalised with the recommendation of the Audit Committee. Following factors may be considered while drafting the Internal Control Mechanism (SOP) for making the process more adequate and effective.
a) SOP should define a clear process for identification of Designate Persons. SOP should contain the name of person who are responsible for such identification with define SLA. Process/ documents which leads the identification of Designated Person should be digitised.
b) SOP should define a clear process for identification of UPSI and the name of designated persons/ Insider who shall be authorised to deal with such respective UPSI.
c) SOP should define a clear process for communication/ transmission of UPSI, so that its confidentiality shall remain in place.
d) The process for maintaining the list of such person with whom UPSI is shares should be centralised.
e) Periodically audit by Secretarial Audit or Internal Audit or specifically on Internal Control Mechanism (atleast once in a half year). The audit report must contain, the gap in the process, if any, the type of risk, (either it is critical in nature), any deviation if any in the operationalisation of SOP etc.
f) Audit Committee should review the type of UPSI occurred during the period (Quarterly / Half yearly) and the list of persons, have access or/ possessed/ Share such information.
g) To implement the Chinees Wall Mechanism in the Company. The term “Chinese Wall” refers to separation of those areas of the organization which routinely have access to confidential information considered “inside areas” from other areas or departments considered “public areas”. In terms of “Chinese Wall”, any employee in the inside area shall not communicate any UPSI to anyone in public area. In exceptional circumstances, employees from the public areas may be brought “over the wall” and given confidential information on the basis of “need to know” criteria, under legitimate purposes.
h) To add the mechanism to review and monitoring the shareholding of every designated persons and its relative at least once in a fortnight.
Structured digital database:
The board of directors shall ensure that a structured digital database is maintained containing the names of such persons or entities as the case may be with whom information is shared under this regulation along with the Permanent Account Number or any other identifier authorized by law where Permanent Account Number is not available. Such databases shall be maintained with adequate internal controls and checks such as time stamping and audit trails to ensure non-tampering of the database.
Safeguarding UPSI and sharing it on a ‘need to know basis’ is one critical task bothering the management. The software facilitates creation and storage of insider database including those with whom UPSI is shared, fulfilling the statutory requirement of maintaining a structured digital database. Such information may be shared with SEBI when sought on case to case basis.
Maintaining data in scanned mode does not suffice for this requirement. Digital database mechanism means a proper digital system by implementing the same through software or an online process, time stamping and audit trails to ensure non-tampering of the database can be reviewed. Following on-line forms can be added while creating structural digital database in the system.
1. Online form for Digital database of Designated Person:- A form named as DP Master Form can be introduced in the online process, which shall contain the Name of designated person, Employee Code, Designation in the Company, functional/ department, PAN, mobile number, date of adding/removing his/her name in the list of designated persons and the reason of adding / removing his/ her name etc.
2. Online form for Annual disclosure by designated person. This form can be linked with the DP Master form. This online form shall contain all the requirement under SEBI Regulations along with necessary declaration or confirmation.
3. Online Form for submitting the name and details of the person/ Employee with whom any UPSI is shared. A form named as UPSI sharing Form can be introduced in the online process. The form should contain all relevant details including the name of parties including their mobile number and PAN, type of UPSI shared, date/period of sharing UPSI, reason for sharing such UPSI, confirmation on Notice or NDA.
Policy in for internal inquiry in case of leakage of UPSI
The amended regulations place responsibilities on the listed company to initiate inquiries on its own initiative when becoming aware of a leak or a suspected leak of UPSI. Every listed company shall formulate written policies and procedures for inquiry in case of leak of unpublished price sensitive information or suspected leak of unpublished price sensitive information, which shall be approved by board of directors of the company and accordingly shall initiate appropriate inquiries on becoming aware of leak of unpublished price sensitive information or suspected leak of unpublished price sensitive information and inform the SEBI promptly of such leaks, inquiries and results of such inquiries.
By adding this requirement, the SEBI has impowered the Board of Company to initiate the inquiry in case of leakage of UPSI. The Board of the Company is now authorised to send summon to any of the suspect person for clarification or justification. In case, any person does not cooperate the Board of the Company, the same should be informed to the SEBI.
Since, the PIT Regulation does not specify the time limit for completion of inquiry, however by reading the order of SEBI in the matter HDFC and Axis bank, it can be presumed that the such inquiry should be completed within a period of 3 months from the date of knowing the fact of such occurrence of leakage of UPSI and within 7 days from the completion thereof, the Company should file investigation report to the SEBI.
The intent behind such amendments has to be appreciated keeping in mind the need of regulation in light of the maturing of the Indian security market. For the growth of security market and to make these new enforcement mechanisms effective, all insiders and management of the listed companies shall have to act in a bona fide manner.
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