As the term itself explains it is trading by the insider of the Company that is one who is having access to the information of the Company which is not available to public. Insider trading is the act of trading, directly or indirectly, in the securities of a publicly listed company by any person, who may or may not be managing the affairs of such company, based on certain information, not available to the public at large, that can influence the market price of the securities of such company. An insider, who has access to critical price sensitive information with respect to a given company, may tend to use such information to his economic advantage, severely impairing the interests of a public shareholder who is not privy to such information.
|Insider trading has utterly no place in any fair-minded law-abiding economy – stated the Securities Exchange Commission (“SEC”) Chairman Mr. Arthur Levitt in 1998.|
EVOLUTION OF INSIDER TRADING IN INDIA
Post independence first concrete attempt was made in the 1948 by Thomas Committee. The Committee studied Prevention of Insider Trading laws of U.S.A., U.K., Japan, Germany, France and Australia and made recommendations for restricting Insider trading by legislation inter alia the Securities Exchange Act, 1934.
In 1956, Section 307 and 308 were introduced in the Companies Act, 1956. This change made it mandatory to have register of directors and shareholdings under Section 307 and stated for duty of directors and persons deemed to be directors to make disclosure of share holdings in Section 308.
Subsequently, the Sachar Committee and the Patel Committee were constituted in the years 1978 and 1986, respectively, to recommend measures for controlling insider trading in India. The Patel Committee had defined insider trading as “the trading in the shares of a company by the person who are in the management of the company or are close to them on the basis of undisclosed price sensitive information regarding the working of the company, which they possess but which is not available to others”. Along with other recommendations, both the Sachar Committee and the Patel Committee had recommended the enactment of a separate statute for curbing insider trading. Further in 1989, Abid Hussain Committee recommended that the Insider Trading Activities be Penalized by civil and criminal proceedings and also suggested that SEBI formulate the regulations and governing codes to prevent unfair dealings.
SEBI (Insider Trading) Regulations, 1992 was promulgated and brought in to force. This regulation was substantially amended in the year 2002 to plug certain loopholes revealed in the cases of Hindustan Lever Ltd. v. SEBI and Rakesh Agarwal v. SEBI and was renamed as the SEBI (Prohibition of Insider Trading) Regulations, 1992. In 2008 SEBI amended definition of insider.
In 2015 SEBI notified SEBI (Prohibition of Insider Trading) Regulations, 2015 and they are effective from May 15, 2015. Regulator has in 2018 made amendments in the SEBI (Prohibition of Insider Trading) Regulations, 2015 which are effective from April 01, 2019; these amendments will be part of this article.
Without getting into the details, let us see briefly, what amounts to insider trading in India. According to the SEBI (Prohibition of Insider Trading) Regulations, 2015:
“Insider” means any person who is:
(i) a connected person; or
(ii) in possession of or having access to unpublished price sensitive information;
“Unpublished price sensitive information” means any information, relating to a company or its securities, directly or indirectly, that is not generally available which upon becoming generally available, is likely to materially affect the price of the securities and shall, ordinarily including but not restricted to, information relating to the following: –
“Connected person” means, any person who is or has during the six months prior to the Regulations been associated with a company, directly or indirectly, in any capacity including by reason of frequent communication with its officers or by being in any contractual, fiduciary or employment relationship or by being a director, officer or an employee of the company or holds any position including a professional or business relationship between himself and the company whether temporary or permanent, that allows such person, directly or indirectly, access to UPSI or is reasonably expected to allow such access.
AMENDMENTS TO THE SEBI (PROHIBITION OF INSIDER TRADING) REGULATIONS, 2015
SEBI issued the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2018 (PIT Regulations) on December 31, 2018 and they are effective from April 01, 2019.
♦ ‘Legitimate Purposes’ for UPSI Communication
Under Regulation 3 of PIT Regulations it is prohibited to pass the Unpublished Price Sensitive Information (UPSI) for the purpose other than legitimate purposes. However it was not defined under the Regulation that what falls under the ‘legitimate purposes’. After the amendment S.3(2A) makes it mandatory for all the Companies to frame the policy which shall determine the ‘legitimate purposes’; in this Regulation an explanation has also been added which states the term “legitimate purpose” shall include sharing of unpublished price sensitive information in the ordinary course of business by an insider with partners, collaborators, lenders, customers, suppliers, merchant bankers, legal advisors, auditors, insolvency professionals or other advisors or consultants, provided that such sharing has not been carried out to evade or circumvent the prohibitions of PIT regulations.
♦ Due Diligence for UPSI Communication
Regulation 3(3) of the PIT Regulations has after the amendment also covered sharing of information to the Board post compliance under SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011) whenever the transaction attracts open offer.
Further, in case of transactions not attracting open offer obligations, Regulation 3(3) has been amended to provide that cleansing disclosures (i.e. disclosure of UPSI shared in connection with the transaction, that is required to be made at least two trading days prior to the proposed transaction being effected) is to be in such form as the Board of the listed company may determine to be adequate and fair to cover all relevant and material facts.
♦ Maintenance of Structured Digital Database for UPSI Communication
Regulation 3(5) is introduced by the Amendment Regulations, 2018 which provides that the Board of listed companies must ensure that a structured digital database is maintained containing the names of such persons or entities with whom information is shared under Regulation 3, along with the Permanent Account Number (or any other identifier authorized by law where the Permanent Account Number is not available). Such databases are required to be maintained with adequate internal controls and checks, such as time stamping and audit trails to ensure non-tampering of the database.
♦ Insider Trading – Presumption based on Possession of UPSI
There has been explanation added to the existing Regulation 4(1) which states that no insider shall trade in securities that are listed or proposed to be listed on a stock exchange when in possession of unpublished price sensitive information in case of trade it will be presumed that trade has been undertaken on the basis of the UPSI available.
♦ Trading Plans
Regulation 5 (3) is pertaining to the persons who are perpetually in the possession of the UPSI like Directors, Promoters, Company Secretary, CFO, etc.. It is now clarified that pre-clearance of trades is not required for a trade executed as per an approved trading plan, and trading window norms and restrictions on contra trades do not apply to trades carried out in accordance with an approved trading plan.
♦ Designated Persons
Prior to Amendment in under Regulation 7 of PIT Regulations only Promoters, Directors and employees were required to make continual disclosures to the Company. Post amendment the word ‘employee’ has been replaced by the ‘designated persons’ hence the scope of Regulation 7 is extended to members of the promoter group.
Prior to the Amendment Regulations, the Regulation 9(1) of PIT Regulations required only Board of Directors of every company and every other person required to handle UPSI in the course of business operations for formulating a Code of Conduct and imposed common minimum standards for all such codes. Now the Board of Directors of every listed company and the Board or heads of organization of every intermediary must ensure that the Chief Executive Officer or Managing Director must formulate a Code of Conduct with their approval in accordance with Schedule B and Schedule C of the PIT Regulations, respectively.
Regulation 9(4) of PIT Regulations pursuant to Regulation 9(1) and (2) provides for specifying ‘Designated Persons’ on the basis of the role and function in the organisation; this has to be specifies by the Board (or analogous authority as the case may be) in consultation with Compliance Officer. It further provides that Designated Persons must include, promoters of listed companies and promoters who are individuals or investment companies for intermediaries or fiduciaries and the Chief Executive Officer and employees up to two levels below Chief Executive Officer of such listed company, intermediary, fiduciary and its material subsidiaries irrespective of their functional role in the company or ability to have access to UPSI.
♦ Institutional Mechanism for Prevention of Insider Trading
The Amendment Regulations have introduced a new Regulation 9A, of which Regulation 9A(1) states that ‘’The Chief Executive Officer, Managing Director or such other analogous person of a listed company, intermediary or fiduciary shall put in place adequate and effective system of internal controls to ensure compliance with the requirements given in these regulations to prevent insider trading’’.
These internal controls include: (i) all employees with access to UPSI to be identified as “designated employees”; (ii) UPSI to be identified and confidentiality to be maintained; (iii) adequate restrictions on communication or procurement of UPSI; (iv) maintenance of a list of employees with UPSI and execution of confidentiality agreements or notice to be served on all such employees and persons; and (vi) periodic process review to evaluate effectiveness of such internal controls should be conducted.
The Board or head(s) of the organisation of every relevant entity must ensure that the Chief Executive Officer, Managing Director or other analogous person ensure compliance with Regulation 9 and Regulation 9A and the Audit Committee or other analogous body, as the case may be, must review compliance at least once every financial year and verify that the systems for internal control are adequate and are operating effectively.
Every listed company is also required to formulate written policies and procedures for inquiry in case of leaks or suspected leaks of UPSI and to formulate a whistle-blower policy to enable employees to report instances of leak of UPSI. In case of an inquiry initiated by a listed company in case of leaks or suspected leaks of UPSI, the relevant intermediaries and fiduciaries are required to co-operate with the listed company in connection with such an inquiry.
♦ Compliance Officer
Explanation to the definition of the Compliance Officer is added which explains for the meaning of the term ‘financially literate’. As per the Regulation term financially literate means a person who has ability to read and understand basic financial statements i.e. balance sheet, profit and loss account and statement of cash flows.
♦ New Definition “Proposed to be Listed”
There has been amendment to the PIT Regulations and new definition is been introduced for proposed to be listed as the scope of PIT Regulations is been broadened and now they are applicable to the Companies who are listed as well as ‘’proposed to be listed’’. As per PIT Regulations securities of unlisted companies who are ‘’Proposed to be Listed Companies” includes (i) if such unlisted company has filed offer documents or other documents, as the case may be, with SEBI, stock exchange(s) or registrar of companies in connection with the listing; or (ii) if such unlisted company is getting listed pursuant to any merger or amalgamation and has filed a copy of such scheme of merger or amalgamation under the Companies Act, 2013.
♦ Material Events are delinked from the definition of UPSI under amended PIT Regulations.
♦ Code of Conduct – Amendments to Minimum Standards
In relation to Codes of Conduct of listed companies, Schedule B (in case of listed companies) has been amended to, inter alia, provide that Designated Persons and their immediate relatives would be governed by the Code of Conduct. Additionally, the minimum standards set out in Schedule B have been amended to provide that:
(i) contra trade restrictions do not apply to exercise of stock options;
(ii) the trading restriction period can be made applicable from the end of every quarter till 48 hours after the declaration of financial results (while this seems to be a recommendation and not a mandatory requirement, the National Stock Exchange of India Limited (NSE) has clarified that, pursuant to discussions with SEBI, in any case, the trading restriction period is required to commence not later than the end of every quarter till 48 hours after the declaration of financial results); and
(iii) the gap between clearance of accounts by the Audit Committee and the Board meeting should be as narrow as possible and preferably on the same day to avoid leakage of material information.
The Amendment Regulations further removed the following requirements from Schedule B:
(i) that trading window restrictions also apply to persons having contractual or fiduciary relation with the listed company (such as auditors, accountancy firms, law firms, analysts, consultants etc. assisting or advising the company);
(ii) the restriction on Designated Persons applying for preclearance if such Designated Person is in possession of UPSI (even if the trading window is not closed); and
(iii) the requirement to maintain a restricted list of securities (to be used as the basis for approving or rejecting preclearance applications).
In relation to Codes of Conduct of intermediaries and fiduciaries, the new Schedule C provides minimum standards which removes the trading window requirements provided for in Schedule B and provides for restricted lists.
Additionally, both Schedule B and C provide for certain incremental compliance requirements, including requiring Designated Persons to disclose to the listed company, intermediary of fiduciary, as the case may be, the names and Permanent Account Number (or any other identifier authorized by law) of (i) immediate relatives; and (ii) persons with whom such Designated Persons share a ‘material financial relationship’.
The core of securities regulations is the implementation of the purpose that all investors should have equal access to the rewards of participation in securities transactions. In other words all members of the investing public should be subject to identical market risks. Legislators have made deep efforts and research for prevention of such acts in the markets, to enhance effective and efficient functioning of the markets.