CS Dhvani Desai
This article deals with analyzing the insider trading regulations prevalent in India. A lot of material on insider trading regulations is already available on the internet. I have made a sincere effort to provide an insight on these regulations in a manner which can be digested easily, knowing however, that the reality is much more complex than what it seems.
History provides evidences of various efforts undertaken by the statutory bodies to maintain and enforce mechanisms for smooth conduct of the stock market. Nonetheless, the fraudsters do find loopholes or disgorge the information for mutual benefit. Hence, there is constant requirement to fill the gaps by amending the provisions or set precedents for safeguard against any breach of law.
BEHIND THE MAKING OF THE NEW LAW:
A high level Committee under the Chairmanship of Justice N. K. Sodhi was formed to draft a clear and comprehensive policy not only to combat the drawbacks of the 1992 Regulations but also to bring the Regulations in line with the current market scenario.
The insider trading regulations of 1992 were replaced with a new set of regulations to be known as the SEBI (Prohibition of Insider Trading) Regulations effective from 15th May, 2015. The new regulations are presented in quite a unique way with notes following after each regulation, thus providing a background and an intention behind each regulation.
The Regulations are applicable to companies which have their securities listed on a stock exchange or a company which proposes to list its securities on a stock exchange.
The term “Company” has not been defined in the Regulations and hence the definition as provided in the Companies Act, 2013 shall be assigned here. It is however important to note that the powers of SEBI are wide enough to cover entities not falling under the definition of company per se but can also include the entities who issue securities or units traded in the market. E.g. a mutual fund set up as a trust that can issue units of close-ended schemes which are traded in the market (Referred from the Committee Report).
WHO IS RESTRICTED?
An insider is restricted from trading in securities while in possession of unpublished price sensitive information (UPSI).
An insider is the one who is connected with the Company (by default) and the other who is in possession of UPSI.
A. The following fall under the term “connected person”:
♠ One who is associated with the company, directly or indirectly, for a period of 6 months prior to the date on which an act of trading is committed. The following are said to be generally associated with the company:
This period of 6 months is a deeming period and any person can be accused by SEBI if so warranted beyond the deeming period.
In addition to above, for the first time, the Regulations have covered certain persons/ entities (e.g. consultants/ auditors/ law firms etc.) that are not a part of daily operations of the company but by virtue of their frequent communication with the officers of the company may have access to information which is not available to the public at large.
B. The Regulations also provide a list of persons (unless contrary is established) who shall be deemed to be connected persons:
C. A person is also prohibited from obtaining any information considered to be UPSI from an insider on the securities of the company except in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.
WHAT IS RESTRICTED?
Trading in securities while in possession of UPSI is restricted.
The Regulations intent to put a prohibition on an act (trading) of an insider that deprives the general public of an opportunity that could have been availed had the information been made generally available.
The word “dealing in securities” under the erstwhile Regulations has been replaced by the word “trading in securities”. Dealing is generic in nature and would even cover transactions such as demat of shares, pledging of shares to financial institutions, etc. which is not the intention of the current Regulations.
What constitutes “generally available information”?
Generally available information is defined to mean information that is accessible to the public on a non-discriminatory basis.
Display of information on stock exchange would be considered as generally available information; While, discussion by the officers of the company with the Bank to borrow funds for acquiring land would not be considered as generally available. Similarly, information published in newspaper would be considered as generally available; while discussion on a prospective merger with another company would not be considered as generally available information.
WHY THE RESTRICTION?
For any market to work smoothly, the demand and the supply elements should be in check and the same applies even to the stock market. Any imbalance may increase or decrease the price of the scrip. While imbalances are a part and parcel of any market scenario, any purposeful act benefiting only a few insiders and depriving the others of such benefit at large is prohibited.
In order to maintain the decorum of the market, a person is restricted to trade while in possession of UPSI.
ANY EXCEPTIONS/ DEFENSES TO THE RESTRICTION?
Yes! The Regulations have set out instances that would be not be considered a violation for communicating/ providing/ allowing access to UPSI.
a. An UPSI communicated/ provided by means of an open offer under SEBI Takeover Regulations for transactions such as takeovers, mergers and acquisitions which are in the best interest of the company.
An open offer would allow the public to access information provided in the offer letter and thus allow them to make an informed decision, whether to divest or retain its position in the company.
b. In absence of the requirement to make an open offer where the board of directors are of an informed opinion that the proposed transaction is in the best interest of the company and the UPSI is made generally available atleast two trading days prior to the proposed transaction being brought into effect.
c. Trades concluded in the manner as set out in the trading plan disclosed to the public.
a. A transaction already done is an off-market transfer between promoters who possess the same UPSI and have not communicated/ provided such UPSI to other person(s).
b. In case of entities (non-individuals), the individuals who were in possession of UPSI are different from the individuals who took the trading decisions and did not possess UPSI at the time of trading. Provided appropriate and adequate measures were taken to ensure that no provision of the Regulation was violated and no UPSI was communicated by persons possessing such UPSI to persons taking trading decision and there exists no evidence of breaching of such an arrangement.
c. Information communicated for furtherance of the insider’s legitimate purposes, performance of duties or discharge of his legal obligations.
A few examples of a valid defense are stated hereunder:
a. In case of an investment company the person (other than an insider of that company) managing the portfolios of its customers usually takes the decision of trading in securities and may not be in possession of UPSI. He can defend himself if he is charged under insider trading regulations.
b. Information being UPSI received from a person who is not a connected person but such information was procured illegally. The recipient can claim innocence if he was unaware of such person’s violation.
E.g. In a situation where UPSI is illegally procured by the research analyst, a bona fide recipient of that report who traded when in possession of that report should not be visited with the charge of insider trading. (Referred from Committee Report)
c. Stock Options are generally granted by the companies to its employees as a payback for their hard work. In case of stock options the price is predetermined and when the option is exercised at such price while possessing UPSI, such an employee can validly defend himself.
An insider, more importantly the promoters, directors and senior management, is privy to the developments taking place in a company and are in constant possession of UPSI and thus incapable of trading in securities of the company. The Regulations, for this matter, have provided an option to formulate trading plans by insiders who can trade as per the details set out in the plan. The trade plans are to be devised taking the following into consideration:
a. A trade can be carried out only in the manner set out in the plan.
b. The plan is to be formulated in consultation with the compliance officer of the company and is required to be intimated to the stock exchanges. There should not exist UPSI not available to public at the time of formulation and commencement of trade plan.
c. The trade plan should be formulated for minimum 12 months.
d. Only one trading plan is allowed to be formulated and is irrevocable.
e. Trade can be executed only after completion of 6 months from the date of disclosure of the trade plan to public.
E.g. Let us consider the close of the financial period as the quarter ended 30th June, 2017 and the financial results are adopted by the Board of Directors and disclosed to stock exchanges on 31st July, 2017.
No trade by an insider shall take place from 02.06.2017 (considering 20 trading days) till 02.08.2017 (second working day).
f. The plan should specify the value of trades to be effected or the number of securities to be traded along with the nature of the trade and the intervals at, or dates on which such trades shall be effected.
g. The plan should not abuse the market.
E.g. the timing of intimation of the UPSI to the public should not be manipulated to suit the trade by an insider. Such an act would not provide immunity to the insider against the proceedings for market abuse.
A person when appointed as a Key Managerial Personnel (KMP) or a Director of the Company or on becoming the promoter is required to disclose the details of securities held by him of the company as on date of appointment or becoming promoter to the company within 7 days of appointment or becoming promoter of the company.
a. Every promoter, employee and director of the company is required to disclose to the company the number of such securities acquired or disposed of within two trading days of such transaction if the value of the securities traded, whether in one transaction or a series of transactions over any calendar quarter, aggregates to a traded value in excess of Rs. 10 Lakhs or such other value as may be specified.
b. The company shall notify the particulars of trading by persons mentioned above to the stock exchange on which the securities of the company are listed within 2 working days of the receipt of disclosure or from becoming aware of such information.
Disclosures from other Connected Persons
Any company may at its discretion require any connected persons to make disclosures of holdings and trading in securities of such company at such frequency as may be determined by the company to ensure compliance with the Regulations. E.g. The Company may ask a management consultant who advises the company on corporate strategy and is required to review unpublished price sensitive information to disclose his trades to the company.
CODE OF CONDUCT
The Board of Directors of every listed company and every market intermediary is required to formulate and adopt a code of conduct governing trade by its employees and other connected persons.
Apart from the listed entity, every person/ entity (e.g. auditors/ law firms, business consultants/ analysts etc. related to the company) handling UPSI of such company in course of its business is required to formulate a code of conduct to monitor, regulate and report trading by its employees ensuring compliance with the Regulations.
Schedule B to the Regulations provides minimum standards for formulating the Code of Conduct.
CODE OF FAIR DISCLOSURE
In an endeavor to ensure that the information having an impact on the price of securities of the company is disclosed immediately, the Regulations require every listed entity to formulate a code for fair and timely disclosure of events and incidents. The code is also required to be published on the official website of the company.
Schedule A to the Regulations provides principles for drafting the code for fair disclosure of UPSI.
The Regulations may appear to be stringent but according to me they are a boon to third party retail investors. The timely and correct flow of corporate information will ensure that a level playing field is provided to all.
How fruitful the Regulations will be, depends much on the implementation and the intention with which companies adopt it. Educating the employees is important as any mischief can attract huge liability. There may exist ambiguity in interpreting certain provisions due to the nature of the subject and at times the provisions of the regulations may seem to be too broad based and interpretation of the regulations to determine their applicability to a situation with unique facts may seem difficult. For this reason, the Regulations have validly ensured that safeguards are provided to persons whose trade innocently violates a restrictive provision in the regulation. Moreover, Informal Guidance from SEBI can also be availed in case of any interpretation issues.
DEFINITION OF CERTAIN TERMS:
1. Securities: (Under Securities Contracts (Regulation) Act, 1956)
(i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;
(ib) units or any other instrument issued by any collective investment scheme to the investors in such schemes;]
(ic) security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;]
(id) units or any other such instrument issued to the investors under any mutual fund scheme;
(ii) Government securities;
(iia) such other instruments as may be declared by the Central Government to be securities; and
(iii) rights or interest in securities;
2. Company: (Under Companies Act, 2013)
Means a company incorporated under this Act (i.e. Companies Act, 2013)or under any previous company law;
SEBI (Prohibition of Insider Trading) Regulations, 2015;
Report of the High Level Committee to Review the SEBI (Prohibition of Insider Trading Regulations, 1992 under the Chairmanship of Justice N.K. Sodhi
The Article is creation of the author and contains the views of the author. The above should not be taken as final as it may vary on case to case basis. Kindly consult a professional before taking the final course of action.