This article aims at understanding the complex legal aspects of the latest insider trading regulations which were notified in 2019. The insider trading regulations of 2019 completely replaced the regulations of 2015 and created a completely new legal framework. The new regulations introduced various prohibitions and exceptions to the practice of insider trading and rejuvenated the whole meaning of insider trading in India. These new laws were far more stringent than the previous laws and tried to curb this malpractice to a great extent. This article explains all these prohibitions and exceptions in order to help indulge in legal trading practices and avoid any illegalities which could later cause substantial damage.

INTRODUCTION

“An 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.”[1]

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LEGAL REGIME

The first country to make a law against insider trading was America.[2] In India, the first effort to address this problem was made in 1947 by the establishment of the Thomas Committee.[3] The recommendations of the committee were later codified under various provisions of The Companies Act, 1956. Soon with evolution of the corporate sector came in the establishment of Securities and Exchange Board of India (SEBI) in 1988. In 1992 came in the SEBI Act along with SEBI (Prohibition of Insider Trading) Regulations, 1992[4]. This led to a statutory evolution against the practice of insider trading in India. The laws kept on becoming stricter and tighter with time in order to cover every loophole available. In 2015 came in a major development when the SEBI brought in SEBI (Prohibition of Insider Trading) Regulations, 2015[5]which replaced the older regulations of 1992 and addressed most of the problems of the older regulation. In 2018, SEBI formed a committee under the Chairmanship of T.K. Viswanathan[6] to take a deeper look into the problems of the new regulations and give its recommendations. On receiving the Committee’s report[7], SEBI made the latest amendments to these regulations in 2019 which are now the present laws against insider trading in India.

PROHIBITION AND EXCEPTIONS TO INSIDER TRADING IN INDIA

The relevant provisions which govern insider trading in India are Section 195[8] of the Companies Act,2013 along with section 12A[9] and 15G[10] of the SEBI Act, 1992. In addition to these provisions the primary regulations which govern insider trading in India are the SEBI (Prohibition of Insider Trading) Regulations, 2015. The prohibition and exception/defenses to insider trading can be found in the SEBI (Prohibition of Insider Trading) Regulations, 2015.

Section 12A(d) of the SEBI Act.1992 expressly prohibits insider trading[11] while section 15G imposes a penalty of a sum ranging between ten lakhs to twenty-five crore rupees or a penalty of a sum which is three times the amount of profit made, whichever is higher[12]. Section 195 of the Companies Act, 2013 too prohibits insider trading in addition to defining what it is and states that a punishment of five years of imprisonment and/or a fine up to rupees twenty-five crores maybe imposed on the defaulter.

Regulation 3(1) of the SEBI (Prohibition of Insider Trading) Regulations, 2015[13] lays down the first prohibition on insider trading and states that no insider shall communicate any UPSI relating to a company to any person. The term ‘any person’ also included other insider of the company as well. Hence, it states that a person who is in possession of UPSI shall neither communicate such UPSI to outsiders nor insiders. However, it also carves an exception and states that such disclosure of information maybe be allowed in cases where such communication is made for legitimate purposes, performance of duties or discharge of legal obligations. On the recommendation of the T.S. Viswanathan committee, a few examples of legitimate expectations were added wherein such disclosure in ordinary course of business to partners, collaborators, etc. would fall under the exception. However, under regulation 2B it also states that any such person to whom the UPSI is disclosed to for legitimate purpose like lawyers, accountants, partners, etc. from that point will fall under the definition of insider and hence all the prohibition of the regulation would also apply to them too. This concept can be seen to have been borrowed from the US concept of “constructive insiders” as laid down in the case of Dirks v. SEC[14].  This case stated that any such person like lawyers, accountants, etc. who are actually outsider will be construed as insiders from the point at which the UPSI was shared with them under ordinary course of business.

Another exception to this prohibition is carved out in sub-regulation 3 of regulation 3[15] wherein such UPSI is permitted to be disclosed or allowed access to in two circumstances. Firstly, in cases where due to the takeover regulations, obligations to make an open offer arise and the BoD is of informed opinion that doing so would be in the best interest of the company. Secondly, in a case where no obligations arise however the BoD feels that disclosing such information would be in the best interest of the company. In the second case, the UPSI about a transaction should be made public atleast two days prior to the said transaction takes place. The important thing to note here is that in both such cases the disclosure has to be made to the entire public and not a selective group. What this does it that it gives every person an equal opportunity to make full use of such information and eliminates the possibility of a few people benefitting from the information. Hence it purports to the motive of the regulation which was to avoid unlawful gain by a few.

An important point regarding this prohibition was highlighted by SAT in its judgement of Samir Arora v. SEBI[16]. Here, Samir Arora was accused of disclosing certain UPSI about a merger and eventually making a profit for himself. However, it was later found that the information disclosed by him was false or uncertain as at the day of disclosure no such merger decision had taken place. SAT ruled that since the information was false the prohibition of non-disclosure won’t be attracted as the information has to be true to constitute a UPSI and to attract a charge of insider trading[17].

The second prohibition against insider trading is laid down under regulation 3 sub-regulation 2[18] which prohibits any person i.e. insider or outsider from procuring any UPSI related to a company. This prohibition goes in tandem with the first prohibition and restricts any person from getting access to UPSI regarding a company. The same exception of “legitimate purpose” has been carved out in this provision as well.

The third and the most important exception is laid down in regulation 4[19] which prohibits any person in possession of UPSI of a listed company from trading in securities of that company on the stock market[20]. It was held by SAT in Chandrakala v. SEBI[21] that if an insider deals in securities while in possession of UPSI then it would be presumed that he traded on the basis of such UPSI[22]. However, six exceptions have been carved out to tis prohibition in regulation 4.

Firstly, an exception has been made for an off-market inter-se transaction. These are transactions between two people who are both ‘insiders’ and possess the same UPSI and have taken a conscious decision to trade. Since both parties possess the same UPSI, there would be no unlawful gain to either as both of them have agreed to the transaction on the basis of same information i.e. UPSI. Secondly, the block deal window mechanism falls under the exception. However, such block deals should again take place between two persons who both have the same UPSI as this would remove the risk of unlawful gains. Third is the exception wherein the trading took place under statutory of regulatory obligations. Hence, when such trading was forced by legal requirements then the prohibition would not apply. The fourth exception allows transaction which are in furtherance of stock options. Hence, when the purchase price is pre- determined than such a prohibition on trading would not apply. This exception however leaves some room for misuse and hence needs to be relooked. Fifth exception applies to non-individual insiders and states that when a group of insiders (where some possess UPSI) deal together, it should be proved that the insiders who actually took the trading decisions were not in possession of UPSI and were different entities from those possessing such UPSI. Lastly, an exception is created for trades conducted on the basis of trading plan.

Trading plan is an instrument which helps the people, who are continuously in possession of UPSI due to the nature of their job, to trade in securities. It is an instrument whereby such people can plan for trades in future. What this does is that it creates a certain time lag between the trading decision and its execution due to which the UPSI which the person might possess while deciding would become publicly available and hence not lead to an unlawful gain by such person. According to regulation 5[23] such trading plan needs to be presented atleast six months prior to the execution of such proposed transaction. It is important to note that only the number of securities is decided in a plan and the price of such securities would be the price as listed on the stock market on the day of execution of the plan. Hence, in those six months, all the UPSI would be public and won’t lead to an unfair gain by the person. Also, such plan shall entail trading for a period of at least twelve months and shall have to be approved by a compliance officer who will then make a public disclosure of such plan. Such plan should also not overlap an existing trading plan and nor shall entail any such transaction which shall lead to market abuse. It is also important to note that under regulation5(4), the trading plan has been made an irrevocable instrument and once approved it has to be mandatorily enforced by the person irrespective of monetary nature i.e. profit or loss on the day of execution. However, if the UPSI which was possessed at the time of proposing the plan is still not made public on the day of execution, then such execution might be delayed.

CONCLUSION

It is very clear from this discussion that the laws prohibiting the practice of insider trading have evolved to a great extent from its onset. The laws have just gotten stringent with every new legal statute. This has gone onto show us that the authorities consider this malpractice as an alarming issue and have tried implementing new and stringent statutes to curb it. With this attitude of the authorities, it is implied that they take this issue seriously and any violation of the laws in this particular area will be dealt with great consequences. Hence, it is important for every person engaging in stock trading to be aware of these prohibitions and exceptions as laid down in the legal statute and indulge in legal trading in order to avoid great deal of scrutiny and consequences in the future.

[1] Nishith Desai Associates, Insider Trading Regulations- A Primer (Jun. 8, 2020, 17:50),http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Insider_Trading_Regulations_-_A_Primer.pdf.

[2] Securities and Exchange Act,1934, 15 U.S.C § 78a.

[3] Anand Kumar Tripathi, The Concept of Insider Trading in India, CLC/VI/2011, pg. 174.

[4] SEBI (Prohibition of Insider Trading) Regulations, 1992.

[5] SEBI (Prohibition of Insider Trading) Regulations, 2015.

[6] SEBI, Report of Committee on Fair Market Conduct under chairmanship of Dr. T. K. Viswanathan (Jun 8, 2020, 19:30), https://www.sebi.gov.in/reports/reports/aug-2018/report-of-committee-on-fair-market-conduct-for-public-comments_39884.html.

[7] Ibid.

[8] The Companies Act, 2013, Sec. 195.

[9] Securities and Exchange Board of India Act, 1992, Sec. 12A.

[10] Securities and Exchange Board of India Act, 1992, Sec. 15G.

[11] Securities and Exchange Board of India Act, 1992, Sec. 12A.

[12] Securities and Exchange Board of India Act, 1992, Sec. 15G.

[13] SEBI (Prohibition of Insider Trading) Regulations, 2015, Reg. 3(1).

[14] Dirks v. SEC, 463 U.S. 646 (1983).

[15] SEBI (Prohibition of Insider Trading) Regulations, 2015, Reg. 3(3).

[16] Samir Arora v. SEBI, [2005] 59 SCL 96 (SAT).

[17] Samir Arora v. SEBI, [2005] 59 SCL 96 (SAT).

[18] SEBI (Prohibition of Insider Trading) Regulations, 2015, Reg. 3(2).

[19] SEBI (Prohibition of Insider Trading) Regulations, 2015, Reg. 4.

[20] Based on SEC v. Texas Gulf Sulphur Co., 2 A.L.R. Fed. 190.

[21] Appeal No. 209 of 2011 decided on January 31, 2012.

[22] Appeal No. 209 of 2011 decided on January 31, 2012.

[23] SEBI (Prohibition of Insider Trading) Regulations, 2015, Reg. 5.

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