Mutual Fund Units now under ambit of SEBI Prohibition of Insider Trading Regulations- Detailed analysis of Amendment

I. Amendment to Regulation 2 of SEBI (Prohibition of Insider Trading), Regulations, 2015

Regulation

Existing Provision Amended Provision
2(1) (i) “securities” shall have the meaning assigned to it under the Securities Contracts (Regulation) Act, 1956 (42 of 1956) or any modification thereof except units of a mutual fund; Words – except units of a mutual fund are omitted
Analysis & Impact In July 2022, Securities & Exchange Board of India came up with Consultation Paper on applicability of SEBI (Prohibition of Insider Trading), Regulations, 2015 to Mutual Fund (MF) units. The objective of this regulation was to harmonize the regulations in securities vis-à-vis mutual fund units.

Impact of this particular amendment can be understood with the help of example;

A is an Insider as per the definition of PIT Regulations. He has access to Unpublished Price Sensitive Information (UPSI) of a traded entity – X Limited.

Now, being in possession of UPSI, Mr A purchases shares of X Limited from the stock exchange and sells it post its publication and books profit. He has in this case violated PIT Regulations and if successfully prosecuted, SEBI can impose a penalty of 3x the profit or Rs 25 Crores whichever is higher.

Similar to this, Mr A has UPSI of a mutual fund’s particular scheme which may affect its NAV. Until now, if he would have traded on this information, it would not be an offence under the PIT Regulations, but the same is now pari passu to offence as dealt in other securities.

Instead of buying the shares on stock exchange, Mr A purchases unit of mutual fund scheme – Y. This scheme has a shareholding in X Ltd. So indirectly on any gain due to UPSI, Mr A would also get a profit. Whether such inter-related transactions would also be part of PIT Regulations are a question to be examined.

Regulation Existing Provision Amended Provision
2(1) (i) “trading” means and includes subscribing, buying, selling, dealing, or agreeing to subscribe, buy, sell, deal in any securities, and “trade” shall be construed accordingly “trading” means and includes subscribing, redeeming, switching, buying, selling, dealing, or agreeing to subscribe, redeem, switch, buy, sell, deal in any securities, and “trade” shall be construed accordingly
Analysis & Impact Effectively to cover what trading includes, earlier the words subscribing, buying, selling etc. were used for shares to be bought and sold.

Since, the new regulations are amended to include units of Mutual Funds, the appropriate terminology for the same is inserted, i.e. redeeming, switching and to redeem or to switch.

II. Insertion of Chapter II A: Restrictions on Communication in Relation to and Trading by Insiders in the Units of Mutual Funds.

Regulation Provision
5A (1) Provisions of this chapter shall apply only in relation to the units of mutual fund
5A (2) Provisions of Chapter IIIA and V shall also apply in relation to the units of a mutual fund
Analysis The inserted Chapter(s) II A, IIIA and V are only with respect to Mutual Fund Units.

Regulation Provision
5B (1) (a) Definition of Associate – to be same as that in SEBI (Mutual Fund) Regulations, 1996 [Regulation 2 (c) ]

(c) “associate” includes a person,—

(i) who directly or indirectly, by himself, or in combination with relatives, exercises control over the asset management company or the trustee, as the case may be, or

(ii) in respect of whom the asset management company or the trustee, directly or indirectly, by itself, or in combination with other persons exercises a control, or

(iii) whose director, officer or employee is a director, officer or employee of the asset management company;

Regulation Provision
5B (1) (b) Definition of Connected Person
Analysis Connected person is defined as follows;

i. Any Person, who at present or in past, 2 months priort to act was directly, indirectly or in any capacity including by frequent communication had any relationship with mutual fund or asset management company or trustees which allowed him access to UPSI or reasonably is expected to have such access.

ii. Following person(s) shall be deemed to be connected persons, unless contrary established

a. Immediate relative of person in Clause (i) (or)

b. Sponsor, holding company or associate company or subsidiary company of the Sponsor or Asset management company and

Trustees; (or)

c. Board of Directors and key management personnel of sponsor of the mutual fund; or

d. Directors or employees of registrar and share transfer agents, custodians or valuation agencies of the mutual fund who have access or are reasonably expected to have access to unpublished price sensitive information relating to a mutual fund scheme or its units in the course of business operations; or

e. an official or an employee of fund accountant providing services to a mutual fund who have access or are reasonably expected to have access to unpublished price sensitive information relating to a mutual fund scheme or its units in the course of business operations; or

f. an official or an employee of a self-regulatory organization recognised or authorized by the Board; or

g. an official of a stock exchange for dissemination of information; or

h. Directors or employees of auditor, legal advisor or consultants of the mutual fund or asset management company who have access or are reasonably expected to have access to unpublished price sensitive information relating to a mutual fund scheme or its units in the course of business operation; or

i. an intermediary as specified in section 12 of the Act or an employee or director thereof who have access or are reasonably expected to have access to unpublished price sensitive information relating to a mutual fund scheme or its units in the course of business operations; or

j. a banker of the mutual fund or asset management company; or

k. a concern, firm, trust, HUF, company or association of persons wherein a director of an asset management company and Trustees or his immediate relative or banker of the company, has more than ten per cent of the holding or interest

Regulation Provision
5B (1) (c) “generally available information” means information that is made available to the unitholders or made accessible to the public on a non-discriminatory basis;
Analysis Similar to PIT Regulations with respect to Shares

 

Regulation Provision
5B (1) (d) “insider” means any person who is:

i. a connected person; or

i.  in possession of or having access to unpublished price sensitive information pertaining to a scheme;

Analysis Similar to PIT Regulations with respect to Shares
Regulation Provision
5B (1) (e) “systematic transactions” in the units of mutual fund are those transactions which are automatically triggered for execution on a periodic basis as instructed by the investor including Systematic Investment Plans, Systematic Transfer Plans or Systematic Withdrawal Plans;
Analysis Similar to PIT Regulations with respect to Systematic Plan provision, here Systematic Investment Plans (SIPs), Systematic Transfer Plans (STPs) and Systematic Withdrawal Plans (SWPs) are included.

Regulation Provision
5B (1) (f) “unpublished price sensitive information” shall mean any information, pertaining to a scheme of a mutual fund which is not yet generally available and which upon becoming generally available, is likely to materially impact the net asset value or materially affect the interest of unit holders and shall include the instances where there is a likelihood of:

i. a change in the accounting policy;

ii. a material change in the valuation of any asset or class of assets;

iii. restrictions on redemptions, winding up of scheme(s);

iv. creation of segregated portfolio;

v. the triggering of the swing pricing framework and the applicability of the swing factor;

vi. material change in the liquidity position of the concerned mutual fund scheme(s);

vii. default in the underlying securities which is material to the concerned mutual fund scheme(s)

Regulation Provision
5 C Communication or procurement of unpublished price sensitive information and maintenance of a structured digital data base.
Analysis Pari passu to Chapter II – Restrictions on Communication and Trading by Insiders

Regulation Provision
5 D Trading when in possession of unpublished price sensitive information.
Analysis Pari passu Chapter II – Regulation 4; Trading in securities

Regulation Provision
5 E Disclosure by certain persons
Analysis Pari passu to Chapter II – Regulation 7 and 7 (2); Disclosure by certain persons Designated Person – is defined as per Section 5 G

Regulation Provision
5 F Code of Conduct
Analysis Pari passu to Chapter IV – Regulation 8

 

Regulation Provision
5 G (1) Designated Person shall include:

i.  Head of the asset management company (designated as Chief Executive Officer/Managing Director/President or by any other name),

ii. Directors of the asset management company or the trustee company,

iii. Chief Investment Officer, Chief Risk Officer, Chief Operation Officer, Chief Information Security Officer, Fund Managers, Dealers, Research Analysts, all employees in the Fund Operations Department, Compliance Officer and Heads of all divisions and/or departments or any other employee as designated by the asset management company and/or trustees.

5 G (2)
Analysis Pari passu to Chapter IV – Regulation 8

Regulation Provision
5 H Institutional Mechanism for Prevention of Insider trading.
Analysis Pari passu to Regulation 9

III. Analysis of Schedule B1 – Minimum Standards of Code of Conduct for Mutual Funds to regulate, monitor and report trading by the Designated Persons in the units of own mutual fund schemes

1. Compliance officer shall report to board of directors and chairman of audit committee of asset management committee, minimum once a year or higher frequency as stipulated by board.

2. Chinese walls procedure (a barrier that separates two or more groups, usually as a means of restricting the flow of information) shall be put to ensure no person gains information to UPSI except for legitimate purpose and that proper process are in place to permit any designated person to cross the wall.

3. Internal code of conduct shall be in place to be followed by Designated Persons and its relatives.

4. Compliance officer shall determine closure period for designated person
when it is known that person is expected to be in possession of UPSI.

5. Duration of closure period shall be determined by compliance officer.

6. While closure period not applicable, trading in mutual fund units shall be subject to pre-clearance of compliance officer on values of proposed trade being higher than as prescribed.

7. Prior to clearance, compliance officer shall take declaration that applicant is not in possession of any UPSI.

8. The code of conduct formulated by the chief executive officer or managing director of the asset management company shall specify any reasonable timeframe, which in any event shall not be more than seven business days, within which trades that have been pre-cleared have to be executed by the Designated Person, failing which fresh pre-clearance shall be required for the trades to be executed

9. The code of conduct shall also specify the period, which in any event shall not be less than two months, within which a Designated Person who is permitted to trade shall not execute a contra trade. The compliance officer may be empowered to grant relaxation from the strict application of such restriction for reasons to be recorded in writing provided that such relaxation does not violate these regulations or other requirements specified by the Board. In case a contra trade is executed, inadvertently or otherwise, in violation of such a restriction, the profits or loss avoided from such trade shall be liable to be disgorged by the asset management company and credited under intimation to the Board, to the Investor Protection and Education Fund established by the Board under the Act.

10. Format for reporting trades executed shall be notified in stipulated code of conduct.

11. Code of conduct shall also have guideline for prompt information to stock exchanges on violation of regulations.

12. Designated partners shall disclose names and PAN of:

a. Immediate relatives

b. Persons with whom they share material financial relation (any party being recipient of any payment as loan or gift, equivalent to 25% of Designated Partner’s salary exception to arm’s length price dealings)

c. Contact details of such persons

13. MFs shall establish process to identify how any person received inside information.

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