PIT compliance for Pledge of shares for bonafide purpose at the time of trading window closure

Prohibition of Insider Trading (PIT) compliance for Pledge of shares for bonafide purpose at the time of trading window closure

The sub-clause 4 (3) of Schedule B of the PIT Regulation provides that the trading window restrictions mentioned in sub-clause (1) shall not apply in respect of-(a) transactions specified in clauses (i) to (iv) and (vi) of the proviso to sub-regulation (1) of regulation 4 and in respect of a pledge of shares for a bonafide purpose such as raising of funds, subject to pre-clearance by the compliance officer and compliance with the respective regulations made by the Board.

Thus following factors should be analyzed:

• Pledge of shares has to be for a bonafide purpose such as raising of funds- It may be noted that though one example has been mentioned as raising of funds, but even if there is any other bonafide purpose, exception can be made. Therefore pledging of shares as margin does fall within the purview of “bonafide purposes”
• Pre-clearance has to be given by the Compliance officer- In my view this would not be a typical pre-clearance since after closure of trading window it would be difficult to prove that insiders did not have access to the price sensitive information. Therefore preclearance would have to be given by the Compliance Officer on request by the Insider citing Regulation 4(3) giving proper justification and establishing bonafide purposes.
• The third and debatable point is that compliance has to be made with respective regulations made by the Board.

We should also refer to Clause 10 of Schedule B of the PIT Regulation which grants power to the Compliance officer to provide relaxation from such strict restrictions for reasons to be recorded, subject to the compliance of these regulations; the same is mentioned as under:

Clause 10 –The code of conduct shall specify the period, which in any event shall not be less than six 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 strict application of such restriction for reasons to be recorded in writing provided that such relaxation does not violate these regulations. Should a contra trade be executed, inadvertently or otherwise, in violation of such a restriction, the profits from such trade shall be liable to be disgorged for remittance to the Board for credit to the Investor Protection and Education Fund administered by the Board under the Act.

The guidance note of ICSI issued for PIT (which is also similar to the Memorandum issued by SEBI available on its site for amending the PIT Regulations) also give insight as to how to deal with such a situation:

1. “the pledgor or pledgee may demonstrate that the creation of pledge or invocation of pledge was bona fide and prove their innocence under proviso to sub-regulation (1) of regulation 4 of the Regulations”

2. “The obligation to make disclosure under PIT Regulations is irrespective of any loss caused to any of the public investors and irrespective of whether the insider gained any unfair advantage on account of such non-disclosure or not” – Extract of SAT Order dated June 12, 2014.

We can also refer the informal guidance issued by SEBI in case of (Geetanjali Trading and Investments Pvt. Ltd) and its two wholly owned subsidiaries are promoter and promoter group entities of Asian Paints Limited (a listed company)- where in SEBI has informed the applicant that any pledge transaction may be carried out. It was further stated that when any pledge transaction is carried out, it shall be expected to be within the spirit of the SEBI PIT Regulations and as has been brought out in the SEBI Guidance Note, the onus to demonstrate, bone fide intention behind such transactions shall lie with pledgor/pledge. Further, SEBI had also advised that pledge should be created in accordance with provisions of the applicable laws with appropriate disclosures in compliance with various SEBI Regulations. In such a case, the defence provided in Regulation 4(1) of SEBI PIT Regulations will be available.

The specimen format for seeking pre-clearance also provide the option to mention the proposal for seeking pre-clearance “Pledge”.

To ring fence the above discussion, pledge can be created with the following action points:

• Pre-clearance application to be given. Compliance officer to then take necessary action of giving pre-clearance.
• Considering that the trading window is already closed and communication of the same has been sent to the Exchanges and this will be an exception, we should deliberate whether stock exchanges need to be informed. It seems that the safest way is to make disclosure since SEBI insists that disclosures are an important factor while considering the malafide of any transaction.