SEBI (POIT) Regulations 2015 – includes pledge under `trading’ by `insider’

Business needs capital which promoters arrange. Since promoters conceive the idea of the business, bring in fund, human capital they are allowed to control the enterprise they build. While ownership control remains with the promoter, the Board of Directors of a company may comprise of different persons nominated by the promoter or promoter group.  As enterprise grows a promoter requires fund and there is a system of going to the public for capital. Such capital can be arranged through listing of the shares of a company. Presently, India has two stock exchanges namely, the National Stock Exchange of India (`NSE’) and the Bombay Stock Exchange (`BSE’) where shares of companies are listed. The shares are securities within the definition of S 2 (h) of the Securities Contracts (Regulation) Act,1956. They are traded on the stock exchanges and are governed by securities laws. SEBI is the regulatory authority that monitors  observance of the securities laws and frames regulations from time to time in the interest of the investors. Latest is the  SEBI (Prohibition of Insider Trading) Regulations, 2015 ( `REGULATIONS’) in force from 15/5/2015 is one regulation replacing the earlier Regulation of 1992.

Listed companies  are required to make public disclosures through its website and reportings under the Companies Act,2013 and the Listing Agreement.  The  Regulations prohibit  trading by insiders based on`unpublished price sensitive information.’(`USPI’) in their possession. R 2 (1) (n) defines uspi  as `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 : –

(i) financial results; (ii) dividends; (iii) change in capital structure; (iv) mergers, de-mergers, acquisitions, delistings, disposals and expansion of business and such other transactions; (v) changes in key managerial personnel; and (vi) material events in accordance with the listing agreement.

Note to the provision states that information relating to accompany or securities, that is not generally available would be unpublished price sensitive information if it is likely to materially affect the price upon coming into the public domain. The types of matters that would ordinarily give rise to unpublished price sensitive information have been listed above to give illustrative guidance of unpublished price sensitive information.’

(ii) Trading by  insiders based on uspi  can affect  price of scrips which give skewed prices against market phenomena as laid down in Economics.

R 2(1)(l) defines `trading’ which `means and includes subscribing, buying, selling, dealing, or agreeing to subscribe, buy,sell, deal in any securities and “trade” shall be construed accordingly.’

Note to the provision states that `under the parliamentary mandate, since the Section 12A(e) and Section 15G of the Act employs the term `dealing in securities,’ it is intended to widely define the term “trading” to include dealing. Such a construction is intended to curb the activities based on unpublished price sensitive information which are strictly not buying, selling or subscribing, such as pledging etc when in possession of unpublished price sensitive information.’

For a stable economy, a `perfectly competitive market’  (`pcm’) is essential.  Stock Exchanges are said to reflect the health of the economy so there must be a  pcm   A pcm  fulfills the  following criteria :

i.  There must be many buyers and many sellers in the market.

ii. All firms must produce  homogenous commodity meaning  output of one firm would be indistinguishable from  output of another firm.

iii. Any firm may enter or leave  the market  at any point of  time.

iv. All sellers and  purchasers must have perfect knowledge of the market as a whole implying  that there must be close contact between  sellers and  purchasers.

v. There must be perfect mobility of the factors of production.

vi. All purchasers must be equal in the eyes of  the sellers and all sellers must be equal in the eyes of the purchasers. Biasness and partiality must be completely absent.

Therefore,   knowledge or information  control  is essential for a pcm  to prevail .   . The Securities Market is no different and the market must have all the characteristics  of a pcm . Accordingly, the regulator has tightened the scope of application of  `uspi’ defined  in  the SEBI ( Prohibition of Insider Trading ) Regulations,2015 effective from 15/5/2015( `REGULATIONS’).

As per the Regulations , `generally available information’ [ R 2(1)(e) ](`gai’)  meaning information that is accessible to the public on  non-discriminatory basis is permitted as the base of any trading. An insider who trades on the basis of gai  is not prohibited to do so by the Regulations.

Background of Insider Trading and its Regulations

Insider Trading is a practice followed from the inception of the securities market. It became known to the public  in the 80s and 90s when several deals were reported . To  check such practice  SEBI  formulated the SEBI(Insider Trading) Regulations, 1992   amended in 2002 after loop holes surfaced in the 1992. Cases like Hindustan Levers ltd vs. SEBI,  Rakesh Agarwal vs SEBI etc., were dealt under the Regulations of 1992. Several loop holes were noticed in the Regulations, accordingly, amendments to the  Regulations made vide the  Amendment Regulations of  2002 and the Regulations came to be known as the SEBI (Prohibition of Insider Trading ) Regulations,1992 instead of SEBI (Insider Trading ) Regulations,1992. While the Regulations of 1992 was more punitive, the Regulations of  2002  was more preventive. The  Regulations of 2015 is  wider in scope  to check the practice of the insider trading .  The Companies Act, 2013 includes provisions prohibiting insider trading. The new Regulations includes, `dealing’ in securities  under the  definition of `trading’ [R 2(1)(l)] and  as per the provisions of Ss 12A(e) and 15G of the SEBI Act,1992, `dealing’  includes pledge. So pledge by insiders is barred by the new Regulations.

Pledge of shares by promoters has increased. Promoters raise resources to fund their business. Funds garnered through pledge can be invested for acquisition of further shares in the company which can distort the market equilibrium. In the Financial Year 2015 there was a 30 per cent spurt  in the value of pledged-shares by listed companies compared to Rs 1.94 lac crore form Rs 1.52 lac crore in the previous year. While creating pledge, the pledgor has to state the purpose of obtaining the loan against pledge. The new insider trading regulations conjecture with the RBI guidelines on loans against shares issued in the previous  year would  reduce  misapplication of  share-pledge route to a considerable extent.

Shares of listed companies  traded in dematerialized form  and pledge.

  All shares of listed companies  in order to be traded must be in dematerialized form maintained with Depository Participants (`DPs’) who maintain their accounts with NSDL or CDSL, depositories, regulated by the Depositories Act,1996 (`ACT’). Shares maintained with DPs can be pledged as per S 12 of the said Act. S 12 (1) of the  Act,  which deals with pledge or hypothecation of securities held in a depository. Subject to such regulations and bye-laws, as may be made in this behalf, a beneficial owner may with the previous approval of depository create  pledge or hypothecation in respect of a security owned by him through a depository. S 12 (2) of the Act states that every beneficial owner shall give intimation of such pledge or hypothecation to the depository shall make entries in the records accordingly. Again S 12(3) states that any entry in the records of a depository under sub-section (2) shall be evidence of a pledge or hypothecation.

As per  S 89 of the Companies Act,2013 read with the Companies (Management and Administration ) Rules,2014,  for creating of pledge of dematerialized shares the registered owner of shares has to furnish Form No. MGT -4  being    declaration by the registered owner of shares who does not hold the beneficial interest in such shares. This has to be followed by furnishing  of Form no. MGT – 5 being declaration by the beneficial owner who holds or acquires beneficial interest in shares but whose name is not entered in the register of members. On receipt of MGT 4 and 5, the company has to file    Form no. MGT – 6 with the Registrar of Companies (`RoC’).

Pledge distinguished from Mortgage

Wharton’s Law Lexicon defines pledge as bailment of goods by a debtor to his creditor, to be kept till the debt is discharged. A mortgage of goods is in the Common Law distinguishable from a mere pledge or pawn. By a mortgage the whole legal title passes conditionally to the mortgagee; and if the goods be not redeemed at the stipulated time, the title becomes absolute at law although equity allows a redemption. But in a pledge, a special property only passes to the pledgee, the general property remaining in the pledgor. Also, in the case of the pledge the right of a pledge is not comsummated, except by possession; and ., ordinarily when that possession is relinquished, the right of the pledgee is extinguished or waived. But in the case of a mortgage of personal property the right of property  passes by the conveyance to the mortgagee, and the possession is not or may not be essential to create or support the title. From the above it is clear that pledge and mortgage are different. Shares are pledged and immovable properties are mortgaged. Pledge is governed by the Contract Act,1872 , mortgage falls under the Transfer of Property Act, 1882 .


 As per the  new Regulations pledge  by an insider in possession of upsi falls under `trading’ [R 2(1)(l)] which is barred and the insider will have to comply with the provisions of the  regulations.

Author : CS Saibal Chandra Pal, Advocate

[ Opinion expressed is that of the Author]

Copyright & Publishing Rights with Author.

Securities Law & Financial Sector Regulatory Practice

Edited by :   Soubhik Chakraborty, Advocate

Email: saibal2004@rediffmail.com

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