Trading by Insiders – approach under SEBI (Prohibition of Insider Trading) Regulations of 2015

 1. Introduction

Stock market is all about dealing in securities. It is a specialized market. Stock markets are formed under the Securities Contracts (Regulation) Act,1956 and the operations are regulated by the Securities Contracts (Regulation Rules,1957. SEBI formed as per the Securities and Exchange Board of India Act, 1992 is the regulator of the market. Objectives of the stock market are to : (i) mobilize resources, (ii) facilitate buying and selling of securities;(iii) facilitate process of efficient price discovery; and (iv) facilitate settlement of transactions in accordance with the predetermined time schedules.   The regulator has notified regulations on insider trading in securities which cover not only buying and selling of securities but also dealing in securities drawing reference to Ss 12A(e) and 15G. Price discovery of scrips is one of the main functions of the stock market. Based on this price discovery, billions of dollars are poured into the stock market. Stock Exchange constitutes one of the segments of the capital market. It is an important institution for the economy of every nation. Gloabalisation like other things have brought the capital market of countries closers. Practices followed in the capital market are more or less common. To-day there are securities like Global Depository Receipts/ American Depository Receipts and Indian Depository Receipts that are popular instruments transacted in the capital market world wide. Price at which securities are traded are recorded and are used for various purposes. Therefore, the opening, traded and closing prices of securities are meticulously recorded. Closing price of scrips is significant and is used to calculate the SENSEX of BSE and NIFTY of NSE. It is computed by the exchange on the weighted average price of all trades executed during the last 30 minutes of the continuous trading session. In case there is no trade in the last 30 minutes, the last traded price of a scrip, in the continuous trading session, is taken to be the official closing price. Stock Exchanges have market hours and the said hours of BSE and NSE are as follows:

i) Pre-open session : a) Order entry and modification opens : at 9 hours. b) Normal/Retail Debt/Limited Physical Session : at 9.15 hours. c) Normal/ Retail Debt/Limited Physical Session : at 15.30 hours. d) Block Deal Session : during 9.15 hours to 9.50 hours. c) Closing Session is held between 15.40 hours and 16 hours.

Stock market has benchmarks that are very popular and help to signify many things. NSE benchmark of the stock exchange price is reflected in the CNX Nifty which is called the Nifty 50 or simply Nifty. NSEs Benchmark Stock Market Index for the Indian Equity Market is owned and managed by India Services and Products (IISL) which is the wholly owned subsidiary of the NSE Strategic Investment Corporation Limited. `CNX’ in the name, `CNX Nifty’ stands for `CRISIL’ NSE Index’. CNX manages 22 sectors of the economy.

BSE (Bombay Exchange Sensitive Index) is the benchmark index of BSE. It is composed of 30 of the largest and most actively traded stocks on BSE. Initially compiled in 1986 it is the oldest stock index in India.

2. Regulatory provisions  

SEBI as regulator of the securities market in India has announced a number of regulations which are being followed and has an efficient surveillance system to control unethical practices. It aims at providing a transparent market for securities so that the trades are based on fair practices. Information is vital for the securities market and due its importance, regulations were announced to curb insider trading. The SEBI( Prohibition of Insider Trading) Regulations, 2015 (`REGULATIONS’) came into force on 15<sup>th</sup> May,2015 replacing the earlier regulations. The Regulations  divide information into two types : i) generally available information ( R 2 (1)(e) ), and (ii) unpublished price sensitive information ( R 2(1)(n)). ` Trading’ ( R 2 (1) (l) ) by` insiders’ (R 2(1)(g)) based on `generally available information’ does not trigger the Regulations , however, trading on `unpublished price sensitive information’ by insiders is barred by the Regulations.

A `generally available information’ (R 2(1)(e)) means information available to public on non-discriminatory basis. Note to the provision states that it is intended to define what constitutes generally available information so that it is easier to crystallize and appreciate what unpublished price sensitive information is. Information published on the website of a stock exchange, would ordinarily be considered generally available. As per R 3(1) of the Regulations no `insider’ ( R 2(1)(g)) meaning any person who is: (i) a connected person; or (ii) in possession of or having access to uspi , shall communicate, provide, or allow access to any `price sensitive information’ (R 2(1)(n)) meaning 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 ( R 2(1)(i)) meaning assigned to it under the Securities Contracts(Regulation) Act,1956 or any modification thereof except units of mutual funds, 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 it is intended that information relating to a company 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.

Chapter – II of the Regulations state the restrictions on communication and trading by insiders . Communication or procurement of upsi is laid down in R 3. As per R 3(1) no insider shall communicate, provide, or allow access to any uspi, relating to a company or listed securities or securities proposed to be listed, to any person including other insiders except where such communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.

Note to this provision is intended to cost an obligation on all insiders who are externally persons in possession of upsi to handle such information with care and to deal with the information with them when transacting their business strictly on a need-to-know basis. It is also intended to lead to organisations developing practices based on need-to-know principles for treatment of information in their possession.

R 3(2) states that no person shall procure from or cause communication by any insider of upsi , relating to a company or securities listed or proposed to be listed, except in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.

Note to the provision states that it is intended to impose a prohibition on unlawfully procuring possession of upsi. Inducement and procurement of upsi not in furtherance of one’s legitimate duties and discharge of obligations would be illegal under this provision.

R 3(3) states that notwithstanding anything contained in this regulation, upsi may be communicated, provided, allowed access to or procured, in connection with a transaction that would:-

(i) entail an obligation to make an open offer under the takeover regulations where the board of directors of the company is of informed opinion that the proposed transaction is in the best interests of the company;

Note to the provision states that it is intended to acknowledge the necessity of community, providing, allowing access to or procuring UPSI for substantial transactions such as takeovers, mergers and acquisitions involving trading in securities and change of control to assess a potential investment. In an open offer under the takeover regulations, not only would the same price be made available to all shareholders of the company but also all information necessary to enable an informed divestment or retention decision by the public shareholders is required to be made available to all shareholders in the letter of offer under these regulations.

ii) not attract the obligation to make an open offer under the takeover regulations but where the board of directors of the company is of informed opinion that the proposed transaction is in the best interests of the company and the information that constitute uspi is disseminated to be made generally available at least two trading days prior to the proposed transaction being effected in such form as the board of directors may determine.

Note to the provision states that it is intended to permit communicating, providing, allowing access to or procuring UPSI also in transactions that do not entail an open offer obligation under the takeover regulations if it is in the best interests of the company. The board of directors, however, would cause public disclosures of such upsi well before the proposal transaction to rule out any information asymmetry in the market.

(4) For purposes of sub-regulation (3), the board of directors shall require the parties to execute agreements to contract confidentially and non-disclosure obligations on the part of such parties and such parties shall keep information so received confidential, except for the purpose of sub-regulation (3), and shall not otherwise trade in securities of the company when in possession of upsi.

The new regulations of 2015 bars insiders from trading in securities if they are traded on the basis of information falling under uspi. However, if the information is generally available information then trading in securities is permitted even by those falling within the definition of insider . An upsi becomes a generally available information once forty-eight hours elapse from announcement of the financial results as per clause 41 of the Listing Agreement and the insiders can act as per the Code of Conduct adopted by the company.

R 4 of the Regulations state that no insider shall trade in securities that are listed or proposed to be listed on a stock exchange when in possession of uspi. Provided that the insider may prove his innocence by demonstrating the circumstances including the following :

i) the transaction is an off-market inter se transfer between promoters who were in possession of the same upsi without being in breach of R 3 and both parties had made a conscious and informed trade decisions;

ii) in the case of non-individual insiders :

a) the individuals who were in possession of such upsi were different from the individuals taking trading decisions and such decision-making individuals were not in possesson of such unpublished price sensitive information when they took the decision to trade; and

b) appropriate and adequate arrangements were in place to ensure that these regulations are not violated and no upsi was communicated by the individuals processing the information to the individuals taking trading decisions and there is no evidence of such arrangements having been breached.

iii) the trades were pursuant to a trading plan set up in accordance to R 5.

Note to the provision states that where a person who has traded in securities has been in possession of upsi his trades would be presumed to have been motivated by the knowledge and awareness of such information in his possession. The reasons for which he trades or the purposes to which he applies the proceeds of the transactions are not intended to be relevant for determining whether a person has violated the regulation. He traded when in possession of upsi is what would need to be demonstrated at the outset to bring a charge. Once this is established it would be open to the insider to prove his innocence by demonstrating the circumstances mentioned in the provisio, failing which he would have violated the prohibition.

R 4(2) states that in case of connected persons the onus of establishing that they were not in possession of upsi shall be on such connected persons and in other cases, the onus would be on the Board.

R 4 (3) states that the Board may specify such standards and requirements, from time to time, as it may deem necessary for the purpose of these regulations.

The provisions in the Regulations aim at curbing trading in the stock market on biasness. Trade curb on the basis of Uspi by an insider within the meaning of the Regulations is the aim of the Regulations.

3. Discussion

The Regulations have been framed to protect the pricing of the securities traded on the stock exchanges. If trading is unfair then the trade mechanism would restrict free pricing. This would lead to adverse economic effects. No doubt the new regulations has tried to plug all previous loop holes wherever apparent and is forward looking to meet future challenges in the securities market. However, the Regulations is silent on the challenge faced in a situation which led to the conviction of Rajaratnam and Rajat Gupta in the US. One reason is that such a situation is not expected in the country or the framers have no answer to the clue. Insider Regulations are dependent of various other laws like the Indian Contract Act, 1872 , Information Technology Act,2000, Criminal Procedure Code, 1973, Indian Evidence Act, 1872 to name a few. The Regulation fails to cover passing of information by an insider. The Regulations has not included officials of RTAs appointed by companies. Further Depository Participants have not been included in the list. If pledge comes within the purview of the trading then Depository Participants automatically stand to be included. Connected persons should have stock brokers of the promoter and promoter group included. Professionals connected with the promoters also do not fall outside the lense.

4. Conclusion

Indian capital market has a long way from 1992 when the SEBI Act came into force. Trading mechanism with the modern and equipped technical support has made the country one of the leading ones having an efficient capital market. To-day there a number of FIIs that are trading on the Indian capital market making it a market having international presence.