The malfeasance of insider trading has attracted the attention of regulators from jurisdictions across the world, especially in the light of discovery of massive frauds, both in the Indian and international capital markets. The lacunae in the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 (the “existing regulations”) has had a detrimental impact on the rights of public shareholders, corporate governance norms and dented confidence in financial markets overall. Securities Exchange Board of India (SEBI), has sought to usher in a new regime to close the prevailing loopholes and curtail the malpractices prevalent in the securities market and in its meeting held on 19th November, 2014 (“Meeting”), approved amendments that cover norms related to insider trading, delisting and enforceability of the listing agreement among others. It is to be noted that presently, SEBI has issued a press release bearing PR No. 130/2014, which only describes the important measures in principle and its complete implications can only be ascertained on release of the detailed amendment regulations.
Justice N.K Sodhi Committee Report
SEBI constituted an eighteen (18) member committee under the chairmanship of Justice N.K Sodhi (“Committee”), to review the existing regulations and its report has endeavoured to align the existing regulations with international practices, and adapting the same to Indian conditions and practices. The report has drawn heavily on literature pertaining to International Organization of Securities Commissions (“IOSCO”). It has made suggestions to address specific regulatory concerns balancing the needs of the Indian market as well as its investors. The report was submitted by the Committee on 7 December, 2013 (“Committee Report”) and discussed in the meeting in which SEBI approved the SEBI (Prohibition of Insider Trading) Regulations, 2014 (“proposed regulations”). Certain key features of the proposed regulations are discussed in the following paragraphs.
Definition of “Insider”
The definition of “insider” has been broadened to include “persons connected on the basis of being in any contractual, fiduciary or employment relationship that allows such person access to unpublished price sensitive information”. SEBI has made an effort to provide clarity to the definition by disintegrating it, into two parts, (i) Connected persons (ii) Unpublished Price Sensitive Information (“UPSI”).
The proposed regulations have enhanced the scope of a “connected person”. The criteria is not only limited to persons that occupy responsible positions in the company or those having professional/business relations with the company (which is the case currently) but extends to persons who are associated with a company in any manner, who have or are reasonably expected to have access to UPSI. The proposed regulations state that “immediate relatives” shall be presumed to be “connected persons” albeit with a right to rebut the presumption. Regulation 2(h) of the existing regulations enlists certain categories of persons who are deemed to be connected. It has been observed in several SAT cases, that the deeming provisions cannot be construed as exhaustive in nature. The proposed regulations build upon the principle laid down by judicial precedents over the years. However, it is to be seen, whether the proposed regulations do away with the deeming provisions completely as suggested in the Committee Report or retain the definition as provided in Regulation 2(h).
The Committee has rightly observed in its report, that whether a person is a “connected person” or not shall always necessarily be a mixed question of fact and law, which has to be decided on a case to case basis. It is in the background of this premise that the concept of UPSI has been clarified, and has been made more principle based. Principally, any information not generally available, and which may impact the price of a security shall be treated as UPSI. The phrase “Generally available information” has been defined so as to include, dissemination of information on a non-discriminatory platform, such as the stock exchange. Further, the Committee Report attempts to clarify the definition by using various illustrations, which seeks to establish that any information that is available on a non-discriminatory basis, and which is capable of being assessed by any person without any breach of law shall be considered as “Generally available”.
The Committee Report seeks to cast liability on public servants holding statutory positions that provides them with an opportunity to be in possession of UPSI. However, SEBI has not adopted such a liberal view in the Press Note.
Communication of UPSI
Under the existing regulations, it is not clear as to whether the offence of “insider trading” takes place only when one trades on unpublished information or whether the offence is committed immediately upon receipt of the information. The proposed regulations categorically prohibit disclosing and procuring UPSI as well as trading on receipt of such UPSI. Therefore, it could be the case that a mere disclosure of UPSI in itself constitutes an offence under the proposed regulations whether or not the recipient has utilised the UPSI to gain an undue advantage. However the most significant point to be noted here is that, the Committee Report as well as the Press Note issued by SEBI, employ the use of the word “trading” in place of “dealing”. In case the above-mentioned change is reflected in the charging provisions of the official regulations, it will serve the purpose of restricting the scope of the Insider Trading Regulations to capture only the market abuse of insider trading.
However the proposed regulations provide sufficient leeway for communication of UPSI, in the event of discharge of legal obligations, performance of duties or communication in furtherance of legitimate purposes such as due diligence for private equity investments which so far, was prohibited under the existing regime.
In order to provide clarity to the charging provisions of the proposed regulations, provisions enlisting valid defences to be taken against allegations of insider trading have been introduced. It is to be noted that SEBI has, in its order in the case of Rakesh Agrawal v. SEBI, [(2004) 1 CompLJ 193 SAT = 2004 49 SCL 351 SAT], emphasized on the element of mens rea, to be taken cognizance of, before setting out a charge of insider trading. The Committee report provides for these defenses only with respect to an offence of trading with UPSI and not an offence relating to communicating or receiving the UPSI. In light of the suggestions made by the report, it will be interesting to observe the approach adopted by the SEBI in the final regulations.
The concept of “Trading Plans” on the lines of Rule 10b5-1 of the Exchange Act, 1934, United States shall be adopted in the proposed regulations. Typically, “pre-arranged trading plans” allow officers and directors of public companies to trade in a pre-determined number of shares at a pre-determined time. A “trading plan” can be used as an affirmative defense against allegations of insider trading. It is understood that SEBI shall provide necessary safeguards, to ensure that the plans ascribe only to bona fide transactions.
The proposed regulations prescribe mandatory disclosure of UPSI before trading, to avoid asymmetry of information in the market. The proposed amendment is in line, with Section 194 of the Companies Act 2013, which prohibits derivative trading by directors and Key Managerial Personnel on securities of the company.
Further SEBI has sought to relax the burden of repeated disclosures, by doing away with Regulation 13(3), which mandates disclosure of any change of 2% in the shareholding structure of the company, for persons holding more than 5% shares or voting rights. The rationale behind eliminating this regulation is to avoid repetition of disclosures as such a provision already exists in the Takeover Code.
Code of Fair Disclosures and Code of Conduct
The proposed regulations prescribe for a principle based Code of Fair Disclosures, which shall be published on the company’s official website. The Code of Fair Disclosures shall govern the disclosure of events and circumstances that would impact the price discovery of its securities. Further, the board of directors of every company and market intermediary registered with SEBI would be required to formulate a Code of Conduct to regulate, monitor and report trading by its employees and other connected persons.
A brief perusal of the proposed regulations will lead us to believe that SEBI has indeed adopted a more principle based approach to deter insider trading in the securities market. This is evident from the tests laid down to understand and determine concepts such as UPSI, “Connected persons” or even “Generally available information”. The existing regulations, instead of defining these terms in clear and unambiguous language, have provided deeming provisions that haves misled both the regulator as well as the investor so far. The proposed regulations purport a wider definition, and have annotated each provision with legislative notes as an aid to interpretation. Another significant development is the exception carved out for due-diligence process, in case of merger & acquisition transactions, which clearly reflects upon the mindset of the regulator to facilitate rather than impede businesses. On the other hand, by shifting the “burden of proof” to the alleged offender, SEBI has strengthened its enforcement mechanism that has proven to be a major lacuna in the existing regime. Theoretically speaking, the reforms proposed shall serve good purpose in reducing rampant violation of insider trading norms, however until case-law develops it will be difficult to assess the practical implications of the proposed regulations.
[The author is an Associate, Lakshmikumaran & Sridharan, New Delhi]