The SEBI (Prohibition of Insider Trading) Regulations, 2015 tries to address the lacunae prevailing in the SEBI Regulations 1992. Are the changes adequate enough to protect the interest of the vestors?
After two decades, Securities Exchange Board of India (SEBI), on January 15, 2015 notified the SEBI (Prohibition of Insider Trading) Regulations, 2015 which will replace the SEBI (Prohibition of Insider Trading) Regulation, 1992. Based on the recommendations of the N.K. Sodhi Committee Report, the new regulations aims at fulfilling the inadequacies of the 1992 regulations, consolidating the changes brought about by various amendments, circulars and notifications, and overhauling the insider trading norms to meet the changing needs and to bring them to global standards.
Let us analyses the changes brought about by the new regulations to strengthen the legal framework for prohibition of insider trading.
The new regulations define an ‘insider’ as ‘any person who is a connected person or who is in possession of or having access to ‘unpublished price sensitive information’ (UPSI). Under the 1992 Regulations anyone who ‘has received’ or ‘has/had access to’ UPSI could be called an insider. However, the new regulations limit this to those in ‘possession of UPSI’ and do not rely on the source through which the person is in possession.
The definition has further been strengthened by expanding the definition of ‘connected person’. While the expression ‘insider trading’ has not been defined, it is covered under Section 195 of Companies Act 2013.
Regulation 2(1) (d) of the new regulations covers within its ambit ‘connected person’ and ‘deemed to be connected person’. Any person who has access to UPSI by being in any contractual, fiduciary or employment relationship or by being a director, officer or an employee of the company or holds any position including a professional or business relationship between himself and the company is called a connected person.
It is to be noted that persons associated with the officers of the company by ‘frequent communication’ are also treated as connected persons. Similar to the 1992 Regulations, the person should be associated with the company six months prior to the concerned act of insider trading.
The new regulations include ‘immediate relatives’ under ‘deemed to be connected person’, whereas the 1992 Regulations provided for the word ‘relative’ which is defined in Section 6 of the Companies Act 1956. However, presumption of immediate relatives is deemed to be a legal fiction and is rebuttable.
Thus, it largely depends on the facts and circumstances of the case to call a person connected with respect to the offense of insider trading. If there is an absence of direct evidence of access to UPSI, it will be seen if the person is reasonably expected to have access of the UPSI.
Any information that is accessible to the public on a non-discriminatory basis is known as generally available information. Unpublished price sensitive information is 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. It is evident that now ‘generally available’ is the main criterion to determine what constitutes UPSI. However, whether some information is available on a non discriminatory basis would be a question of fact applying the standard of a reasonable man. For instance, information published on website of a stock exchange would ordinarily be considered generally available.
It is to be noted that the new definition of UPSI extends to both a company and its securities unlike the old definition which restricted itself to the information related to a company.
Ordinarily, UPSI would constitute i) Financial results, ii) dividends, iii) changes in capital structure iv) mergers, demergers, acquisitions, delisting, disposals and expansion of business v) changes in key managerial personnel vi) material events in accordance with the listing agreement.
The definition of Compliance Officer has been introduced in the new regulations. Compliance officer means any senior officer, designated so and reporting to the board of directors or head of the organization, in case board is not there, who is financially literate and is capable of appreciating requirements for legal and regulatory compliance under these regulations and who shall be responsible for compliance of policies, procedures, maintenance of records, monitoring adherence to the rules for the preservation of unpublished price sensitive information, monitoring of trades and the implementation of the codes specified in these regulations under the overall supervision of the board of directors of the listed company or the head of an organization, as the case may be.
The new regulations impose greater responsibility and duty on ‘compliance officer’ to ensure the administration of the regulations. These duties largely include review, approval and notification of the trading plan to the stock exchanges, implementation of the code of conduct and overall compliance of the regulations.
New regulations has used the wider expression ‘trading’, replacing the word ‘dealing’, which was used in the 1992 Regulations. Trading means and includes subscribing, buying, selling, dealing or agreeing to subscribe, buy, sell and deal in any securities. Trading includes dealing and this is intended to aid in curbing activities such as ‘pledging’ while in possession of UPSI. Moreover for the purposes of charging provision i.e. Regulation 4 the term ‘trading’ is rightly used.
The new regulations place a wide variety of restrictions on communication, procurement or trading of UPSI, relating to a company or securities listed or proposed to be listed, to any person including other insiders. Unlike the 1992 Regulations, the new regulations impose restrictions on the procurement of UPSI by other persons. The legislative notes further clarify that no person shall illegally or through inducement, procure from or cause the communication by an insider of UPSI.
However, both communication and procurement are allowed if it is done in furtherance of legitimate purposes, performance of duties or discharge of legal functions. Sub-regulation (3) of Regulation 3 allows exercise of due diligence by board of directors for certain transactions where an insider may communicate, provide, allow access or procure UPSI which are as follows –
Where the UPSI is made generally available at least two trading days prior to the proposed transaction in such form as the board of directors may determine. Thus, there is public disclosure of UPSI well before proposed transaction in order to avoid selective disclosure.
For the aforementioned purpose, it is mandatory on the board of directors to require parties to execute agreements to contract confidentiality and non-disclosure obligations on the part of such parties, except for the purpose of sub-Regulation
and such parties shall not otherwise trade in securities of the company when in possession of UPSI.
Regulation 4 of the new regulations, while imposing prohibition on trading by insiders when in possession of UPSI, provides specific defences for insiders and nonindividual insiders to prove their innocence. These circumstances can be demonstrated as follows-
The novel concept of trading plan has been introduced which acts as a safe harbour for insiders to pre-arrange sale of securities pursuant to a formulated trading plan. The concept of trading plan brought into the new regulations is similar to the United States Securities Exchange Commission Rule 10b5-1. However, adequate safeguards have been adopted in India to overcome abuse of such trading plans.
Trading plan refers to trade planned at present to be executed in future. Thus, regulations require a trading plan to set out details on the value of trade to be effected or number and nature of securities to be traded. Further, it must enlist the intervals or dates on which trade would be executed.
The task of approval, implementation and regulation of trading plans has been entrusted to the compliance officer. The compliance officer shall review the trading plan to assess its potential for violation of the new regulations before approving it. He is authorized to take any such undertaking which may be necessary, for the approval and implementation of the plan. Further, a trading plan requires mandatory public disclosure before commencement. Upon approval, the compliance officer is required to notify the formulated trading plan to the stock exchanges on which securities are listed. Since, trading plan is an exception to the rule of insider trading, public disclosure ensures that people are given adequate notice about such plans and the integrity of market is maintained.
The concept of trading plan is intended to enable persons who are constantly privy to UPSI to execute trade, as a result, it is possible that the persons formulating a plan might possess certain UPSI at the time of its formulation. A lapse of a minimum period of six months has hence been prescribed between public disclosure of a plan and its commencement. This time lag acts a cool-off period to ensure that any UPSI which was in possession of the insider while formulating a trade plan becomes generally available. Furthering this intention, the new regulations provide that the implementation of trading plan would be deferred by the compliance officer for such a period, until which any UPSI in knowledge of the insider, at time of formulation of the trading plan which has not become generally available, becomes so available. However, the legislative note clarifies that the period of 6 months is only a statutory cool off period and would not grant immunity to the insider for any action done if the insider were in the possession of the same UPSI both at the time of formulation and implementation of the plan. This provision for deferring the implementation may in certain cases lead to inordinate delay in implementation of plan since certain projects take years to complete before they are revealed to the public. Deferring the implementation of plan till such a date may render the plan obsolete.
Despite being an exception, formulation of a trade plan does not grant absolute immunity to an insider if he indulges in market abuse practices. Further, the Regulation also prohibits trading between 20th day prior to and two days subsequent to the declaration of financial results.
In order to ensure strict compliance of the trade plan, the Regulations provide that a trade plan once approved becomes irrevocable and must be mandatorily implemented without any deviations. Further, no trade can be executed beyond the scope of the trading plan.
Formulation of overlapping trade plans is prohibited under the Regulations. Senior management for whom the concept of trading plans has been incorporated is capable of timing publication of UPSI so as to enable them to take advantage of a trading plan. Multiple trading plans would result in insider planning disclosure to meet one or the other trade plan, thus indulging in insider trading under disguise of trading plan. Further, a trading plan entails trading for a period not less than twelve months. This ensures that trading plans are not formulated for short spans of time rendering the defence of time gap between formulation of plan and actual trade inconsequential.
Laying emphasize on the person who takes trading decisions rather than the one who has title over the securities, the New regulations provide that disclosure made by a person shall also include disclosure relating to trading by ‘immediate relatives’ of such persons and by any other person for whom such trading takes place. Disclosures include disclosure of trading in derivatives and the trade value of derivatives; as long as such trade is permitted by law. Further, companies are obligated to maintain record of disclosures made to it for a minimum period of five years.
Every promoter, director and key managerial person of the company must disclose his holdings of securities in the company, notwithstanding the percentage of shares or voting rights held by such persons in the company. Initial disclosure is to be made within thirty days from the Regulations taking effect and in case of new appointments, within seven days of appointment as a director or key managerial person or promoter.
Similarly, continual disclosure is not based on the percentage of voting rights or on the number of shares traded in, rather on the basis of value of trade a person is involved in. Emphasis has now been shifted from the voting rights held, to the size of trading done by a person.
Disclosure with respect to any trade undertaken by an employee, director or promoter is to be made within two days of trading when the transaction exceeds ten lakh rupees or any such value which may be specified. Such trade may be undertaken in one transaction or an aggregate of series of transactions undertaken over a calendar quarter. Further, the company is required to notify the details of such trade within two days of receipt of disclosure to the stock exchange on which the securities are listed.
In order to monitor and prohibit insider trading, the New regulations empower the companies to seek disclosures from any connected person or class of connected persons with respect of their holdings and trading in securities. This enables companies to seek information from lawyers, auditors, and management consultants etc, who may at some point or the other have access to UPSI.
Unlike the 1992 Regulations, New regulations have no such requirement of e filing of disclosures. Also, there is no provision for any penalties in case of failure in disclosures in the new regulations.
As per Regulation 8, the board of directors of every company listed on the stock exchange is under an obligation to formulate a Code for Fair disclosure of UPSI. Such a Code needs to be published on the official website of the company and notified to the stock exchange on which the securities are listed. Additionally any subsequent amendments made to the Code must be intimated to the stock exchange.
While formulating a Code of Fair Disclosure, the board of directors must comply with the principles set out in Schedule A without violating the Regulations. Schedule A mandates that companies must set out policies to ensure that UPSI is handled only on a need to know basis. Procedure must be formulated to facilitate prompt, uniform and universal dissemination of UPSI to the public, so as to avoid selective disclosure and maintain market integrity. For the above purposes, a senior official shall be designated as the Chief Investor Relations Officer.
The Code should lay down mechanisms to deal with queries on news reports and market verification requests. Further, proceeds meetings with analysts and investor relation conferences must be mandatorily recorded or transcribed and published on official website. Moreover, no UPSI must be shared with analysts and research personnel.
Regulation 9 mandates every listed company and market intermediary to formulate a Code of Conduct to regulate, monitor and report trading by employees and connected persons. Entities operating outside the capital market such as lawyers, auditors, analysts, consultants etc, and in access of UPSI, are also obligated to formulate a Code of Conduct. Further, a compliance officer is to be designated to administer the Code of Conduct.
A Code of Conduct must be in line with the standards set out in Schedule B of the Regulations and must comply with the following:
In Rakesh Agarwal v. SEBI, the Securities Appellate Tribunal held that it would not be an offence if an insider deals in securities on the basis of UPSI for no personal gain or profit. However, the legislative note to Regulation 4 of New regulations clearly states that any trade in securities while in possession of UPSI would be presumed to have been motivated by the knowledge and awareness of such information in his possession. Thus, mens rea behind the transaction is not intended to be relevant. Trading while in possession of UPSI is sufficient ground to bring a charge against an insider of a connected person.
In case of insider or any other person, the onus of showing that he was in possession of UPSI at the time of trading would be on the person levelling the charge (especially SEBI). Thereafter, an opportunity is given to such persons to prove their innocence by citing aforementioned circumstances. However, in case of connected persons the onus would be on such connected persons.
Insider trading is a statutory offence as per the SEBI Act 1992. Any contravention of the new regulations shall be dealt with by SEBI in accordance with the Act. Section 12A (d) of the Act prohibits a person to engage, directly or indirectly, in insider trading. Moreover Section 11(2) (g) empowers SEBI to prohibit insider trading in securities. Besides, the Section 458 of Companies Act, 2013 authorizes SEBI to appoint such officer who shall have the power to file a complaint in the court of competent jurisdiction. Section 15G of the SEBI Act 1992 imposes monetary penalty of twenty-five crore rupees or three times the amount of profits made out of insider trading, whichever is higher for the offence of insider trading. Also, Section 24 of the Act imposes a punishment of imprisonment for a term which may extend to ten years, or with fine, which may extend to twenty-five crore rupees or with both to any offender of insider trading.
The new regulations herald a much needed change into the insider trading regime in India. Revamping the 1992 Regulations, the new regulations promise a fair mechanism of justice delivery system. There have been instances in the past where the principles of natural justice were violated and the aggrieved innocent party suffered indiscriminately due to the use of arbitrary power by the market regulator. However, despite the changes, the new regulations lack clarity at certain places which needs to be sorted to ensure smooth enforcement of the regulations. The legislature has supplemented the regulations with ‘legislative notes’, however it is unclear whether these have a binding force of law or not. Though the regulations intend to apply to companies proposed to be listed there are clouds of doubt around the term as to what its precise meaning is. Further, the Regulations fail to define legitimate purpose, which is an exception to communication of UPSI. The Regulations make no mention of the investigation procedure to be followed when any case of insider trading is revealed. It is hoped that these issues would be resolved with justified interpretation by the authorities and courts to pave way for progress and correct implementation of prohibition of insider trading regulations by the capital market regulator.
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