In this blogpost, Tanusree Banerjee, Student, South Calcutta Law College, writes about the new securities and exchange board of India (prohibiton of insider trading) regulations, 2015
Introduction
Insider Trading and laws prohibiting it had always been a centre of attraction as it is a fascinating subject. It is now under the spotlight because of the new rules which had been brought into effect by the capital market regulator on 15th May 2015.
As we know that the basic norms governing the world of insider trading forbid anyone from dealing with the firm’s share publicly who has access to the insight knowledge of unpublished price sensitive information. If someone is convicted of doing such an offence, such person could be penalized with 10 years of imprisonment or to pay a fine of up to Rs.25 crore or thrice the amount of profits made.[1]
Given that there may be several officers in a company who may always possess price sensitive information the objective to the Insider Trading Regulations in order to prevent the misuse of such information may not always, be intended with the ground reality of performing several crucial functions of the company by such officers. These come about in no small part because unprincipled traders will always find new laws and escape holes in the rules and regulations governing the insider trading and will continue to make profits out of it in their own secretive ways so as to avoid prosecution.
Even if we keep that aside for a moment, still it is very important for the capital market regulator to structure the insider trading practice since the stock market is getting affected by this which often lead to a huge loss for genuine investors.
Keeping in mind the drawbacks in the insider trading regulations, the Securities and Exchange Board of India (SEBI) has introduced the SEBI (Prohibition of Insider Trading) Regulations, 2015 which will make the insider trading laws more stringent by replacing the SEBI (Prohibition of Insider Trading) Regulations, 1992.
A Brief Analysis of the SEBI (Prohibition of Insider Trading) Regulations, 2015
As we know insider trading is a globalized phenomenon, it was a very good initiative taken by SEBI by introducing new regulations which can match the line of global business. The new regulations are more restrictive, appealing and promising to constrain the insider trading.
Every law should be dynamic in its nature, in order to maintain a constant pace with the changing needs of society. Similarly, laws related to a financial transaction must also need a constant change in order to fulfil the need of the present market dynamics. Based on this concept, we can clearly state that insider trading is also a crucial part of the business transaction, and we have seen that its laws were last notified in the year 1992 and have not changed since then. This lead to impediments in the smooth transactions of listed securities.
The SEBI (Prohibition of Insider Trading) Regulations, 2015 do not take into account the flow of price-sensitive information during the due diligence exercise of a company as part of any restructuring of the company. For instance, for the comfort of private equity investors, demand is made for all legal and financial documents of the company. It is unclear how the regulations would operate vis-a-vis the financial and legal advisors of the incoming investors, should price sensitive information be disclosed to them during due diligence.
This more often leads the unscrupulous investors getting a hand on the price sensitive information about the target company prior to buying stocks, which ultimately becomes a penalized offence of insider trading.
SEBI has introduced these new regulations, trying to make the due diligence a device to curb insider trading. The regulations provide that due diligence needs to be a prerequisite process to determine that whether target listed company is a good deal for the investor; it also states the lacuna and the risks involved in such transaction and helps to determine the stopping cost and acquiring price. However, uncertainty may arise that whether the company and the acquirer will be charged for violation of the law if the deal does not go through.
The new regulations propounded new dynamics of the capital market. For instance, it provides provisions for due diligence when a person wants to acquire a listed company which is subject to competent compliance and proper disclosure, it further defines the term trading and direct more structured disclosure regime.
Give it to that the acquirer becomes an “insider” under the New Insider Regulations. Unlike the earlier SEBI (Prohibition of Insider Trading) Regulations, 1992 when he gets the knowledge “unpublished price sensitive information” (“UPSI”) about the target listed company, which is not readily available to the public. Now, through due diligence sensitive information can be shared or communicated with the acquirer with relation to the business transaction.
The above clause is subject to certain restrictions; it specifically states that the person who has the knowledge of UPSI must sign a confidentiality and non-disclosure agreement. There can be no trade in securities, of the target listed company by the acquirer who has an insight knowledge of UPSI.
These provisions are covered in Regulation 3(3) and 3(4) of the New Insider Regulations. Regulation 3 (3) which permits communication, provision, allowing access to or procuring UPSI to the acquirer, covers only two situations for a transaction: one, when the transaction results in an “open offer” under the SEBI takeover regulations and second when the transaction does not result in an “open offer”.
When the resultant of a transaction is an “open offer”, the UPSI necessitates that the public shareholders of the target listed companies decide whether to retain their shares in the open offer or sell them. When the letter of offer is sent to these companies, this option is readily made available to them. In the event of the transaction not resulting in an open offer, the UPSI should be published two days prior to the actual acquisition by the acquirer.
Prior to the completion of transactions with the acquirer, in both the cases, the UPSI should be made available to the public, thereby bringing centralization of information in the market.
Due to this centralization of information in the market, no one has the other upper hand and the information reception is the same at everyone’s level. According to Regulation 3(3) only two situations are provided which result in acquisition although it is silent where there is no acquisition even after due diligence.
Therefore, we can clearly observe that SEBI has given liberty to the Company to determine the process and the manner of disclosing the UPSI prior to the proposed transaction.
This situation leads to the dilemma of the uncertain reaction of the market and it is also difficult to say the effect and the consequences of such public disclosure of UPSI prior to the proposed transaction, in such instances where an open offer obligation is not set off under the Takeover Code.
Now the question arises that in the case of an M&A transaction if the acquirer does not want to complete the deal, then what will be the status of the UPSI which has already been shared with the acquired? The answer to this is that the acquirer is not entitled to share such information about the target listed company unless it is made public. This was a very prominent step mentioned under the new regulations in order to constrain insider trading.
Further, it is stated under Regulation 3(1) of the New Insider Regulations provides that no insider will allow access to any UPSI relating to a company, or securities listed or proposed to be listed, to any person except under three circumstances: when the communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.
Although the New Insider Regulations is silent on the issue that what will happen if a due diligence of a terminated deal does not come under the purview if the three above mentioned exceptions. It is quite a possibility that it will be used for other legitimate or lawful purposes.
Apart from introducing some basic rules of insider trading, the new regulations have brought some impeccable and significant changes in the world of insider trading. For example, in addition to listed companies, the new regulations apply to companies that are proposed to be listed as mentioned under Regulation 3 of the New Insider Regulations.
The words ‘relating to a company or proposed to be listed’ prima facie seems unwarranted – as definition of UPSI covers information relating to the company or its securities. SEBI may have included these words to give a clear information that UPSI relating to securities need not to be restricted only to the listed companies.
However, the words” proposed to be listed” creates ambiguity as it puts the acquirer of the unlisted company in a jeopardize situation that if he has an insider of a “proposed to listed” company knows any insider information he cannot deal with the securities of such company. Well, this might lead to problems as it might cover the companies who have filed a DRHP (draft red herring prospectus) with SEBI.
The new regulation has increased the scope of the definition “connected person”, now it covers anyone who is in connection or is associated with the company or an organization, even by a conversation with an employee which gives a reason to believe that UPSI can be exchanged. It also includes deemed close relatives, members of the board of directors (which earlier was not treated as a connected person under Section 12A of SEBI Act, under 1992 regulations) and people connected with a decision (that is price-sensitive) as ‘connected persons’. Now includes holding company, subsidiary company and associate company. As regards mutual funds, under 1992 Regulations only employees having fiduciary relation with the company were treated as deemed to be connected. Now the condition of ‘fiduciary relation’ is dropped. Thus, all employees of mutual fund / asset management company are deemed to be connected, person”.[2] The regulations bar any form of communication of such information by the people as mentioned above.
The restrictions on communication by the new SEBI regulations can lead to prosecution even on innocent disclosure of information to any person who falls under the purview of the definition “connected person”. For instance, if a mother shares some information with her daughter, and she does nothing to misuse it, still both of them fall in the wrong side of the new law.
Apart from this, the new regulations also cover the public servants like high-ranking officers, who may not have personal or any professional relationship with the company, but who may be aware of a judgment or policy which, when made public, may impact the price of shares of the company.
Furthermore, the new regulations provide that the compliance officer of the company must supervise and monitor the employees and the connected person while they are trading. As we have observed that the scope of the definition has increased based on such demarcation, the compliance officer may find difficulty while delivering his obligation under this Rules.
The new regulations provide provisions for the formulation of trading plans. According to this provision, one can formulate a trading plan, get it approved by the compliance officer and trade in accordance with it subject to the conditions as specified in the rules, so that any insider information is not misused. “This provision intends to give an option to persons who may be perpetually in possession of unpublished price sensitive information and enabling them to trade in securities in a compliant manner. This provision would enable the formulation of a trading plan by an insider to enable him to plan for trades to be executed in future. By doing so, the possession of unpublished price sensitive information when a trade under a trading plan is actually executed would not prohibit the execution of such trades that he had pre-decided even before the unpublished price sensitive information came into being.” [3]
After the new regime has come into existence, many companies are facing difficulty while trading. “For instance, India Inc is still grappling with the strictures and stipulations. The biggest grey area has been the dos and do not’s on price-sensitive information.
The trading plan would be disclosed to the public, and a person cannot trade within six months of such public disclosure. Further, once approved, the person cannot back out or deviate from the plan.”[4]
As mentioned earlier, the new regulations not only restrain dealing in security but also communicating or procuring of insider information, except where this is in furtherance of, among other things, legitimate purposes.
The phrase “legitimate purposes”, too, has not been defined. Thus, it is very unclear as to what purposes are legitimate enough to allow insider information to be communicated or procured.
The new regulations also direct the companies to formulate codes for regulating, monitoring and reporting trading by employees or connected persons, and fair disclosure of material information, such as financial information, key business decisions, etc., by the company.
These rules are becoming very problematic and cumbersome for large companies, who have a large number of shareholders and employees. SEBI must take certain steps to solve such kind of problem, although that seems unlikely. However, there’s hope that the regulations are interpreted by courts and authorities in a progressive manner, and timely clarifications are issued by the capital market regulator.
The new regulations covered up the lacuna very effectively of the old Act. This can be clearly and briefly explained with the Satyam’s case study. One of the issues faced by the SEBI when dealing with the Satyam scandal was that SRSR Holdings Pvt. Ltd., a holding company, which owned almost all of the shares held by the promoter group of Satyam (SRSR Holdings held 8.27% of the total shareholding of Satyam while the total shareholding of the promoter / promoter group of Satyam was about 8.6%)[5], in which the Directors of the Company had information regarding the financial irregularities present in Satyam, still it went ahead and pledged such securities of Satyam to financial institutions for acquiring loan that amounts to Rs.1258 crore[6]. This Company took the defence that the pledge securities does not constitute the trading of securities as per the old regulation under the definition “dealing in securities”[7]. Based on this we can say that, one of the major change in the new 2015, regulation is that there has been the inclusion of pledge of securities and other activities which are not strictly restricted to buying, selling or subscribing, when in possession of UPSI under the definition of “trading” [8] in order to circumvent the prohibition on sale when in possession of inside information, as similar to Satyam’s case. However, such a move may curb the ability of promoter to bona fide secured credit for the company on an emergency basis. [9] Furthermore, if we consider the lender’s perspective, we can state that these new norms add transparency to the process. Now the share pledge route is clearer and these new trading regulations are in supposition with the RBI[10] guidelines on loans against shares issued on July 1, 2014. Thus, we can say that the silver lining of this is that the pledger or pledgee can use the defences available to them under Regulation 4 and demonstrate that the creation or invocation of the pledge was bona fide, unlike the view which was taken by the Whole Time Member of SEBI in the aforementioned case.
Conclusion
SEBI has remodelled the entire structure of the insider trading mechanism, which is seen to be a very deep-seated problem in India. The country can gloat of the dynamic capital market with its efficient and effective laws and an efficient Regulator. This new regulation has provided a shield to the investors to protect their interest while playing in the securities market. This action of SEBI will provide a much-needed filip and exposure to the players of Indian capital market and facilitate further economic expansion. But above all this, only one thing that is required to be observed is that all the actions of this newly introduced regulations are actually needed to be practiced and must possess a realistic approach rather than just a provision that is comprehended in any statute for the sake of it to be amended later on. From this, we can hope that these regulations may successfully bring new insight to the “insider trading” mechanism in the capital market of India.
[1] Section 24 of The Securities and Exchange Board of India Act, 1992.
[2]Pandya Prakash, “SEBI Insider Trading Regulations 2015 and 1992- Comparison” at http://pkpandya.com/sebi-insider-trading-regulations-2015-and-1992-comparison/(last visited on: February 28,2016).
[3]Pandya Prakash, “SEBI Insider Trading Regulations 2015 and 1992- Comparison” at http://pkpandya.com/sebi-insider-trading-regulations-2015-and-1992-comparison/(last visited on: February 28,2016).
[4]Prasad Ganesh and Khan Sanjay, “What SEBI’s new insider-trading rules mean and where they fall short” at http://www.livemint.com/Money/qMDHjPWNMJLza41fy8LWBO/What-Sebis-new-insidertrading-rules-mean-and-where-they-fa.html(last visited on: February 28,2016).
[5] Phrabhakar Shashank, “The Satyam Case: Insider Trading and Pledge” at (last visited on: February 28,2016).
http://indiacorplaw.blogspot.in/2015/09/the-satyam-case-insider-trading-and.html
[6] Phrabhakar Shashank, “The Satyam Case: Insider Trading and Pledge” at (last visited on: February 28,2016).
[7] Section 2(d) of the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992.
[8] Section 2(l) of Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015
[9] Phrabhakar Shashank, “The Satyam Case: Insider Trading and Pledge” at (last visited on: February 28,2016).
[10] Reserve Bank of India.
