This article is written by Madhav Gawri, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
Table of Contents
Introduction
When there is a sudden change or a continuous trading pattern of a particular security on the Stock market, then there is always a specific reason for the same. The reason sometimes can be the effect of insider trading. It means trading based on the particular information that is not public but would affect the concerned security market price. The data is sensitive and should remain hidden, or else it would result in an appreciable adverse effect to the trader who is in possession of that information. Therefore, to protect investor interest and investment SEBI has declared insider trading as illegal. Moreover, sensitive information about a proposed merger or an acquisition or a takeover surely causes an appreciable effect for the person who uses the information to trade in the market. In a transaction about M&A, the process of due diligence is very important. In this transaction, the acquirer is preferable because he has sensitive information that other investors don’t. The process of share-acquisition or asset purchase is value-enhancing in nature. Therefore information pertaining to M&A transactions should be kept at bay to protect the investor and as well as to strike a balance to facilitate the due diligence process of M&A.
Insider trading regulations pertaining to M&A
SEBI (Securities Exchange Board of India) regulates, manages, and facilitates India’s secondary securities market. Moreover, it has been bestowed upon to make the requisite regulations to manage and control insider trading’s offence. Regulation 3 of the SEBI (Prohibition of Insider Trading) Regulation, 2015 provides that communication of unpublished price sensitive information (UPSI) is an offence. But during the process of due diligence in an M&A transaction, there are certain pieces of information that needs to be communicated to certain interested parties. Therefore, to maintain parity between those specific parties and other investors, regulation 3(3)[1] permits the company to communicate or its agents in the process of due diligence in a merger and acquisition transaction. Sub-clauses (i) and (ii) respectively permit such communication for acquisitions which reach the thresholds mandating the making of an open offer under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 and those not which do not cross such thresholds.
This exception allows the acquirer to gain access to the requisite information about the target company. But this exception invites numerous implications in an M&A deal. According to the condition, UPSI being shared should be legitimate and in the company’s best interest.
Moreover, regulation[2] requires the ‘opinion of the board.’ This implies that in an M&A deal whereby UPSI is being shared during due diligence (and not during reverse due-diligence), only the board of the target company is legally required to opine that the proposed transaction is in their company’s best interests. The acquirer company’s board need not so opine for the exception to apply.
Uncertainty regarding the phrase ‘legitimate purposes’
UPSI’s communication in the ordinary course of business would not lead to any legal liability if the communication were made in the ordinary course of business, profession, or employment or under any law. But the rule has been changed. Communication of UPSI must be made for ‘legitimate purposes.’ The phrase has not been given a straight and simple meaning to it, but a rather complication to understand the intended. It is unclear whether communication made regarding a pre-existing legal obligation or the phrase or also covers communication made in some personal legitimate situation, like in the situation of a husband and wife sharing information amongst themselves and the law has to respect the virtue of communication between a husband and wife under the Indian Evidence Act, 1872.
Uncertainty of the phrase ‘proposed to be listed’
A person is prohibited from trading based on the UPSI of a listed company and a proposed to be listed company.[3] The phrase proposed to be listed is not defined under the regulation. Therefore, it creates a huge uncertainty as to the recognition of a company proposed to be listed. The difference can create while defining and comparing the terms ‘proposed’ and ‘intended’ to be listed. The former indicates a more concrete step that already has been taken and the company is in the process of being listed. The requisite documents have already been filed with government authority. On the other hand, the latter indicates the mere intention to get the company listed in the future. No, concrete steps have been taken yet before any concerned authority.
This ambiguity plays a larger role in an M&A deal. Generally, in a reverse takeover, the intention is to get the acquiring company listed. Thus, in an M&A deal where no company is listed at that time, but one intends to get listed, then it can lead to very serious market manipulation in the securities market.
Steps to be taken to disregard insider trading during M&A
The company and the concerned authorities itself can take some steps to disregard the concept of insider trading during the transaction during M&A. These steps are:
- ensure that directors and officers are made aware that they may be prohibited from trading in securities of the issuer during very early-stage M&A activity and well before the issuer may be required to disclose a potential M&A transaction;
- when faced with unsolicited expressions of interest or when planning for an expected M&A transaction, an issuer should make a point to consider at each stage of the process whether the facts and circumstances of the particular potential transaction amount to a “material fact” that warrants a trading blackout being imposed on insiders or other employees;
- in determining whether potential M&A constitutes a “material fact” at an early stage as opposed to a later stage when a transaction is more specific, an issuer should consider all circumstances relevant at an early stage, including the nature of the counterparty and the likelihood that they have a serious interest in a transaction and the issuer’s suitability for, and interest level in, a potential M&A transaction; and
- implement procedures to restrict knowledge of early-stage or unsolicited M&A activity to a core team of selected management, directors and advisors as a way to control information while materiality is being assessed and avoid potential inadvertent trading offences.
Conclusion
Insider trading always has some serious implications on the securities exchange market. Moreover, SEBI’s actions are intended to protect and safeguard investors and other interest parties’ interest. But the regulations made and formulated about insider trading and the implication of insider trading on mergers and acquisitions transitions lack proper guidance and clarity. The way the regulations are formulated, it creates ambiguity and confusion rather than clarity and guidance. These ambiguities under the SEBI (Prohibition of Insider Trading) Regulation, 2015 can have an adverse impact on the sharing of unpublished price sensitive information during a merger and acquisitions transaction and between the mergers and acquisition deals in itself. Merger and acquisition deals are generally value-enhancing in nature; therefore, the sensitive information should always be protected so as to maintain parity in the market. Moreover, mergers and acquisition transactions provide a very gaining base for insider traders, and it always coincides with their interest in insider trade. But the regulation clarifications and making the restriction, guidelines, and law clearer are very important. The insider trading regulations have a long to go and develop properly so that it has a positive impact on the market.
References
[1] SEBI (Prohibition of Insider Trading) Regulation, 2015
[2] Regulation 3(3), SEBI (Prohibition of Insider Trading) Regulation, 2015
[3] Regulation 3 & 4, SEBI (Prohibition of Insider Trading) Regulation, 2015
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