This article is written by Nikunj Arora, student of Amity Law School, Noida, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.

Introduction

In 2015, Martha Stewart, a famous businesswoman and TV personality, sold her brand name for only a fraction of its original worth. Several analysts attributed that the devaluation to Stewart’s widely reported legal troubles concerning insider trading. In 2004, Martha Stewart was imprisoned for (05) months at Alderson in West Virginia for related charges. Martha Stewart allegedly obtained non-public knowledge that a particular stock investment was about to lose money, hence, she sold the stock early, i.e., before the announcement. This knowledge is known as “insider trading/insider information”. This particular information is only available to high-level executives or major shareholders in a company. It is illegal to use insider information to profit from potential stock exchanges as it disadvantages public stockholders and betrays the trust of investors, which is important for the health of the stock market. 

In India, the first step towards the regulation of insider trading was taken in 1948. A committee was constituted under the chairmanship of Mr P.J. Thomas. Section 307 and 308 were introduced under the Companies Act, 1956 through the recommendations of the Thomas Committee which changed the way for certain mandatory disclosures by the directors and managers but were not effective in preventing insider trading.

The Sachar Committee and the Patel Committee was instituted in 1978 and Abid Hussain Committee in 1989. Based on the recommendations made by these committees Securities and Exchange Board of India (“SEBI”) (Insider Trading) Regulations, 1992 was brought into force and amended in 2002 as loopholes were revealed in Hindustan Lever Ltd. v. SEBI and Rakesh Agarwal v. SEBI, thereby, renaming it as SEBI (Prohibition of Insider Trading) Regulations, 1992 (“1992 Regulations”). In 2015, SEBI brought SEBI (Prohibition of Insider Trading) Regulations, 2015 (“Insider Trading Regulations”). In 2018, SEBI constituted a committee under the chairmanship of Shri T.K. Viswanathan. On recommendations of the committee, SEBI made the latest amendment to Insider Trading Regulations in 2019. 

Basic concepts/key terms

Insider trading

The term ‘insider trading’ has not been defined either under the Insider Trading Regulations or 1992 Regulations. However, insider trading refers to trading/dealing in the securities of a certain company by any one person or class of persons who are the management of the company or connected persons based on knowledge of unpublished price sensitive information which is not generally available to the public. Such trading based on unpublished sensitive information is illegal. 

Insider

Under the Insider Trading Regulations, an insider means any person who is either a connected person or anyone having access to UPSI. It is clear that anyone who owns or have access to UPSI to be considered an ‘insider’ regardless of how such person came in possession of such information.

Connected person

Under the Insider Trading Regulation, connected person means:

• Any person who is associated with a company directly or indirectly or has been associated with the company during the six (06) months before the concerned act.
• Such person is associated with the company in any capacity including:

1. because of time-to-time communication with its officers; or
2. by involving in any contractual, fiduciary, employment relationship; or 
3. by being a director; or
4. by being an employee of the company; or
5. holds any relationship either professional or business, between himself and the company.

• The above-mentioned considerations allow such person, directly or indirectly, access to unpublished price sensitive information. 

Reg. 2(1)(d)(ii) of the Insider Trading Regulation provides the categories of persons which shall be considered to be deemed connected persons.

Unpublished price sensitive information

The Insider Trading Regulation states that the unpublished price sensitive information (“UPSI“) means any information, directly or indirectly related to the company or its securities that is not generally available to the public, and which upon becoming generally available to the public, is likely to materially affect the price of the securities. Such information shall include the information relating to the following: 

1. Financial results of the company;
2. Dividends of the company;
3. Change in capital structure of the company;
4. Any mergers, demergers, acquisitions, delistings, disposals and expansion of the business;
5. Any change in key managerial personnel; 
6. Any material events under the listing agreement. 

Prohibitions & exceptions on insider trading

In India, the other related provisions other than the Insider Trading Regulations which govern insider trading are Section 195 of the Companies Act, 2013, read with Section 12A and 15G of the SEBI Act, 1992 (“Act”). 

Section 195 of the Companies Act, 2013 provides that no person, which includes any director or key managerial personnel of a company, shall enter into insider trading. This section also defines the terms ‘insider trading’ and ‘price-sensitive information’.

According to Section 12A(d) of the Act, no person shall engage in insider trading, either directly or indirectly. On the other hand Section, 15G of the Act imposes a penalty for insider trading which is not less than ten lakh rupees (Rs 10,00,000) but which may extend to twenty-five crore rupees (Rs 25,00,00,000) or 3 times the amount of profits which are made out of insider trading, whichever is higher. 

The restrictions/prohibitions

The Insider Trading Regulations provides the following restrictions on any communication or procurement of UPSI and trading:

1. The Regulations restricts/prohibits an insider to communicate, provide or allow access to any UPSI which is related to a company or securities listed, to any person including other insiders.
2. The Regulations restricts/prohibits a person to procure any UPSI from an insider, which is related to a company or securities listed, to any person including other insiders.
3. The Regulations restricts/prohibits an insider, when in possession of UPSI, to trade in securities that are listed or proposed to be listed on a recognized stock exchange. 

The exceptions

• The UPSI communicated or procured under Regulation 3(1) and 3(2) respectively, shall be communicated or procured only for the lawful purposes or for performance of duties or for discharge of legal obligations.
• A UPSI may only be communicated or procured under the following circumstances: 

1. If such UPSI requires an obligation to make an open offer under the Takeover Code, where the board of directors believes that the proposed transaction is or will be in the best interest of the company. 
2. If such UPSI does not require or attract the obligation to make an open offer under the Takeover Code but where the board of directors believes that the proposed transaction is or will be in the best interest of the company and the information constituting UPSI is made generally available to the public at least two (02) trading days before the proposed transaction is being effected as per the board of directors. 

• Exceptions related to Reg. 4(1) of the Insider Trading Regulations:

1. The transaction is an off-market transfer between or among the promoters who were in the possession of the same UPSI and both the parties had made an informed trade decision. Since the parties have the same UPSI, there would be no unlawful gains.
2. In the cases involving non-individual insiders: 

1. The individuals who are in possession of such UPSI, were different from the individuals taking trading decision or decisions who did not own such UPSI when they decided to trade; and 
2. Appropriate arrangement or arrangements were taken place to ensure that there is no violation of these regulations and no UPSI was communicated to the individuals taking trading decision or decisions by the individuals owning the information and there is no evidence showing breach of such arrangements. 

Disclosures of trading by insiders

Initial disclosures

Continual disclosures

Disclosures by connected persons 

To monitor compliance with these regulations, any listed company may, at its discretion, require any other connected person or connected persons to make disclosures of holdings and trading in securities of the company in such form and frequency as determined by the company. 

For example, a listed company may ask a management consultant who would advise the company on corporate strategy and need to review UPSI to make disclosures of his trades to such company. 

Fair disclosure & conduct

Code of fair disclosure

1. The Insider Trading Regulations states that the board of directors of every listed company shall formulate a code of practices and procedures for fair disclosure of UPSI and publish it on its official website. Such disclosures shall adhere to the principles as provided under the Insider Trading Regulations.
2. Every such code of practices and procedures for fair disclosure as mentioned above of UPSI shall be intimated to the stock exchanges where the securities are listed. This provision was added by SEBI for transparent disclosure of the policy formulated under Regulation 8(1) of the Insider Trading Regulations. 

Code of conduct

1. The Insider Trading Regulations requires the board of directors of every listed company and market intermediary to formulate a code of conduct to regulate and report trading by its employees and other connected persons to comply with these regulations. Such board of director shall adopt the minimum standards as stated out in the Insider Trading Regulations.
2. The Regulation requires every other person who is required to handle UPSI to formulate a code of conduct to regulate and report trading by employees and other connected persons towards achieving compliance with these regulations. Such a person shall also adopt the above-mentioned principles.
3. The Regulation requires every listed company, market intermediary and other persons formulating a code of conduct to identify and designate a compliance officer.

Some examples of the companies implementing the above-stated codes:

1. JAYPEE INFRATECH LTD. (see here)
2. BIRLASOFT LTD. (see here)
3. POWER FINANCE CORPORATION LTD. (see here)
4. SHOPPERS STOP (see here)
5. BEML LTD. (see here)

Conclusion

The Insider Trading Regulations have substituted the 1992 Regulations and tried to address the problem of insider trading fully. SEBI has significantly amended the regulations and the framework related to insider trading in India and has widened the scope and definition of an ‘insider’ and ‘connected person. The Insider Trading Regulations seems to be better, more practical than the 1992 Regulations and is in line with the worldwide approach to inside trading. Through its better compliance and enforcement, the Insider Trading Regulations ensures more protection to the investors in the securities market. In the matter of M/S. Sigrum Holdings Ltd., under section 15-I of the SEBI Act, 1992, read with Rule 5 of SEBI (Procedure for holding an inquiry and imposing penalties by adjudicating officer) Rules, 1995, SEBI imposed a penalty of six crores and eighteen lakh rupees (Rs 6,18,00,000) on the Managing Director of the company for violating insider trading regulations. SEBI has adopted a ‘zero-tolerance approach’ for the cases involving insider trading based on UPSI. 

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