This article is written by Sharanya Ramakrishnan who is pursuing a Certificate Course in Capital Markets, Securities Laws, Insider Trading and SEBI Litigation from LawSikho.

Introduction 

In order to achieve significant economic growth of our country, it is of utmost importance to have a fair, just and well-organised Securities Market. Ensuring ‘fair market conduct’ is a crucial responsibility of our Indian market regulator, namely the ‘Securities and Exchange Board of India’ (SEBI). It therefore becomes necessary to prohibit, prevent, detect, and penalize activities such as market manipulation and insider trading.

Background

SEBI formulated the Prohibition of Insider Trading Regulations, 1992, to handle market abuse relating to “insider trading”. These regulations were amended in the year 2002 to straighten certain discrepancies observed therein and strengthen it further. Subsequently, an immense need was felt to address the challenges faced in closure of cases relating to insider trading and to bring about a clear, comprehensive and definitive regulatory policy.

This resulted in the constitution of a Committee chaired by former Chief Justice Mr. N.K. Sodhi, which made a range of recommendations to formulate an effective legal framework to prohibit insider trading. Based on the recommendations made by the Sodhi Committee, SEBI (Prohibition of Insider Trading) Regulations, 2015 (hereinafter referred to as “PIT Regulations, 2015”) came into force on 15th May, 2015.

SEBI established a Committee on Fair Market Conduct, chaired by Dr. T K Viswanathan, Ex-Secretary General, Lok Sabha and Ex-Law Secretary (“the Viswanathan Committee”). The Committee made a slew of recommendations to prevent market abuse and strengthen the surveillance and enforcement mechanisms undertaken by SEBI to protect the interest of investors. The Committee submitted its report to SEBI on 8th August, 2018, containing all its recommendations. Thereafter, SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2018 were notified by SEBI on 31st December, 2018 which came into effect on 1st April, 2019.

In addition, SEBI also introduced multiple amendments in 2019 dealing with the concepts of legitimate purpose, compliances to be followed by listed companies and new defences to insider trading. 

Timeline of Amendments in PIT Regulations, 2015

Amendments	Effective from
SEBI (PIT) (Amendment) Regulations, 2019	21st January, 2019
SEBI (PIT) (Second Amendment) Regulations, 2019	25th July, 2019
SEBI (PIT) (Third Amendment) Regulations, 2019	26th December, 2019
SEBI (PIT) (Amendment) Regulations, 2020	17th July, 2020

Brief overview of the major amendments in the PIT Regulations, 2015

SEBI (PIT) (Amendment) Regulations, 2018

• Determining and stipulating the legitimate purposes for sharing Unpublished Price Sensitive Information (hereinafter referred to as UPSI) in the Code of Fair Disclosures of the Company and measures for tracking the flow of information.
• Formation of a database of persons to whom price sensitive information is shared.
• Certain additional defences when trading is permitted while in possession of UPSI.
• Doing away with the requirement of pre-clearance and removal of prohibition of trading post-closure of trading window for trades in compliance with the trading plan.
• Setting up a broad framework for institutional mechanism to enable entities to frame a Code of Conduct and create an efficient system of internal controls to guarantee compliance with various provisions in the Regulations.
• Creating a whistle-blower policy to generate awareness amongst employees and enable them to report occasions of leak of UPSI.
• Formulating a distinct Code of Conduct for listed entities and intermediaries.

SEBI (PIT) (Amendment) Regulations, 2019

Initial and continual disclosures to be made by persons falling under “Members of the promoter group” within the meaning of Regulation 2(1) (pp) of Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.

SEBI (PIT) (Second Amendment) Regulations, 2019 

• Compulsory closure of trading window from close of the quarter till 48 hours after announcement of financial results.
• Permitting certain additional transactions by Designated Persons on closure of trading window such as pledge of shares for bona fide purpose, acquisition due to conversions of warrants, subscribing to rights issue, etc.

SEBI (PIT) (Third Amendment) Regulations, 2019 

• Introducing the concept of “Informants”.
• Submission of Voluntary Information Disclosure Form to office of Informant Protection.
• Provision with respect to “Informant Reward”.

SEBI (PIT) (Amendment) Regulations, 2020

• Maintenance of a structured digital database containing details of persons handling UPSI.
• Provisions regarding violation of Code of Conduct and insider trading norms.

Understanding what constitutes a legitimate purpose

Regulation 3 of SEBI (PIT) Regulations, 2015 restricts communication or procurement of UPSI and at the same time also provides certain exceptions to the same. As per Regulation 3, “any person shall not:

– communicate, provide, or allow access to any UPSI; or

 – procure from; or

 – cause the communication by any insider of UPSI;

relating to a company or securities listed or proposed to be listed; except in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.”

To effectively understand the term “legitimate purpose” and to deal with the possible ambiguities and misuse in sharing UPSI under the guise of legitimate purpose, the following amendments were introduced by SEBI in the PIT Regulations, 2015:

Regulation 3(2A)

If the term “legitimate purpose” is left undefined, it can be left open for several interpretations.  The Viswanathan Committee took note of the fact that legality of any transaction under which UPSI is communicated/procured is principally subjective in nature and can only be determined after consideration of facts and circumstances under which it was dealt with. The Committee was also of the view that it might be difficult to explicitly define such a term. In order to mitigate the difficulties arising therein, the PIT Regulations, 2015 were amended to include Regulation 3(2A) which provides as under:

“The board of directors of a listed company shall make a policy for determination of “legitimate purposes” as a part of “Codes of Fair Disclosure and Conduct” formulated under the Regulation 8. 

Explanation – For the purpose of illustration, the term “legitimate purpose” shall include sharing of UPSI in the ordinary course of business by an insider with partners, collaborators, lenders, customers, suppliers, merchant bankers, legal advisors, auditors, insolvency professionals or other advisors or consultants, provided that such sharing has not been carried out to evade or circumvent the prohibitions of these regulations.”

By inserting this Regulation, sufficient freedom has been given to the board of directors of a listed company to create their own policy relating to “legitimate purposes” so long as it does not violate the provisions of these Regulations.

Following are certain illustrative cases where sharing of UPSI can be considered as ‘legitimate purpose” in the aforesaid policy:

1. Call for information made by government or statutory authorities such as Ministry of Corporate Affairs, SEBI, etc.
2. Pursuant to an order of courts or tribunals or under any proceedings.
3. Pursuant to any contractual obligations of the company such as due diligence for mergers, acquisitions, share purchase agreements, joint venture agreements, etc.
4. In cases where sharing of information is deemed to be a business requirement including cases where it is needed for endorsing the business.
5. In case of holding companies and subsidiaries, where either or both of them are listed, communicating/procuring information in the ordinary course of business by reason of consolidation of accounts.

Regulation 3(2B)

As soon as UPSI is shared for legitimate purposes, the company has no control over the manner it can be put into use by the persons who come into possession of such information. Any misuse of such information for insider trading can make it extremely problematic to determine a connection between the company and the persons in possession. To avoid such difficulties, it would be judicious for the company to enter into a confidentiality agreement with the recipients of UPSI. Regulation 3(2B) was therefore inserted by SEBI (PIT) (Amendment) Regulations, 2018 which provides as under:

“Any person in receipt of unpublished price sensitive information pursuant to a “legitimate purpose” shall be considered an “insider” for purposes of these regulations and due notice shall be given to such persons to maintain confidentiality of such UPSI in compliance with these regulations.”

Intimation to the recipients of UPSI of their responsibilities towards avoiding misuse of such information by way of serving an advance notice and entering into confidentiality agreements is a step towards addressing the problems in connection with sharing of UPSI.

When communication or procurement of UPSI is permitted

Regulation 3(3) of the SEBI (PIT) Regulations, 2015 provides for certain exceptions where communication/procurement of UPSI is allowed in transactions where:

(a) an open offer is triggered.

(b) an open offer is not triggered.

Where an open offer is triggered

As per Regulation 3(3),

“Notwithstanding anything contained in this regulation, an unpublished price sensitive information may be communicated, provided, allowed access to or procured, in connection with a transaction that would:

(i) entail an obligation to make an open offer under the takeover regulations where the board of directors of the listed company is of informed opinion that sharing of such information is in the best interests of the company;”

The above provision was inserted to stipulate that, in cases involving mergers/takeovers where change of control and trading in securities takes place, it would become necessary to communicate/procure UPSI to analyse a potential investment. However, it is pertinent to note that sharing of UPSI shall be done only if the board of directors of the target listed company is of the informed opinion that such a transaction is in the best interests of the company.

Where an open offer is not triggered

As per Regulation 3(3),

“Notwithstanding anything contained in this regulation, an unpublished price sensitive information may be communicated, provided, allowed access to or procured, in connection with a transaction that would: 

(ii) not attract the obligation to make an open offer under the takeover regulations but where the board of directors of the listed company is of informed opinion that sharing of such information is in the best interests of the company and the information that constitute unpublished price sensitive information is disseminated to be made generally available at least two trading days prior to the proposed transaction being effected in such form as the board of directors may determine to be adequate and fair to cover all relevant and material facts.”

In the second case, even though the transaction does not entail an obligation to make an open offer under the takeover regulations, but the board of directors consider sharing of UPSI to be in the company’s best interest, such communication/procurement is permitted. However, the board of directors should mandatorily ensure that such UPSI is publicly disclosed prior to the aforesaid transaction to enable uniform dissemination of UPSI.

Regulation 3(4) of the SEBI (PIT) Regulations,2015 provides that to utilise the exemptions enumerated under sub-regulation (3) above, the board of directors shall entail the parties to implement agreements to ensure confidentiality and non-disclosure obligations on the part of such parties and such parties shall maintain confidentiality of the information received, except for the purpose of sub-regulation (3), and shall not otherwise trade in securities of the company when in possession of UPSI.

When trading while in possession of UPSI is permitted

As per Regulation 4 of SEBI (PIT) Regulations, 2015, trading while in possession of UPSI is prohibited. However, there are certain exceptions where trading in securities while in possession of UPSI is permitted. Such trading is permitted in circumstances stated below:

• Transactions being off-market inter-se transfers amid insiders having possession of the same UPSI, provided that:

1. Regulation 3 is not violated.
2. The parties made a conscious and well-versed decision to trade.
3. Such transactions are to be reported by the insiders to the company within 2 working days and the company will in turn inform the concerned stock exchange within 2 working days.

Transactions taking place between persons in possession of UPSI through the block deal window mechanism.

• Transactions carried out on the basis of a statutory or regulatory requirement.
• Transactions undertaken on the exercise of stock options only in cases where the exercise price is determined beforehand.
• Trades carried out in accordance with a trading plan.
• In cases where insiders are non-individuals:

1. individuals carrying out trades are dissimilar to the ones in possession of UPSI and such individuals made trading decisions without having knowledge of UPSI.
2. suitable arrangements are made to confirm that PIT regulations are not breached and there is no communication of UPSI between individuals possessing UPSI and individuals carrying out trades and there is no evidence of such arrangements having been breached.

Certain important judgements dealing with handling of UPSI

Circumstances provided in proviso to Regulation 4(1) of SEBI (PIT) Regulations, 2015 are merely illustrative.

SEBI in the matter of Dynamatic technologies Ltd held that, “Even assuming that the Noticee was in possession of the UPSI, proviso to Regulation 4(1) provides that an insider may prove his innocence by demonstrating the circumstances “including” those mentioned in the said proviso. Therefore, circumstances enumerated in the proviso to Regulation 4(1) to prove innocence, are merely illustrative and not exhaustive and an insider can demonstrate circumstances other than those mentioned in the said proviso, to prove his innocence.”

Consequently, the aforesaid circumstances are only an illustrative list and several other situations can be established by an insider to prove his innocence.

Innocent recipient of UPSI and cannot be said to have committed violative insider trading

The legislative note to Regulation 4 states that, when an insider trades while in possession of UPSI, he is alleged to have been motivated by the knowledge and awareness of UPSI. Nevertheless, the insider has an opportunity to prove his innocence.

SEBI disposed of insider trading charges against Kotak Mahindra Life Insurance Company (Kotak) in the matter of selective disclosure of unpublished price sensitive information by Manappuram Finance Ltd (MFL). In the present case, Kotak received a research report by Ambit Capital Private Ltd (Ambit) which provided their analysis of MFL after analysts of Ambit had a meeting with the management of MFL. The title of the report “takeaway from meeting with management”. The recommendations of MFL’s stock in the Research Report was “Under Review” from its earlier recommendation of “Buy”. Kotak sold shares of MFL subsequent to the receipt of the research report.

Kotak contented that it is an innocent recipient of UPSI and cannot be said to have committed violative insider trading, since the UPSI that it came to possess, did not motivate the decision to trade. It also stated that it is not correct to allege that the recipient of the Research Report could reasonably be said to have been aware that it contained UPSI, merely because the report referred to the meeting with the management of MFL.

The Adjudicating Officer of SEBI accepting the contentions of Kotak held that, “Meeting between analysts and management of listed companies is not unusual practice in the industry before preparation of research reports. It is primarily a company’s management duty to not divulge any unpublished price sensitive information during such meetings and legal obligation on research analyst not to publish research reports based on any unpublished price sensitive information. In this connection, I am inclined to accept submissions of Noticee pleading that, it did not occur to them to suspect the research report as containing UPSI.”

On-market trades, admittedly between two or more promoters of a listed company, having equal symmetry of access to information does not constitute violation of insider trading regulations

In the matter of Emami Limited, the main contention of the petitioners was that since the list of defences set out in the proviso to Regulation 4(1) of the PIT Regulations is illustrative, the impugned trades between promoters were such that none of them received any undue advantage or suffered losses as there was no asymmetry of availability of information among concerned parties and therefore is not violative of Regulation 4(1) of the PIT Regulations.

SEBI accepting the contention stated “that it is fairly agreeable that the list of defenses envisaged under regulation 4(1) of PIT Regulations, 2015 is not exhaustive and the Notices cannot be precluded from bringing on any other defenses that are not listed under regulation 4(1). Although the transfers have been effected on market, it is pertinent to note that it is not the allegation that there was any asymmetry of availability of information among the Notices. Therefore, I am of the view that, in the facts and circumstances, the Notices had made a conscious and informed trade decision as the same was pre-arranged. Therefore, the Notices have not violated the provisions of regulation 4(1) of PIT 2015 read with Section 12A(d) of the SEBI Act, 1992”.

Conclusion

The Amendments to insider trading regulations have brought clarity to several ambiguous concepts in the PIT regulations, 2015. As a result of these amendments, an effective system encouraging a transparent and regulated framework dealing with sharing and handling UPSI has been created. The adequacy of defences against insider trading and whether any legitimate and genuine transactions were getting enclosed within the guise of insider trading have been deliberated in great detail in light of these amendments.

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