This article has been written by Mohit Kar, a student of the third year studying in Maharastra National Law University, Aurangabad.
The Securities and Exchange Board of India (“SEBI”) vide a discussion paper floated on June 10, 2019 has made a detailed mention about informant mechanism related to regulation of insider trading in order to curb several challenges faced by the securities regulator. If you know someone making a quick buck out of trading in shares based on insider information, and you are willing to report it to the regulator, there may be a reward for you. The mechanism that the capital regulator SEBI plans to introduce will provide “near absolute confidentiality along with appropriate safeguards”. The safeguard clauses would help bolster the mechanism for early detection of fraud and manipulation in insider trading cases.
What is Insider Trading?
Insider trading is an activity that is done on the basis of unpublished price sensitive information (“UPSI”). UPSI refers to certain internal strategies that are implemented by a company and not revealed to the general public at large. Insider trading is outlawed since it allows persons with access to material non-public information to gain large amounts of profit. In, N. Narayanan v. Adjudicating Officer, SEBI, it was held that Insider trading curbs the market growth. Even if the quantum of the dealings is relatively less, it affects the overall integrity of the market.
India recognised the flaws of insider trading quite early. Hence, right from the year of 1947 with the formation of the Thomas Committee, India had made its first integrated effort to regulate it. The committee gave its recommendations in the year 1948, on the basis of which provisions related to regulating Insider trading were added to the Companies Act, 1957. These changes were not very effective in achieving the objective of preventing insider trading. Thus, on the basis of the recommendation by the Abid Hussain Committee, SEBI promulgated comprehensive legislation of the prohibition of Insider trading, Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992. The Regulations were subsequently amended and gave way to SEBI (Prohibition of Insider Trading) Regulations in 2002. In 2015, SEBI put in place a new framework for prohibition of insider trading based on the report of an expert committee which has been amended since. Currently, the SEBI (Prohibition of Insider Trading) Regulations, 2015 (the 2015 Regulations) are applicable.
The most recent case of violation of the PIT Regulations is the NSEL scam. As a result of the investigation of the NSEL scam, multiple people were found guilty of the violation of the PIT Regulations. One such person against whole the SEBI ruled against was the then MCX’s director Hariharan Vaidyalingam, who was found guilty of insider trading under the PIT Regulations. In the adjudication Order passed by SEBI against Hariharan Vaidyalingam, it was held that:
“…hereby impose a monetary penalty of Rs. 1,25,00,000/-(Rupees One Crore Twenty Five Lakh Only) on the Notice, Shri Hariharan Vaidyalingam (PAN: AABPV4103E) under section 15G of SEBI Act, 1992 for the violation of the provisions of Regulation 3(i) of the SEBI (PIT) Regulations, 1992 read with Regulations 12(2) of the SEBI (PIT) Regulations, 2015 which will be commensurate with the violations committed by the Notice.”
Similarly, in the matter of Financial Technologies India Ltd. (“FTIL”), SEBI ruled against Naishadh P. Desai, the then Senior Vice President & Company Secretary of FTIL, as he was found guilty of trading in securities of FTIL without taking pre-clearance of trades, therefore violating PIT Regulations as well as the Model Code of Conduct for Prevention of Insider Trading for Listed Companies. In the adjudication order passed by SEBI against Naishadh P. Desai, it was held that:
“…hereby impose a monetary penalty of Rs. 12,00,000/-(Rupees Twelve Lakh Only) on the Noticee i.e. Mr. Naishadh P. Desai under section 15HB of the SEBI Act, 1992 for the violation of the provisions of Clause 3.3.1 of Model Code of Conduct for Prevention of Insider Trading for Listed Companies specified under Schedule I of Part A read with Regulations 12(1) of SEBI (PIT) Regulations, 1992 and Regulation 12 of SEBI (PIT) Regulations, 2015.”
The Whistleblower Mechanism
According to the paper, any informant willing to disgorge details of insider trading will be eligible for monetary considerations subject to SEBI’s pre-conditions. If the sum is at least 5 crores, then the informant would be entitled for monetary considerations. The monetary reward will amount to 10% of collected sum, but it will not exceed Rs.One (1) crore. There is also a provision for interim reward not exceeding 10 lakhs. The final reward will be made after the recovery of the sum and it will be disbursed from the Investor Protection and Education Fund (“IPEF”). The interim sum paid will be adjusted during the final reward.
The proposed mechanism will be laid down by amending the SEBI (Prohibition of Insider Trading) Regulations, 2015. Some of the salient features of the paper are as follows:
- Voluntary Information Disclosure Form (“VIDF”): SEBI will make it mandatory for the informant to fill a Voluntary Information Disclosure Form. The VIDF will comprise among other things the credible, complete and original information related to insider trading including those pertaining to UPSI. The informant would be required to reveal the identity. The informant is however provided the option to maintain anonymity and secrecy.
- Disclosure of Source of Information: The informant will have to reveal the source of original information. He will be required to provide an undertaking that the information is not sourced from SEBI insider.
- Office of Informant Protection (“OIP”): The establishment of Office of Informant Protection has also been proposed by SEBI. The OIP would function as a mechanism relating to receipt and registration of VIDF. It will also settle upon the issue of grant of reward to the informant upon completion of enforcement action and other related matters. As per SEBI’s proposed move, the OIP would act as a medium of exchange between the informant/ legal representative and the board. A hotline guiding and encouraging persons to file information shall be maintained.
- Confidentiality of Informant: The informant will be provided the option to maintain anonymity and secrecy. The informant will nonetheless have to furnish VIDF through a representative who should be a practising advocate.
- Protection of Informant: As there is apprehension of complainants being victimized, the capital regulator has proposed that all listed companies and intermediaries would include in their code of conduct, provisions to ensure that such individuals are not “discharged, terminated, demoted, suspended, threatened, harassed, or discriminated against, directly or indirectly.”
- Maintenance of Hotline: OIP has been directed to maintain a hotline to act as a guide to persons to file information as per regulations but not to register any complaint or information. This hotline would make things simpler for a person willing to disgorge the necessary details.
- Exemption under the RTI: Section 8(1)(g) and Section 8(1)(h) of the Right to Information Act has maintained an exemption from disclosure of information for the purposes of law enforcement. The same principles would be applicable to the current policy.
Potential downsides of the mechanism
- The proposal has provided for both an interim reward and a final reward. But these rewards will only be disbursed once SEBI passes a final order against the person directed to disgorge the money. This implies that the grant of reward will only occur if there is successful enforcement of action, which will result in only a small number of whistleblowers receiving the reward.
- The financial incentives being provided might create a nuisance in itself; it could lead to expedient and uninformed parties to pass on rumours which might result in innocent parties getting their reputation hampered.
- The discussion paper has kept a threshold limit of 5 crore rupees for cases to come under its purview. This will lead to the exclusion of many of the smaller transactions from getting the necessary actions.
- SEBI has made a mention about the regulatory action against frivolous and vexatious complaints. On a normal parlance, Insider trading cases are very difficult to prove, even the complainant himself fails to produce credible evidence. So there is a need of setting up of a proper metes and bounds as to what constitutes a frivolous complaint.
- In its outset, the paper has laid a provision for the formation of an additional wing of SEBI for investigation of such complaints. Such a process would be not only be time taking but also cost additional resources.
While Insider trading losses are worth crores of rupees annually, the need to invest in whistle blowing has never been so obvious.
When implemented and applied correctly, whistle blowing mechanisms can be an effective component of an anti-fraud program. They prevent and deter such fraudulent activity and detect it on the spot. Unfortunately, these mechanisms are often misused. In some cases, they are set up, but then poorly communicated and, therefore, quickly forgotten. In others, employees simply do not use it because they do not trust management or the process, or for fear of reprisal or being sidelined. SEBI with the circulation of this paper and the proposed amendment to the 2015 regulations has made it clear about its intent to put a stop to the leakage of UPSI. This could lead to greater awareness amongst concerned individuals and garner benefits to regulators, but simultaneously it might bestrew SEBI’s attention with a large number of frivolous/vexatious complaints.