The Securities and Exchange Board of India (Sebi) has added yet another unique feature of its understanding of insider trading. An informal guidance letter issued to a listed commercial bank will put the Indian regulator in a unique unparalleled position in the world - of holding a view that violative insider trading can take place even when the person trading has no access to inside information.
According to the informal guidance, trades by a discretionary portfolio manager who independently trades at her own discretion on behalf of her clients who have authorised her to trade without any reference to the clients would constitute insider trading by the clients, where the clients are insiders to issuers of securities. In other words, if an insider to a listed company were to appoint a portfolio manager to invest her savings at the portfolio manager's sole discretion, every trade by the portfolio manager made without any reference to the insider would still be assumed to be motivated by the insider's access to unpublished price sensitive information.
An informal guidance letter issued by the regulator is not law - it is only an indication of the regulator's view of the law. And that is what makes the position even more troublesome - it is a publicly stated view of the law enforcer that is evidently contrary to the principle of law.
The aim of any law interdicting insider trading is to prevent the abuse of access that an insider would have to unpublished price-sensitive information, to which the rest of the market has no access. The point in prohibiting violative insider trading is to prevent abuse of such asymmetrical access. When an insider puts her money away to a "discretionary" portfolio manager (where the discretion of the portfolio manager alone would be at play and not the discretion of the client who is an insider), she essentially cuts off the nexus between the decision-making mind that leads to the trade from her own state of mind. In short, it is the state of mind of the person who trades that should be looked at to see if there has been an abuse of access to the inside information. However, in the informal guidance, Sebi has taken the position that the title to the securities that are traded would alone matter regardless of the person who traded having had no access to the inside information.
This is what will make India unique - no reasonable judge in any reasonable jurisdiction can rule that violative insider trading can take place even when the person who took the trading decision had no access to inside information. The insider trading regulations does not state so, but the regulator has said so. The law on insider trading only prohibits trading when in possession of unpublished price-sensitive information. When the person who trades is herself not the insider - she is a discretionary portfolio manager, duly authorised to take the trading decisions at her own discretion - the law does not support bringing a charge of insider trading.
Of course, there can emerge positive evidence to show that the discretion was in fact exercised by the insider and not by the portfolio manager. Circumstantial evidence to show contact between the insider and the portfolio manager around the time of the trades, abnormal scale of the trades around the time of the contact, and other such conventional circumstantial evidence that would lead to a reasonable conclusion that there was communication of inside information can be brought to bear. Merely because a discretionary portfolio manager has been appointed, the insider would not get immunity. However, unless there is some evidence to suggest possession of inside information by the portfolio manager who is a free agent to act as per her discretion, her state of mind cannot be presumed to be the same as her client's state of mind.
This is precisely why investing in a mutual fund would not result in insider trading. A mutual fund is a discretionary portfolio manager for a pool of clients while a discretionary portfolio manager directly appointed by a client manages multiple clients' investment pools respectively. There is no other difference between the two.
Despite the law being clear, and a principles-based law at that, a contrary reading by the very regulator that administers the law has set the cat among the pigeons. Every market intermediary and listed company would now have to ban discretionary portfolio management as a carve-out of its clients' trading permissions. Portfolio managers will get standing instructions not to trade in securities where the client is an insider - this is easier with a client who is an insider to a listed company, but impossible where the client is an insider to an advisor, thereby becoming connected to numerous listed companies that his organisation is an advisor to. It would be as tough for employees of regulators who handle information relating to multiple listed companies to place their savings in discretionary portfolio management services.
The committee that proposed draft regulations based on which the regulations were notified actually had a stated exception for discretionary portfolio managers' trades made without reference to the client. (Disclosure: the author was part of the committee.) If a reference to the client could be circumstantially shown, indeed a charge can be brought, but a trade without any reference to the client still being deemed to be violative is a new one.
The author is a practising counsel. He tweets at the Twitter handle: @SomasekharS
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
