Regulating insiders

Including mutual funds will be progressive

A consultation paper from the Securities and Exchange Board of India (Sebi) suggests bringing units of mutual funds within the ambit of the Prohibition of Insider Trading Regulations, 2015 (PIT, 2015). Units of mutual funds are specifically excluded from the definition of securities under the PIT at the moment. Other pooled investment vehicles such as alternative investment funds and real estate investment trusts are considered securities. This is a progressive step which brings mutual funds under regulations that govern direct trading in securities. This would enable the regulator to initiate serious enforcement actions against individuals who may misuse access to sensitive non-public information to profit from trading mutual fund units. Asset management companies (AMCs) will be asked to formulate a code of conduct to regulate, monitor, and report dealing in units by employees and their relatives.

Employees of AMCs are often in possession of unpublished price-sensitive information (UPSI) and there are known instances where this has been misused. The paper cites a case where the registrar and transfer agent of a mutual fund redeemed all their units from a scheme, being privy to sensitive information which had not yet been communicated to the unit-holders. In another instance, a few key personnel of a fund redeemed their holdings in schemes because they had sensitive information that was not communicated to the unit-holders. It is easy to also conceive instances where executives of an AMC might buy units on the basis of inside information, which enables them to benefit in the future. Sebi already has several circulars pertaining to trading in securities by employees of AMCs and the trustees of mutual funds. Such transactions and trading plans have to be reported to compliance officers well in advance, and there are also time periods or specific circumstances when employees of AMCs cannot transact in the units of the mutual funds concerned.

This consultation paper hopes to close gaps in regulation. The regulator has to thrash out the details and norms of disclosures of unit-holdings by executives of AMCs, connected persons, and their relatives. Sebi proposes such transactions be disclosed in seven days, and every transaction above Rs 10 lakh must be disclosed on an independent platform; but systematic plans are exempt after the disclosure of the initial trade. Sebi proposes to insert a new chapter into PIT regulations to specifically cover transactions in fund units. The definitions of technical terms such as “systematic transactions”, “insider”, “designated persons”, and “connected persons” need to be expanded and fine-tuned.

The paper also discusses what could be considered “independent platforms” where information may be made available for general consumption. This could include the websites of the stock exchanges and collective fund-platforms like the Association of Mutual Funds of India (AMFI). While regulation to plug insider trading in units is laudable, this must have a light touch. For example, there are legitimate reasons why an insider may share UPSI with trustees, registrars, share transfer agents, custodians, valuation agencies, accountants, the AMFI, credit rating agencies, legal advisors, auditors, etc. These legitimate purposes should not be obstructed by regulations. If the right balance is found, it should lead to cleaner practices across this important asset-class.