Insider trading laws are ambiguous

WITHOUT CONTEMPT

An accusation of violating insider trading regulations is a very serious one. It conjures images of shady bootleggers conspiring to profit from deceit of the market, innocent of unpublished price sensitive information. Any law, particularly, a law that seeks to govern such a serious issue, ought to be precise and unambiguous.

Under Indian securities laws, regulations prohibiting insider trading were among the first to be made after the Securities and Exchange Board of India (Sebi) got statutory teeth.

The Sebi (Prohibition of Insider Trading) Regulations, 1992 remained unattended for nearly a decade. Even if one were to ignore the stark errors in English grammar and syntax, the insider trading regulations raise some serious operational difficulties.

The regulations prohibit any person from dealing in securities while in possession of "unpublished price sensitive information".

The term "price sensitive information" in relation to any company is defined as any information relating to the company, which if published, is likely to materially affect the price of securities of that company. Regulation 3 prohibits every insider from communicating or counselling unpublished price sensitive information and from dealing in securities while in possession of such information.

Moreover, should an insider in fact communicate such information to any other person (such sharing may be required in the course of business), such recipient too would get prohibited from dealing in securities.

The term "insider" itself has been defined to mean any person "connected" with the relevant company, and any person "deemed to be connected" with the company and who is reasonably expected to have access to unpublished price sensitive information.

The concepts of "connected person" and "deemed connected person" are also defined, and specific listed relationships could cast a person in such relationship, into either category.

Every person who actually has had access to unpublished price sensitive information is automatically treated as an insider, thereby attracting prohibition on dealing in securities. Although the scheme of Regulation 3 did not need to be meddled with, a new provision in the form of Regulation 3A was inserted in February 2002.

Regulation 3A reiterated that no company shall deal in securities of any company or of any other company associated with such company, while in possession of unpublished price sensitive information. This inclusion was unnecessary since the charge of Regulation 3 was not restricted to individuals and did not preclude coverage of corporate insiders.

The only drawback of Regulation 3 too was rectified in the February 2002 amendment. The charge of Regulation 3 was changed from a prohibition on securities dealing "on the basis of" unpublished price sensitive information, to a prohibition on securities dealing "while in possession of" unpublished price sensitive information.

Without this amendment, to successfully sustain a charge of insider trading, it would not have been adequate to prove that an accused had unpublished price sensitive information while dealing. One would also have had to prove that he actually used the information. Now, it would suffice to show that the person charged with insider trading had the information.

However, the law remained silent on how to deal with possession of insider information in one arm of an organisation and concurrent dealing in securities by another arm of the same organisation, unaware of the former's possession of insider information.

For instance, every promoter of Indian listed companies would at all times be an insider, and would therefore, potentially, never be able to make any legitimate creeping acquisition. Every merchant banker advising any listed company would be an insider, and its proprietary arm would never be able to deal in securities.

Therefore, after substantial furore, in November 2002, Regulation 3B was inserted to provide for the ingredients of a valid defence. One loosely drafted defence was that a company could prove that acquisition of shares of a listed company was "as per" the takeover regulations.

This term can be quite meaningless, particularly in view of the plethora of provisions in a self-contained code like the Indian takeover regulations, regulating acquisitions at one end and mere disclosure of acquisitions at the other end.

Another important defence is that the individuals in a company who are in possession of insider information and the individuals who deal in securities should be distinct, should be segregated and the information with one arm ought not to have flowed to the other arm. While proving the negative is tough, both these defenses under Regulation 3B explicitly purport to be a defence only against a charge under Regulation 3A.

A court ought to read Regulation 3B as amounting to a defence not under against Regulation 3A but also Regulation 3, particularly since the charge of Regulation 3A is but a repetition of the charge of Regulation 3.

However, the fear of reputation risk around even having to defend a charge of insider trading makes consumers of the law fearful of Sebi taking a contrary view. Such ambiguity in such an important piece of law begs urgent correctional intervention.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)

somasekhar@jsalaw.com