Regulatory enforcement against insider trading is attracting attention worldwide. Recently, the United States’ Federal Bureau of Investigation (not the securities market regulator) launched its own criminal action against a French doctor for communicating informa-tion to a hedge fund mana-ger, about a drug trial by a company to which he was a consultant. The funds sold the stock within a week before a press release on the drug trial was issued.
Last month, a US appeal court ruled that one could read into an agreement to keep information confidential, an implicit undertaking not to deal in securities while in possession of such information. In that case, the largest shareholder of a listed company had been approached by the CEO to test his appetite for fresh preferential allotment of shares, he got upset with the idea of dilution, and while keeping the information about the proposed transaction confidential, he sold his shares. The lower court had ruled that a duty to keep information confidential would not include a duty not to deal in securities, and therefore the charge of insider trading could not be brought.
In India, the Securities Appellate Tribunal (SAT) remanded a case back to the Securities and Exchange Board of India (SEBI) asking SEBI to be explicit about whether the persons accused of insider trading were “connected persons” or “deemed to be connected persons” in order to attract the provisions of the SEBI (Prohibition of Insider Trading) Regulations, 1992 (“Insider Trading Regulations”).
The Insider Trading Reg-ulations contain an explicit prohibition on insiders from dealing in securities while in possession of unpublis-hed price sensitive informa-tion, as also on communica-ting and counseling of unpublished price sensitive information. The third prohibition in the Insider Trading Regulations is on the recipient of any such information from dealing in securities.
The definition of “insider” is broken into two parts. The first, lays down the ingredients of whether a person who is a “connected person”, or a person “deemed to have been connected” with the company, can be reasonably be expected to have had access to unpublished price sensitive information. The second part is much simpler – a plausible reading of the clause would mean any person who has received or has had access to unpublished price sensitive information would automatically be regarded as an “insider”, thereby attracting the prohibition on dealing in securities while in possession of unpublished price sensitive information.
There has been a debate among lawyers about whether anyone and everyone who is in receipt of information can be regarded as being an insider. One approach is to argue in the affirmative – simply put, if the intent is to prohibit insider trading, it should not matter whether the person who traded while in possession was a “connected person” or if he had any “deemed connection” with the company. Under this approach, so long as the regulation notionally defines any person receiving information as an “insider” for purposes of the Insider Trading Regulations, the attraction of the prohibition contained in the regulations should be regarded as absolute.
The alternate approach is that unless the person who received the information is an “insider” i.e. either falling within the definition of a “connected person” or being a person deemed to be so connected, the charge of the Insider Trading Regulations would not be attracted. The force behind this approach is from the argument that the regulat-ions would not have expen-ded such a detailed const-ruct on the concepts of “connected person” if all they had to say was that no per-son should deal in securities when in possession of unpublished price sensitive information.
The most severe impact of the Insider Trading Regulations is the aspect of the prohibition on communicating and counseling of information except for purposes of ordinary course of business, employment, profession or disclosures mandated by law. Investments in shares of Indian listed companies either by promoters (who are perpetually insiders) or by third party investors through a preferential allotment (who desire to conduct a due diligence) involve serious issues of whether it is kos-her to make the invest-ment. The key question is whether at the time the investment is made, there is symmetry in the availability of price-sensitive information to the investing person and the rest of the world at large.
The “safe harbour” provisions in the Insider Trading Regulations that are seem-ingly intended to deal with conduct of due diligence on a listed company just state that “it shall be (sic) defence to prove that acquisition of shares of a listed company was as per” the Takeover Regulations. An acquisition “as per” the Takeover Regula-tions can mean anything ranging from an acquisition that is exempt from making an open offer under the Takeover Regulations, to an acquisition that triggers an open offer, to an acquisition that triggers a disclosure obligation.
Regulations that deal with so serious a charge, and attract the most pungent attention worldwide, necessarily need greater precision. A repair is long overdue. (The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)
Email: somasekhar@jsalaw.com
