Asset managers escape insider trading rules

When it comes to asset managers, the Securities and Exchange Board of India’s new insider trading regulations have left a question mark. Under the new regulations, mutual fund (MF) units have been left out of the definition of ‘securities’. This might lead to rise to situations where employees would be able to trade on advance knowledge, which would affect the net asset value (NAV) of a scheme.

Experts say there might be difficulties in bringing such people to book because employees or other insiders wouldn’t be in violation of insider trading regulations when it comes to MF units. “Mutual fund units are explicitly carved out of the definition of the term ‘securities’ in the MF regulations. Therefore, there cannot be insider trading action under these regulations,” said Somasekhar Sundaresan, partner, J Sagar Associates.



MF units were part of the draft regulations. Also, they were mentioned in a report by the Sodhi committee, which formulated the new insider trading regulations. “Such a security may be issued by any entity — ranging from a company that issues shares, debentures or…a mutual fund,” it had said.
 

 

ON THE INSIDE TRACK

• The draft regulations covered insider trading in mutual fund units
   
• The final regulations have excluded MF units from the definition of securities
   
• Insider trading on price-sensitive information in MFs was dealt with in an earlier circular
   
• It deals with employees and others having information which would affect net asset value

However, in the final Act, the provision was changed to specifically exclude MF units. “‘Securities’ shall have the meaning assigned to it under the Securities Contracts (Regulation) Act…. except units of a mutual fund,” said the final regulations.



An email sent to the regulator did not immediately receive a reply.

In the case of MFs, price-sensitive information is dealt with in a circular issued in 2001. However, the scope of this is limited, say experts. Among other things, the circular says employees don’t require prior permission for buying or selling MF units, though details have to be reported in seven days. No such reporting is required in the case of money market MFs.

The circular deals with insider trading by detailing a handful of circumstances under which trading in units is disallowed ahead of public disclosure. These include a likely change in the scheme’s investment objectives, a proposed change in the valuation methodology and the likelihood of a bonus issuance.



“Since such expressly-listed prohibitive scenarios don’t take into account all possible NAV-sensitive future action, for instance the possibility of a change in the expense ratio, the possibility of using the information to one’s advantage remains,” said Tejesh Chitlangi, partner, IC Legal.

The new insider trading regulations have addressed a number of thorny issues. These have recognised the need for due-diligence by companies taking a strategic stake in a listed player, which might include access to insider information. Also, these have sought to provide a number of defenses under which insiders can transact in shares under certain circumstances.

The new regime became effective on May 15.

However, when it comes to MFs, the problem of enforcement remains. “This can be eliminated by giving more powers for compliance officers to prescribe closure of dealing windows for employees prior to the implementation of any potential material action in a mutual fund scheme,” said Chitlangi.

Executives in the sector say there is limited room for insider trading in MF units. “On a day-to-day basis, gains are minimal in MF units. So, it doesn’t seem likely that people would run the risk of prosecution,” said the chief executive of an MF.