Insider trading norms to raise compliance hurdle for companies

But due-diligence exemptions a relief for private equity, strategic investors

The Securities and Exchange Board of India (Sebi)’s new norms to prevent insider trading in listed companies are likely to lead to some hurdles for companies.

The regulations also cover third-party entities. The regulator has also tried to reduce ambiguity around due-diligence activities. “Companies will, by law, be entitled to require third-party connected persons to disclose their trading and holdings in securities of the company,” stated the markets regulator on Wednesday evening.

In legal terms, a third party is any individual or entity that does not have any direct connection with the company but could be impacted by the goings-on in it. This will mean companies will have to insist on disclosures from third-party vendors and manufacturers if they hold stake and shares of the company, which might lead to an increase in compliance costs.
 

INSIDE STORY

• Sebi’s insider trading rules seek mandatory disclosure of shares and securities, including of third parties
• This means that companies would also have to look at entities such as suppliers and distributors and their holdings
• Keeping an eye on such outsiders would come with its own set of difficulties and increase compliance burden for listed entities, say experts
• The regulator has also allowed communication of price-sensitive information for legitimate business transactions
• Regulations will protect PEs and VCs against charges of insider trading while conducting due diligence

Companies feel though the move might not result in a rise in costs, it will increase the compliance burden.

“In my view, and going by the preliminary reading of the Sebi release, the intent appears to be for disclosures by third parties that might have access to unpublished price-sensitive information. So, companies with third parties, including vendors that could potentially have access to such information, will have to ensure robust internal processes and checks in place,” said Raja Lahiri, partner, Grant Thornton LLP

The Sebi board repealed the two-decade-old Prohibition of Insider Trading (PIT) Regulations by widening the definition of insider and connected persons and clearing a new definition of unpublished price-sensitive information.

Sebi’s new PIT regulations are based on recommendations of the N K Sodhi committee, which had given a report on the issue to the regulator in December last year.

To protect the interest of investors, companies will now have to disclose unpublished price-sensitive information at least two days before trading, in case communication of such information is allowed.

Communication of such information is prohibited except for legitimate purposes or for discharge of legal obligations. Experts believe this will mean companies and private equity (PE) players looking at potential mergers or acquisition of a large chunk of shares will be allowed to conduct due-diligence on the companies.

This provision will protect PE players, venture capital funds and other similar investors against the charge of insider trading while conducting due-diligence.

“Sebi’s fillip to allow communication of unpublished price-sensitive information with safeguards for legitimate business transactions appears to be a pragmatic move. However, the regulations mention fair disclosures will be principle-based, meaning instances and situations will have to be examined on a case-to-case basis and clarity/guidance might need to be given on what construes ‘adequate safe-guards’,” Lahiri said.