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Worldwide, the spirit of regulations dealing with insider trading is that no insider should gain an advantage over the market. The Securities and Exchange Board of India (SEBI) had more than 2 decades back in 1992, notified the SEBI (Prohibition of Insider Trading) Regulations, 1992 (1992 Regulations). However, the 1992 Regulations have had their share of challenges arising out of ambiguous drafting, insiders escaping charges and has therefore been a subject matter of constant criticism.
In this backdrop, SEBI in March 2013 appointed a Committee under the chairmanship of Justice N K Sodhi to review the 1992 Regulations and specify a clear regulatory policy. The Committee report (Report) proposing the new set of regulations governing insider trading (Draft Regulations), was recently published by SEBI and invited public comments on the same by December 31, 2013. In a nutshell, the Draft Regulations define ‘Insider’ to mean any person who is either a connected person or is in possession of unpublished price sensitive information (UPSI). UPSI has been defined to mean any information which is not generally available and which upon becoming generally available is likely to materially affect the price of the securities.
A person is connected person if his association with a company would allow or is reasonably expected to allow such person access to UPSI relating to said company. Subject to availability of certain defence/s, no insider is permitted to trade in listed securities when in possession of UPSI or even communicate or allow access to UPSI to any other person, except on a need to know basis.
Since the public consultation period is now over and SEBI is in the process of finalising the new insider trading regulations based on the Committee Report, this piece deals with some of the concern areas in the Report and Draft Regulations, which SEBI should carefully examine. The Report broadly appears to be reasonable and well thought, however some of the recommendations if implemented may result in ambiguity and subject the regime to misutilisation. Some of such contentious issues which warrant SEBI’s attention are discussed hereunder.
First, some of the defences suggested in the Draft Regulations against a charge of insider trading need to be omitted in final regulations. For instance, the Draft Regulations permit an insider to claim a defence that the nature of such insider’s trade was contrary to the manner in which any person acting reasonably would have traded when seeking to take advantage of the UPSI. However, a common piece of information may be viewed as positive by some and negative by others. An inside information pertaining to a potential M&A deal or an announcement pertaining to expansion in business lines may be construed positive by one individual whilst negative by other, based on their respective perceptions and judgment criterion. It’s not surprising to see two research houses putting opposite recommendation (one buy and other sell) on the same stock at a matching time period, based upon their own research standards and perceptions.
Another defence laid down in the Draft Regulations, which warrants SEBI’s scrutiny is the one whereby a trade between counterparties having parity in possession of the UPSI is proposed to be a valid defence, since both would be in possession of very same UPSI, and one could not have victimized the other. However, such a trade may not be beneficial to investors at large and in fact skew the share prices of the subject company when such deal happens off market at a price which is in variance with the existing market price.
Second, in continuation to the point made above, SEBI whilst listing out defences may retain a power to grant exemptions from strict applicability of the regulations on a case to case basis, the aspect not been considered by the Committee in the Draft Regulations. Such a power is recognized in other SEBI regulations like the takeover regulations as well. On one hand, it may not be possible to contemplate all the possible defence scenarios and on the other hand, putting some of the contentious ones in black and white may be a fodder for wrong doers and cause a lot of nuisance value in courts for SEBI whilst establishing its claim. SEBI will therefore have to be careful whilst finalizing the defences under the final regulations.
Third, the Report requires the insiders of the likes of promoters, directors of the company (which are perpetual insiders) to upfront disclose their future trading plan, six months in advance, and trades as per the trading plan are then required to be executed. This provision would practically restrict the perpetual insiders from even genuinely buying/selling shares of their own companies and may likely create speculation in markets with public having an advance knowhow of the future trading plans of the insiders. SEBI may consider dropping this provision as the same may create genuine practical difficulties for the promoters and directors of the companies.
Fourth, legal/financial due diligence by potential large investors on listed companies for enabling their investment has been proposed to be allowed and which is an excellent move. One of the prescribed conditions is to publicly disclose the investor’s due diligence findings on a company constituting UPSI, at least two trading days in advance of the investment (not applicable in a takeover transaction). The concern is again from the perspective of market reaction to a large quantum of UPSI which instantly goes in public domain and therefore may result in unwarranted movement in company’s scrip price. Due diligence being a genuine commercial activity should be permitted subject to certain reasonable safeguards and not in the form currently proposed.
SEBI may finalise the Committee’s recommended Draft Regulations whilst carefully addressing the above concerns. Insider trading is not only a civil wrong but is also a punishable crime, which may technically attract imprisonment for a period upto 10 years or a hefty fine upto Rs. 25 crore (and in certain circumstances even higher), or both. Accordingly, the law regulating insider trading has to be cautiously devised and implemented. The real success of the new regime would also depend upon the SEBI’s ability to pass disgorgement orders (repayment of illegal gains by wrongdoer to those affected) for insider trading violations. Imposition of penalties/imprisonment would not compensate the actual victims and hence should be coupled with disgorgement orders, where practical and tenable.
SEBI’s Chairman Mr. UK Sinha was recently quoted saying that the strengthening of regulatory mechanism pertaining to insider trading would be SEBI’s one of the key focus areas in 2014. There is an expectation that SEBI’s New Year resolution would be fulfilled and culprits may no more escape in absence of effective regulations. At the same time, the desire is that no innocent gets punished. SEBI is expected to do a balancing act whilst finalising the regulations and enforcing the same.
The writer is Partner, IC Legal
