Jurisdiction - India
Corporate/M&A
Amarchand & Mangaldas

24 March, 2015

 

 

The new Insider Trading Regulations

 

Corporate law in India has undergone a paradigm shift with the new insider trading regulations. The Securities and Exchange Board of India (“SEBI”) ushered in the new year with the notification of the SEBI (Prohibition of Insider Trading) Regulations, 2015 (“2015 Regulations”). This was one of the most anticipated changes in the Indian securities market, as it is an overhaul to the two decade old insider trading regime in India.  The 2015 Regulations will come into effect from May 14, 2015 and repeal the SEBI (Prohibition of Insider Trading) Regulations, 1992 (“1992 Regulations”).

 

SEBI has been focused on regulating and developing the Indian capital market in an effort to boost investor confidence.  The 1992 Regulations had many inadequacies in terms of their interpretation and drafting. SEBI had attempted to address these issues with their amendments to the 1992 Regulations. The recommendations of the High Level Committee under the Chairmanship of Justice N.K Sodhi were released in a report (“the Sodhi Committee Report”). There was a need to systematically review and provide a more robust and efficient mechanism aligned with global norms to curb insider trading in India. The 2015 Regulations are created to put in place a framework for prohibition of insider trading in securities, arguably giving SEBI more power compared to the 1992 Regulations.

 

The re-written regulations do expand the definition of “connected person”, provide perpetual insiders a trading opportunity, and legitimize communication for the interests and benefits of the company. This article attempts to highlight some of the key takeaways of the 2015 Regulations and some preliminary thoughts on the implications.

 

I.  Definition of “Connected Person”

 

The definition of “connected person” is no longer a position based definition but has been expanded to cover any person associated with the company in any capacity, including by reason of frequent communication with its officers, in a fiduciary, employment or contractual capacity, in the 6 month period prior to the concerned trade. There should be some sort of relationship which should exist with communication of information regarding companies or securities. While this has certainly expanded the definition of “connected persons” bringing a wider sub-set of persons within its scope, SEBI has disregarded the suggestion made by the Sodhi Committee to specifically treat public servants (including SEBI officials) as a “deemed connected persons”.

 

It has been specified that the onus of proving that the connected persons were not in possession of unpublished price sensitive information (“UPSI”) is on the connected person.

 

II.  UPSI and Generally Available Information

 

The 2015 Regulations categorize information which is potentially available in relation to a company into (i.) generally available, and (ii.) UPSI. Generally available information has been defined to mean information that is accessible to the public on a non-discriminatory basis. The note to this definition clarifies that information published on the stock exchanges’ websites will ordinarily be considered as generally available information. UPSI has been defined to mean any information relating to a company or its securities, directly or indirectly, that is not generally available, and which upon becoming generally available is likely to materially affect the price of securities.

 

Under the 2015 Regulations, there is no longer a specific requirement for the company itself to publish or authenticate the information in order for the information to fall outside the ambit of UPSI. This is a better position commercially, however, keeping in mind the definitions of generally available and UPSI, it is likely to lead to confusion about (i.) whether information not disclosed by the company itself can constitute generally available information, and (ii.) the extent to which such information should be disseminated in the public domain, for it to be considered as available on a non-discriminatory basis. The test should be what is the certainty and reliability of the information. SEBI is likely to continue to treat information as generally available only when released by the company publicly, especially since SEBI has not included other instances of generally available information from the Sodhi Committee Report in the 2015 Regulations. A lot is dependent on how the courts will interpret this.

 

III. Definition of Trading

 

As per the 2015 Regulations, “trading” means subscribing, buying, selling, dealing or agreeing to subscribe, buy, sell and deal in any securities. This aligns the definition with the restriction under the Section 195 of the Companies Act, 2013, which also includes dealing and agreeing to deal under the definition of insider trading. As per the notes to the definition, it is intended to cover transactions other than purchase and sale of securities, such as pledge.

 

Again SEBI has taken a contrary view to the Sodhi Committee Report by expanding the definition of “trading” beyond including only purchase and sale of securities. This expanded definition is ambiguous and does not specify dealing (apart from pledges). Based on this, insiders (ie. promoters) will not be permitted to pledge shares of their companies while in possession of UPSI, unless they disclose all such UPSI prior to making the pledge. The intention here is to avoid insiders from obtaining undue advantage of UPSI to raise funds. However, such a wide definition of trading is bound to give rise to uncertainty.

 

It is relevant to note that the SEBI Act, 1992 continues to provide penalty for trading on the basis of UPSI and not trading while in possession of UPSI (as prescribed in the 2015 Regulations). This inconsistency was present in the 1992 Regulations as well and has not been statutorily resolved.

 

IV. Communication for Legitimate Purposes

 

A February 22, 2002 press release by SEBI had stated that communication of price sensitive information per se is not an offence. However, the 2015 Regulations stipulate that insiders are prohibited from communicating, providing or allowing access to UPSI unless required for legitimate purposes, performance of duties or discharge of legal obligations. The note to the 2015 Regulations provides the purpose of the provision which is to ensure that organizations develop practices based on “need to know” principle for treatment of information in their possession.

 

The 2015 Regulations allow insiders to have greater flexibility to share UPSI for legitimate purposes and in the interests of and for the benefit of the company rather than leaving it to a narrow exemption and not covering all the legitimate purposes as in the 1992 Regulations. This change makes the 2015 Regulations more akin to the liberal international regimes such as the US and the UK. Internationally, regulators have acknowledged and recognised that UPSI may in certain circumstances have to be shared selectively, including with major shareholders and other persons in order to fulfil their duty. Similarly in India, promoters would require information for legitimate reasons, including to fulfil the role envisaged  for them under the securities regulations.

 

It is relevant to note that Section 195 of the Companies Act, 2013 had been aligned with the 1992 Regulations, prescribing the ordinary course of business exception. Additionally, Section 195 defines insider trading as trading in securities by specified personnel who are expected to have access to any UPSI. This standard is wider that that prescribed under the 2015 Regulations, which require actual possession of UPSI. There needs to be alignment on this issue between the Companies Act, 2013 and 2015 Regulations to avoid consistency.

 

V. Communication in relation to transactions

 

Under the 2015 Regulations, UPSI may be shared in relation to transactions triggering open offer under the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 (“Takeover Regulations”), provided that the board of the company is satisfied that the transaction is in the “best interests” of the company. Also, the 2015 Regulations permit sharing of UPSI in relation to transactions that do not attract the obligation to make an open offer under the Takeover Regulations, provided that the board is satisfied that is in the interest of the company and the UPSI is made generally available two trading days prior to the trade.

 

The board of directors have an obligation to ensure that confidentiality and non-disclosure contracts are duly executed between the parties and that such parties ought to keep information received as confidential and they do not trade in securities of the company when in possession of the UPSI.

 

Even though SEBI makes these exceptions in the 2015 Regulations, there will still be some issues regarding them. There is no clear standard on how SEBI will adopt to verify if the decision of the board of the company was valid and whether SEBI will sit in judgement over the commercial wisdom of the board. Also, at the assessment stage of the transaction, it may not be possible for the board to form an opinion that the transaction is in the best interests of the company. In transactions involving transfer of shares, the company’s interests may not be affected or the company may be indifferent to the transaction. It is unclear if the benefit of the provisions will be available and it is possible that SEBI envisages such communication to be permitted only in the case of primary issuances. Additionally, if UPSI is to be disclosed two trading days in advance to the transaction, it may lead to price volatility and therefore deal uncertainty.

 

VI. Defenses to Insider Trading

 

 

The 2015 Regulations recognize many more defences to insider trading than the 1992 Regulations, which only recognized the Chinese wall arrangmenets implemented by companies.  The 2015 Regulations recognize the following defences:

 

(i.) Off market transactions between promoters who were in possession of the same UPSI. It is important to note that the parity of information defense is only available for inter-se transfers between promoters off the exchange. In turn, this will restrict market deals in listed companies and bring them under scrutiny if any one of the parties is an insider.

(ii.) In case of non-individuals where trading decisions were not taken by persons in possession of UPSI and arrangements were in place to ensure that no UPSI was provided to the person making trading decisions.

(iii.) Trades undertaken pursuant to a trading plan. For this to be viable, the 2015 Regulations prescribe

 

(a.) the trading plan shall not provide for commencement of trading earlier than 6 months from public disclosure of such plan, (b.) the trading plan shall not provide for trading 20 days prior to the need of the financial period for which results will be announced by the company and until 2 days after declaration of such results, (c.) the trading plan shall not relate to trading for a period of less than 12 months and not overlap another trading plan, (d.) the trading plan should set out either the value of trades to be effected or the number of securities to be traded along with the nature of trades, and the interval or dates of trades, (e.) the trading plan, once approved, will be irrevocable and will have to be mandatorily implemented and the insider will not be entitled to deviate from it or trade outside the scope of the trading plan, and (f.) the trading plan shall not commence unless the UPSI in possession of the insider at the time of formulation of the trading plan becomes generally available.

These requirements in relation to a trading plan make it an impractical defence for any perpetual insider as the timelines are too long and public disclosure of the plan will mostly lead to artificial price movement and may also be exploited by an insider. It will also not be possible for an insider to put in effect a trading plan, unless, the trades have to be executed notwithstanding the market position.  Although there is a prohibition on an insider to make any other trades, it is likely that SEBI may not view this to cover trading in securities on account of corporate actions.

 

SEBI has disregarded some of the other defences recommended by the Sodhi Committee Report. However, interestingly, the 2015 Regulations state that an insider may prove his innocence by demonstrating the circumstances, including, the instances specifically mentioned therein. It will be interesting to see how this is applied going forward and whether a defence hinging on mens rea will be available to insiders.

 

VII. Disclosure Requirements

 

Every promoter, employee, and director of a listed company is required to disclose to the company acquisition and disposal of securities if the traded value of securities traded in a calendar quarter exceeds INR 10,00,000. The disclosures to be made by an individual under the 2015 Regulations include disclosure of trades in derivatives and those relating to trading by such person’s immediate relatives, and by any other person for whom such person takes trading decisions. In case of investment managers and advisors, the trades undertaken by their respective clients will also have to be disclosed. Any listed company may now require any other connected person to make disclosure of holdings and trading in securities in such form and frequency as may be determined by the company.

 

VIII. Code of Fair Conduct and Disclosure

 

The 2015 Regulations prescribe principles for listed companies and/or market intermediaries to include in their disclosure and fair conduct codes unlike the 1992 Regulations which prescribed model codes of conduct and had a force of law. Additionally, every other person who is required to handle UPSI in the course of business operations is required to formulate a code of conduct to regulate, monitor, and report trading by employees and other connected persons towards achieving compliance with the 2015 Regulations and appoint a compliance officer.

 

IX. Other Changes

 

The restriction on communication and trading also covers communication of UPSI relating to and trading of securities proposed to be listed. However, the 2015 Regulations do not specify the trigger to identify when securities will be treated as securities proposed to be listed. It is likely that the filing of a draft prospectus with SEBI will be considered as the threshold.

 

The 2015 Regulations introduce the definition of “compliance officer” and one of the requirements is for the officer to be financially literate and capable of appreciating requirements for legal and regulatory compliance. This criteria has been interpreted as being highly subjective and the market will have to wait to see how SEBI will interpret such requirements. Additionally, listed companies will also have to appoint a Chief Investor Relations Officer to deal with the dissemination of information and disclosure of UPSI by the company.

 

Securities have been defined by reference to the Securities Contracts (Regulations) Act, 1956. However, mutual fund units have been expressly excluded. The new definition now clearly suggests that derivatives will also be covered under the ambit of the insider trading regulations.

 

X. Conclusion

 

The new insider trading regulations were long overdue and take into account many of the recent deals that have been taking place and the issues that have been highlighted due to recent events. While SEBI has expanded the scope for scrutiny by the widening of many of the definitions and the vagueness in the drafting of the regulations, they have attempted to address many of the issues where there was a lacunae. The court’s interpretation of the new regulations is highly anticipated and will bring light to many of the issues.

 

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For further information, please contact:

 

Cyril Shroff, Partner, Amarchand & Mangaldas
cyril.shroff@amarchand.com

 

 

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