Insider trading—and the laws that seek to contain it—is always an intriguing subject, all the more relevant now because the capital market regulator is introducing new rules governing it that come into effect on 15 May.
Norms governing insider trading prohibit anyone who has access to inside information in a company from dealing in that firm’s publicly traded shares. If found guilty of insider trading, a person could be sent to prison for up to 10 years or be required to pay a fine of up to ₹ 25 crore or thrice the amount of profits made.
To be sure, proving guilt in insider trading cases is not an easy matter and leads to many possible complications. These come about in no small part because unscrupulous traders will always have incentive to find new loopholes in insider trading laws or ways for them to continue making money in new and secretive ways that will avoid prosecution.
Despite that, it’s important to curb insider trading since it ruins the efficient functioning of stock markets and can lead to honest investors losing millions.
To tighten gaps in existing norms, the Securities and Exchange Board of India (Sebi) will, on 15 May, introduce the Sebi (Prohibition of Insider Trading) Regulations, 2015, that will replace the existing Sebi (Prohibition of Insider Trading) Regulations, 1992.
The new regulations appear to be promising, more practical, and largely in line with the global approach to insider trading. They also seem to be equipped to ensure better compliance and enforcement. It is, therefore, only natural for everyone to be talking about the new norms.
Most financial regulations require constant modifications to keep pace with the ever evolving market dynamics. Insider trading is no different. The existing regulations were notified in 1992. In the past two decades, the laws and understanding of insider trading (both globally and in India) have evolved significantly.
Despite several amendments, certain provisions of the existing regulations were proving to be impediments in smooth transactions of listed securities.
For example, the existing regulations do not explain properly how to regulate due diligence. This becomes an issue because financial investors, such as private equity funds, usually invest only after conducting a thorough legal and financial investigation of the target company.
More often than not, this results in such investors getting access to insider information about the target company prior to buying the shares, which in turn can result in the offence of insider trading.
Similarly, in the absence of a specific definition, nobody clearly understood what is meant by trading.
Sebi, therefore, constituted a committee under the chairmanship of former judge N.K. Sodhi to undertake a comprehensive review of the existing regulations, as a result of which the new regulations came into being.
Some housecleaning was indeed much in order and the new regulations are definitely a big step forward.
For example, among other things, the new rules specifically define trading, prescribe a more structured disclosure regime, and permit due diligence exercises when someone wants to buy a listed company, subject to appropriate disclosures and compliance.
Apart from the housecleaning and simple fixes, the new regulations also bring about some significant changes which will have practical effects that are perhaps not very well understood yet, as is to be expected in an area this complex. For instance, in addition to listed companies, the new regulations apply to companies that are proposed to be listed.
It is unclear what “proposed to be listed" means. Does it mean that if I get some insider information about a company which intends to go for an initial public offering in a couple of years, I wouldn’t be able to trade in the securities of such company?
Unfortunately, it’s really unclear as to what is meant by the phrase. It may be intended to cover companies that have filed a draft red herring prospectus with Sebi. This could create some problems.
The definition of “connected persons" now covers anyone who has a connection with a company that is expected to put the person in possession of insider information.
The existing regulations covered a specific set of people under the definition of connected person. However, the new regulations cover even public servants such as judges and bureaucrats, who may not have any professional relationship with the company, but who may be aware of a judgment or policy which, when made public, may impact the price of shares of the company.
Also, the new regulations require the compliance officer of the company to monitor trading by employees and connected persons. Given the wide ambit of the definition of a connected person, it may be an uphill task for the compliance officer to do so.
Trading is not allowed by an individual while in possession of insider information. There could be confusion about whether a person who is a director of a company, for example, and will likely always be in possession of some insider information, will be allowed to trade at all in that entity.
The new regulations allow for the formulation of trading plans. Under this, a person can formulate a trading plan, get it approved by the compliance officer and trade in accordance with it. However, such trading needs to comply with certain specific conditions to ensure any insider information in not misused.
For instance, the trading plan would be disclosed to the public and a person cannot trade within six months of such public disclosure. Further, once approved, the person cannot back out or deviate from the plan.
The new regulations prohibit not only dealing in securities when in possession of insider information, but also communicating or procuring of insider information, except where this is in furtherance of, among other things, legitimate purposes.
The phrase “legitimate purposes", too, has not be defined. Accordingly, it is unclear what purposes are legitimate enough to allow insider information to be communicated or procured.
The new regulations also require companies to come up with codes for regulating, monitoring and reporting trading by employees or connected persons, and fair disclosure of material information, such as financial information, key business decisions, etc., by the company.
Compliance with these codes appears to be cumbersome, particularly for companies with large shareholder and employee bases. For instance, in a company with 10,000 staff, it would require dedicated resources just to monitor trading activities of the employees.
Sebi might need to clarify some of these issues before the rules kick in, although that looks unlikely.
However, there’s hope that the regulations are interpreted by courts and authorities in a progressive manner and timely clarifications are issued by the capital market regulator.
Ganesh Prasad is a partner and Sanjay Khan is an associate at Khaitan and Co. Llp.
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