The Justice NK Sodhi Committee has recommended an overhaul of the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992, and has put together a set of recommended regulations titled the SEBI (Prohibition of Insider Trading) Regulations, 2013.
Stock traders, investors, listed companies, promoters, directors and others connected with key decision making of listed companies as well as legal practitioners often struggle with tricky interpretational dilemmas under the existing regulations when evaluating an acquisition or divestment proposal. In this regard, the committee’s recommendations appear to take a more investor-friendly and pragmatic approach in some respects, without deviating (in principle) from the need to regulate insider trading activity in listed securities and dissemination of unpublished price sensitive information (UPSI). A few highlights of the proposed regulations are discussed below.
Definition of “insider” streamlined and “connected person” expanded: The existing regulations define an “insider” as “any person” who is or was connected with the company or is deemed to have been connected with the company and is reasonably “expected to have access to” UPSI or has received or had access to such UPSI. A large set of persons was deemed to be connected with the company.
The proposed regulations do away with this deeming fiction. Insiders are defined as connected persons and persons who are actually “in possession of” UPSI, and a “connected person” is defined as anyone who is or has, during the six months prior to trading, associated in any capacity with the listed company including by way of frequent communication, contractual relationship, fiduciary relationship, and employment.
Interestingly, public servants and persons holding a statutory position (who could have access to UPSI) are now included within the fold of insider. There is a rebuttable presumption that “immediate relatives” are connected persons if they are dependent financially on a connected person, or consult a connected person in taking decisions relating to trading in securities. In contrast, the existing regulations borrow the extended definition of the term “relative” from the Companies Act, 1956.
The streamlining (and in certain ways strengthening) of the definitions of “insider” and “connected person” should boost investor sentiment, and the stronger regulatory intent should promote more honesty in the price discovery mechanism.
Trading and not dealing when in possession of UPSI: Under the proposed regulations, actual “trading in securities” when “in possession of UPSI” would constitute the offence of insider trading, compared with “dealing in securities” (which includes “agreeing to subscribe, buy, sell or deal in any securities”) while in possession of UPSI under the existing regulations.
Investors should welcome this change as the standard adopted by the proposed regulations is far more realistic and less vacuous than the existing standard. That said, the penal section under the SEBI Act, 1992, should be amended to reflect the proposed position so as to avoid ambiguity in construction of the law. The SEBI Act imposes an even higher standard of “on the basis of”, which has led to nuanced interpretations in the past.
Further, UPSI under the proposed regulations would not include information that is “generally available” so long as it is available freely and on a non-discriminatory basis, irrespective of whether such information is “published”. Under the existing regulations only “published” information is excluded from UPSI. This change too adds clarity and should comfort acquirers who rely on non-published information.
Defences: The proposed regulations include various defences to a charge of trading while in possession of UPSI. For instance, a recipient of UPSI without knowing it to be such would escape guilt. Similarly, where both parties to a transaction have parity in the UPSI, the transaction would not fall foul of the law. The reading in of a requirement of mens rea to establish the offence of insider trading is a positive move in the direction of sophisticated regulation.
Due diligence: The proposed regulations acknowledge due diligence as a key facet of an acquisition. Currently, parties often have to make judgment calls on what could constitute UPSI when conducting due diligence. For any foreign acquirer, apprehensions about being caught under the insider net for genuine due diligence inquiries has hampered decision-making and deflated investor sentiment.
Under the proposed regulations, insider trading would not apply to information based on legal and financial due diligence where SEBI’s takeover code is being triggered for an open offer. For minority investments too, such diligence investigation would be kosher so long as UPSI disclosed is made public at least two days prior to the actual trade.
It is hoped that SEBI will implement the proposed regulations without much deviation from their current form. A clear regulatory environment is key to listed company deal-making and the committee’s recommendations are certainly a step in the right direction.
Aakash Choubey is a partner and Vatsal Gaur is an associate at Khaitan & Co, Mumbai. Views are personal.
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