Introduction

The Securities and Exchange Board of India (“SEBI”), the securities market regulator, extended a rather stormy welcome to 2019 with multiple amendments to the SEBI (Prohibition of Insider Trading) Regulations, 2015 (“PIT Regulations”). The first set of amendments, issued vide notification dated December 31, 2018 will be effective from April 1, 2019, whereas the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2019, published on January 21, 2019 came into force from the date of publication (collectively, the “Amendments”). These Amendments are a fruition of the recommendations of the Report of Committee on Fair Market Conduct, set up by SEBI in 2017 and chaired by Dr. T.K. Viswanathan (“Viswanathan Committee Report”).  

From a practical perspective, the most significant amendments may be categorised into three heads – clarification on the concept of “legitimate purpose”, compliances for listed companies and the introduction of new defences to insider trading.

Communication of UPSI for “legitimate purpose”:

The Amendments seek to bring greater clarity to some existing concepts where ambiguity has led to some debate in the past. One of the most consequential clarifications is the “Explanation” to Regulation 3(2A), which throws some light on what is considered a “legitimate purpose” for sharing unpublished price sensitive information (“UPSI”).

For context, as per Regulation 3(1), an insider is prohibited from communicating, providing or allowing access to the UPSI to any person, unless the same is done “in furtherance of legitimate purpose.” The Amendments state that sharing of unpublished price sensitive information in the ordinary course of business by an insider with partners, collaborators,[2] lenders, customers, suppliers, legal advisors, auditors, insolvency professionals or other advisors or consultants would amount to “legitimate purpose”, as long as such information has not been shared to circumvent the provisions of the PIT Regulations.

While the abovementioned text is part of an “Explanation” to Regulation 3(2A), it is essentially a crucial, yet open-ended, guidance to listed companies, who are now required to formulate policies for determination of “legitimate purpose”, as elaborated in the section below.

Further, SEBI has introduced Regulation 3(2B), which requires a due notice to be issued to any person who has received UPSI in furtherance of a “legitimate purpose” to ensure maintenance of confidentiality in respect of such UPSI in compliance with PIT Regulations and such person shall be considered as ‘insider’[3]. The conundrum here is the fact the Amendments do not specify who it is that is required to issue such notice. SEBI is arguably the most active regulatory body and is fairly quick to penalise any form of non-compliance. In such circumstances, it is perhaps a cause of concern when there is ambiguity in respect of the person/officer on whom the obligation of compliance is cast.

Compliances for listed Companies:

The Amendments impose a range of compliance requirements on listed entities, largely to do with formulating a code of conduct and maintenance of records.

• Determination of “Legitimate Purpose”: As mentioned above, Regulation 3(2A) now imposes an obligation on the board of directors of listed companies to prepare a policy for determination of “legitimate purposes” for which UPSI may be shared as a part of Codes of Fair Disclosure and Conduct formulated under the Regulation 8 of PIT Regulations. The concept of legitimate purpose by its very nature is subjective, and the move to allow companies to define the ambit of such ‘legitimate purpose’ is not only practical, but also a step forward in encouraging healthy corporate governance.

• Maintenance of digital database; setting up internal controls: Next, as per Regulation 4(5), the board of directors of a listed company is required to record the details along with Permanent Account Numbers (PANs) of persons who receive UPSI in a structured digital databaseand maintain the same with adequate internal controls and checks (such as time stamping and audit trails) to safeguard it from any tampering. Further, Regulation 9A sets out a framework for putting in place internal controls within a company for prevention of insider trading. This includes identification of employees with access to UPSI as designated employees, maintenance of a list of employees and other persons with whom UPSI is shared, entering into confidentiality agreements with such employees/persons, and formulation of a whistle blower policy for reporting leaks of UPSI.

• Identification of “designated persons”: Regulation 9 read with Schedule B of PIT Regulations impose an obligation on the Chief Executive Officers or Managing Directors of listed entities and intermediaries to formulate a code of conduct “to regulate, monitor and report trading by its employees, connected persons (“designated persons”) and immediate relatives of designated persons. The board of directors is required to specify such ‘designated persons’ on the basis of their role and function in the organisation, which includes, inter alia, promoters, employees of material subsidiaries with access to UPSI, Chief Executive Officers, etc.

There are two significant changes to note here. Firstly, the Chief Executive Officer/Managing Director has been specifically identified as the persons on whom the obligation of compliance is cast. Secondly, listed companies and intermediaries are now prescribed separate codes of conduct. “Fiduciaries” are also required to adhere to the code of conduct prescribed for intermediaries under Schedule C of the PIT Regulations. The term “fiduciaries” has been explained in the Explanation inserted in substituted Regulation 9 (2) to include professional firms such as law firms, accountancy firms, analysts, auditors, insolvency professional entities, banks and others who assist or advise listed entities.

In essence, these requirements push for increased accountability, a more diligent corporate culture and the establishment of institutional mechanisms within each listed company to prevent leak of UPSI.

Additional defences to Insider Trading

Arguably, the most crucial amendments to the PIT Regulations are the introduction of multiple new defences to insider trading.

• One such defence is the exercise of stock options at a pre-determined exercise price by employees as per new proviso in Regulation 10.

• Another one is in respect of transactions executed on block deal window mechanism between persons who are in possession of UPSI as per substituted Regulation 4.

• A third and more interesting defence is off-market trades between insiders with access to the same UPSI, as long as such trades are notified to the company within two working days and the UPSI hasn’t been disclosed in relation to a proposed transaction. Prior to the Amendments, this defence was only available to promoters as per new proviso in Regulation 4.

This amendment would be mostly innocuous, but in light of the fact that companies are now allowed to dictate the “legitimate purpose” for which UPSI may be shared, it could be argued that there is a possibility for such a defence to be abused. Now that this defence is available to all insiders, the pool of people to whom this defence is available could potentially be large depending on the policy formulated by the Company for determination of “legitimate purpose”.

However the Amendments do put in place safeguards such as mandating companies to share “particulars” of such off-market transactions with the stock exchange within two (2) trading days from the receipt of the information. Furthermore, Regulation 4(1) iterates a presumption of knowledge and motivation against a person in possession of UPSI. As per the Viswanathan Committee Report, the purpose behind the introduction of provision is to underline the legislative intent to impose strict accountability in case of insider trading.

Conclusion

The Amendments have certainly brought clarity to some ambiguous concepts in the PIT Regulations. They are also clearly a leap forward in encouraging a transparent framework for prevention of insider trading. However, whether or not the Amendments successfully manage to achieve the fine balance between regulations of insider trading and encouraging a more autonomous framework of corporate governance remains to be seen.

[2]https://www.sebi.gov.in/legal/regulations/dec-2018/securities-and-exchange-board-of-india-prohibition-of-insider-trading-amendment-regulations-2018-dated-december-31-2018_41570.html

[3] Supra note 4.

Author: Vayshnavi Ganesh, Associate, IC Universal Legal

Note: This article has been published in Legal Desire International Journal of Law, 19th Edition (ISSN:2347-3525)