Wednesday, December 3, 2008


1) SEBI has amended the SEBI Prohibition of Insider Trading Regulations 1992 vide a notification dated 19th November 2008 which I briefly highlighted here. There are some far reaching amendments.

2) An important amendment is to the definition of “insider”. As I mentioned earlier, no word has been added or deleted but by dropping a comma and breaking the definition into two parts, a significant change has been made.

a) Before the amendment, an Insider had to, firstly, be a person connected or deemed to be connected to the Company. Such connected person should then either reasonably expected to have access to unpublished price sensitive information (“UPSI”) or should have received it or had access to it.

b) This definition was ambiguous. A person merely receiving UPSI or merely having access to it could also be said to be an Insider, as per one interpretation. It is probably this ambiguity that the amendment tackles though by changing the definition upside down!

c) Now, the amendment says that an Insider:-

i) a person connected or deemed to be connected to the Company and who can be reasonably expected to have access to UPSI. OR

ii) A person who receives or has access to UPSI.

d) Thus, a new category of, what one could call, deemed insiders has been created.

e) Readers may recollect the classic case of the printer of company documents who used the price sensitive information in such documents to deal in their shares and make profit (United States v. Chiarella 445 US 222). Of course, the Supreme Court acquitted this printer since, from, what little I recollect, the allegation was that he violated fiduciary duty to shareholders of the target Company and the Court held that he did not. A version of this case was also fictionalized by the best selling novelist Lawrence Sanders in his novel “Timothys Game”. Such a printer would though be an Insider in India as per this amended definition. So would any other person who receive or have access to UPSI.

f) In practice, such a broad definition may cause problems. Taken to its extreme and I seek readers views on this - would even a hard working analyst who takes a lot of effort and puts 2 and 2 and 2 and 2 together and counts 8 also become an Insider since he now has access to UPSI? I feel that the answer is no for various reasons but the law could have said that a link with the Company is specifically required. This may even have also been intended since the words used are that such persons should have “received” or “had access to” UPSI.

3) Going further, listed companies and certain other persons are required to frame a code of internal procedures intended to prevent Insider Trading (“the Code”). The Code should be framed “as near thereto the Model Code” provided. It is now provided that the framing of the Code as near to such model should be “without diluting it in any manner”. Further, the Company should “ensure compliance of the same”.

4) Disclosures of holding and changes therein are now required in respect of even dependents (as defined by the Company) of the directors or officers of the listed company. Disclosure of such changes is now also required to be made to the stock exchanges. Disclosure of holdings in derivatives is also to be made when a person becomes a director or officer.

5) The Model Code itself has been amended. There are two major changes.

a) Clause 4.2 of the Model Code has been amended. As per this amended clause, directors/officers/designated employees, who buy or sell shares, cannot now carry out a reverse transaction for six months. Thus, if such person buys even 1 share, he cannot sell any shares for six months and if he sells even 1 share, he cannot buy any shares for six months. Further, such persons cannot deal, at all, in derivatives of the Company. This bar is over and above the general prohibition on insider dealing.

b) The devil in me tells me that the ban is only on such directors, etc. and the dependents of such persons are not affected by such ban!. Of course, such dependent may have to answer to the charge of Insider Dealing generally.

c) This bar also does not apply to Promoters!!! This is absurd. Of course those Promoters who are directors, officers or designated employees would face the bar. So also, the prohibition on Insider Trading generally would continue to apply.

i) The bar also does not apply to other Insiders.

d) This bar on such transactions is total. There are no circumstances whether of urgent need or otherwise under which the bar can be lifted. There is also no provision under which even SEBI could grant exemption.

e) An interesting question arises. Does the bar apply also to shares acquired through exercise of employees stock options or under a Share Purchase Scheme? This can be seen in two ways. If such a person has sold shares, can he acquire shares under an ESOPs scheme in the next six months? Alternatively, if he has acquired shares under an ESOPs scheme, can he sell shares in the next six months?

i) The crucial word to examine is “buy”. I think there is a good case to argue that the word “buy” would include shares acquired under an ESOPs scheme. However, I still think that shares acquired under ESOPs schemes are not intended to be covered. Consider a related bar on shares acquired through an IPO. The existing clause, continued without any change, requires shares acquired by such persons through IPO should be held for at least 30 days. Obviously, if the intention was to cover shares bought in any manner, then such a separate bar was not required at all. I know the provisions are not happily worded. I also know it could be argued that the 30 day lock in for IPO acquired shares is meant to be a special case. However, taking all things into account, perhaps the intention is not to cover shares acquired under ESOPs Schemes.

ii) A poser for readers. Would such bar apply to sale of shares under a buyback offer by the Company or under an open offer under the Takeover Regulations?

6) There are a few other amendments and issues.

7) A final poser for readers. What are the consequences if a director, etc. violates the ban on reverse transactions or on taking positions in derivatives? More specifically, what if a director buys 10000 shares today and sells them after 15 days (lets focus only on the six month ban for now)? The devil in me gives a strange possible answer which I will share here after one or two days - J.



Umakanth V said...

Mr. Thakur, thanks for your detailed and incisive comments on the amendments to the Insider Trading Regulation. On the definition of an “insider”, I would like to supplement your discussion on the US position in Chiarella. The new definition now brings within its fold not just tippers, but also tippees, of information. The case in Chiarella falls within the “classical theory” of insider trading where the person dealing in shares ought to owe a duty to the other shareholders with whom that person trades in order for that person to be convicted of insider trading. As you have observed, in Chiarella, since the printer owed no such duty, he was held not to have committed insider trading.

Even though the US position has advanced further with the shift towards the “misappropriation theory” of insider trading, involving the leading U.S. Supreme Court cases of Dirks v. Securities and Exchange Commission (463 U.S. 646 (1983)) and United States v. O’Hagan (521 U.S. 642 (1997)), the recent SEBI amendments go even farther than that. Under the misappropriation theory, there need not be any duty owed to the party with whom the share trading occurs, but there should be a duty owed to the party who is the source of the information, and that duty should have been breached. In other words, the tippee should owe a duty to the insider (tipper) not to trade on the basis of that information. But, the new position in India is that there is no requirement to owe such duty to anyone. If one merely “receives or has access” to such information and then trades in the shares, there is deemed to be a case of insider trading. In this extreme scenario, if one overhears a conversation in a public place (such as a restaurant or an airplane) or stumbles upon a confidential document left lying on a street corner, if that is unpublished price sensitive information, the person is automatically an insider.

In such a scenario, we still need to wait and watch as to how courts/tribunals will interpret such wide provisions, and whether they would still read in elements of mens rea or fiduciary duty into such provisions. Therefore, the test probably lies not in enacting wide legislative provisions, but in being able to successfully prosecute offenders through courts of law. Only then can we measure the effectiveness of the regulation.

Umakanth V said...

On a related note, there has been a longstanding demand from the industry and practitioners to make relaxations to the insider trading norms when private equity transactions are involved in listed companies (i.e. PIPE deals) so that investors could conduct due diligence on the target company. Here is a recent article I came across on this issue ( With the current approach to make the insider trading regulations more stringent, is there any likelihood that exceptions will be made for PIPE deals, etc. from a due diligence standpoint?

Jayant Thakur, CA said...

Thanks, Mr. Umakanth, for your very detailed comments.

Just one point. This refers to a situation where a person receives information not from the Company or from any “Insiders” (as in your example - a person finds a confidential document lying on a street corner). Would such a person be deemed to an insider under the amended definition? Maybe I am pursuing a lost cause but I wonder whether some connection between a “deemed insider” under this new category and the Company/Insiders is still required?

SEBI’s discussion paper of March 2008 which initiated these amendments recommends that tippees should also be made liable for Insider Trading. This paper clearly talks of a link between a tipper and tippee. It says “The regulations prohibit persons from tipping people about inside information by insiders i.e. the tipper. However, there seems to be no liability for a person who improperly receives a tip i.e. a tippee from trading” and then recommends that such “tippee of information be also held liable”.

Further, for there to be a tippee, there has to be a tipper. Of course, none of these two terms – tipper or tippee – find place in the new definition.

Going even further, a person who “receives” UPSI is now deemed to be an insider. For a person to “receive” something, there should be somebody to “give” it. Also, a person having “access” to UPSI is also a deemed insider and I wonder whether “access” would mean access to the source, i.e., either the Company or the original Insider.

Perhaps I am splitting hairs but I am not comfortable with the idea that such absolute liability could be created in law without saying it in absolute terms. But, as you also said, just as in case of mens rea and fiduciary duty, we will have to wait to see whether Courts read such connection also into the words.


- Jayant

Jayant Thakur, CA said...

Just one more comment on tippers and tippees, in the ligher vein, sharing an anecdote on this which I read from a book on Insider Trading.

When the term “Tippee” was proposed to be introduced in UK in 1993 through its Criminal Justice Act, 1993, there was widespread criticism. One issue extensively debated in the House of Lords by these guardians of the English Language was whether there was any word such as “tippee” and in any case whether it was elegant. Lord Wigoder reportedly said that he became a “flabbergastee” at inclusion of the word “tippee”. This was notwithstanding the fact that this term was coined as early as 1969 by Professor Louis Loss of Harvard in the first edition of his Securities Legislation. It was even included in the Oxford Dictionary in 1989.

This term was nonetheless dropped in the revised version of the Bill.

And we say that it is our politicians who waste time of Parliament on frivolous issues! - :).

- Jayant

Umakanth V said...

Mr. Thakur, I am a willing "concuree" of your views, and I hope the courts and tribunals will be as well by supplying a purposive interpretation to the definition.

Jayant Thakur, CA said...

:) :) :)!