On December 5, 2008, a comment on the recent amendments to the SEBI (Prohibition of Insider Trading) Regulations, 1992 ("Insider Trading Regulations") was made here. I have a different perspective on the issue.
Every listed company is required under Regulation 12 of the Insider Trading Regulations to formulate a code of internal procedures. Such a code is required to be modeled on the Model Code set out in Schedule I to the Insider Trading Regulations (“Model Code”). The recent amendments have inserted a mandate that such an internal code ought not to dilute the terms of the Model Code, and the listed company ought to “ensure compliance” with the such an internal code.
The recent amendments also included a prohibition, inserted in the Model Code, on directors, officers and employees of listed companies from effecting a transaction contrary to the nature executed by them within a period of six months. To put it simply, if a person covered by the internal code were to buy shares of his company, he ought not to effect a sale transaction within a period of six months.
Prior to the amendment, Para 4.2 of the Model Code entailed a position that if a person covered by the internal code were to effect a contra transaction within a period of 30 days, his original investment would not be considered to have been made “for investment purposes”. In other words, such an investment could be considered to have been made for speculative purposes. Speculative transactions by an insider would be a strong circumstance when considering a larger charge of insider trading. Demonstration of guilt of insider trading will necessarily be an inferential exercise.
The recent amendment has done away with this position and has in fact inserted a provision in the internal code that an employee ought not to effect a contrary transaction within six months. This provision is a good practice requirement that companies have been asked to implement.
A contrary transaction within six months does not necessarily mean an act of insider trading has taken place. Insider trading, in simple terms, has been defined as an act of trading while in possession of unpublished price sensitive information. The very execution of a contra trade within six months does not necessarily mean that a violative transaction has been effected. However, it is a good practice to ensure that employees are not found actively buying and selling securities of their own employer-company.
Therefore, there is indeed no need to envisage an imposition of the severest penalty of Rs. 250 million for a breach of such a “good practice” measure. Such a breach is best left to the listed employer company to punish. If the employer company does not take action, the company would be guilty of breaching Regulation 12, which now requires the company to ensure compliance with the internal code.
The scheme of good securities regulation is for the statutory regulator to be a regulator of last resort. If the market regulates itself and each unit of the market regulates its constituents (as indeed would listed companies have to regulate their employees) most of the job would be well done. Therefore, there ought not to be any concern of such a scheme of regulation laying bare a loophole, or that an unintentional lapse has occurred in formulating the regulatory scheme.
There is another aspect of the matter that should be borne in mind. When the Insider Trading Regulations mandate a listed company to formulate an internal code to govern its employees, it would follow that the regulatory mandate is that employees adhere to such an internal code. If the employee breaches the code, the employee would have breached a statutory code, which although internal, is nevertheless statutory in character.
It is settled law that regulatory legislation ought to be purposively construed, as opposed to the rule for interpreting fiscal statute, which should be strictly construed. In the event of an ambiguity in interpreting fiscal statute, the view that would favour the taxpayer ought to be adopted. However, with regulatory legislation, the view that would further the remedy and suppress the mischief ought to be adopted.
Therefore, the purpose of Regulation 12 of the Insider Trading Regulations being to provide for a framework that would entail all directors, officers and employees adhering to the internal code of conduct that is of a standard not lower than the Model Code, a breach of the internal code would arguably be a breach of the Insider Trading Regulations.
The sanction for such a breach is manifold. While a simple breach in the form of effecting a contra transaction within six months ought not to attract severe penalties, which are reserved for the specific violations listed in Section 15G of the SEBI Act, 1992 (“the Act”), the residuary penalty provision in Section 15HB of the Act which enables imposition of Rs. 10 million could arguably be invoked.
Similarly, any breach of any provision of the Act, or any of the rules and regulations made under the Act is punishable with imprisonment or fine or both. Of course, the standard of proof and the rules for sentencing in a criminal trial are far more stringent than an action for imposition of civil penalty under Section 15HB of the Act.
However, as stated earlier, if there has been a simple breach of a contra transaction within a span of six months, without any offence of insider trading (trading while in possession of unpublished price sensitive information) capable of being inferred, there would in fact be no ground to impose a penalty. Indeed, even the listed company may warn an employee against such a breach that falls short of an offence of insider trading.
More importantly, Sections 11 and 11B of the Act clothe the regulator with sweeping powers to issue directions in the interest of the capital market. Any insider found to have been repeatedly breaching even the internal code could face a direction not to act in any particular manner (perhaps even not to deal in securities of his employer company for a prescribed period), and attendant with such a direction is severe stigma, loss of reputation, and of course, a bad tarnishing of regulatory track record.
Every breach of every provision of law need not necessarily have a stringent penalty. Even where imposition of penalty is provided for, it is not necessary that penalty ought to be imposed. In Hindustan Steel Ltd. vs. State of Orissa (AIR 1970 SC 253), the Supreme Court said:-
"A penalty will ordinarily be imposed in cases where the party acts deliberately in defiance of law, or is guilty of contumacious or dishonest conduct, or acts in conscious disregard of its obligation; but not, in cases where there is a technical or venal breach of the provisions of the Act…”
The Supreme Court somewhat disturbed this position in Chairman, SEBI vs. Shriram Mutual Fund & Another by stating in an ex-parte decision that once there is a breach, civil penalty has to necessarily follow, and there is no need for existence of a guilty mind.
In the circumstances, the requirement not to execute a contra transaction within six months could in fact have severe consequences. Contra trading within the six-month timeframe on the comfort that there is no real sanction, could prove perilous.