Thursday, December 26, 2013

SAT on Insider Trading and the Role of the Compliance Officer

A couple of years ago, we had discussed the order of SEBI’s adjudicating officer imposing a penalty of Rs. 5 lakhs (Rs. 0.5 million) on the compliance officer of Satyam Computer Services Limited. We had noted that this imposed a somewhat unduly onerous obligation on compliance officers and wondered “whether a different outcome would ensue if the compliance officer in Satyam’s case were to go on appeal”.

As it happens, the compliance officer did prefer an appeal but a different outcome did not ensue, as earlier this week the Securities Appellate Tribunal passed an order confirming the findings of SEBI’s adjudicating officer. The background to the role of the compliance officer under the SEBI (Prohibition of Insider Trading) Regulations, 1992 (the “PIT Regulations”) and the more detailed facts of the case are set out in the previous post discussing SEBI’s order. To summarise, the primary issue is whether the compliance officer had a duty to close the trading window in Satyam’s shares, which he failed to discharge. On December 6, 2008, the compliance officer was informed by the chairman of the company about the potential acquisition of two other companies. On December 13, 2008, notices were sent to the board members scheduling a meeting on December 16, 2008 to discuss the acquisition proposal. In this background, SAT notes:

15. Short question, therefore, to be considered herein is, whether information relating to acquisition of two infrastructure companies by Satyam disclosed by Chairman Mr. Ramalinga Raju to appellant on December 6, 2008 was a price sensitive information warranting closure of trading window by appellant as Compliance Officer and if so, for failing to close the trading window when in possession of such price sensitive information, whether, imposition of penalty of ` 5 lac upon appellant is justified?

The SAT found an obligation on the compliance officer to close the trading window on December 6, 2008 upon receipt of information regarding the fact that the company was considering the acquisition proposal. This was despite the premature nature of the proposal, which was only tentative at that stage and was yet to be considered by the board, which may or may not have approved the proposal at the scheduled board meeting. SAT states:

18. … Model Code contained in PIT Regulations further requires Compliance Officer to keep the trading window closed during the period when information referred to in para 3.2.3 is unpublished. Object of keeping the trading window closed under para 3.2.3 of Model Code in addition to prohibition contained in regulation 3 of PIT Regulations is to doubly ensure that directors/officers and designated employees of the Company do not misuse ‘Price Sensitive Information’ and trade in securities of the Company while in possession of such unpublished price sensitive information. Therefore, Compliance Officer is mandatorily obliged under Model Code to keep the trading window closed when in possession of price sensitive information specified in para 3.2.3 of Mode Code. If Compliance Officer fails to close the trading window inspite of being in possession of price sensitive information, then he would be violating PIT Regulations. In such a case, whether any employee/director by taking undue advantage has traded in securities of that company or not, Compliance Officer would be liable for violating PIT Regulations.

The onerous nature of responsibilities imposed by SEBI have been confirmed by the SAT, which therefore requires careful consideration of situations in which compliance officers must act in order to close the trading window so as to not fall afoul of their obligations under the PIT Regulations.

Wednesday, December 25, 2013

SEBI Proposal for Infrastructure Investment Trusts

Recognizing the deficit in financing infrastructure development in India, SEBI has floated a proposal for a separate investment vehicle for infrastructure investments. Last week, it issued a Consultation Paper on Infrastructure Investment Trusts, on which comments are invited from the public by January 20, 2014.

SEBI’s rationale is to ensure that the lack of an effective investment framework does not hamper infrastructure investments and development of the sector. SEBI seems to have been inspired by specific investments structures elsewhere such as the business trust in Singapore and Hong Kong as well as the master limited partnership in the US (which we have discussed earlier).

SEBI has suggested two plausible mechanisms to set up investment trust facilities. One is to create it as a special category of mutual funds by way of a separate chapter in the SEBI (Mutual Funds) Regulations, 1996. The other option is to create a new vehicle of infrastructure investment trusts (InvITs), under a new set of regulations to be promulgated for the purpose. In either scenario, the investment is to be obtained into a special purpose vehicle (SPV) that carries out the infrastructure project.

The primary purpose of the proposal is to attract greater equity investment in the infrastructure sector. It also allows the sponsors of infrastructure holdings to monetize their investments, somewhat similar to the facility provided by real estate investment trusts (REITs) to developers of real estate projects.

Whichever model is followed for infrastructure investments, it is accompanied by stringent conditions regarding the type of investments, stage and type of infrastructure projects, manner and extent of distribution of profits, etc. The conditions are too detailed to merit a discussion in this blog post, but they can be found in the consultation paper.

While this is an interesting effort on the part of SEBI to facilitate infrastructure investments, there could be doubts regarding the impact it may have in actually promoting the same. Past experience has suggested that creation of additional investment structures and routes may not necessarily translate into greater flow of investments to the desired extent. Moreover, the foresight displayed by SEBI in this regard must be supplemented by reforms to be initiated by other related regulators, a matter that SEBI itself has acknowledged in the consultation paper. For example, the RBI would have to provide facilities for foreign investment in instruments to be issued by InvITs. The tax authorities will have to create the necessary environment to attract the required investments. Often, such matters may not necessary follow within a short time frame, thereby leading to dwindling responses from the investors. The route established by SEBI for qualified foreign investors nearly two years ago is a case in point.

Finally, the quagmire faced by infrastructure development and financing is a deeper one. Of this, equity investments in the infrastructure sector form only a small part. The present step by SEBI will address only that part. The larger issues relate to the availability of debt financing, the lack of depth of the corporate bond markets, the fact that the bankruptcy regime in India is still behind the curve, and so on. These are apart from the other concerns in the infrastructure sector that pertain to project-related issues such as land acquisition, permits and consents, environmental issues, resettlement and rehabilitation, etc. Granted that SEBI’s role is limited to the equity and bond markets, but its efforts will have to be considered in the light of the bigger picture.

RBI’s Stance on Bitcoins and Other Virtual Currencies

Earlier this month, we had highlighted some legal issues pertaining to Bitcoin, as that form of virtual currency has been gaining ascendancy the world over. We had stated that the Reserve Bank of India (RBI), as the currency regulator, would certainly be seized of the issue. It now emerges that it is indeed the case.

Yesterday, the RBI issued a press release warning users, holders and traders of virtual currencies (VCs), including bitcoins, of the various risks they may be exposed to. After noting that bitcoins and other VCs are not authorised by any central bank or monetary authority, the RBI also states that “it is presently examining the issues associated with the usage, holding and trading of VCs under the extant legal and regulatory framework of the country, including Foreign Exchange and Payment Systems laws and regulations.” The RBI highlights some of the specific risks and concerns with the use of VC, for which interested or affected readers are advised to refer to the specific terms of the press release.

The present effort is merely an interim one to serve as a caution to the public. It is possible that a more detailed pronouncement regarding the legality and acceptability of VCs under the banking, payment and foreign exchange laws can be expected in due course. One cannot envisage anything but for the RBI to tread cautiously in this field, which is beset with imponderables that leading financial regulators around the world are grappling with.

Monday, December 23, 2013

Overhauling the Insider Trading Regulations: Part 3

[This is a continuation of two previous posts (here and here) in this series]

Trading Plan

The Committee has recommended the concept of a trading plan, which is novel in the Indian context but prevalent in some other jurisdictions. This concept has been recommended almost on an experimental basis, to be reconsidered by SEBI based on the initial experience. Such a trading plan has been found to be necessary to facilitate regular trading and monetizing of securities by insiders on a regular basis who may otherwise be unable to trade in securities of the company. The logic appears to be that once a trading plan has been established by an insider without being in possession of UPSI, then it does not matter if such insider subsequently comes into possession of UPSI because the decision to trade has already been taken prior to that.

The facility of a trading plan has been recommended with several conditions so as to prevent any abuse of the mechanism. For example, trading can be commenced only after 6 months of the public disclosure of a trading plan – a sort of cooling-off period. No trading is permitted around the time of declaration of financial results. The trading plan must be for a period of at least 12 months, thereby requiring a long-term commitment on the part of the insider. The details of the trading plan must be announced and also disclosures regarding the actual trades effected.

The concept of a trading plan would bring some certainty to insiders who may wish to trade. This is particularly so because in several cases under the existing Regulations, parties have adopted the argument before SEBI or SAT that trades were carried out as part of their regular investment / divestment plans not just in the company concerned but more generally in respect of their other investments. This has often operated persuasively to suggest that the insiders were not trading on the basis of UPSI. The trading plan mechanism will now formalize such an arrangement by imposing more objective conditions. It remains to be seen, however, whether the trading plan will utilised effectively, and more importantly that it will not be subject to abuses. As the Committee notes in its report, the experience from other jurisdictions where the concept is prevalent has not been without controversies.


Disclosure obligations are quite pivotal in insider trading regulations, especially for acquisition and disposal of shareholdings by promoters and other substantial investors. The existing Regulations do contain significant obligations on disclosure of material investments and divestments. That approach has been further solidified in the proposed regulations, which require promoters, employees and directors of the company to notify the company of their holdings, and also material changes in the holdings from time to time. The company in turn has obligations to notify the stock exchange so as to make the disclosures public.

Code of Conduct

The regulation of insider trading tends to be enforced in two ways, i.e. (i) through public enforcement by the regulator, and (ii) self-enforcement by the companies themselves. This two-pronged approach, which is embodied in the existing Regulations, is sought to be continued in the proposed regulations as well. Hence, listed companies and market intermediaries are required to establish a code of conduct on insider trading and also for fair disclosure of material information.

Burden of Proof

The evidentiary aspects of insider trading are crucial, as they can determine the effectiveness of substantive regulation. Often, there is no direct evidence in insider trading cases, and regulators are compelled to rely extensively on circumstantial evidence. This makes the task of the regulators highly onerous. In India, given that insider trading is a serious offence, the SAT has laid down a fairly significant burden before an insider trading charge can be sustained. Given this background, the explicit statement by the Committee regarding the relative burdens of the regulators and the insider is welcome.

The Committee’s proposal is that the burden on the regulator is to show that a person is an insider and that he or she was in possession of UPSI at the time of trading. Thereafter, the burden shifts to the person to show either that he or she is not an insider or that any of the defences is available. However, the Committee has refrained from specifying greater details regarding the evidentiary burden as that is left to the facts of each individual case. While this approach is helpful, a lot would depend on the manner in which the proposed regulations are implemented by the regulator and the appellate authority (i.e. SAT). If, on the facts of each case, the burden of the regulator is progressively raised, then effectiveness of the regulations may be in doubt. Hence, there is a need for appropriate sensitization of the implementers of the regulations as to the burden of proof and other evidentiary aspects (given that most evidence in this area is likely to be circumstantial). For example, US courts have remained open to finding a charge of insider trading solely on the basis of circumstantial evidence.

Short Swing Profits

One area that has not received express attention in the Committee’s report relates to the rule against short swing profits. After substantial debate, the existing Regulations were amended in 2008 to state that insiders who buy or sell shares in a company shall not enter into an opposite transaction, i.e. sell or buy, respectively, any shares during the next 6 months following the prior transaction. Insiders are also prevented from taking positions in derivative transactions in shares of the company at any time. The proposed regulations do not provide for a similar rule against short swing profits. However, there is no discussion in the report as to whether this was considered and debated before arriving at a conclusion to drop the rule.

Concluding Observations

The review of the insider trading regulations is timely, and provides the much needed certainty and clarity in that area of the law. However, its effectiveness will depend upon the manner of implementation by the regulator and interpretation by the appellate authority.

The Committee has adopted a somewhat novel approach (at least in the Indian financial regulation context) of providing notes and explanations to the specific regulations that will aid their interpretation and thereby minimize any ambiguity. The notes are stated to be an integral part of the regulations, and not merely an external aid. While this is a useful approach, one cannot rule out difficulties that may arise in the interpretation. For example, if there is a conflict between a regulation and its note/explanation, which one would prevail?

To conclude, the review is a necessary step, but if the implementation is not effective it carries the risk of being the proverbial “old wine in a new bottle”.


For a further analysis of the Committee’s recommendations and proposed regulations, please refer to the following:

1. Discussion on The Firm – Corporate Law in India;

2. Sandeep Parekh in the Financial Express (here and here);

3. Tejesh Chitlangi in The Hindu; and

4. S. Murlidharan in FirstPost Business.

Sunday, December 22, 2013

Overhauling the Insider Trading Regulations: Part 2

[This is a continuation of a previous post in this series]

Operative Provisions

The operative provisions (or charging provisions, as they are referred to by the Committee) go to the heart of the prohibition on insider trading, which also constitutes an offence for the breach thereof.

 The scope of insider trading usually tends to capture two somewhat distinct but related aspects:

1. The communication or procurement of UPSI by an insider; and

2. The trading in securities by an insider while in possession of UPSI.

Each of these aspects has been considered distinctively in the Committee’s report, which are accordingly discussed here as well.

Communication or counseling

The proposed insider trading regulations stipulate that an insider shall not communicate or provide access to UPSI, except where such communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations. This would ensure that insiders communicate UPSI only on a need basis, and not such that the information is liable to be misused by the recipients to indulge in trading in the company’s securities.

Due Diligence

While the aspect of communication or counseling is understandable as an integral part of the offence of insider trading, this prohibition has hitherto given rise to several practical difficulties. Primary among them is the fact that this prohibition makes it impossible for companies to provide information to potential investors who may be willing to invest in the company only after conducting the customary due diligence by investigating into the affairs of the company. Since the benefit of such due diligence is not available to other shareholders or potential investors in the company, it could create an informational disparity.

Although facilitating such due diligence would cause the company to breach its obligation not to communicate UPSI, there are sound arguments put forward to justify such due diligence efforts.  No investor would be willing to infuse a substantial amount of funds in a company without conducting due diligence. This is particularly the case with long-term investors, both strategic as well as financial (such as private equity funds), or even in the case of an M&A such as a takeover that may be in the overall interest of the company. The argument is that such investment would benefit the company as a whole and therefore the release of information in due diligence ought not to breach the rationale against insider trading. This argument tends to have greater force when such investor is investing in new shares to be issued by the company because the company thereby obtains additional funding for its business requirements. It may have lesser force when the investor is buying shares in the secondary market from an existing shareholder because the proceeds of such an acquisition go to the shareholders rather than to the company, although the company may derive indirect benefits.

Under the existing Regulations, there is considerable ambiguity about the workability of the arguments and rationale discussed above. Going by the plain wording of the Regulations, it appears that communication of information during due diligence would amount to a technical breach. While SEBI does not appear to have initiated legal action against any company for violation of insider trading regulations merely on account of facilitating a due diligence, it has refrained from positively acknowledging that such due diligence is permissible. This has given rise to a great deal of ambiguity, due to which parties have been compelled to either conduct a limited due diligence so as to not constitute a technical breach of the regulations, or to follow other methods such as disclosing any such information before the investment actually occurs so as to not fall afoul of the regulations.

Fortunately, the Committee has addressed this practical issue head-on, which is likely to put at rest this thorny issue which has been daunting transactional lawyers in India for several years now. Under the proposed regulations, due diligence would be permitted in specific circumstances. A distinction has been made in cases where the investment or acquisition would result in an open offer under the takeover regulations, and in other cases where no such open offer is attracted. When an open offer is attracted, the board of the company must be of the informed opinion that the transaction and the due diligence are in the best interests of the company. This would enable M&A transactions such as mandatory takeover offers to be accompanied by due diligence that would benefit the potential investors/acquirers. Arguably, since the mandatory takeover offer would be made to all shareholders uniformly at a minimum price to be determined under the takeover regulations, the disclosure of selective information to the acquirer would not materially jeopardize the interests of the other shareholders.

Where the obligation to make an open offer is not attracted under the takeover regulations, an additional condition has been imposed. That is, the due diligence findings that constitute UPSI are disseminated to be made generally available at least 2 trading days to the effective date of the transaction. While the concerns of the Committee are understandable, this requirement could give rise to some concerns.  It is not clear as to how the markets would deal with the disclosure of such information, and whether this could result in some sort of speculative trading or other unintended consequences. This aspect will have to be carefully considered not just from a regulatory perspective, but also from transactional planning perspective when parties are considering the structuring and implementation of a transaction and the manner in which they would disclose specific information. A lot would depend on the manner in which market practice evolves on this count.

Trading and UPSI

The principal charging provision in the regulations prohibits an insider from trading in securities when in possession of UPSI relating to such securities. This is a considerably wide provision. All that is required for an offence to be committed is that the insider was in possession of UPSI at the time of trading.

The wording of this proposed regulation is consistent with the 2002 amendments to the existing Regulations, but is wider than its original form introduced in 1992. In the original form, the prohibition applied only if the trading was “on the basis of” the UPSI.  This required an element of correlation such that the trading was occasioned by the presence of the UPSI, which was an element always difficult to prove on the part of the regulator. In order to avoid the need for such a correlation, the wording was altered in 2002 to read that the insider ought to be merely “in possession of” the UPSI  at the time of trading. While this wording should have made it easier for the regulator to initiate and successfully conclude insider trading actions, that has not been the case due to the higher burden imposed by the Securities Appellate Tribunal (SAT) in various cases.  Although not entirely evident from these rulings, the higher burden may have been a result of the fact that the penalty section for insider trading under section 15G of the SEBI Act continues to carry the words “on the basis of”.  This results in an incongruous position whereby the charging provision is considerably wider than the penal provision, thereby resulting in the inability of the regulator or the appellate authority from successfully imposing a penalty using a reduced burden of proving a case of insider trading.

In order to obviate this incongruity, it is necessary that section 15G of the SEBI Act be amended to bring it in line with the regulations on insider trading. Of course, this requires legislative intervention and is beyond the purview of the Committee, but it is hoped that the final recommendations of the committee as well as SEBI’s efforts in implementing it would include persuading the Central Government to initiate and ensure the passage of the requisite amendment to section 15G. Failing this, the efforts of the Committee in streamlining the regulations on insider trading would be set at naught due to this somewhat minor incongruity which may have rather severe ramifications in the implementation of the regulations.


The scheme adopted in the proposed regulations is to have an omnibus charging provision relating to insider trading, which would be carved out by specific defences available to the insiders. Such an approach creates a carefully crafted balance between the duties and obligations of the regulator on the one hand and the insiders on the other. To start with, the regulator would have to demonstrate only that the insider had possession of UPSI while trading in the securities of the company. The burden then shifts to the insider to demonstrate that he did not have the UPSI in or that he was entitled to one or more of the defences made available.

The defences set out by the Committee take into account several practical considerations where the direct prohibition on insider trading may not have the requisite effect. Some of the differences set out are as follows:

1.  Where the trading by insider is contrary to the nature of the UPSI, for example where an insider sells the shares of a company when the UPSI is of a positive nature, and vice versa;

2. Where a tippee has received information from a tipper and had no reason to believe that the information he possessed was UPSI;

3.  Where the counterparty in a transaction has the same level of UPSI as the insider, due to which there exists no informational disparity;

4.  Where an insider exercises stock options for which the exercise price was predetermined in accordance with the regulations applicable to stock options;

5. In case of companies and other entities, where the individual making the decision to trade in the securities of a company is different from the individual who has position of UPSI, which is a classic instance that occurs when there are systems and procedures for separating information through appropriate Chinese walls.

These defences could be useful for insiders who can demonstrate that they were not motivated by the existence of the UPSI when they carried out  trades in the securities of a company, although the burden of establishing the application of  one or more of the differences would lie on the insider.

In the next and final post, I discuss some of the other miscellaneous provisions of the regulations proposed by the committee, and conclude by making some general observations on the overall tenor and approach of the report.

(continued in Part 3)

The Law Governing the Arbitration Agreement and Ostensible Authority of an Agent

The influence of the principle of ‘severability’ of arbitration agreements, some may think, has extended far beyond the core problem it was intended to deal with: allowing an arbitral Tribunal to determine the existence or validity of the contract that contains the arbitration clause. Nor is it necessarily confined to arbitration agreements: the underlying principle is that a defendant who denies that a contract ever came into existence, or that it is valid, must first run that argument before the forum chosen (arbitral Tribunal or court) in the putatively valid contract. This principle is illustrated in the classic speech of Lord Hoffmann in Fiona Trust v Privalov. But it is not—as Lord Hoffmann himself recognised—without exceptions and it has also given rise to difficult questions about the effect it has on other well-established principles of arbitration law or the conflict of laws. Hamblen J considered two such issues in his recent judgment in Habas v VSC. The first, the law governing the arbitration agreement, is a well-known controversy in Indian law as well. It is a question of great practical importance in India, with the rapid growth of neutral arbitration clauses especially where the law governing the main contract is not the law of the country of the seat (for example an Indian and a Japanese company enter into a contract governed by Indian law but with a London arbitration clause). The second issue in Habas is a novel and interesting point that highlights the importance of a close analysis of the Fiona Trust principle—suppose a defendant enters into a contract through an agent who, it is said, lacked actual authority to agree to a particular seat of arbitration (but not to arbitration itself as a mode of dispute resolution), can the seat be treated as a relevant factor in the choice of law analysis?

The first question has produced somewhat contradictory answers in the English courts in recent years. The starting point is uncontroversial enough: as with any contract, the applicable law is the law expressly or impliedly chosen by the parties or, in the absence of choice, the system of law with which the transaction has its ‘closest and most real connection’. However, the principle of severability has led some to suggest (notably in C v D) that the arbitration agreement may be more closely connected to the seat of arbitration even if the matrix contract is not, on the footing that it is a (separate) agreement to resolve disputes. As Shantanu has pointed out, the most recent Court of Appeal authority on this point—Sulamerica v Enesais not easy to interpret. Indeed, signalling that the courts may be retreating from the obiter views expressed by Longmore LJ in C v D, Andrew Smith J recently held, after considering Sulamerica, that the choice of a law to govern the matrix contract is an ‘implied’ (and perhaps even ‘express’) choice of the law governing the arbitration agreement. However, the seat retains its importance in cases where the parties do not choose a law to govern the matrix agreement: it is likely in such cases that the law of the country of the seat will govern the matrix contract as well as the arbitration agreement, unless there are strong indications to the contrary. In Habas, Hamblen J accepted this (at [101]) but was faced with a more difficult question: what if the defendant alleges that the agent lacked actual authority to agree to that particular seat of arbitration? Can the seat then be used as an indication of closest connection?

This question arose in a dispute between a Turkish manufacturer of steel [“Habas”] and a Hong Kong engineering company [“VSC”] over whether a contract for the sale (by Habas) of steel had indeed been concluded. In the course of negotiations for this contract, Habas and VSC never communicated with each other directly: Habas acted through its agent, Steel Park, which communicated with VSC or another agent, Charter Alpha. In cases like this, it is more usual to find the defendant alleging that there was no contract because some essential term was not agreed or that its agent was bribed and so on and therefore that the chosen forum lacks jurisdiction. In this case, however, the disagreement between the parties during negotiations was not about the commercial terms but about dispute resolution: VSC had initially proposed Hong Kong arbitration and Hong Kong governing law while Habas had proposed Turkish arbitration and Turkish governing law. The last draft of the contract that Habas directly signed contained an arbitration clause with a Turkish seat. However, VSC later proposed to amend the seat to London and Steel Park accepted that amendment. A London arbitral Tribunal found that it had jurisdiction and awarded VSC damages for Habas’ failure to supply the agreed steel. Habas challenged the jurisdiction of the Tribunal on the ground that, under Turkish law, Steel Park would not be treated as having had actual or ostensible authority to bind it to London arbitration. This was notwithstanding the fact that Habas, in October 2009, had issued an ‘Agency Letter’ to Steel Park which had been forwarded to Charter Alpha and VSC—this letter would, under English (but not Turkish) law, have given Steel Park ostensible authority to conclude an agreement to sell steel with a London arbitration clause. So to resolve the jurisdiction question, it was necessary to ask the first question set out above: what law governs the arbitration agreement? Since the seat of arbitration under the putatively valid contract was London, and since the contract contained no choice of law clause for the matrix agreement, Hamblen J held that English law prima facie governed the arbitration agreement.

It is important to notice that this case differs from many cases on this subject in this way: here the defendant’s attack on the seat of arbitration was not parasitic on an attack on the main agreement (bribery, failure to agree essential terms, contract invalid under proper law etc): the attack was specifically on the seat of arbitration since Steel Park was said to have lacked actual or ostensible authority to agree to London arbitration (although not to arbitration itself). So Habas argued that the fact that London was the seat of arbitration had to be disregarded in the choice of law analysis in which event Turkish law would become the proper law, under which Steel Park would have lacked ostensible authority. Virtually the only authority for this proposition is the following passage from Dicey, Morris and Collins in relation to a choice of law clause:

… it may be thought unlikely that P [ie principal] could be bound and entitled by virtue of a law which governed the contract with the third party only because A [ie agent], in excess of his actual authority, agreed to its selection as the applicable law.  The problem is similar to that raised by the question of capacity and can be resolved in a similar way.  Where the agent exceeds his authority in choosing the law to govern his contract with the third party, P should only be regarded as entitled or bound if he would be so under the law applicable in the absence of choice.

Hamblen J declined to accept the argument made in this passage for a number of reasons, the most important of which (apart from prior Court of Appeal authority) were that there is no “logical or principled link between the issue of authority and the issue of the law with which the contract has its closest connection” [108] and that “it involves English law according special treatment to actual authority for conflicts purposes”. In other words, since the (putatively valid) contract contained a London seat, the arbitration agreement was governed by English law; since it was governed by English law, Steel Park did not lack ostensible authority to agree to a London seat; therefore the Tribunal did not lack jurisdiction. It is respectfully submitted that this conclusion (although perhaps inevitable at first instance given prior authority) may need to be reconsidered in appeal because it does not appear to sufficiently distinguish between a direct attack on the seat or the choice of law and an attack on those matters through an attack on the main agreement. If Habas had argued that the entire contract was void and therefore there was no arbitration clause or London seat, Hamblen J’s decision would have been perfectly right; but it is not inevitable that the same answer must be given when the argument is that the arbitration clause is void or (as in this case) the chosen seat could not have been chosen by the agent. 

The parallel to Fiona Trust is clear, with the important difference that Habas’ argument did not deny authority to conclude an arbitration agreement (which Lord Hoffmann accepts is an exception to his general rule, at [17]) but rather said that although the agent could have agreed to arbitration, it could not have agreed to a London seat. Hamblen J is correct that there is no ‘logical link’ between this lack of authority and the applicable law, since the seat is only taken as an indication of with which system the contract is most closely connected, but it is not clear why there should be, as long as the choice of this seat is specifically attacked (whatever the reason for the lack of authority). Of course, Hamblen J rightly points out that Habas’ argument went further than this: it was not confined (as Dicey, Morris and Collins is) to the choice of law clause itself but extends to any clause that is relevant in the choice of law analysis. One may indeed ask: if the DMC argument is extended (as Habas argued it should be) to an attack on the seat, why should it not be extended to an attack on any other clause that is relevant to the choice of law question, such as place of performance? Ultimately that may be the strongest argument in favour of Hamblen J’s view and it seems likely that this question will be considered by the appellate courts in the future.

Saturday, December 21, 2013

Overhauling the Insider Trading Regulations: Part 1


The legal regime governing insider trading in India is at least two decades old. The SEBI (Prohibition of Insider Trading) Regulations, 1992 were one of the initial few regulations that were prescribed by SEBI upon its establishment. However, the experience regarding the implementation of the legal regime on insider trading has been fraught with considerable difficulties. Although several actions were initiated by SEBI, including a few high profile ones, its track record of success has been far from clear. A substantial part of it had been attributed to the lack of robustness in the SEBI Regulations.

Taking that into account, several incremental amendments were made to the Regulations in 2002 largely as a result of the lessons learnt from the experience until then. While these efforts were helpful in plugging some of the more obvious loopholes in the Regulations, SEBI more recently found the need for a complete overhaul of the Regulations so as to provide an efficient means to curb undesirable insider trading and to enhance fairness and information symmetry in the capital markets.

Towards this end, earlier this year SEBI appointed a committee under the chairmanship of Justice N.K. Sodhi to review the existing insider trading regulations and to propose necessary changes to the legal regime. After consultations and deliberations, the Committee issued its report last week along with the proposed draft of the SEBI (Prohibition of Insider Trading) Regulations, 2013.

The Committee’s report identifies the inadequacies of the current legal regime and seeks to address them not just through incremental changes, but by reconsidering the regulatory approach. Given the importance of robust regulation of insider trading as a means of ensuring confidence of investors in India’s capital markets, this represents an important step. The report and draft regulations seek to streamline the regulatory approach, to simplify the regulations and to reduce the ambiguity and amorphousness that pervaded the pre-existing regulations.

In this series of posts, I propose to highlight some of the key recommendations of the committee and discuss the likely impact it may have on combating insider trading in the Indian markets.

At the outset, it is interesting to note that the proposed regulations adopt the approach of setting out detailed definitions that are carefully constructed followed by relatively straightforward operative or charging provisions. Hence, there is a lot at play in the definitions.  It would be useful to discuss the scope of some of the definitions before dealing with the operative provisions.



The insider trading regulations apply to listed companies or those that are proposed to be listed on a stock exchange. The expression “company” would include other types of entities that are eligible to access the capital markets.

Since SEBI possesses jurisdiction over listed companies or those that are to be listed, there is no difficulty when it comes to the application of the insider trading regulations to such companies. This is also consistent with the provisions of the Companies Act, 2013, which the Committee has expressly taken note of.

One concern here relates to the application of the law against insider trading to public unlisted companies and private companies.  This is not within the purview of SEBI and hence the beyond the scope of the Committee.  However, at a more general level the provisions of the Companies Act, 2013 (primarily section 195) that contain a prohibition against insider trading also apply to public unlisted companies and to private companies. This is bound to give rise to practical difficulties. Not only will the prohibition against insider trading become applicable in an unnecessarily wide manner, but it also militates against the concept and understanding that insider trading is relevant only in a market that is capable of price discovery, i.e. where there is a market for securities and therefore liquidity, which arise only in the case of listed companies.


As far as the types of instruments to which the prohibition applies, the Committee was of the view that it would apply to all types of “securities”, a term which has been defined in the Securities Contracts (Regulation) Act, 1956. Hence, the scope of the regulations would cover plain vanilla instruments such as shares, debentures and bonds, as well as more sophisticated instruments such as hybrids and derivatives.


The definition of an “insider” has been considerably streamlined. It now means either a “connected person” or any person who is in possession of unpublished price sensitive information (UPSI). The previous distinction between a connected person and deemed connected person has been done away with.

In this scheme of things, every connected person would be an insider. Apart from that, any outsider who may be in possession of UPSI would also be considered an insider.

The definition of a  “connected person” has received greater attention. According to the Committee’s recommendations, such a person requires association with the company in any capacity due to which it may receive access to UPSI. The immediate relatives of such a person are also generally considered to be connected persons unless they can establish otherwise.

Two aspects of this definition require greater discussion. First, a person may become a “connected person” even if such person does not carry a formal position within the company. Therefore, advisers, external consultants and the like (whether in a formal or informal capacity) would be captured within the definition. The relevant test is whether the person is “associated with a company in any capacity including by reason of frequent communication with its officers or being in any contractual, fiduciary or employment relationship”.  Compared to this, the approach under the existing regulations appears to require the existence of a formal capacity, as SEBI had decided in an earlier order discussed here. The scope of a connected person is therefore somewhat widened.

Second, the expression “connected person” is defined to encompass any person who is a public servant or occupies a statutory position that allows such person access to UPSI.  As discussed in the Committee’s report, such persons would include a judge deciding a case pertaining to the company, or a public servant who maybe involving in formulating policy that may affect the operations of the company. Although the express statements in the report only cover members of the judiciary and the executive, the scope of the prohibition may very well extend to members of the legislative arm of the government. The committee may have drawn inspiration from the legislative developments in the US where the STOCK Act or the Stop Trading on Congressional Knowledge Act seeks to apply insider trading rules to members of Congress and their staff. While the inclusion of public servants within the scope of the insider trading regime is necessary and overdue, much will depend upon how forcefully the legal regime is implemented against them.

UPSI and Generally Available Information

The committee has sought to provide a somewhat exclusionary definition of UPSI.  It means any information that is not generally available and which, if made available, is likely to materially affect the company’s securities. Although the definition of UPSI includes certain specific matters such as financial results, dividends, changes in capital structure, M&A and changes in key management personnel, these are only indicative in nature and do not constitute mandatory UPSI. This represents a significant departure from the existing regulations where such significant pieces of information are deemed to constitute UPSI.

Since UPSI is defined with reference to information that is not generally available, the expression “generally available information” acquires importance. It is defined to mean information that is accessible to the public on a non-discriminatory basis and includes research and analysis based thereon.  Although the definition itself is fairly simplistic, it is accompanied by a detailed explanation on what amounts to generally available information. A parallel to this is the concept of publication under the existing regulations, which has been the subject matter of a great deal of consternation. For example, there have been questions as to whether the publication has to be by the company itself or by third parties such as the media, and whether the information has to be general in nature or specific as to the details. This was the basis on which the appellate authority was unable to find a charge of insider trading against Hindustan Lever Limited and certain of its officials in the first high-profile case of insider trading in the mid-1990s.

While the Committee report and the draft regulations seek to provide the much necessary explanation and categorization of what amounts to generally available information, it might be too much to expect complete certainty in this behalf, as much would also depend on the facts of specific cases which would have to be interpreted by the regulators and the courts.


Finally, in terms of definitions the Committee seeks to clearly define the expression “trading” in order to distinguish it from the wider expression “dealing”. “Trading” means the acquisition and disposal of securities. Hence, creating a security over the shares of a company would not amount to “trading” in those securities.

In the next post, I will discuss some of the more operative provisions proposed by the Committee.

(continued in Parts 2 and 3)