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.

Disclosures

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”.

(concluded)

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.

1 comment:

Anonymous said...

But isn't it also true that the older the wine, the better?