Thursday, November 20, 2014

SEBI Reforms – Part 1: Insider Trading

Yesterday, SEBI’s board unleashed a series of capital market reforms. These relate to insider trading, delisting, enforceability of the listing agreement and several other matters. In this post, I briefly examine the implications of the reforms on regulations pertaining to insider trading.

The SEBI board has approved a new set of regulations dealing with insider trading. While the text of the regulations are awaited, here I discuss some of the broad reforms announced. The impetus for reforms in this area came from the report of the SEBI appointed committee that was issued in December 2013 (as previously discussed here). In the current reforms, SEBI has broadly adopted the recommendations of the committee on several aspects, but it has either not adopted others or made significant changes.

First, the crucial definition of “insider” has been widened to include “persons connected on the basis of being in any contractual, fiduciary or employment relationship that allows such person access to unpublished price sensitive information (UPSI).”  It expands the nature of connections a person may have with the company so as to fall within the scope of an insider. Also, any person who is in possession of or has access to UPSI would also be an insider. At the same time, some proposals of the committee in this behalf have not been accepted, such as the inclusion of a public servant with access to UPSI as a connected person.

Second, immediate relatives would be presumed to be connected persons, with the burden shifted on to them to show that they were not in possession of UPSI. The evidentiary aspects of insider trading have been given great importance given the difficulties SEBI has faced in the past to establish that a person was in possession of UPSI. While the use of circumstantial evidence has worked in some cases, in others it has failed. This burden shifting effort may end up being somewhat crucial in SEBI’s efforts to curb insider trading.

Third, as regards communication of UPSI, certain allowance has been made for “legitimate purposes, performance of duties or discharge of legal obligations”. These has been a substantial discussion about the need for communication of UPSI in genuine commercial or investment transactions, such as due diligence for a private equity investments, which fell within the scope of the prohibition under the existing regime. The new regime makes some leeway for such genuine transactions (with some conditions) that may benefit the company and its investors more generally.

Fourth, where communication of UPSI is permitted, such as in the case of due diligence discussed above, the UPSI must be disclosed to the markets at least 2 days prior to the trading in the securities. This is necessitated so that information symmetry is created in the market such that no investor has any undue advantage.

Fifth, the scope of UPSI and “publication” have been clarified. For example, for information to be generally available (so as to fall outside the scope of UPSI), such information must be accessible to the public on a non-discriminatory platform which would ordinarily be the stock exchange platform. In other words, dissemination through the stock exchange is considered the preferred channel of publication. Furthermore, the definition of UPSI has been aligned with the information and disclosure requirements under the listing agreement.

Overall, some of the changes are indeed significant, given the mixed success of the present insider trading regime. However, as is usually the case, a lot will lie in the wording of the regulations and their interpretation.

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