Friday, March 17, 2017

SEBI’s Interference in a Compliance Officer’s Decision under Insider Trading Regulations – A Recent Informal Guidance

[Guest post by Suvan Law Advisors, a law firm specializing in regulatory laws. They can be reached at info@suvanlaw.com. Disclosure: Partners of Suvan Law Advisors contributories to Justice Sodhi Committee Report on Insider Trading.]

SEBI has issued a ‘path-breaking’ Informal Guidance dated February 3, 2017 to Kirloskar Chillers Private Limited (“Kirloskar Private”), which has been made public by SEBI yesterday. This guidance, which may otherwise look innocuous, sets a different tone going forward on how compliance officers may view the SEBI (Prohibition of Insider Trading) Regulations, 2015 (“PIT Regulations”).

Facts

1.   Kirloskar Private is part of the promoter group of Kiroskar Brothers Ltd. (“KBL”), which is a public listed company.

2.   KBL had issued a Code of Fair Disclosure of Unpublished Price Sensitive Information (“UPSI”) and Code of Conduct to regulate monitor and report trading by insiders of KBL (“CoC”) in accordance with the PIT Regulations.  

3.   Kirloskar Private, intending to acquire 50,000 equity shares of KBL, made an application to the Compliance Officer of KBL seeking pre-clearance under the CoC. Kirloskar Private had also attached a declaration/undertaking that it did not possess any unpublished price sensitive information.

4.   The Compliance Officer rejected the request without any grounds initially and upon request, he provided the reasoning that there is already an approved pre-clearance in place for promoters and there is no balance number of shares available to trade.

Issues

Kirloskar Private approached SEBI for an informal guidance on the following broad issues:

1.   Whether Kirloskar Private or any other entity that qualifies as a promoter group requires a pre-clearance from KBL merely because it is a promoter, even though it has no role in the management of KBL or have any access whatsoever to UPSI?

SEBI’s View: SEBI has referred to clause 6 of Schedule B of the PIT Regulations and has stated that pre-clearance is required only by “Designated Persons” if the value of the proposed trades is above such thresholds as the board of directors may stipulate. Thus, a promoter, if designated as a “designated person” by the board of directors in consultation with the compliance officer, will be required to obtain pre-clearance for trading.

2.   What are the factors that the compliance officer is permitted to consider while approving or rejecting an application seeking pre-clearance for a proposed transaction?

SEBI’s View: The Compliance Officer may approve or reject a pre-clearance request after necessary assessment as per the PIT Regulations and the Code of Conduct.

3.   Whether the Compliance Officer has the power to reject the Application of Kirloskar Private based on the grounds stated in his communications, which are extraneous to requirements of CoC and PIT Regulations?

SEBI’s View: Any question with respect to the Compliance Officer may be referred to the board of directors and audit committee for examination in accordance with extant laws and the relevant facts of the case. Further, it is assumed that any actions of Compliance Officers, Board of Directors or other entities entrusted with ensuring adherence to PIT Regulations should be to ensure compliance in letter and spirit to the PIT Regulations and not for any ulterior motive.

Analysis

This informal guidance arises out of a very interesting set of facts, and is likely to have a significant impact on how listed companies devise their Codes of Conduct going forward.

Applicability of CoC

The first crucial issue is regarding applicability of the Code of Conduct. Since the PIT Regulations in their new avatar give flexibility to companies to decide on whom the code of conduct is to be applied, it varies from company to company. According to clause 3 of Schedule B to PIT Regulations, the Code applies to designated persons, which includes employees and connected person based on their functional role in the organization. Promoters who do not have any functional role in the Company have typically not been included in the definition of “Designated Persons” by the companies.

In this case, the Code of KBL provided that all insiders, designated employees, auditors, consultants and other advisors are required to seek pre-clearance. Although promoters do not seem to be specifically covered under this definition, it is possible that they fall under one of the broad categories mentioned therein. If the definition of designated person was tighter, this situation would not have emerged.

Appeal from decisions of Compliance Officer

The decision of the Compliance Officer adversely affected the substantive right of Kirloskar Private to acquire shares. Moreover, the reasoning provided by the Compliance Officer is not acceptable to them. The informal guidance provided by SEBI rightly does not delve into correctness of the decision of the Compliance Officer. However, this does not mitigate the need to have a review mechanism from the decisions of the Compliance Officer, who has been given significant decision making power under the PIT Regulations. Hence, SEBI, taking recourse to definition of compliance officer, has viewed that an action of a Compliance Officer, whether it is extraneous to his or her powers, is to be examined by the board of directors and the audit committee.

To sum up, SEBI holds that: -

1.   Unless a promoter is designated as a “Designated Person” by the board of directors in consultation with the Compliance Officer, no pre-clearance for trading is needed.

2.   The actions of Compliance Officers, Board of Directors and other entities in adherence to Insider Trading Regulations are going to be judged from an “ulterior motive” test.

3.   An action of a Compliance Officer, whether it is extraneous to his or her powers, is to be examined by the board of directors and the audit committee.

4.   The PIT Regulations by nature are prohibitive and the applicability of its provisions is with respect to insiders and such concerned securities to which a UPSI might pertain; so that there is no undue advantage accrued to such class of investors, on account of their access to UPSI, at the expense of other investors or general market participants.

On a different note, when the PIT Regulations were being formed, a novel experiment in the form of a Trading Plan, for those who are perpetually in possession of UPSI, was suggested in Justice N. K. Sodhi Committee Report. Unfortunately, the same has not picked up for various reasons. The Committee itself had suggested a review of PIT Regulations based upon review of empirical evidence and feedback after the concept of trading plan is introduced. Perhaps the time has come up for review of the Regulations. In the next iteration of the PIT Regulations, the role of compliance officer in the gamut of obligations should be one of the critical aspects that needs to be debated.

- Suvan Law Advisors


1 comment:

Leena Bhat said...

Very informative and let's us know that the latest regulations slightly takes away the absolute power of the Compliance Officer.