Overhauling rules to protect investors from 'insiders'

Written by ENS Economic Bureau | Updated: Dec 16 2013, 14:24pm hrs
InvestmentInsider trading has often been pointed out as a prime reason for the dwindling confidence of minority shareholders in the stock markets.
It is an irony that minority shareholders who are critical for the stability, liquidity and depth of the securities market are always the most vulnerable lot and various interest groups try to unethically benefit at their cost. While they are at a disadvantage to the institutional investors on account of their relative incompetence in investing, they also at times feel themselves cheated at the hands of promoters, senior officials of the company or other individuals who have access to unpublished price sensitive information. The menace, popularly known as insider trading has often been pointed out as a prime reason for the dwindling confidence of minority shareholders in the stock markets.

Last week a committee appointed by the Securities and Exchange Board of India (Sebi) in March 2013, came out with its recommendations to replace the two-decade-old norms on insider trading and thereby plugging loopholes in the regulations and providing the much-needed confidence to small investors that their interests are being protected.

However, framing of new laws can only be the beginning as experts say that Sebi will have to improve on investigations to establish criminality in the court of law.

Important proposals

In a major move, the committee that was assigned with the task of framing new norms to address insider trading, has proposed to bring government officials framing policies and even judges, who have access to price-sensitive information, within the purview of insider trading norms and has recommended that they should not be allowed to trade in the stock when in possession of such information.

A new feature of the Proposed Regulations is that of treating public servants and persons holding statutory positions that are reasonably expected to have access to UPSI (unpublished price sensitive information) as connected persons and thereby prohibit them from trading when in possession of UPSI, said the report.

The committee has argued that a judge who are hearing arguments of a case and will pronounce the judgement is a connected person and similarly a public servant involved in policy framing will also qualify as a connected person.

Therefore, the restrictions on trading that would apply to connected persons would apply to such persons as well, it added.

In another major recommendation, the committee has proposed to broaden the definition of insider and said that it will presume immediate relatives (who are either financially dependent or consult an insider when trading in securities) as connected persons. It also stated that any person in possession of UPSI would be considered an insider.

The committee has, therefore, widened the definition of insider to cover larger number of individuals who have access to insider information and thereby can illegitimately benefit from the same.

It has also been proposed to prohibit insiders from communicating or providing access to UPSI to others unless required for discharge of duties or for compliance with law.

The committee has also proposed that every listed company should formulate a code of conduct to regulate, monitor and report trading in securities by its employees and other connected persons. Even auditors, law firms, accountancy firms, analysts, consultants who handle UPSI may formulate a code of conduct.

Experts feel that a look at the regulations was definitely required and it does address some of the concerns. There was a need to improve the legal provisions and the committee has worked towards bringing more clarity on definitions and expanding their scope, said Sandeep Parekh of FinSec Law Advisors.

Window for ESOP holders

The employee stock ownership plan (ESOP) has now become an important medium of incentivising the employees and it is even recognised by the regulator. However, if the regulation bans all insiders from trading them on the pretext that they have access to price sensitive information, it is not going to work.

The committee has provided a window to the insiders that allows them to trade in securities through a pre-scheduled trading plan where they will be required to disclose their trading plans for at least 12 months and would not be allowed to execute them before six months of such disclosure.

Experts say that through this option senior employees of the company will also be allowed to sell their holdings in the company, including ESOP holding. The committee, however, did not provide complete immunity from investigation on trading through such plan. The committee decided that the trading plan would not provide absolute immunity from investigation into whether such manipulation of timing had been used to circumvent the prohibition on violative insider trading, said the report.

Are stronger laws enough

While experts agree that the a look into the existing two-decade-old regulations was much desired, they feel that the real task is to improve on the quality of investigation and taking it to its logical conclusion.

Legal experts feel that a lot of individuals escape from the charges not because the law is bad but because the investigation has not been appropriate and conclusive and therefore they fall flat in a court of law.

The quality of law is very important on which the committee has admirably done. Equally important is the implementation. The test of this law depends upon the capability and integrity of the investigation, said MS Sahoo, secretary ICSI and former whole time member at Sebi.

Legal experts feel that Sebi generally tries for civil offence and not criminal offence where you can put people behind bars and that is what really deters people from committing such crimes. Sebi will have to improve the capability of its investigation team so that it can be conclusive and the crime can be established, said a legal expert.

The critical part is enforcement- how good is the investigation and analysis and that will have to be definitely improved, said Parekh. Sebi has, however, in the recent past set up a forensic cell too.

The Securities bill may be helpful

When it comes to crime related to insider trading, the Sebi Bill 2013 which is yet to be cleared by the parliament, may provide the desired armour to the Sebi to establish instances of insider trading. The bill that has already been promulgated twice as an ordinance by the President is yet to be cleared by Parliament.

It seeks to provide Sebi with powers to go through call data records which may prove to be very useful to Sebi while establishing instances of insider trading. UK Sinha, chairman Sebi, earlier this year said, The CDRs can be very useful to establish that two parties have been talking to each other and could be related entities.

Instances of strong punitive actions by Sebi such as those set up by the US Securities and Exchange Commission (SEC) in the manner they pronounced judgements in insider trading cases relating to Rajat Gupta and Raj Rajaratnam in the recent past, would really help lift investors confidence in the stock markets and their objective behaviour.

Therefore, while change in the regulations is a welcome move, Sebi will now have to focus on the real aspect of implementing it on the ground.