The real new development is the expansion of the defences for honest conduct...
As was expected, Sebi came out with a spanking new regulation on insider-trading. While the new regulation is not yet in the public domain, a press release highlights the significant changes compared to the current regime. The new regulations seem to be squarely in line with the recommendations of the Justice Sodhi Committee report. The committee had done a great job with the report. There were some issues with the draft regulations the committee had attached to their report which, it is presumed, will be cleaned out. Similarly, some suggestions have been dropped from the regulations, such as the inclusion of public servants in the prohibition. There are significant changes in the new norms, but the changes are not the ones highlighted by most media.
There is no significant expansion of the definition of insider-trading, but there is an expansion of people who are deemed to be insiders. Thus, immediate relatives for example have been added to the list of deemed insiders. Such deemed insiders, if they trade in advance of publication of undisclosed price-sensitive information, would need to disprove that they in fact did not commit insider-trading. Or, as we lawyers like to call it, the burden of proof given a seemingly opportunist trade is on the deemed insider, and the person must disprove his guilt. The other class of people, or everyone else besides the deemed insiders, don’t have this albatross around their necks. So, Sebi must prove that they had access to privileged information which they misused. This is a useful expansion, but the real new development, which has not been highlighted by many, is the expansion of the defences for honest conduct.
Till now, many honest transactions used to fall within the prohibition. Many of those now have additional protection of the law. This is a great development, because the purpose of this law is to outlaw abuse of power, rather than outlaw legitimate commercial transactions. The Sebi press release specifically seeks to protect “legitimate purposes, performance of duties or discharge of legal obligations”. The classic example of such legitimate purpose is conducting of due diligence by an institutional investor or a private equity investor. Since due diligence, by its nature, means that the investor has access to price-sensitive unpublished information, the subsequent purchase after the diligence would fulfil the elements of the prohibition. That is, of trading based on access to unpublished price-sensitive information. This has been subjected to the requirement of advance disclosure of the information at least 2 days prior to the investment. The question of whether this condition imposed is practical will need to be debated. The exact impact of this to proprietary and confidential information which may become available to competitors will also need to be re-looked at by Sebi at some point of time. This point was of course hotly debated in the committee.
There has been a restriction on the definition of when price-sensitive information is considered generally available and, therefore, published. Information will be considered published only if made on the stock exchanges. This may unnecessarily chill the flow of information and reduce the flow of information. Thus, CNBC, which has viewers in the lakhs, would not be considered as a wide and simultaneous distribution of information even though many more live viewers would have simultaneous access to the information than those visiting the website of the exchange.
A provision of trading plans has been introduced as a defence to possible charges of insider-trading. The way this would work would be as follows. Let’s say a director who routinely has access to inside information needs to sell shares which are allotted to him by way of sweat equity or ESOPs. Such a person would find it quite difficult to sell shares since even though he is not exploiting an informational advantage of an insider, he could be charged of the offence. Such insiders now can plan to share their sale plans for the year ahead. For instance a sale of 50,000 shares each month, every month for the next year. Such a person would be obliged to sell, no matter how low the prices fall. But at the same time, he would be immune from charges of insider-trading since the sale was based not on the basis of inside information, but rather on the basis of a determinate and irrevocable plan. The problem with this well-meaning immunity is that it may not be practical. Since the plan has to be disclosed to the market at large, it would be easy for investors to front run the insider and exploit the fact that such insider is bound to sell no matter how low the price goes. There would be an incentive to cheat such an insider by artificially depressing prices just before the expected date of trading. This would therefore work only for companies whose shares are extremely liquid and where the trading plan is not for a very large quantity.
The scope of securities to which the prohibition applies has been expanded to include derivatives. This would be more by way of clarification, as even the old regulations would have covered such trades. A more explicit prohibition is good as an insider is more likely to use derivatives to maximise his exploits. After all derivatives provide the maximum bang for the buck if one has certain and privileged information.
Finally, a welcome move is to eliminate the multiple disclosures between the insider trading code and the takeover code. This norm of similar disclosures under different regulations caused multiplicity of disclosures, unnecessary compliance burden and no net benefit to investors.
Overall, the new regulations are welcome though they will need to be tested on the ground before a definitive conclusion can be drawn.
By Sandeep Parekh
Parekh is the founder of Finsec Law Advisors and author of the book Fraud, Manipulation and Insider Trading in the Indian Securities Market