A Structured Digital Database benefits all—investors, intermediaries and issuers
By DB Modak
On January 1, 2021, SEBI ordered Mukesh Ambani and Reliance Industries Ltd to pay a combined penalty of Rs 40 crore for ‘manipulative’ and ‘fraudulent’ trading in November 2007. This is in addition to penalties declared in 2017, of Rs 1,000 crore. It took SEBI 10-12 years to reach these conclusions.
SEBI was established on April 12, 1988, and became autonomous on April 12, 1992. Over its short life, it has established itself as an effective regulator of India’s stock market, changing our ‘satta bazaar’ from a club of insiders into a safe space for small investors.
The US SEC team of 4,200 people regulate the US stock market with a total market-cap of $36.26 trillion, as of September 30, 2020, across some 4,400 companies. SEBI’s 800 people regulate the Indian stock market with a total capitalisation of Rs 161 trillion ($2.11 trillion), as of October 8, 2020, across about 5,500 companies. Resultantly, before the ‘Ease of Doing Business’ rankings were paused in August 2020, India ranked between fourth and 13th position (of 192), in the last five years.
A key reason was SEBI’s approach to insider trading, which has long been a global menace. The US deemed it illegal from 1934 onwards, but began strict enforcement only in the early 1980s, much like the UK. SEBI issued regulations to prohibit insider trading in 1992 itself.
The SEBI (Prohibition of Insider Trading) Regulations, 2015, are a dynamic and ambitious initiative. From April 1, 2019, SEBI requires listed companies to maintain a Structured Digital Database (SDD) to track movement of Unpublished Price Sensitive Information (UPSI) among Designated Persons (DPs) and Connected Persons (CPs). Companies must also track trading activity of DPs and CPs to prevent them from trading in company shares when they have UPSI. The SDD must be maintained, tamper-proof, for eight years. In July 2020, SEBI prohibited outsourcing of an SDD, and asked fiduciaries and market intermediaries to implement their own SDDs regarding their clients.
All these moves aim to nip insider trading at the root, to change trading behaviour from the ground up, and bring about good governance, greater protection of minority shareholders and better health of stock markets.
Why curb insider trading now?
Possibly, to protect the pillars of what is becoming a modern securities market.
One such pillar is market intermediaries. They invest significantly in locating non-inside information, using research and publicly available data—including social media content. If insider trading flourishes, such intermediaries may leave the market, making it far less efficient.
If small individual investors feel that they are likely to be ripped off by insiders, they will also leave, resulting in lesser liquidity in the markets.
Reduced liquidity will lead to the few investors paying less for stocks because of the increased risk that they won’t find a buyer when they want to sell. This too makes markets inefficient and increases cost of capital.
If insider trading continues, the number and diversity of investors drops, market inefficiency increases and businesses struggle to raise funds.
SDD benefits all: Investors, intermediaries and issuers
No other jurisdiction asks companies to create an SDD. The US SEC has powers to conduct wiretapping and other activities, but it doesn’t ask for an SDD. This innovation is a unique aid for the Indian regulator. Paper is susceptible to theft or damage. An SDD is virtually indestructible.
Issuers need money from investors. When companies comply with regulations, they show investors their commitment to protecting investor interests. Such companies are obviously better investment vehicles. They can raise more money, more easily, more affordably.
However, they need to change long-standing habits. For instance, SDDs are to be maintained since April 1, 2019. Yet several companies are unaware of the regulation or ignore it. SEBI requires secretarial auditors to report on compliance with SEBI regulations, but implementation is sketchy. People interpret the regulations to suit their level of action or inaction.
Enforcement, not just enactment, is the secret to a law-abiding society. For a law to be successful, it is not sufficient to merely enact it, it is necessary to vigorously enforce it. Few follow a law because it is on the statute book. Knowing that flouting it will result in dire consequences ensures compliance.
Intent versus action: Is SEBI doing enough?
SEBI’s regulatory pronouncements indicate intent. So do SEBI’s investigations. Several Compliance Officers (COs) have been personally penalised, and many companies too.
However, systemic rigour is less evident, investigations appear desultory, and the time to penalty is woefully long. SEBI doesn’t look interested in translating intent into sustained action. So, many companies still outsource SDDs or haven’t simply implemented an SDD. Secretarial auditors too may not report non-compliances.
Moreover, SEBI asking companies to report insider trading violations to stock exchanges is seen as proof of weakened implementation. Several company secretaries highlight continuing lack of clarity on certain regulations.
Does SEBI lack manpower? Does SEBI want to minimise the burden on companies post-Covid-19? These reasons aren’t substantial, especially since the cost of SDD implementation is tiny.
The road ahead
Simple, low-cost, low-manpower technology solutions can help SEBI enforce its well-intentioned regulations effectively. SEBI can run training programmes to engage compliance professionals via the NISM (National Institute of Securities Markets), in collaboration with the ICSI (Institute of Company Secretaries of India). Like the MCA, SEBI can run a web-questionnaire asking companies to report actual SDD implementation, or intent, by March 2021. Also, secretarial auditors can be web-asked to report the presence or absence of an SDD.
SEBI’s current approach disincentivises compliance, and encourages nonchalance, which bodes ill for small investors and the market. SEBI, as a regulator, has taken markets where they ought to go, even if they may not have so felt. Before the current slippage becomes a landslide, SEBI must act—vigorously, visibly and urgently.
The author is director, Axar Digital Services, a company that produces an SDD solution