Insiders among us

Sebi's draft regulation on insider trading is a 21st century text that retains basic structures while introducing new standards of fair play.

Published:December 14, 2013 3:03 am

In November 1992,the (Prohibition of Insider Trading) Regulations were issued probably the first regulation from the Securities and Exchange Board of India (Sebi). Along the way,amendments occurred in 2002,2003 and 2008. Is the patchwork holding together after all these years? Some may scoff at this draft regulation (DR) as an attempt to fix what is not broken. Is it a brand new regulation or old wine in a new bottle?

The incisive comments of the chairman of Sebi’s insider trading committee,Justice N.K. Sodhi,in the preface to the report,answer that by its very nature,insider trading is difficult to prove and the initial burden to bring home a charge could be heavy. This is borne out by the low number of cases in our country. Being both a crime and a civil wrong,the law must draw a clear and bright line as to what the treatment of persons falling on either side of the line will be. Finally,insider trading is an evocative subject and warrants a regulation with precise,unambiguous and predictable terms that balances multiple,and at times conflicting,perceptions of various stakeholders in the market system. While the DR remedies existing hurdles to bringing charges,it is truly a 21st century legislation that retains the basic structure and introduces brand new standards of fair play in simple language embellished by accompanying legislative notes.

The first bright line is the change in the definition of a connected person. This identifies a person as “insider” and is clear and far-reaching in its inclusiveness — “by reason of frequent communication with its officers”,or “being in any contractual,fiduciary or employment relationship”,and “includes any person who is a public servant or occupies a statutory position”. Substituting the extant unwieldy clause that enumerates persons in possible situations of being “connected” or “deemed connected”,which are potentially endless,with a crisp principle-based definition casts the net wide for trapping insiders. The definition of insider itself therefore has not required to be changed. The explicit inclusion of public servants is not to be over-hyped,since even under the current provisions such persons could be “insiders”,for receiving or having access to unpublished price sensitive information (UPSI) and are culpable if trading while in possession.

The big change — a truly bold and meaningful legal provision — is 4(2) of the DR that lays the onus of proving the absence of insider trading on such connected persons,if called into question. All connected persons will need to be on high alert when they trade. But this is not without its set of defences,especially a simple instrument introduced as the “Trading Plan”. Industry leaders need not worry,since the DR has described how the “Trading Plan” will serve those without interest or intent of abusing UPSI that naturally vests in them. Another defence is the potentially controversial “parity” clause,that when two persons both in possession of UPSI trade with each other it will not be a violation. This may lead to a skilful synchronisation of orders,since an anonymous trading screen precludes certainty of the counter-party and the spillover of trades to other persons may provoke complaints of misuse of UPSI. Nevertheless,it may be reasonably expected that the fear of proving one’s innocence may result in a change in behaviour and inculcate respect for the fiduciary duty to shareholders. Over time,this may dispel the view in the market that insider trading is rampant. A strong yet fair law has been proposed.

The third definition that is critical to charging insider trading is UPSI. The DR substantially improves current regulations that cryptically define “unpublished” and list events as “deemed price sensitive”,which are rebuttable by the accused. The DR definition of UPSI reverts closer to the pre-2002 one. It removes deeming clauses and enumerates events that no prudent person can deny are price-sensitive. It incorporates “generally available information” to critically distinguish situations where information is or is not publicly available,the latter being a pre-requisite for establishing a charge of insider trading. Illuminating notes in the DR is a feature that harks back to simple illustrations available in hoary legislations like the Contract Act and the IPC. Though the bugbear of equity analysis and research communities has been addressed,if a research report were to contain non-public information gathered from discussions with a company the axe would fall on the research firm or the company management or both. The firm could claim that approaching the company was non-discriminatory and other firms were equally placed to do so.

The compliance officer’s role in monitoring and approving a trading plan has been made important as has the code of conduct for companies been strengthened. Having adopted a principle-based approach that any security listed on any public platform for price discovery would come within the scope of the DR,read with acceptance of “securities” as defined in the Securities Contracts (Regulation) Act,1956,the question of insider trading in government securities and currency derivatives looms large. Prices of these asset classes are dependent on actions and announcements by the government and the RBI and this leads to a much larger scope of these regulations than may have been intended.

The writer is former executive director at Sebi

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