Photographer: Alex Kraus/Bloomberg

Insider Trading Regulations: SEBI Notifies New Rules Of The Game

Starting April this year, listed companies will have to deal with a narrower definition of unpublished price sensitive information (UPSI) and they’ll be able to share such information for board-determined legitimate purposes but only if the disclosure is in the best interest of the company.

Market regulator SEBI has recently notified amendments, approved in September last year, to its insider trading regulations. The changes were prompted by the recommendations of the Fair Market Conduct Committee chaired by TK Viswanathan.

UPSI: Scope Narrowed?

So far, in describing the scope of UPSI, SEBI regulations listed information relating to:

  • Financial results.
  • Dividends, change in capital structure.
  • Mergers, de-mergers, acquisitions, delistings, disposals and expansion of business and such other transactions.
  • Changes in key managerial personnel.
  • Material events in accordance with the listing agreement.

Come April, ‘material events in accordance with the listing agreement’ will cease to be included in the definition of UPSI. The TK Viswanathan committee had pointed out that the listing regulations require disclosures of material events or information which may or may not be price sensitive. And so, the committee had suggested for its explicit exclusion from the definition of UPSI.

This exclusion doesn’t necessarily narrow the scope of information that can be UPSI, Sumit Agrawal, founding partner at RegStreet Law Advisors, pointed out. But it helps in reducing confusion since it was subjective as to whether a particular piece of information required disclosure under listing regulations or not, he added.

Haigreve Khaitan, a partner at Khaitan & Co. and member of the Viswanathan committee, which had recommended this change, agreed. He pointed out that the UPSI definition is an inclusive definition and anything that is material and price sensitive is already covered.

Because of the extensive nature of the listing agreement now, there can be events which have no bearing on price. For instance, appointment of a director or the term of a director getting over. This requires a notification under the listing agreement. Just because I’m notifying this under listing agreement doesn’t mean this information has any bearing on the price. 
Haigreve Khaitan, Partner, Khaitan & Co.

Legitimate Purpose: Onus On Boards

Currently, SEBI’s insider trading regulations prohibit communication and procurement of UPSI, unless it’s for legitimate purposes, performance of duties or discharge of legal obligations. But what qualifies as a ‘legitimate purpose’ is unclear. After its September board meet, SEBI had indicated that it will define ‘legitimate purpose’ but the final notification has placed this onus on the board of directors.

But SEBI has provided a helpful explanation:

“Legitimate purpose shall include sharing of UPSI in the ordinary course of business by an insider with partners, collaborators, lenders, customers, suppliers, merchant bankers, legal advisors, auditors, insolvency professionals or other advisors or consultants, provided that such sharing has not been carried out to evade or circumvent the prohibitions of these regulations.”

This amendment has been influenced by the Uday Kotak Committee report on corporate governance, Bharat Vasani, a partner at Cyril Amarchand Mangaldas pointed out. The committee had stated, he explained, that there could be genuine business situations—acquisitions, mergers, divestments, rights issue—where you need to share information with the controlling shareholder for the transaction to be successful. This would be possible now, with additional safeguards that SEBI has prescribed, namely a digital record of persons with whom UPSI has been shared, their PAN etc, Vasani added.

This issue had most recently come to the fore in the Tata-Mistry battle, when Cyrus Mistry had written to the market regulator pointing out that the Tata Son board often shared unpublished price sensitive information with former Chairman and Tata Trusts Trustee Ratan Tata in violation of insider trading regulations.

Advocate PR Ramesh said that it is to address situations like these that the regulator has directed boards to codify the information sharing process.

If boards decide that sharing information with promoters is legitimate purpose, they’ll have to sign non-disclosure agreements with them. The intent of the insider trading regulations is to prevent trading based on UPSI. There is nothing wrong in having UPSI but you shouldn’t trade on it. Currently, promoters were demanding information and getting it without signing any confidentiality agreements. So, this is a good move.
PR Ramesh, Advocate, Bombay High Court

If SEBI sees that boards are misusing this leeway, it will clamp down and may make its regulations prescriptive, Vasani said.

Higher Burden, More Defences

SEBI has reiterated that if entities trade in securities while in possession of UPSI, it’ll be assumed they’ve traded on the basis of it. But there’s some relief by way of additional defences.

Currently, off-market inter-se transfer between promoters can be used as a defence against insider trading. April onwards, block trades between insiders who have the same UPSI, transaction made as a result of regulatory obligation, exercise of stock option at a pre-determined price will also be acceptable defences against insider trading.

The regulator has now recognised that if both parties are trading with the same level of information, it shouldn’t amount to insider trading, Vasani said. For instance, large corporate groups wanting to reduce their cross-holdings through block trade. Equally, if a regulator—say the Competition Commission—makes divesture a condition for approving a merger, a transaction emanating from such a situation shouldn’t amount to insider trading, Vasani added.

That said, this doesn’t give a license to anyone to misuse these defences and SEBI can investigate cases where it suspects foul play, he said.

Material Relationships: Disclosures

The new regulations require designated persons to disclose names, contact information and Permanent Account Number of their immediate relatives as well those with whom they share a material financial relationship.

Two definitions become important here – designated persons and material financial relationship.

Designated persons hasn’t been defined. Perhaps, companies will take a cue from the Viswanathan committee report which had suggested it to mean promoter, CEO and upto two levels below CEO of the listed company and its material subsidiaries, irrespective of their functional role in the company or ability to have access to UPSI. Employees of the listed company, its associate or subsidiary company may also be identified as designated persons based on their functional role and the likelihood of them having access to UPSI.

The second one - material financial relationship – will mean a relationship where the designated person has given via gift, loan etc, an amount that is equivalent to 25 percent of his annual income in the last 12 months. Arm’s length transactions will be excluded from this treatment.

Though one cannot dispute the need for this disclosure, operationally it will become a challenge, Agrawal said. ‘There could be situations where immediate relatives won’t be comfortable with sharing their information. How do you comply with this?”

Intermediaries, Buckle Up!

Currently, listed companies and market intermediaries are required to put in place internal controls to check insider trading. Now on, this will apply to all intermediaries and fiduciaries such as auditors, accountancy firms, law firms, analysts, consultants etc. Internal controls will include - ensuring employees with UPSI are identified as designated employees, restrictions on communication of UPSI etc.

Additionally, listed companies will need to frame policies to deal with the leak of UPSI, inform SEBI and conduct an inquiry. Relevant intermediaries and fiduciaries will need to assist the listed company in such an investigation.