New insider trading regulations: wouldn’t less be more?

With effect from May 15, 2015, the new insider trading regulations, notified by the Securities and Exchange Board of India (SEBI) have come into force. The SEBI (Prohibition of Insider Trading) Regulations, 2015 (New Regulations) will replace the SEBI (Prohibition of Insider Trading) Regulations, 1992 (Old Regulations). The need for bringing in the New Regulations could well be understood from the fact that more than two decades have passed since SEBI issued the Old Regulations. More important than the time period, are the changes that listed companies in India, the stock markets and the Indian economy as a whole have undergone since 1992.

Insider trading regulations in India prohibit individuals and entities that have access to unpublished price sensitive information of a company, from dealing in that company’s publicly traded shares.Persons found guilty of insider trading can be punished with fine of up to INR 25 crore or thrice the amount of profits made from such an act of insider trading and could also be sent to prison for up to 10 years.

If listed companies were expecting any relaxations from the New Regulations, it would be wise to say that SEBI has just kept them guessing. At the same time, imperative changes including widening the scope of ‘connected persons’, strengthening the definition of an ‘insider’, rationalising disclosure events, removing redundant provisions, among others, have been introduced. From a bird’s eye view, the New Regulations appear progressive. However, on digging deep, one finds that some of the changes proposed and new concepts introduced by the New Regulations, lack definitive clarity, much needed to make them acceptable and effective. On reading the New regulations it appears that SEBI has tried to do all it could, to curb insider trading at every level, but then the question arises, that from aregulatory perspective is ‘more’ always good or would ‘less’ be more? This article highlights key obligations introduced in the New Regulations, which many believe, may result in a logistical nightmare forlisted corporations.

Compliance officer

Similar to the Old Regulations, the New Regulations require every listed company to (i) formulate aninternal code of conduct on insider trading; and (ii) appoint one of its officials who is qualified to understand and implement provisions of the regulations, as compliance officer. Although individual persons are responsible for their non-compliance (if any), it is the duty of the compliance officer to monitor and regulate acts of the employees, and ensure that the company is being managed as per the provisions of the regulations. Though the Compliance Officer is the nodal head envisaged in the regulations, in most companies such an officer is supported by a secretarial/compliance teams, which fulfil compliance obligations, as mandated not just by the insider trading regulations, but alsoby the Companies Act, Listing Agreementsand various other laws. Over the years, corporations have developed mechanisms to regulate and monitor their acts in conformity with the existing insider trading law. The New Regulations expand the roles and responsibilities of the compliance officer in an implausibly expansive manner. 

Continual disclosures 

Subject to trading thresholds, the New Regulations impose an obligation on every promoter,employee and director of a listed company to disclose to the company and stock exchanges, details of securities traded by them. Under the OldRegulations, such a disclosure obligation was only on promoters, directors and officers of the company. Here it would be significant to note that the term ‘officer’ has been replaced by ‘employee’, in the New Regulations. The term employee has neither been defined in the New Regulations nor a special carve out has been made only to cover a certain class of employees, for disclosure purposes.Such a change brings all the employees of a corporation, under the ambit of the regulations. While this may theoretically ensure a stricter check on insider trading, it however pushes the scope of duties of the compliance officer to unfathomable limits.As number of employees in any large corporation would be many fold greater than the number of high ranking officials. 

In the past couple of years, before the New Regulations were in place, SEBI has followed an expansive approach in determining the applicability of disclosure provisions. In widely reported orders passed by SEBI, employees of large diversified business houses, holding technical-operational positions have been indicted for their failure in making disclosures under regulation 13(4) and 13(5). It is otherwise understood that such disclosures are to be made only by high ranking officials and employees, expressly designated by the Company. Based on this understanding, the employees and the corporations even challenged the orders before the Securities Appellate Tribunal (SAT), but while the appeal was pending, in January 2015, the companies decided to withdraw their challenge. In such a situation, it becomes imperative for the regulator to define the scope of the disclosure provisions under the New Regulations. 

Restrictions on exercising ESOPs

SEBI is already facing criticism for the restrictions imposed by the New Regulations on exercise of employee stock options (“ESOPs”). Unlike the Old Regulations, the New Regulations do not exemptexercise of ESOPs by employees during the trading window closure period. Further it appears that the exemption available for trading of converted shares and subscription of fresh ESOPs within the restricted period of six months, has been withdrawn. Stock options are usually used by companies as incentives, to be granted to its preferred employees. The changes introduced by the New Regulation do little to keep employees interested, in such instruments.

While the sudden change in substantive law here, is a question of independent analysis, from a strict compliance point of view as well it will have far reaching implications.In practice, the compliance officer will now have an additional set of trades to be ‘aware of’ and be ‘responsible for’.

Compliance officer responsible to connected persons 

While the Compliance Officer's obligation vis-a-vis his/her company is understandable, from the text of the new law one understands that the compliance officer will now also be responsible for monitoring and reporting conduct of 'connected persons'. Here, it would be worthwhile to note that ‘connected persons’ may include company's bankers,financial and legal advisers, among others. In practice, the statutory responsibility of ‘monitoring and reporting’ of trades is carried out by the compliance teams by educating and informing the insiders about the non-trading events and disclosure thresholds, and then reporting all non-compliant trades to SEBI. The question intriguing everyone is – how will compliance teamsof companies monitor and report trades executed by all classes of connected persons, in addition to their own employees?

Vide a circular issued on Monday, May 11, 2015, SEBI has asked companies to immediately ensure verification of their respective codes of ‘fair disclosure’ and ‘prevention of insider trading’, the stock exchanges. Companies have also been asked to transact only with such intermediaries and professional firms which havetheir respective codes of conduct in place. From the text of the circular, it appears that the liability of intermediaries’ non-compliance with the New Regulation, may also fall on the Companies. No one would disagree that a strict monitoring of such trades could be an effective check on insider trading, but the heavy workload on the compliance teams, could cause extra-logistical issues. If not addressed in-time, these may adversely affect the implementation of the regulations per se.

Trading plan

A novel concept of submitting investment trading plans to the compliance officer has been introduced under the New Regulations. This option could be availed by those insiders who are expected to be perpetually in possession of unpublished price sensitive information (UPSI). Such a submission of the trading plan will allow the insiders to implement their pre-decided trades without any presumption of possession of UPSI. One may argue that the provision has been introduced to avoid indictment of insiders, caused due to unintentional trading during window closure period. Although the intention of the regulator is noble and clear, it is difficult to categorize the persons who would be entitled to formulate a trading plan, as the term ‘person perpetually in possession of UPSI’ has not been defined in New Regulations. Some guidance can be sought from the Justice Sodhi Committee Report, which recommended inclusion of 'promoters' and 'KMP' of the company as 'persons perpetually in possession of UPSI'. But the regulator has specifically avoided providing a definition, thereby adding to the confusion.    

All would agree that a pervasive regulatory regime will only help in making our capital markets and corporationsinvestor friendly. But such a regime also needs to evaluate practical difficulties being faced by corporations, already struggling with existing compliance requirements.Therefore one may wonder if ‘more’ regulation is necessarily good or wouldn’t ‘less’ be more workable.

On the whole, the New Regulations could be appreciated as SEBI's first (if not the best) foot forward, in the right direction. Till the time further clarity is received from SEBI, the aforesaid provisions may cause some distress to corporations. Here the age old wisdom of prevention being better that cure, should hold good. While regulatory clarity may come with some time, running a regulatory health check-up, making a few organisationalchanges, including amendments to the internal code of conduct of companies and service contracts, is advisable. While preventive actions could be taken now, the real implications of the New Regulations will surface only after SEBI actively starts enforcing them.

(Nishant Singh is a Partner in the M&A and General Corporate practice of IndusLaw, Mumbai while Vaibhav Ganjiwale is an Associate in the M&A and General Corporate practice of IndusLaw, Mumbai. Views are personal.)

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