February 15, 2024

SEBI Guidelines on Insider trading: Navigating legal compliance

This article has been written by Ms. Komolika Srivastava, a final-year student of ILS Law College, Pune.

 

ABSTRACT

Illegal insider trading, involving unauthorized securities transactions based on non-public information, poses a significant threat to market integrity. SEC enforcement targets individuals, including corporate officers, directors, and employees, with severe penalties outlined in Section 15-G of the Securities and Exchange Board of India Act, 1992. The SEBI (Prohibition of Insider Trading) Regulations, 2015, define crucial terms, establish a comprehensive framework, and grant discretionary authority to the Board of Directors.

The concept of Unpublished Price Sensitive Information (UPSI), defined in Regulation 2(1)(n), is central, with a focus on preventing false UPSI disclosures, aligning with legal precedent. The regulations introduce a Structured Digital Database (SDD) for monitoring UPSI access, enhancing transparency, and deterring personal gains through insider trading. Regulation 5 provides for a Trading Plan, allowing specific insiders to trade under predefined conditions.

Initial Disclosures mandate prompt disclosure of holdings by key role assumers, fostering transparency. The 2019 amendment emphasizes the need for publicly traded companies to address security breaches. Case laws, including the Amazon Insider Trading Case and Rakesh Agrawal vs. SEBI, illustrate regulatory actions, emphasizing the requirement for an advantage in insider dealings. Understanding the evolving regulatory landscape, penalties, and key features is crucial for the ethical and legal navigation of financial markets.

 

INTRODUCTION

Illegal insider trading involves improperly buying or selling securities, violating a fiduciary duty, or breaching a relationship of trust. This typically occurs when individuals trade securities based on material, non-public information about the security. Insider trading violations encompass not only direct trading but also the sharing or “tipping” of such information and trading by those who exploit or misappropriate confidential details.

SEC enforcement actions often target various individuals, including corporate officers, directors, and employees who engage in securities trading after gaining knowledge of significant, confidential corporate developments. Additionally, cases may involve friends, family members, or business associates who trade securities after receiving inside information. Employees of law, banking, brokerage, and printing firms may also be implicated if they trade based on information acquired while providing services to the relevant corporation. Government employees, political intelligence consultants, and others who misuse confidential information obtained from employers or connections may also face insider trading charges. Given that insider trading erodes investor confidence in the fairness of securities markets, the SEC considers the detection and prosecution of such violations a top enforcement priority.

 

SEBI (PROHIBITION OF INSIDER TRADING) REGULATIONS, 2015

According to Regulation 2(1)(g) of the SEBI (Prohibition of Insider Trading) Regulations, 2015, the term “Insider” is defined as a person who is deemed to be “Connected” with the company. This connection implies that the individual could either have access to Unpublished Price Sensitive Information (UPSI) directly or receive such information from another individual within the company. In essence, a Connected Person is someone who has or has access to UPSI, making them subject to the regulations governing insider trading. This definition underscores the importance of regulating individuals with a connection to the company who may be privy to sensitive information, ensuring the fair and transparent functioning of the securities market.

 

CONNECTED PERSON [2(1)(D) OF THE SEBI (PROHIBITION OF INSIDER TRADING) REGULATIONS, 2015]

The term connected person is defined in regulation 2(1)(d) of the SEBI (Prohibition of Insider Trading) Regulations, 2015, which includes the following person: 

  • Any person associated with the company during the six months before the concerned act 
  • An immediate relative 
  • Holding/associate/subsidiary company 
  • An official of the stock exchange or clearing corporation 
  • A Banker of the company 
  • A concern, firm, trust, HUF, company, or AOP wherein the above person has an interest or holding more than 10% 
  • Legal consultants and auditors and other persons having direct or indirect interest in the company

 

UNPUBLISHED PRICE SENSITIVE INFORMATION [2(1) (N) OF THE SEBI (PROHIBITION OF INSIDER TRADING) REGULATIONS, 2015]

As per Regulation 2(1) (n) of the SEBI (Prohibition of Insider Trading) Regulations, 2015-
“unpublished price sensitive information” means any information, relating to a company or its securities, directly or indirectly, that is not generally available which upon becoming generally available, is likely to materially affect the price of the securities and shall, ordinarily including but not restricted to, information relating to the following: – 

  • financial results 
  • dividends 
  • change in capital structure 
  • Capital Restructuring 
  • changes in key managerial personnel

Examining the realm of insider trading, the essence of Unpublished Price Sensitive Information (UPSI) becomes paramount, particularly in light of the precedent set in the case of Samir C. Arora v. SEBI. This legal precedent underscores that insider trading charges hinge on the veracity of UPSI. Importantly, the disclosure of false UPSI does not fall within the scope of the Prohibition of Insider Trading (PIT) Regulations, as it fails to meet the criteria of influencing security prices.

 

PENALTIES AND OFFENSES

Section 15-G of the Securities and Exchange Board of India Act, 1992, delineates the consequences for contraventions of insider trading regulations. Any individual found in violation of these regulations faces penalties, ranging from a minimum fine of 10 lakhs to a maximum of 25 crore rupees or three times the profit derived from the insider trading transaction, whichever is higher. This robust penalty framework underscores the severity of insider trading offenses.

 

BOARD’S DISCRETIONARY AUTHORITY

A discernible trend within these regulations is the substantial discretionary power accorded to the Board of Directors and compliance officers concerning matters related to insider trading. Regulation 3(3) allows the communication or procurement of UPSI, provided it aligns with the regulations and is considered in the “best interests of the company.” The definition of “best interests of the company” remains open to interpretation by the Board, offering flexibility in decision-making.

 

CODE OF ETHICS

Regulation 8 mandates the development of a code of fair disclosure and conduct. Although Schedule 2 offers a suggested format for this code, the Board is not bound to adhere to it, allowing adaptability in tailoring the code to suit the unique needs and circumstances of each company.

 

STRUCTURED DIGITAL DATABASE (SDD)

Regulation 3(5) introduces the necessity of maintaining a Structured Digital Database (SDD) to document individuals possessing UPSI. This measure aims to thwart insider trading for personal gains, safeguarding the interests of the company and its shareholders. The SDD must be tamper-proof, include features like timestamping and an audit trail, and be overseen by the compliance officer or an individual authorized by the Board. The database must be preserved for a minimum of 8 years post the completion of the relevant transaction, with the possibility of extension in the case of SEBI proceedings or investigations. A compliance certificate, affirming the proper upkeep of the SDD, is required to be filed with SEBI, serving as a confirmation of the company’s adherence to these regulations.

 

TRADING PLAN IN INSIDER TRADING REGULATIONS [REGULATION 5]

The Insider Trading Regulations aim to restrict insiders, especially those in key managerial roles, from engaging in securities trading while possessing Unpublished Price Sensitive Information (UPSI). However, Regulation 5 introduces a trading plan as an exception, allowing certain insiders like directors and promoters to trade under specific conditions.

  • Definition and Purpose of Trading Plan:

 A trading plan is a pre-determined strategy enabling insiders to trade in securities on a future date, decided well in advance of any UPSI related to those securities. This provision seeks to balance the need for key managerial personnel to fulfill their decision-making and fiduciary duties while upholding the integrity of the market.

  • Cool-off Period and Public Disclosure:

Regulation 5(2) mandates a six-month cool-off period from the public disclosure of the trading plan. This ensures that UPSI related to the security becomes publicly available, preventing any disproportionate impact on the trading plan.

  • Duration of Trading Plans:

Trading plans must remain in effect for at least 12 months, with restrictions on execution during the proximity to financial result declarations. This prevents frequent alterations to trading plans during sensitive periods when insiders may possess UPSI.

  • Irrevocability of Trading Plans:

Once a trading plan is formulated and approved by the compliance officer, it cannot be revoked. This prevents insiders from avoiding the execution of a trading plan by later possessing UPSI, potentially indicating losses if the plan is executed.

  • Pre-clearance and Notification:

Insiders developing a trading plan must obtain pre-clearance from the Compliance Officer to ensure compliance with the regulations. Additionally, the Compliance Officer is obligated to notify such plans to the stock exchanges where the securities are listed.

While these measures represent positive strides in preventing insider trading and bolstering public confidence, addressing potential shortcomings in the regulations is essential for their effectiveness in achieving their intended purpose and maintaining market fairness.

 

INITIAL DISCLOSURES OF INSIDER TRADING

Upon assuming roles such as key managerial personnel, directorship, or becoming a promoter or part of the promoter group in a company, individuals must promptly disclose their holdings of company securities. This disclosure should encompass the securities held as of the date of appointment or entry into the role of a promoter. The obligation to make such disclosures must be fulfilled within seven days from the commencement of the respective roles. This requirement aims to promote transparency and ensure timely reporting of insider holdings within the company.

 

REGULATION REGARDING INSIDER TRADING (PIT), 1992

Originally, businesses were required to establish measures to prevent the unauthorized release of sensitive information. However, a significant revision in 2019 mandates that publicly traded companies must now formulate effective plans to address potential security breaches and leaks of confidential information.

Given the stringent regulations against insider trading, which carry penalties such as fines and imprisonment, investors must be well-informed about these rules. Having a solid understanding of the regulations is essential to ensure compliance and steer clear of any illicit activities that could result in legal consequences. This highlights the importance of staying acquainted with the regulatory framework to maintain ethical and lawful conduct within the financial markets.

 

CASE LAWS

  • Amazon Insider Trading Case 

In September 2017, Brett Kennedy, a former financial analyst at Amazon.com Inc. (AMZN), faced charges of insider trading. Kennedy allegedly provided information on Amazon’s first-quarter earnings in 2015 to Maziar Rezakhani, a fellow University of Washington alum, before the official release. In exchange for this inside information, Rezakhani reportedly paid Kennedy $10,000. The Securities and Exchange Commission (SEC) also revealed that, as a consequence of the tip from Kennedy, Rezakhani made $115,997 by trading Amazon shares in a related case. This incident highlights the legal consequences and regulatory actions taken against individuals involved in insider trading activities.

  • Rakesh Agrawal vs. SEBI

In the legal case involving Rakesh Agrawal and the Securities and Exchange Board of India (SEBI), Rakesh Agrawal, who served as the Managing Director of ABS Industries Ltd., was engaged in negotiations with Bayer A.G., a German registered company, concerning a potential takeover of ABS.

The insider trading allegation in this case pertains to Rakesh Agrawal’s acquisition of ABS shares from the market through his brother-in-law, Mr. I. P. Kedia, and subsequently tendering these shares in the open market after Bayer’s takeover announcement. This resulted in a substantial profit for Agrawal, leading to accusations of violating regulations 3 and 4 of the insider trading regulation.

The Securities Appellate Tribunal (SAT) rendered a verdict in this case, stating that merely dealing in securities while possessing unpublished price-sensitive information is not adequate to establish guilt. The crucial factor is whether the dealing results in an advantage to the individual. The law specifically prohibits insiders from gaining an unfair advantage. In this context, the SAT held that Rakesh Agrawal had acted in the best interests of the company and was not found guilty of insider trading. The emphasis was on the need for the dealing to confer an advantage, and since Agrawal’s actions were deemed in the interest of the company, he was exonerated from the charges.

 

REFERENCES

 

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