On 31 December 2018, the Securities and Exchange Board of India (SEBI) notified various amendments to the SEBI (Prohibition of Insider Trading) Regulations, 2015 (Insider Trading Regulations) pursuant to the recommendations made by the Committee on Fair Market Conduct (the Committee) in August 2018. These amendments are set to come into force with effect from 1 April 2019.
We outline below a snapshot of some of the more substantive amendments to the Insider Trading Regulations and the implications thereof for listed companies and other stakeholders:
Legitimate Purposes of Sharing UPSI
The Insider Trading Regulations prohibits the communication and procurement of unpublished price sensitive information (UPSI) unless it is required for ‘legitimate purposes’, performance of duties or discharge of legal obligations.
Whilst ‘legitimate purposes’ continues to remain an undefined term, as per the recommendations of the Committee, an illustrative explanation has been included stating that the term would include sharing of UPSI in the ordinary course of business by an insider with third parties such as business partners, lenders, advisors and consultants, provided that such sharing is not carried out to evade or circumvent the Insider Trading Regulations. Further, the board of directors of every listed company has been mandated to put in place a policy for the determination of what would constitute ‘legitimate purposes’ as part of its code of fair disclosure. By way of clarification, the amendment also provides for any person in receipt of UPSI pursuant to a ‘legitimate purpose’ to be considered as an ‘insider’ for the purpose of the Insider Trading Regulations and for due notice to be given to such insiders to maintain confidentiality of the UPSI shared.
In keeping with the subjective nature of the exception, SEBI has put the onus on listed companies to develop their own practices for sharing of UPSI on the basis of ‘legitimate purposes’. In addition to the circumstances specified in the illustrative explanation, listed companies could consider including other situations which could merit disclosure of UPSI on this basis. For example, listed Indian subsidiaries of foreign parents could find it appropriate to include disclosure of financial information to their respective parent companies to enable preparation of consolidated accounts on a group-wide basis.
Defences to Insider Trading Allegations
The Insider Trading Regulations provide for an inclusive, but limited, set of defences that may be relied upon by an insider who is charged with insider trading, in order to prove its innocence. Pursuant to the Committee’s recommendations, the ambit of the defences available to insiders have been expanded:
- The existing safe harbour for off-market inter-se transfers between promoters in possession of the same UPSI has now been extended to all insiders of a listed company, but with a caveat that the exception would not be available in case the UPSI is obtained by the insider from the listed company as part of a due diligence exercise in connection with a transaction involving securities of the company.
- The same defence as above has now been included for on-market transactions between insiders in possession of the same UPSI which are executed through the block deal window mechanism, but again subject to the same caveat as above in respect of UPSI obtained as part of a due diligence exercise in connection with a transaction involving securities of the company.
- New defences have been included in respect of transactions carried out in a bona fide manner but pursuant to statutory or regulatory obligations and exercise of stock options in respect of which the exercise price has been pre-determined in compliance with applicable law.
The expansion of the scope of the inter-se transfer exemption to insiders who are non-promoters, including by way of block deals executed on the stock exchanges, is a welcome development. The new defence in respect of transactions pursuant to statutory or regulatory obligations is also very helpful, especially for promoters of listed companies who may be required to sell down their shareholding in order to comply with the minimum public shareholding requirement.
Code of Conduct and Designated Persons
Taking into account the impracticality of a listed company enforcing its insider trading code of conduct on third parties and consistent with the Committee’s recommendations, SEBI has provided for separate codes of conduct to henceforth apply to listed companies and intermediaries / ‘fiduciaries’ associated with listed companies (e.g., auditors, accounting firms, law firms, analysts, consultants, etc.). As a consequence, listed companies would no longer be required to inform any associated third parties of the opening and closing of the companies’ trading windows, or implement any other provisions of their respective codes of conduct with respect to such third parties.
Significantly, the scope of ‘designated persons’ of listed companies (i.e., who are governed by the internal code of conduct) has now been substantially codified. In addition to the existing requirement for the board of directors and compliance officer to specify designated persons on the basis of their role and function in the organisation, the amendment provides for certain categories of persons to be mandatorily included in the list of designated persons. The list of such deemed designated persons includes all promoters of listed companies, the CEO and employees up to two levels below the CEO of listed companies and their material subsidiaries (irrespective of their functional role in the company or ability to have access to UPSI) as well as support staff of listed companies (e.g., IT staff and secretarial staff) who have access to UPSI.
The implications of all promoters of listed companies – regardless of whether they are individuals or corporate entities – being deemed to be ‘designated persons’ are potentially far reaching. By virtue of being classified as designated persons, promoters of listed companies will henceforth be legally prohibited from trading in securities when the company’s trading window is closed. More importantly, when the trading window is open, promoters of listed companies will henceforth be required to seek pre-clearances from the respective compliance officers of the underlying listed companies before trading in excess of the specified thresholds. The upshot of this requirement is that promoters will no longer be able to consolidate or sell down their shareholding in listed companies without the knowledge of the underlying listed company. It is unclear whether this was indeed the intention of the Committee and SEBI, particularly in the context of corporate promoters who would otherwise be entitled to rely on the “Chinese Wall” exemption to trade in securities of a listed company even when certain individuals inside the corporate entity have access to UPSI.
In keeping with the Committee’s proposal for listed companies to put in place a mechanism to aid investigations into insider trading, SEBI has mandated designated persons to disclose on an annual basis the names and identification / contact details of not only their immediate relatives but also of persons with whom they share a “material financial relationship”(defined as any relationship in which the amount received by the recipient is more than 25% of the payer’s annual income, otherwise than on an arm’s length basis); in addition, designated persons have also been mandated to disclose their education and employment history on a one-time basis. The extension of the ambit of coverage beyond immediate relatives appears to be intended to cover cases where a designated person may have funded an otherwise unconnected person to trade on his behalf in order to evade detection.
Trading Window and Trading Plans
Whilst the compliance officer of every listed company continues to have the discretion to determine the timing of closure of the trading window, in the context of financial results, the trading restriction period will need to commence from the end of every quarter and last until 48 hours after the declaration of the financial results. In addition, a further obligation has been imposed to ensure that the gap between the clearance of accounts by the audit committee and the board meeting be as narrow as possible and preferably on the same day in order to avoid leakage of material information.
Whilst no changes have been made to the substantive regime governing trading plans (which, as noted by the Committee, continues to remain unpopular with promoters and perpetual insiders), clarificatory language has been included to the effect that trades pursuant to approved trading plans will not require pre-clearance and will not be subject to trading window norms and restrictions on contra trades.
Additional Compliance Obligations for Listed Companies
- Tamper-proof Information Database: The board of directors of every listed company will need to ensure the maintenance of a structured digital database with adequate internal controls and checks, including time stamping and audit trails, containing the names of persons or entities with whom UPSI is shared along with their respective identification details.
- Off-Market Transfers between Insiders: Off-market inter-se transfers between insiders having possession of the same UPSI are required to be reported by the relevant insiders to the listed company within two working days, and then by the listed company to the stock exchanges within two trading days from the receipt of the insider’s disclosure or from becoming aware of such information. This puts the onus on the listed company to report the occurrence of such trades to the stock exchange even if it has not received any disclosures from the insiders themselves.
- Amendments to Existing Insider Trading Policies: Every listed company would be required to amend its existing insider trading policies to address the various additional requirements specified by SEBI. As mentioned above, the code of fair disclosure will need to be updated to include the policy for determination of legitimate purposes. As for the code of conduct to regulate, monitor and report insider trading, the existing policy will need to be amended to incorporate the specified amendments regarding designated persons, trading window closure, timing of audit committee and board meetings, etc., as also to exclude third parties from their scope. As part of the same set of amendments, listed companies could also address the new requirement of putting in place a process to deal with bringing people “inside” on “sensitive transactions”.
- Institutional Framework and Responsibility of CEO / MD, Board and Audit Committee: Consistent with the Committee’s recommendations to have a mechanism for institutional responsibility to prevent insider trading, SEBI has introduced a new provision putting the onus on the CEO / MD (or equivalent) of every listed company to put in place an adequate and effective system of internal controls (i.e., separate from the code of conduct) to ensure compliance with the Insider Trading Regulations, and for the board of directors to ensure that the CEO / MD (or equivalent) secures such compliance by the listed company. Further, the audit committee of every listed company has been mandated to review the compliance with the provisions of the Insider Trading Regulations at least once in a financial year and to verify whether the systems for internal control are adequate and are operating effectively.
- Inquiry into Leakage of UPSI: Following the Committee’s noting on recent cases involving leakage of UPSI through WhatsApp messages and the need for listed companies to find out the source of the leak and plug the loopholes in the internal control systems, a new regulation has been included requiring listed companies to formulate written policies and procedures approved by the board of directors for inquiries related to the leak or suspected leak of UPSI. Listed companies have also been mandated to initiate appropriate inquiries on becoming aware of such leaks and to inform SEBI of such leaks, inquiries and the results of such inquiries, promptly. Listed companies are also required to put in place a whistle-blower policy to enable its employees to report instances of leakage of UPSI. Since listed companies are already required to have a whistle-blower policy under the Companies Act, 2013, such existing policies could be amended in order to address concerns related to the leakage of UPSI.
This material is for general information only and is not intended to provide legal advice. For further information, please contact:
Yashasvi Mohanram
Partner