Securities and Exchange Board of India Adopts Broad Prohibitions On Insider Trading And Disclosure
For American Bar Association subcommittee on India March 2015
With RAJIV DHARNIDHARKA
On January 15, 2015, the Securities and Exchange Board of India ("SEBI") published "SEBI (Prohibition Of Insider Trading) Regulations, 2015." The new regulations take effect on May 15, 2015, replacing previous regulations issued in 1992. The regulations affect not only "traditional" insiders (corporate officers, directors and employees), but also professionals who work with such companies such as financial advisors, auditors and attorneys. The regulations apply to companies listed (or proposed to be listed) on stock exchanges recognized by the India Central Government, and\or the securities of such companies. This article reviews the most significant aspects of the regulations, including drawing some comparisons to US law.
Broad prohibition on securities-related transactions
Regulation 4(1) prohibits trading by insiders in securities of listed companies while in possession of unpublished price sensitive information. The breadth of this prohibition is evident when one examines SEBI's accompanying guidance Note and the definitions of the key terms:
Trading with possession of unpublished price sensitive information is presumptively illegal. SEBI's Note to Regulation 4(1) explains that when a person trades when in possession of unpublished price sensitive information, "his trades would be presumed to have been motivated by the knowledge and awareness of such information in his possession," regardless of the reasons for the trades or intended use of proceeds; and hence trading in possession "is what would be need to be demonstrated at the outset to bring a charge." It is then the burden of a person who traded such information "to prove his innocence by demonstrating" the circumstances set forth in a list of defenses.
"Unpublished price sensitive information." "Unpublished price sensitive information" means information relating to a company or its securities, directly or indirectly, that is likely to materially affect the price of the securities upon becoming generally available. Regulation 2(1)(n). This sophisticated approach places the functional significance of this category of information into the very text and definition of the phrase, where the US equivalent is "material nonpublic information."
"Trading." "Trading" includes "dealing" in securities, which SEBI acknowledges in an accompanying guidance Note extends beyond buying, selling, or subscribing securities - "dealing" includes "pledging etc when in possession of unpublished price sensitive information." Regulation 2(1)(l), Note. In contrast, the principal US securities fraud laws, Exchange Act Section 10(b) and Securities & Exchange Commission ("SEC") Rule 10b-5, prohibits manipulation or deceit in connection with the purchase or sale of securities.
"Insider." The SEBI regulations define this term as a "connected person" or a person "in possession of or having access to unpublished price sensitive information." Regulation 2(1)(g). The corresponding Note confirms that this definition is to be taken literally: anyone in possession of or having access to unpublished price sensitive information "should be considered an 'insider' regardless of how one came into possession of or had access to such information."
"Connected person." The SEBI regulations define this term to include any person associated with a company in any capacity (including by frequent communications with officers); any person in any contractual, fiduciary or employment relationship with a company; any director, officer or employee; and persons in professionals or business relationships with a company, whether temporary or permanent, that allows or reasonably is expected to allow such persons access to unpublished price sensitive information. Regulation 2(1)(d)(i). The regulations also presume that immediate relatives of connected persons are "connected persons." Regulation 2(1)(d)(ii)(a). "Connected person" status remains in place for six months after a person ceases to be a director, officer, employee, or temporary insider, which means that departing officers and employees must wait before selling their shares in a company if they possess unpublished price sensitive information. Regulation 2(1)(d)(i).
Strict defenses to insider trading
As noted above, the SEBI regulations presume that trading with possession of unpublished price sensitive information is illegal, and then leave it to the accused to prove his or her defense. There are some strict requirements and limitation to the defenses an accused may employ.
Connected persons must prove they did not have unpublished price sensitive information. The SEBI regulations place the burden on connected persons to establish that they were not in possession of unpublished price sensitive information at the time of their trades. Regulation 4(2). (For other persons accused of insider trading, the burden is on SEBI.) In other words, if you are what US law generally regards as an "insider" and you trade, you are presumed to have known about and traded on material information that had not been disclosed to the public. Coupled with the broad definitions of "insider" and "connected persons" described above, the regulations place substantial risk on any securities trading by a broad set of persons affiliated with listed companies.
Trading plan must be approved by a compliance officer and publicly disclosed. Other affirmative defenses to insider trading in the SEBI regulations cover transfers between promoters and trades made on behalf of the insider by separate persons insulated from the unpublished price sensitive information. Regulations 4(1)(i), (ii). In other words, conceptually, if the insider delegates complete trading authority to someone else who is kept away from inside information, the trades are not the insider's at all and there is not a violation-understanding that it is the insider's burden to prove that these circumstances existed at the time of the trades. In the same manner, the final affirmative defense is for trades made pursuant to a pre-existing trading plan adopted by the insider. Regulation 4(1)(iii). SEC Rule 10b5-1(c) also allows trading plans, but the SEBI regulations require more formality in their adoption: an insider must present a proposed trading plan to a company's compliance officer for review, comment, approval, and disclosure to the public and any exchanges on which the security is listed. Regulations 5(1), 5(3), 5(5).
Explicit limitations on trading plans. The SEBI regulations also include explicit limitations for trading plans that are not found in US law but have been suggested by some regulators and commentators. A plan cannot allow trading in a trading window around the release of financial results; a plan must extend for at least twelve months in duration; there can only be one plan at a time; and the plan cannot be used for "market abuse," which includes manipulating the timing the release of unpublished price sensitive information. Regulation 5(2) & Notes. In addition, once approved, a trading plan is irrevocable and must be executed to its completion without any trades outside the plan. Regulation 5(4).
Don't ask, don't tell regime for inside information
Notwithstanding its title, the SEBI regulations address more than just insider trading. Chapter II of the regulations also includes restrictions on communications of unpublished price sensitive information which, speaking colloquially, envision a "don't ask, don't tell" regime.
Prohibition on communicating information other than on a need-to-know basis. Regulation 3(1) prohibits communicating or allowing access to unpublished price sensitive information relating to a listed company or its securities to any person-even other insiders-except where this is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations. The Note explains that this regulation is designed to lead organizations to develop practices based on need-to-know principles. As in SEC Regulation FD, the SEBI regulations include carve-outs for M&A related disclosures under confidentiality agreements. Regulation 3(3), 3(4). Regulation FD, however, contains exceptions not found in the SEBI regulations, for disclosures to the press and to rating agencies.
Prohibition on asking for information. Regulation 3(2) is an innovative provision that to our knowledge has no counterpart in the US securities laws (and could be challenged on First Amendment grounds): it prohibits procuring from or causing the communication by any insider of unpublished price sensitive information relating to a listed company or its securities, again except when in furtherance of legitimate purposes, performance of duties, or discharge of legal obligations.
Disclosure and corporate governance
In addition to the topics regulated above, the SEBI regulations set forth trading disclosure requirements (in Chapter III) and corporate governance requirements that may also apply to outside consultants and advisers (in Chapter IV).
Requirement to disclose trades to the company. Regulation 7(a) requires disclosures to the company of the securities holdings by broad set of persons (which includes all "key managerial personnel"). Regulation 7(2) then provides that all promoters, directors and employees must disclose all acquisitions or disposals of securities to the company within two days of the trade, if the value of the traded securities is over 10 lakh rupees; the company then must disclose the transactions to the exchange. These requirements also extend to trades by immediate family members and other persons for whom the reporting person makes trading decisions. Regulation 6(2). A company also may require other connected persons (such as management consultants) to make these disclosures. Regulation 7(3) & Note.
Code of Conduct for companies and advisers. Listed companies and other persons required to handle unpublished price sensitive information in the course of business operations must formulate a Code of Conduct to regulate, monitor and report trading by employees with an eye towards achieving compliance with the regulations and a model Code attached as Schedule B. Regulations 9(1), 9(2). This includes auditors and law firms assisting or advising listed companies, and market intermediaries, all of which are mentioned in the accompanying Note. Schedule B, the minimum standards for a Code of Conduct, is lengthy and detailed. It requires "Chinese Walls procedures" (sic), trading windows, pre-clearance of trades by the compliance officer (who is authorized to seek declarations from prospective traders that they are not in possession of any unpublished price sensitive information), and lists of disciplinary actions for violations of the rules.
Compliance officer for companies and advisers. Regulation 9(3) requires listed companies, market intermediaries and all other persons formulating a Code of Conduct to identify and designate a compliance office to administer the Code and the other requirements of the SEBI regulations.
Code of Fair Disclosure for companies. Boards of listed companies must formulate a Code of Fair Disclosure of unpublished price sensitive information and publish it on the company's Internet site. Regulation 8(1). Schedule A, the minimum standards for a Code of Fair Disclosure, is short but detailed. It requires (since this a minimum) listed companies to designate a senior officer as chief investor relations officer, and to set policies to advance such ends as ensuring that information shared with analyst and research personnel is not unpublished price sensitive information.