Investors in the stock market often fail to realise when they lose money on their trades that it could be due to insider trading. Or, for that matter, that their gains could have been higher if not for the presence of an insider in the trade. The logic is simple — a person in possession of privileged non-public price sensitive information, which is an insider, has an unfair advantage over others who do not possess similar information.
The SEBI appointed a Committee under the chairmanship of Justice N.K. Sodhi in March 2013 to review the existing regulations. The recommendations of the Committee released recently, appear well reasoned at first glance.
First, concepts such as ‘insider’, ‘unpublished price-sensitive information’, ‘connected person’ and ‘generally available information’ have been clearly defined. Insider would mean any person who is either a connected person or is in possession of unpublished price sensitive information (UPSI).
UPSI would mean any information which is not generally available which upon becoming generally available, is likely to materially affect the stock’s price. The information that is accessible to the public on an equal and non-discriminatory basis would be considered generally available information. Any person associated with a company in any capacity that would allow him access to UPSI relating to the company or whose association is reasonably expected to allow such access would be a connected person.
Second, no insider is allowed to trade in listed securities when in possession of UPSI. The insiders are also prohibited from communicating or allowing access to UPSI to any person except on a need to know basis.
Third, with respect to burden of proving the wrong, in trading by insiders who are connected persons, the onus would be on connected person to demonstrate that such person was not in possession of UPSI. In trading by unconnected insiders, the onus would be on SEBI to demonstrate that the unconnected insider was in possession of UPSI while trading.
Fourth, various disclosure obligations with respect to trades by promoters, employees, directors and their immediate relatives have been prescribed with a requirement for listed/to be listed companies to formulate Codes of Disclosure and Conduct.
Areas of Concern
Some of the regulations proposed in the Report may be impractical such as the one requiring the perpetual insiders (promoters, directors etc.) to disclose their trading plan six months in advance of their proposed trading which later has to be mandatorily carried out. This will create practical difficulties for the promoters/directors in even genuinely buying/selling shares of their own companies, and may also create speculation in markets as public is likely to get influenced by any buy/sell trading plan of promoters/directors disclosed in advance.
Due diligence by large investors on listed companies has been proposed to be permitted before making investment, subject to fulfilment of certain safeguards. The findings that constitute UPSI are required to be publicly disclosed at least two trading days prior to the proposed transaction (unless it’s a takeover transaction). Such requirement may lead to fluctuations in the stock price as a large volume of UPSI is made public at one go.
Further, the menace of insider trading would be difficult for SEBI to prove in cases of insiders who are not connected persons as the onus would be on the regulator to demonstrate that the insider was in possession of UPSI while trading, which is going to be extremely difficult for SEBI.
The author is Partner, IC Legal, Mumbai.