Insider Trading Regulations in India: A Critical Analysis

How India’s law on insider trading developed from the early committee reports to the SEBI (Prohibition of Insider Trading) Regulations, 2015, the key definitions, the codes every listed company must adopt, and the penalties for non-compliance.

Summary

It was noted over time that employees of an organisation are able to obtain sensitive information and frequently participate in unfair trade in order to acquire an unfair edge over others. This activity came to be recognised as an unethical activity with potentially negative repercussions: insider trading.

The active implementation of criminal regulations and laws has intensified the focus on punishing and deterring insider trading. It is a widespread market phenomenon that has prompted most major economies to explore legal action and has also captivated the public’s interest in recent decades.

As a result, in order to limit these unfair practices, rules and regulations restricting insider trading were created with the goal of ensuring the fair transfer and exchange of securities in the market.

Introduction

What Is Insider Trading?

Insider trading refers to the act of trading securities that are listed in organised securities markets by people who are known as “insiders”. This trading is based on privileged, material or non-public information about such securities that is exclusively available to them and not to the public at large. This insider information is known only to the company’s insiders, putting the company’s shareholders at a disadvantage.

Historical Development

The Thomas Committee Report (1948): Instances were recognised of agents, directors, auditors and officers having strategic information about the corporation’s economic situation, such as the size of an issue of bonus shares, a dividend to be declared, or the conclusion of a favourable contract with any company, prior to its disclosure to the public.

The Bhabha Committee (1952): Proposed that directors be required to report their stock purchases and sales in a separate register kept by the company. As a result, when the Companies Act of 1956 was enacted, Sections 307 and 308 were included to address some of these issues. Section 307 required companies to maintain a register of directors’ shareholdings; Section 308 required directors and persons deemed to be directors to disclose their shareholdings.

The Sachar Committee (1978): Suggested requiring complete transparency of transactions by people who have insider information, and prohibiting such transactions unless there are extraordinary circumstances. The Sachar Committee further suggested that the insider should be held legally accountable to the aggrieved parties, including the company, for recovery of wrongful gains.

The Patel Committee (1984): Proposed that insider trading be made a cognizable and criminal offence, in addition to enacting specific laws. The Patel Committee’s recommendations were substantially reaffirmed in the 1988 report of the Abid Hussain Committee.

In 1992, the SEBI (Insider Trading) Regulations, 1992 were enacted in response to the need for suitable and strict laws to deal with offenders engaging in unfair practices in the financial market, as well as the suggestions given by multiple committees.

The 1992 Regulations were amended in 2002, 2003 and 2008 to address the gaps in their implementation. The amendments of 2011 established a comprehensive Model Code of Conduct by placing several limits on the transactions that may be entered into by a company’s directors and representatives. The Legislature also added Section 195 to the Companies Act, 2013, allowing insider trading prohibitions to apply to both private and publicly traded companies.

Effective?

Despite extensive amendments to the existing legislation, SEBI was unable to prove the allegations levelled against insiders on multiple instances due to a lack of clarity in the basic definitions in the Regulations. SEBI formed the Sodhi Committee to make major reforms, with a focus on clarity in the definitions of “insider”, “connected person” and other terms. As a result of the recommendations of the Sodhi Committee, the SEBI (Prohibition of Insider Trading) Regulations, 2015 were enacted.

Improved Definitions

Insider: Regulation 2(1)(g) of the SEBI (PIT) Regulations, 2015 provides that any person who is either a “connected person” or has access to or is in possession of Unpublished Price Sensitive Information (UPSI) is an insider, regardless of how such information is obtained by that person. It is not required that such person has any fiduciary duty to the company, or that the source of the UPSI be traced to the company. This is because, unlike the 1992 Regulations, the focus of the 2015 Regulations is on UPSI rather than on the insider.

Connected Person: Regulation 2(1)(d) of the SEBI (PIT) Regulations, 2015 provides that any individual who has, directly or indirectly, been associated with the company during the six months prior to the concerned act, or has frequent communication in any capacity with its officers, directors or employees, or has a business relationship with the company, whether permanent or temporary, that gives access to UPSI, is deemed to be a “connected person”. Furthermore, Regulation 2(1)(d)(ii) of the 2015 Regulations specifies the categories of people that are considered connected persons.

It is a mixed matter of fact and law whether a person is connected with the company in the above capacities, or whether such affiliation enables or is reasonably anticipated to provide access to UPSI. In this respect, the Justice N.K. Sodhi Committee proposed that, in the absence of actual proof of UPSI access, the test be whether the individual in issue is reasonably anticipated to have such access, based on the facts and circumstances of the case.

Unpublished Price Sensitive Information (UPSI): Regulation 2(1)(n) of the SEBI (PIT) Regulations, 2015 provides that UPSI is any information, directly or indirectly linked to the company or to its securities, that is not generally available to the public and is likely to substantively influence the price of the securities once it becomes generally available. Such information may include information related to financial results, changes in capital structure, dividends, changes in key managerial personnel, mergers, de-mergers, delisting, acquisitions, expansion of business, disposals and other such information related to the company.

Compliance Officer: Regulation 2(1)(c) of the SEBI (PIT) Regulations, 2015 provides that the compliance officer is any designated senior officer who reports to the board of directors or, where there is no board, to the head of the organisation. The compliance officer should be financially literate and capable of appreciating the requirements for legal compliance under the Regulations, and is responsible for compliance with policies and procedures, record-keeping, monitoring the preservation of UPSI and the implementation of the codes, under the supervision of the board of directors of a listed company or the head of the organisation, as the case may be.

The terms “officer” and “senior officer” are not defined in the 2015 Regulations. As a result, the definition of “officer” in the Companies Act, 2013 should be consulted. Section 2(59) of that Act defines an officer as any director, manager or key managerial personnel, or any person in accordance with whose directions or instructions the Board is accustomed to act. However, the Companies Act, 2013 also does not define the term “senior officer”.

Compliances Under the SEBI (Prohibition of Insider Trading) Regulations, 2015

The SEBI (Prohibition of Insider Trading) Regulations were introduced by SEBI in January 2015. SEBI used the powers granted to it under Section 30 of the Securities and Exchange Board of India Act, 1992, read with Sections 11(2)(g), 12A(d) and 12A(e) of that Act, to make the Regulations, which replaced the two-decade-old SEBI (Insider Trading) Regulations, 1992.

All companies whose securities are listed on a stock exchange are required, under Regulations 8 and 9 in Chapter IV of the 2015 Regulations, to formulate codes for regulating, monitoring and reporting trading in order to prevent insider trading in their securities, and compliance with these codes must be observed by designated persons.

Code of Conduct (Chapter IV, Regulation 9)

The major objective of the code of conduct under the SEBI (Prohibition of Insider Trading) Regulations, 2015 is to protect the confidentiality of UPSI and to avoid its misuse. This Code of Conduct accordingly applies to all insiders, the designated persons of a company and their immediate relatives.

In order to prevent insider trading in a company’s securities, a code of conduct must be formulated by (a) the board of directors of every listed company and (b) the board of directors or head of the organisation of every other person who is required to handle UPSI in the course of business operations.

It must also be ensured that timely initial disclosures of holdings and continual disclosures of trades are made in accordance with the SEBI (PIT) Regulations, and that the company keeps these records for a minimum of five years.

Code of Fair Disclosure (Chapter IV, Regulation 8)

The SEBI (PIT) Regulations also require every listed company to develop a code of practices and procedures to ensure fair disclosure of UPSI pertaining to the company and its securities.

To comply with this rule, the board of directors must formulate a “code of fair disclosure” and publish it on the company’s official website, after which any modifications to the code must be promptly communicated to all stock exchanges where the company’s securities are listed.

Checklist for a Code of Conduct

• The code’s purpose and introduction.
• A definition clause with basic terms such as the Board, Act, Company (with the company’s name specified), Compliance Officer, Designated Person, Connected Person, Directors, Insider, Immediate Relative, UPSI, Trading Window, and other terms relating to material events as outlined in the listing agreement.
• The compliance officer’s role and responsibilities.
• Restrictions on insider communications and trade, including the communication and procurement of UPSI, the obligations of those in possession of UPSI, and “Chinese wall” procedures for managing and preventing the abuse of confidential information.
• Trading in the market when in possession of UPSI.
• A trading plan to trade in the company’s securities in accordance with the SEBI Regulations, which is formulated by an insider and presented to the compliance officer for approval and public disclosure, and pursuant to which trades may be carried out. The requirements for a trading plan are provided in Regulation 5(2).
• Pre-clearance of trades, which involves executing trades in accordance with the code of conduct, obtaining prior approval for transactions that exceed the limit defined in the code of conduct, and trading only while the trading window is open.
• Formulation of a Code of Fair Disclosure in accordance with Schedule A, and publication of the code on the company’s official website.
• Trading disclosures by insiders and other related persons, which include:
  • Initial disclosures: promoters, directors and key managerial personnel must report their holdings in the company’s securities.
  • Continual disclosures: Regulation 7(2)(a) provides that promoters, directors and employees must disclose the number of securities acquired or disposed of within two trading days of the transaction, if the value of the securities traded in a calendar quarter exceeds ten lakh rupees.
  • Disclosures by connected persons: connected persons must report their holdings of and trading in securities.
• Procedures and penalties for violating the code of conduct.
• Informing SEBI in the event of a violation of the Regulations.

Compliance Monitoring

By the Compliance Officer

1. It is the duty of the compliance officer to ensure that the listed company’s codes, namely the code of fair disclosure under Regulation 8 and the code of conduct under Regulation 9, are followed effectively.
2. The compliance officer must ensure that the disclosures made by designated persons, directors, promoters and members of the promoter group are properly maintained.
3. The compliance officer must keep track of pre-clearances, stock exchange disclosures and trading window closures.
4. The compliance officer should monitor the implementation of trading plans.
5. The compliance officer must report periodically to the board of the company.
6. The compliance officer must immediately inform SEBI if any violation of the SEBI (PIT) Regulations is reported.

By Directors, Promoters, Key Managerial Personnel and Other Designated Persons

1. Make initial, one-time, periodic, continual and event-based disclosures as prescribed.
2. Follow the company’s code of fair disclosure and code of conduct.
3. Take the necessary precautions before and after sharing UPSI.

By the Board of Directors

1. Formulate a code of conduct and a code of fair disclosure for the prohibition of insider trading.
2. Formulate an inquiry mechanism and procedures in case UPSI is leaked.
3. Track and report trading by employees and other connected persons in order to ensure that the Regulations are followed.

The board of directors must ensure that it fulfils the specific tasks and requirements imposed on it by the SEBI (PIT) Regulations, 2015.

Penalty for Non-Compliance

If any of the requirements of the insider trading regulations are violated, the following penalties may be imposed.

According to Section 195 of the Companies Act, 2013, anybody found guilty of violating that section may face imprisonment for up to five years and a fine of not less than ₹5 lakh, which can extend to ₹25 crore or three times the profit made from insider trading.

It is important to note that the SEBI (Prohibition of Insider Trading) Regulations, 2015 do not contain any separate penalty provisions; rather, the penalty set out in the SEBI Act, 1992 is applicable.

Section 15G of the SEBI Act, 1992 provides that anyone who, either for himself or for others, deals in the securities of a listed company on the basis of UPSI; or communicates UPSI to any person, other than as required in the ordinary course of business or under any law; or counsels or procures any other person to deal in the securities of any company on the basis of UPSI, is liable to a penalty of not less than ₹10 lakh, which can extend to ₹25 crore or three times the profit made from insider trading, whichever is higher.

References

Acts, Regulations and Rules

• The Companies Act, 2013.
• Securities and Exchange Board of India Act, 1992.
• SEBI (Insider Trading) Regulations, 1992.
• SEBI (Prohibition of Insider Trading) Regulations, 2015, No. LAD-NRO/GN/2014-15/21/85.

Books

• Armaan Patkar, Insider Trading: Law & Practice, 1st ed., 2019, Eastern Book Company.

Articles and Reports

• Aarohee, “How to Comply With Insider Trading Regulations (Financial Institutions)”, iPleaders.
• Megha Dalakoti, “Insider Trading in India: Regulations and Controlling Authority”, 2021, iPleaders.
• Paridhi Poddar, “Analysing the Insider Trading Regulations, 2015”, 2021, GNLU Law Review.
• Reema Bali, “Insider Trading in India: Rules Till Now”, 2020, International Journal of Research – Granthaalayah, 8(9), 49–53.
• Roopanshi Sachar & Afzal Wani, “Insider Trading Laws in India: Status Before and After the Enactment of SEBI (Prohibition of Insider Trading) Regulations, 2015”, Vol. 3 Issue 1, International Journal of Legal Developments and Allied Issues.
• Thomas C. Newkirk, “Insider Trading: A U.S. Perspective”, 16th International Symposium on Economic Crime, 19 September 1998.
• P.J. Thomas, Report on the Regulation of the Stock Exchanges in India, 1948.
• Sakshi Rewaria, “An Analysis of Insider Trading in India”, 2021, International Journal of Research Publication and Reviews, Vol. 2 Issue 7, p. 816.
• Report of the High Level Committee to Review the SEBI (Prohibition of Insider Trading) Regulations, 1992, 7 December 2013.