Poor drafting of the recent amendments to the SEBI Insider Trading Regulations has made the bar on six month reverse trading/ derivatives substantively ineffective.
The Model Code relating to procedures, etc. to prevent Insider Trading has been amended to introduce two major bars. Firstly, directors, etc. are now barred from carrying out an opposite transaction for six months. Thus, if such person buys even one share, he cannot sell any shares and if he sells one share, he cannot sell any shares for the next six months. Further, another clause absolutely barred such persons from taking any positions in derivatives. Let us call these two sets of transactions as “Specified Transactions”.
The question is what are the consequences of violation of these two restrictions?
The SEBI Act provides for severe punishment for Insider Trading. Under Section 15G, the specified acts by an Insider attract a penalty of Rs. 25 crores or 3 times the profits made from Insider Trading, whichever is higher. Under Section 24, violation of the Regulations could result in imprisonment upto 10 years or a fine of upto Rs. 25 crores or both. There can be other consequences also.
Would any of such consequences be attracted for violating the bar on carrying out such Specified Transactions – i.e, such opposite transactions or derivatives? The answer seems to be No.
Violations of the Code are to be punished by the Company internally and the Model Code suggests that they “may be penalised and appropriate action may be taken by the company”. The violators shall also be “subject to disciplinary action by the company, which may include wage freeze, suspension, ineligible for future participation in employee stock option plans, etc.”.
Beyond this, it appears that SEBI cannot levy the said penalties of Rs. 25 crores, etc. or prosecute and get such person imprisoned, etc. The reason is the peculiar placement of the amendments. The bar on Specified Transactions is contained in the Model Code. Regulation 12 merely requires listed companies and other entities to “frame” and “enforce” a Code in the lines of the Model Code. There is no requirement in the Act or the Regulations that the Code so made should be followed. While an obligation and enforcement relation has been created between the Company, etc. and such persons, no such obligation or enforcement relation has been created between SEBI and such persons.
If, e.g., the Company does not frame such Code as prescribed, SEBI can levy the said penalties, etc. and take other penal and other action. Further, if the Company does not enforce this Code, then also such penal consequences would follow. But the Regulations do not go further and require that the Code so framed should also be complied with by the directors, etc.
Is this intentional or is it an unintentional drafting lapse? On first impression, one could be tempted to consider that this is intentional. The Consultative Paper on proposed amendments to Insider Trading of March 2008 did consider the requirements of the Model Code to be akin to corporate governance requirements. In fact, it discussed that disclosure of non-compliance was perhaps a better way to punish the Company economically through the markets. It also recommended dilution of the punitive requirements. Effectively, it appeared to suggest a change in approach. However, even considering these original thoughts, it still appears to me that it is not intended by SEBI that such violations should not attract penal consequences.
I think it is not only an unintentional lapse and this also arises on account of an improper appreciation of the structure of the Regulations. SEBI has all along assumed that violations of the Code as framed by the Company are not only punishable with monetary penalties and directions but also subject to prosecution. In the aforesaid Consultative Paper of March 2008, SEBI recommended that the violations of the Code should not result in imprisonment. It further said that “other powers of monetary penalties and directions should be continued”. Thus, SEBI assumed that the violations already attracted all these penal consequences.
On this erroneous presumption, perhaps, SEBI placed the bar on the Specified Transactions in the Model Code.
But where is the provision, in the Act or the Regulations, saying that violations of the Code will attract such penal consequences? Nowhere, I think.
Thus, by possibly an unintentional drafting lapse, the bar on the Specified Transactions will not attract the penalties, prosecution, etc. Taking this further, even violation of the 30 day lock in for shares acquired in IPO or, for that matter, violation of any other provision of the Code, would not attract such punishment.
Of course, this does not mean that such persons can merrily carry out Insider Trading as defined – i.e., trade in shares on the basis of unpublished price sensitive information or communicate such information, etc. Also, persons violating the bars on Specified Transactions would also face, as discussed above, action by the Company for violation of the Code.
– Jayant Thakur