Overhauling the Insider Trading Regulations: Part 3

[This is a continuation of two previous posts
(
here and here) in this series]
Trading Plan
The
Committee has recommended the concept of a trading plan, which is novel in the
Indian context but prevalent in some other jurisdictions. This concept has been
recommended almost on an experimental basis, to be reconsidered by SEBI based
on the initial experience. Such a trading plan has been found to be necessary
to facilitate regular trading and monetizing of securities by insiders on a
regular basis who may otherwise be unable to trade in securities of the
company. The logic appears to be that once a trading plan has been established
by an insider without being in possession of UPSI, then it does not matter if
such insider subsequently comes into possession of UPSI because the decision to
trade has already been taken prior to that.
The
facility of a trading plan has been recommended with several conditions so as
to prevent any abuse of the mechanism. For example, trading can be commenced
only after 6 months of the public disclosure of a trading plan – a sort of
cooling-off period. No trading is permitted around the time of declaration of
financial results. The trading plan must be for a period of at least 12 months,
thereby requiring a long-term commitment on the part of the insider. The
details of the trading plan must be announced and also disclosures regarding
the actual trades effected.
The
concept of a trading plan would bring some certainty to insiders who may wish
to trade. This is particularly so because in several cases under the existing
Regulations, parties have adopted the argument before SEBI or SAT that trades
were carried out as part of their regular investment / divestment plans not
just in the company concerned but more generally in respect of their other
investments. This has often operated persuasively to suggest that the insiders
were not trading on the basis of UPSI. The trading plan mechanism will now
formalize such an arrangement by imposing more objective conditions. It remains
to be seen, however, whether the trading plan will utilised effectively, and
more importantly that it will not be subject to abuses. As the Committee notes
in its report, the experience from other jurisdictions where the concept is
prevalent has not been without controversies.
Disclosures
Disclosure
obligations are quite pivotal in insider trading regulations, especially for
acquisition and disposal of shareholdings by promoters and other substantial
investors. The existing Regulations do contain significant obligations on
disclosure of material investments and divestments. That approach has been
further solidified in the proposed regulations, which require promoters, employees
and directors of the company to notify the company of their holdings, and also
material changes in the holdings from time to time. The company in turn has
obligations to notify the stock exchange so as to make the disclosures public.
Code of Conduct
The
regulation of insider trading tends to be enforced in two ways, i.e. (i)
through public enforcement by the regulator, and (ii) self-enforcement by the
companies themselves. This two-pronged approach, which is embodied in the
existing Regulations, is sought to be continued in the proposed regulations as
well. Hence, listed companies and market intermediaries are required to
establish a code of conduct on insider trading and also for fair disclosure of
material information.
Burden of Proof
The
evidentiary aspects of insider trading are crucial, as they can determine the
effectiveness of substantive regulation. Often, there is no direct evidence in
insider trading cases, and regulators are compelled to rely extensively on
circumstantial evidence. This makes the task of the regulators highly onerous. In
India, given that insider trading is a serious offence, the SAT has laid down a
fairly significant burden before an insider trading charge can be sustained.
Given this background, the explicit statement by the Committee regarding the
relative burdens of the regulators and the insider is welcome.
The
Committee’s proposal is that the burden on the regulator is to show that a
person is an insider and that he or she was in possession of UPSI at the time
of trading. Thereafter, the burden shifts to the person to show either that he
or she is not an insider or that any of the defences is available. However, the
Committee has refrained from specifying greater details regarding the
evidentiary burden as that is left to the facts of each individual case. While
this approach is helpful, a lot would depend on the manner in which the
proposed regulations are implemented by the regulator and the appellate
authority (i.e. SAT). If, on the facts of each case, the burden of the
regulator is progressively raised, then effectiveness of the regulations may be
in doubt. Hence, there is a need for appropriate sensitization of the
implementers of the regulations as to the burden of proof and other evidentiary
aspects (given that most evidence in this area is likely to be circumstantial).
For example, US courts have remained open to finding a charge of insider
trading solely on the basis of circumstantial evidence.
Short Swing Profits
One area
that has not received express attention in the Committee’s report relates to
the rule against short swing profits. After substantial debate, the existing
Regulations were amended in 2008 to state that insiders who buy or sell shares
in a company shall not enter into an opposite transaction, i.e. sell or buy,
respectively, any shares during the next 6 months following the prior
transaction. Insiders are also prevented from taking positions in derivative
transactions in shares of the company at any time. The proposed regulations do
not provide for a similar rule against short swing profits. However, there is
no discussion in the report as to whether this was considered and debated
before arriving at a conclusion to drop the rule.
Concluding Observations
The
review of the insider trading regulations is timely, and provides the much
needed certainty and clarity in that area of the law. However, its
effectiveness will depend upon the manner of implementation by the regulator
and interpretation by the appellate authority.
The
Committee has adopted a somewhat novel approach (at least in the Indian
financial regulation context) of providing notes and explanations to the
specific regulations that will aid their interpretation and thereby minimize
any ambiguity. The notes are stated to be an integral part of the regulations,
and not merely an external aid. While this is a useful approach, one cannot
rule out difficulties that may arise in the interpretation. For example, if
there is a conflict between a regulation and its note/explanation, which one would
prevail?
To
conclude, the review is a necessary step, but if the implementation is not
effective it carries the risk of being the proverbial “old wine in a new
bottle”.
(concluded)
For a
further analysis of the Committee’s recommendations and proposed regulations,
please refer to the following:
1. Discussion
on The Firm – Corporate Law in India;
2. Sandeep Parekh in the Financial Express (here
and here);
3. Tejesh
Chitlangi
in The Hindu; and

4. S.
Murlidharan
in FirstPost Business.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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