for Law and Policy Research, Bangalore and previously a capital markets lawyer
in London. She can be contacted at [email protected]
insider trading regulations on matters relating to due diligence set in the backdrop of international experience]
January 2012, the UK Financial Services Authority (“FSA”) charged a U.S. hedge
fund manager, David Einhorn, and his hedge fund, Greenlight Capital Inc., with
“trading on the basis of inside information” and imposed upon them civil
penalties of about £7.2 million (approximately $11.6 million).[1] This case attracted a lot of attention in the
US and the UK as, in addition to being an example of the FSA’s heightened resolve
to aggressively pursue cases of insider trading, it highlighted significant
differences between the insider trading regimes in the two countries. I bring it up here because it involved a case
of “inadvertent” wall crossing (explained below), which is worth revisiting in
the context of the new SEBI
(Prohibition of Insider Trading) Regulations, 2015 (“Insider Trading
Regulations”) notified last week, that now explicitly permits the communication
of unpublished price sensitive information (“UPSI”) for purposes of due
diligence in connection with a potential transaction.
managed by Greenlight owned approximately a 13.2% stake in Punch Tavern plc, a
company listed on the London Stock Exchange.
The Board of Directors of Punch was contemplating a private placement
transaction and engaged an investment bank to make calls to existing
shareholders to assess their interest in the transaction. Shareholders were
told that they would need to sign a non-disclosure agreement, which would
require them to keep the information confidential and restrict them from
trading in Punch’s shares, before they could receive any information, a process
termed as being “wall crossed.” Einhorn
declined to sign the non-disclosure agreement, but nevertheless agreed to
participate in a conference call where he claimed to have stated that he did
not want to receive inside information. During
the course of the conference call, Einhorn learned that Punch was at advanced
stages of planning an equity offering and that the proceeds of the offering
would be used to repay the company’s convertible debt and to create headroom
with respect to certain covenants on Punch’s securitization vehicles.
three days following the conference call, Greenlight began selling its shares
in Punch and drastically reduced its shareholding to 8.9%. Punch announced its equity offering six days
after the conference call and its share price fell by about 30%, which meant
that Greenlight had avoided losses of approximately £5.8 million by selling in
advance of the public announcement. The
Einhorn case is an example of an “inadvertent” wall crossing, where the FSA
held that Einhorn had received inside information even though he had declined
to sign the non-disclosure agreement. The FSA further stated that while none of
the individual pieces of information Einhorn had received constituted inside
information, the totality of the information met the relevant tests to amount
to inside information.
provision of inside information in the course of granting due diligence access
is a common practice across a number of jurisdictions and the new Insider
Trading Regulations have now been brought in line with international practice
in this regard. SEBI has rightly recognized the practical realities of
commercial transactions that prospective investors may often require non-public
information about a company in order to assess the merits of a particular
transaction. In these situations,
investors look to obtain UPSI not for insider trading but for due diligence on
a company’s finances and business, which ultimately benefits all investors by unearthing
facts that the company might have otherwise been reluctant to disclose. Taking
these factors into account, Regulation 3(3) of the Insider Trading Regulations
allows for firms to communicate UPSI in connection with a contemplated
transaction subject to certain conditions:
make an open offer under the Takeover Regulations, if the board determines the
proposed transaction to be in the best interests of the company; and
offer, if the board determines the proposed transaction to be in the best
interests of the company and any UPSI provided to potential investors as part
of due diligence is made public at least two days prior to the contemplated
transaction taking place.
not specified in the case of open offers because such transactions would in any
event require the company to make any information necessary to arrive at an
informed decision available to all shareholders.)
regulations also require the parties receiving UPSI as part of their due
diligence to sign confidentiality agreements and agree not to trade in the
securities of the listed company while in possession of inside information.
perhaps a necessity, the provision of due diligence access needs to be closely
monitored as it leaves much scope for abuse. Einhorn is perhaps an extreme example as the
broker was trudging into dangerous territory when he offered Einhorn a
conference call without being wall-crossed. Yet this case highlights the perils
associated with providing due diligence access to investors ahead of a
potential transaction and the need for stringent controls over the process. In this regard, the new regulations as they
relate to diligence access leave much unsaid and SEBI will most likely need to
issue additional guidance to ensure that these regulations facilitate
legitimate transactions while minimizing the possibility for abuse. Some areas
that I believe SEBI would need to clarify are:
(1) Process for providing UPSI: The
process employed for selectively communicating UPSI in connection with a
contemplated transaction needs to be carefully thought out to ensure that both
sides have the same understanding of what constitutes UPSI and the implications
of receiving UPSI. Before being provided
with any UPSI, potential investors must be told that they are to be (i) provided
with UPSI that they would need to keep confidential and which would restrict them
from trading and (ii) given an opportunity to decline to receive the
information. This initial conversation
is critical as great care needs to be taken not to inadvertently divulge any
information that could constitute UPSI at this stage. Further, there needs to
be great clarity on precisely which information constitutes UPSI and how long
the trading restrictions would apply. While some of these issues will develop
as part of market practice, guidelines from SEBI on best practices, as well as
a requirement for compliance officers at the relevant parties to be involved
when UPSI is provided, could help ensure discipline in the process.
(2) Form of Disclosure: The
regulations do not prescribe the form in which a company would need to communicate
UPSI to the market prior to the transaction taking place, which has been left
to the discretion of the company’s directors. It is also interesting to note that
only non-public information that is price sensitive (as opposed to all the
non-public information that has been shared with investors during the course of
due diligence) will need to be communicated to the market. While there is logic
to this requirement as companies are not expected or required to communicate
very detailed, granular or commercially sensitive information (such as targets
or customers) that is not price sensitive to the public, this requirement
together with leeway on the form of disclosure leaves much scope for
interpretation by a company’s directors. Sifting through the due diligence
information provided to potential investors ahead of a transaction to determine
the extent of the information that constitutes UPSI may prove to be a challenging
task for directors. SEBI will need to monitor how companies interpret this
requirement and may need to provide additional guidance to ensure that it
achieves the regulation’s objective of providing parity of information to the
market.
(3) Cleansing: Nowhere do the new
regulations deal with all too common a situation. What happens if investors are
provided with UPSI in connection with a contemplated transaction that does not
take place, or, as often happens, is placed on hold for an indefinite period of
time? In such situations, the question
of when a recipient of UPSI on an aborted transaction can resume trading on the
listed company’s securities assumes great significance. Trading restrictions
can only be lifted when investors have been “cleansed” of the UPSI that they
received, i.e., when the UPSI in their possession no longer gives them an
information advantage over other market participants.
If
the transaction does go ahead, the cleansing process is automatic as the new
regulations require disclosure of any UPSI to the market at least two days
ahead of the transaction. On the other
hand, if the transaction does not occur or is postponed, companies are not in
the habit of putting out announcements regarding aborted or postponed transactions.
Potential investors who receive UPSI find themselves in the difficult situation
of not knowing whether the information they have received still constitutes
UPSI or when they can resume trading.
Typically, to cleanse these investors, a company would either need to
make a public disclosure of the UPSI provided to select investors or the UPSI
must no longer be relevant (for example, the transaction terms of an aborted
transaction or if the UPSI has been superseded by subsequent events that have
been disclosed). As potential investors
are unlikely to agree to be restricted in the absence of a clearly articulated
cleansing strategy if the transaction does not take place, SEBI will need to
provide much needed guidance in this complex area.
essential for facilitating commercial transactions and capital raising, providing
UPSI to potential investors as part of due diligence access is fraught with
difficulties. Investors need to be told that they are being provided with UPSI,
the expected time period during which they cannot trade, and the cleansing
strategy if the transaction does not take place. Great care must also be taken
to ensure that potential investors are not provided with any information on the
potential transaction unless they agree to the confidentiality obligations and
trading restrictions to minimize the risk of inadvertently providing UPSI. Some of these issues may be clarified in the
implementation of the new regulations and will evolve as market practice in
this area develops, but SEBI will most likely need to provide further guidance
regarding due diligence access that walks the tightrope between facilitating
legitimate transactions while ensuring that any information flow of UPSI is
tightly regulated.
Aparna Ravi
Your write up in Indian Corporate Law on the above subject was informative.
New Regulation 5 thereof has introduced the concept of Trading Plan for the first time in India. In view of your international experience it will be helpful if you can explain the same and highlight the the pitfalls of the such a plan. Further, while the regulations speaks of trading plan being formulated by the Insider, which term includes connected person which in turn includes the company’s employee (all employees?), Schedule B refers to designated persons who can apply for pre-clearance of trade like present when the trading window is open. Is such a designated person not required to submit a trading plan ?
Your write up on the above issues will be of great help.
Thank you.
G.K. Sureka
Hey! Well written, but UI have a few doubts.
1. How will the time frame help?
As long as the said information is undisclosed, trading based on that information will be illegal, right?
Can you suggest a comprehensive definition of what will include UPSI? I don't think that it is possible because you can have cases like Einhorn at any point of time. :/
2. Regarding the form of disclosure, shouldn't disclosure be allowed in every form. Otherwise, it would result in unnecessary documentation and hassle for the person who is offering such information.
On the other hand, if the transaction does not occur or is postponed, companies are not in the habit of putting out announcements regarding aborted or postponed transactions.