SEBI’s Interference in a Compliance Officer’s Decision under Insider Trading Regulations – A Recent Informal Guidance

[Guest
post by Suvan Law Advisors, a law
firm specializing in regulatory laws. They can be reached at info@suvanlaw.com. Disclosure: Partners of Suvan Law Advisors contributories to
Justice Sodhi Committee Report on Insider Trading.]
SEBI has issued a ‘path-breaking’ Informal
Guidance
dated February 3, 2017 to Kirloskar
Chillers Private Limited (“Kirloskar
Private”
), which has been made public by SEBI yesterday. This guidance,
which may otherwise look innocuous, sets a different tone going forward on how
compliance officers may view the SEBI
(Prohibition of Insider Trading) Regulations, 2015
(“PIT Regulations”).
Facts
1.   Kirloskar
Private is part of the promoter group of Kiroskar Brothers Ltd. (“KBL”), which is a public listed
company.
2.   KBL
had issued a Code of Fair Disclosure of Unpublished Price Sensitive Information
(“UPSI”) and Code of Conduct to
regulate monitor and report trading by insiders of KBL (“CoC”) in accordance with the PIT Regulations.  
3.   Kirloskar
Private, intending to acquire 50,000 equity shares of KBL, made an application
to the Compliance Officer of KBL seeking pre-clearance under the CoC. Kirloskar
Private had also attached a declaration/undertaking that it did not possess any
unpublished price sensitive information.
4.   The
Compliance Officer rejected the request without any grounds initially and upon
request, he provided the reasoning that there is already an approved pre-clearance
in place for promoters and there is no balance number of shares available to
trade.
Issues
Kirloskar Private approached SEBI
for an informal guidance on the following broad issues:
1.   Whether Kirloskar Private or any other entity
that qualifies as a promoter group requires a pre-clearance from KBL merely
because it is a promoter, even though it has no role in the management of KBL
or have any access whatsoever to UPSI?
SEBI’s
View
: SEBI has referred to clause 6 of
Schedule B of the PIT Regulations and has stated that pre-clearance is required
only by “Designated Persons”
if the value of the proposed trades is above such thresholds as the board of
directors may stipulate. Thus, a promoter, if designated as a “designated
person” by the board of directors in consultation with the compliance officer,
will be required to obtain pre-clearance for trading.
2.   What are the factors that the compliance
officer is permitted to consider while approving or rejecting an application
seeking pre-clearance for a proposed transaction?
SEBI’s
View
: The Compliance Officer may approve or reject
a pre-clearance request after necessary assessment as per the PIT Regulations
and the Code of Conduct.
3.   Whether the Compliance Officer has the power
to reject the Application of Kirloskar Private based on the grounds stated in
his communications, which are extraneous to requirements of CoC and PIT
Regulations?
SEBI’s
View
: Any question with respect to the
Compliance Officer may be referred to the board of directors and audit
committee for examination in accordance with extant laws and the relevant facts
of the case. Further, it is assumed that any actions of Compliance Officers,
Board of Directors or other entities entrusted with ensuring adherence to PIT
Regulations should be to ensure compliance in letter and spirit to the PIT
Regulations and not for any ulterior motive.
Analysis
This informal guidance arises out
of a very interesting set of facts, and is likely to have a significant impact
on how listed companies devise their Codes of Conduct going forward.
Applicability of CoC
The first crucial issue is
regarding applicability of the Code of Conduct. Since the PIT Regulations in
their new avatar give flexibility to
companies to decide on whom the code of conduct is to be applied, it varies
from company to company. According to clause 3 of Schedule B to PIT
Regulations, the Code applies to designated persons, which includes employees
and connected person based on their functional role in the organization.
Promoters who do not have any functional role in the Company have typically not
been included in the definition of “Designated Persons” by the companies.
In this case, the Code of KBL
provided that all insiders, designated employees, auditors, consultants and
other advisors are required to seek pre-clearance. Although promoters do not
seem to be specifically covered under this definition, it is possible that they
fall under one of the broad categories mentioned therein. If the definition of
designated person was tighter, this situation would not have emerged.
Appeal from decisions
of Compliance Officer
The decision of the Compliance
Officer adversely affected the substantive right of Kirloskar Private to
acquire shares. Moreover, the reasoning provided by the Compliance Officer is
not acceptable to them. The informal guidance provided by SEBI rightly does not
delve into correctness of the decision of the Compliance Officer. However, this
does not mitigate the need to have a review mechanism from the decisions of the
Compliance Officer, who has been given significant decision making power under
the PIT Regulations. Hence, SEBI, taking recourse to definition of compliance
officer, has viewed that an action of a Compliance Officer, whether it is
extraneous to his or her powers, is to be examined by the board of directors
and the audit committee.
To sum up, SEBI holds that: –
1.   Unless a promoter is designated as a
“Designated Person” by the board of directors in consultation with the
Compliance Officer, no pre-clearance for trading is needed.
2.   The actions of Compliance Officers, Board of
Directors and other entities in adherence to Insider Trading Regulations are
going to be judged from an “ulterior motive” test.
3.   An action of a Compliance Officer, whether it
is extraneous to his or her powers, is to be examined by the board of directors
and the audit committee.
4.   The PIT Regulations by nature are prohibitive
and the applicability of its provisions is with respect to insiders and such
concerned securities to which a UPSI might pertain; so that there is no undue
advantage accrued to such class of investors, on account of their access to
UPSI, at the expense of other investors or general market participants.
On a different note, when the PIT
Regulations were being formed, a novel experiment in the form of a Trading
Plan, for those who are perpetually in possession of UPSI, was suggested in Justice N. K. Sodhi Committee Report. Unfortunately, the same has not
picked up for various reasons. The Committee itself had suggested a review of PIT
Regulations based upon review of empirical evidence and feedback after the
concept of trading plan is introduced. Perhaps the time has come up for review
of the Regulations. In the next iteration of the PIT Regulations, the role of
compliance officer in the gamut of obligations should be one of the critical
aspects that needs to be debated.
– Suvan Law Advisors

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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