Harmonization of Insider Trading Norms and the Companies Act

[Ankit Handa and Arunima Vijay are 3rd year (VI Semester) B.A., LL.B. (Hons.) students at National Law University in Jodhpur]

The Companies Amendment Act 2017 (“CAA ‘17”) has been notified by the Ministry of Corporate Affairs (“MCA”) on 3 January 2018. One of the major aims of harmonisation with the Securities and Exchange Board of India Act 1992 (“SEBI Act”) and regulations made thereunder is clear through the omission of sections 194 and 195 of the Companies Act, 2013 (“CA ‘13”).

Companies Act 2013 Norms on Insider Trading (Prior to CAA’17)

The purpose of norms governing insider trading is to prohibit persons who have access to inside information (which is usually price sensitive) in a company from dealing in that firm’s publicly traded shares.

Section 194 was a penal provision specifically prohibiting forward dealings in securities of the company (as well as holding, subsidiary or associate company) by director (whole time director) or key managerial personnel (“KMP”), while section 195 was a penal provision prohibiting insider trading of securities. It was based on the rationale that certain individuals like directors and KMP owe a fiduciary duty to the company, and should work towards its betterment rather than their own self-interest, which is quite clear from Section 166 of CA’13 which codified the duties of directors.

SEBI Norms on Insider Trading

Sections 64 and 65 of the CAA’17 omitted sections194 and 195 of CA’13 respectively to the result that the prohibitions on forward dealing and insider trading shall now be comprehensively governed by the SEBI Act and Regulations.

In accordance with Section 12A of SEBI Act, 1992, a person is prohibited from engaging in insider trading or dealing in securities while in possession of material or non-public information (forward dealings) and using the same for his or her own advantage in contravention of the provisions of the SEBI Act. Furthermore, the SEBI (Prevention of Insider Trading) Regulations 2015 (“PIT 2015”) comprehensively provides the framework for such preventions.

Impact on and Position of Insider Trading Norms post CAA’17

In the authors’ analysis, the omission of sections 194 and 195 would have an impact on three major fronts in relation to the prevention of forward dealing and insider trading.

1. First, the prevention of insider trading norms shall cease to apply to private companies and public companies with unlisted securities. The erstwhile sections 194 and 195 restricted forward dealing by directors and KMPs and insider trading by ‘any person’ including directors and KMPs respectively of ‘a company. Thus, these strict penal provisions were applicable to even private companies. This was unwarranted as the prohibition adversely affects fund raising and capital formation for private corporates in respect of rights issue and private placement, especially in the context of the rights of first refusal that are frequently contained in shareholders’ agreements of private companies. In view of these practical difficulties expressed by stakeholders, the Company Law Committee suggested that sections 194 and 195 may be omitted from the Act.

Thus, presently, after CAA ’17, the prohibitions on insider trading (as prescribed by section 12A of the SEBI Act and regulations 3(1), 4(1) of PIT 2015) are only applicable to ‘securities that are listed or proposed to be listed’, and insider trading norms will cease to include private companies as well as public companies having unlisted securities.

2. Second, an unambiguous procedure for prosecuting insider trading is now prescribed. Section 458 of CA’13 delegated powers to SEBI to prosecute insider trading only ‘in securities of listed companies and companies which intend to get their securities listed’. However, for private companies and public companies with unlisted securities, it resulted in the necessary implication that the Registrar of Companies (RoC) could conduct an inspection or inquiry under sections 206 or 207 or the Central Government could order an investigation under section 210 or the National Company Law Tribunal could even impose restrictions on securities under section 222. Thus, there were multiple methods and forums for investigating and prosecuting insider trading leading to ambiguity.

However, after CAA’17, the forum and method for investigating and prosecuting insider trading is quite clear and unambiguous. Regulation 10 of the PIT 2015 clarifies that ‘any contravention of these regulations shall be dealt with by the Board in accordance with the Act’ and the SEBI Act (by way of section 15G read with section 15I) prescribes the comprehensive procedure from appointment of adjudicating officer to the investigation as well as the penalties prescribed. Therefore, after CAA’17, a definite procedure and only a single forum and authority in the form of SEBI exists for prosecuting insider trading and forward dealing.

3. Third, a specific jail term as penalty for insider trading no longer exists. While contravention of erstwhile sections 194 and 195 of CA’13 could invite imprisonment for a term extending to two years and five years respectively, section 15G of SEBI Act which specifically prescribes penalty for insider trading limits it to only monetary penalty of twenty-five crore rupees or three times the amount of profits made out of insider trading, (whichever is higher). However, the more general section 24 of the SEBI Act, which relates to offences, provides for imprisonment extending to ten years to any person who ‘contravenes or attempts to contravene or abets the contravention of the provisions of the Act or of any rules or regulations made thereunder’ and can be used to punish insider trading with a jail term.

Thus, post CAA’17, a jail term is not prescribed as a specific penalty for insider trading or forward dealing, though it may be awarded by exercising powers under Section 24. Moreover, by way of section 11 of the SEBI Act, SEBI is also empowered to prohibit an insider from investing in or dealing in securities, declare violative transactions as void, order return of securities so purchased or sold.

The omission of a specific jail term for insider trading is a welcome change because as analyzed by Professor Sandeep Parekh, the threat of a jail sentence for the offender is more of a paper tiger and criminal sanctions for insider trading provide only a small amount of relief even in more heavily regulated countries. As an analysis in the Economic Times notes, the burden of proving a criminal charge is so onerous, the requirement of intent so strict and the courts procedures so lengthy that conviction is an exception. With a conviction rate of less than 3% in India, SEBI should really concentrate on efforts to economically paralyze insider traders instead of the more high profile and far less successful criminal sanctions. The recent action against Reliance Industries Ltd (RIL) where punishment came in the form of a prohibition from accessing the equity derivatives segment for a year and a penalty of Rs 447.27 crore along with an interest of 12 per cent since November 29, 2007, is a case in point of an efficient economic sanction.

Conclusion and Critique

In light of the above discussion, the authors conclude that the step for omission of sections194-195 of the Companies Act is a welcome one since it removes private companies from its ambit, prescribes a definite procedure and single forum for investigation and prosecution and correctly removes the specific provision for imprisonment while keeping the deterrent effect intact in form of section 24.

However, one concern is that a minimum mandatory penalty which existed prior to the CAA’17, i.e. minimum penalty of Rs 1 lakh for contravention of section 194 and Rs 5 lakhs for contravention of section 195, has ceased to exist. A balance needs to be maintained and a minimum monetary penalty is essential for offences like insider trading to have an efficient deterrent effect. This is essential presently, considering that India’s market capitalization nears USD 2 trillion and the tendency to indulge in insider trading becomes enticing.

In August 2017, SEBI formed a committee to review norms pertaining to PIT 2015, and the SEBI (Prevention of Fraudulent and Unfair Trade Practices) Regulations, 2003. This committee, headed by T.K. Viswanathan, former secretary general of the Lok Sabha and former law secretary, will suggest norms to align insider trading with the recently amended Companies Act. The authors hope that the above aspects are taken into consideration.

Ankit Handa and Arunima Vijay

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