Analysing Some Insider Trading Implications For M&A Transactions

[Priya Garg is a 5th year student at West Bengal National University of Juridical Sciences (WBNUJS), Kolkata]

Consequences of Creating the Due Diligence Exception to the Bar on the Communication of UPSI

For the first time, under regulation 3 of the SEBI (Prohibition of Insider Trading) Regulations, 2015 (“PIT, 2015”), communication of unpublished price sensitive information (“UPSI”) per se has been made an offence. However, regulation 3(3) permits such communication by a company or its agents while conducting due diligence in a merger and acquisition (“M&A”) transaction. Under it, sub-clauses (i) and (ii) respectively permit such communication for acquisitions which reach the thresholds mandating the making of an open offer under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 and those not which do not cross such thresholds.

This exception has been appreciated by some industry experts and companies, for it would facilitate an effective conduct of due diligence in M&A deals. This is because the exception allows an acquirer company to gain access to requisite information about its target company even when the information continues to remain unpublished. However, as highlighted by some scholars and experts, regulation 3(3) does come with its own shortfalls. In this backdrop, I would like to offer a further critique to these exception-creating provisions under regulation 3.

Under regulation 3(3), for the exception to the bar on communication to apply, the concerned company’s board should opine that ‘the proposed transaction’ whereby UPSI is being shared is in their company’s best interests. This exception, in its present form, has several implications for an M&A deal.

First, this condition ensures that the M&A transaction whereby UPSI is being shared is legitimate[1] enough for the company’s board to consider it to be in the company’s best interests. Resultantly, this provides some safeguard against the misuse of the exception granted under regulation 3. As a corollary, in cases where an M&A deal, during the negotiation of which UPSI has been shared, does not materialise, this pre-condition requiring the board’s prior consent may qualify the prior communication of UPSI under regulation 3(3) as the communication made for ‘legitimate purposes’ under regulations 3(1) and 3(2). Hence, even in such instances of unsuccessful M&A deals, communication of UPSI would nevertheless continue to remain a legal act under PIT, 2015.

Further, regulation 3(3) requires the opinion of ‘board’ (and not ‘boards’ of companies). This implies that in an M&A deal whereby UPSI is being shared during due diligence (and not during reverse due-diligence), only the board of the target company is legally required to opine that the proposed M&A transaction is in their company’s best interests. The acquirer company’s board need not so opine for the exception to apply.[2]

Third, this requirement of obtaining the board’s consent in relation to the sharing of UPSI is partially a departure from the Sodhi Committee Report’s (the “Report”) recommendations.  In the Report, it was suggested that for the board to permit the sharing of UPSI during due diligence, not only should the proposed transaction of M&A be in the acquired company’s best interests, but also the conduct of due diligence.[3] However, under PIT, 2015, only the proposed transaction is required to be in the concerned company’s best interests.[4]

Ambiguity regarding the meaning of the phrase ‘proposed to be listed’

Under PIT, 2015, prohibition has been imposed on the person possessing UPSI in relation to its communication and dealing in securities while possessing the UPSI. According to regulations 3 and 4, this prohibition applies not only in relation to the company which stands listed but also the one which has been ‘proposed’ to be listed. However, neither under PIT, 2015 nor under the Sodhi Committee’s Report, the term ‘proposed’ to be listed has been defined. This paves  way for uncertainty regarding its scope and ambit. This ambiguity deepens because within the draft regulations incorporated in the Report, while regulation2(1)(c) defines a company as an entity whose securities are listed or ‘intended’ to be listed on a stock exchange, under the salient features of the Report[5] it has been stated that the proposed regulations should cover the securities listed as well as the ones ‘proposed’ to be listed.[6] The terms ‘proposed’ and ‘intended’ in relation to the listing of securities cannot be synonymous. The former involves some proposal by the company at hand to some concerned authority to get itself listed. On the other hand, the latter is a broader term encompassing within itself even the companies which intend to get listed themselves someday but have not yet taken a concrete step before the concerned authorities for that purpose. Hence, to this extent, there was an element of inconsistency in relation to this aspect in the Report. Amidst these circumstances, on the other hand, PIT, 2015 solely uses the term ‘proposed’ to be listed.[7] Nowhere under PIT, 2015 has the phrase ‘intended’ to be listed been incorporated.[8] Therefore, it mystery remains as to whether PIT, 2015 indeed aims at covering the companies which are ‘intended’ (and not only the ones ‘proposed’) to be listed in its usage of the phrase ‘intended’ to be listed.

This ambiguity plays an even larger role in an M&A deal. This is because in such a transaction a company may be acquired with the ‘intention’ of getting either of the participant companies to the M&A transaction listed. For example, the instances of reverse takeover[9] involve the ‘intention’ to get the acquiring company listed more easily as a result part of the M&A transaction. Therefore, in the M&A deal where either of the participant companies is not listed at the time of the deal but ‘intends’ to get listed post-the deal, the unlisted participant company will reel under some uncertainty regarding it being subject to PIT, 2015 at the time of the deal itself.

Uncertainty regarding the meaning of the phrase ‘legitimate purposes’

Under regulation 3(ii) of the SEBI’s (Prohibition of Insider Trading) Regulations,1992 (PIT, 1992), communication of UPSI, even when it amounted to dealing in the securities of the company to which the UPSI belonged, would not attract any legal liability if the communication was made in the ordinary course of business, profession or employment or under any law. In PIT, 2015, for the first time, this rule has been altered. According to the amended provision, communication of UPSI is permitted provided the correspondence has been made in furtherance of ‘legitimate purposes’.[10]

While the exception for the communication made in course of business, profession or employment provided under the PIT, 1992 was relatively easier to comprehend in terms of its meaning and scope, understanding the ambit of the term ‘legitimate purposes’ is a relatively more daunting task. And this concern has been shared by experts across the board.

First, it is unclear if the phrase communication in furtherance of ‘legitimate purposes’ remains confined to the communication made towards the fulfilment of a pre-existing legal obligation or it goes beyond that. Similarly, it is not certain if the phrase covers only the communication made in furtherance of a professional ‘legitimate purposes’ or it also includes sharing of UPSI in relation to some personal ‘legitimate’ objective.[11] The difference between the two kind of situations could be understood by way of an illustration. For instance, where on one hand, the sharing UPSI by company to a law firm advising the company may qualify as a business-related ‘legitimate purpose’, on the other hand, confiding the company’s UPSI by its company’s employee to his spouse may qualify as a personal ‘legitimate’[12] purpose.

Only once did the SEBI get the opportunity to discuss the meaning of this phrase. In 2016, the ousted Chairman of Tata Sons, Cyrus Mistry, alleged that the sharing of UPSI by the Tata group with its Chairman Emeritus, Ratan Tata, amounted to the violation of PIT, 2015. However, SEBI ruled that the sharing of UPSI by a company with its Chairman Emeritus is a communication made in furtherance of ‘legitimate purposes’.

Further, in 2017, the Tata group filed a complaint against its ousted Chairman Cyrus Mistry alleging the violation of PIT, 2015 by the latter. The allegations arose because he, in his petition presented before the National Company Law Tribunal, communicated the UPSI relating to the Tata group. Probably, in this scenario, he can contend that the communication was made in furtherance of ‘legitimate purposes’,[13] i.e. to prove his innocence and establish the alleged wrongdoings at the Tata group which in turn shall serve some public interest. However, it goes without saying that the success of this defence, if at all taken, will hinge upon the satisfaction of the pre-condition under PIT, 2015 that the communication was made strictly on a ‘need to know’ basis.[14] Similarly, even where whistleblowing does not constitute a person’s legal duty, his communication of a company’s UPSI on a ‘need to know’ basis, for the purpose of whistleblowing, be considered as the communication made for legitimate purposes. Further, in order to ensure that this interpretation of ‘legitimate purposes’ does not encourage the circumvention of law under PIT, 2015, a precondition should be read into. This pre-condition should be  that the allegations for proving which a UPSI has been shared should not be a sham or a complete façade  and hence should have been made only bona fide.[15]


The ambiguities[16] that exist under PIT, 2015 can have adverse impact on the sharing of UPSI during M&A transactions and the M&A deals themselves. Further, these ambiguities can have undesired implications for the overall insider trading scenario. This is because M&A transactions do provide a fertile ground for insider trading activities and do raise the temptation to devise ways to circumvent the insider trading regulations. Hence, there exists a need for some clarification – the sooner the better.

Priya Garg

[1] Regulation 3(1) & 3(2), PIT, 2015. 

[2] In case of reverse due diligence, it will be just the opposite. In such cases, yet again due to the use of the term ‘board’ and not ‘boards’ under the provision, the board of the acquirer needs to opine, prior to sharing of the UPSI regaring their company or its securities, that the transaction is in their company’s  best interests. In such instances, however the board of the target company need not so opine.

[3] Chapter II, Restrictions on Communication and Trading by Insiders, N.K. Sodhi Committee, Report of the High Level Committee to Review the Sebi (Prohibition Of Insider Trading) Regulations, 1992 (Dec. 2013) (page 52).

[4] Regulation 3(1) & 3(2), PIT, 2015. 

[5] Part I, Salient Features of The Proposed Regulations, N.K. Sodhi Committee, Report of the High Level Committee to Review the Sebi (Prohibition Of Insider Trading) Regulations, 1992 (Dec. 2013).

[6] Part I, General Aspects 1, N.K. Sodhi Committee, Report of the High Level Committee to Review the Sebi (Prohibition Of Insider Trading) Regulations, 1992 (Dec. 2013).

[7] Regulation 3(1), 3(2) & 4(1), PIT, 2015. 

[8] See Regulation 3(1), 3(2) & 4(1), PIT, 2015. 

[9] A reverse takeover (RTO) is a type of transaction that private companies use become publicly traded without resorting to an initial public offering (IPO).

[10] Regulation 3(1) & 3(2), PIT, 2015. 

[11] Compare with Michael V. Seitzinger, Federal Securities Law: Insider Trading, Congressional Research Services, available at (“a person [would be held] liable for violating the insider trading prohibition laid out in Section 2(a) of the bill if the person intentionally discloses “without a legitimate business [bold inserted] purpose” information that he knows or should know is material information and inside information.”).

[12] Even the Indian Evidence Act, 1872 in India respects the  communication between a husband and his wife. This has been done for the public policy reasons. This communication is considered to be legitimate in the eyes of law to this great an extent that it qualifies as a privileged communication. Hence, one of the spouses cannot be called to testify against the other in relation to the information which he has received under the privileged communication.

[13] Regulation 3(1) & Regulation 3(2)PIT, 2015. 

[14] Note to Regulation 3(1), PIT, 2015; Schedule A, Principle 8, Principles of Fair Disclosure for purposes of Code of Practices and Procedures for Fair Disclosure of Unpublished Price Sensitive Information, PIT, 2015. 

[15] Note to Regulation 3(1); Schedule A, Principle 8, Principles of Fair Disclosure for purposes of Code of Practices and Procedures for Fair Disclosure of Unpublished Price Sensitive Information, Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015. 

[16] Lakshmikumaran&Sridharan, Corporate Amicus (December 2014). See Rakesh Agrawal v. SEBI, (2004) 1 CompLJ 193 SAT; See Umakanth Varottil, Discretionary Portfolio Management and Insider Trading, IndiaCorpLaw (13 August 2016); See Sebi Informal Guidance in the Matter of HDFC Bank Ltd,  Khaitan &Co (2016); Hindustan Lever Limited v. SEBI, FINC014 2002; SuneethKatarki & Namita Viswanath, “Mens Rea” In Insider Trading – A “Sine Qua Non”?, Mondaq (03 June 2015).

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