The Securities and Exchange Board of India (SEBI) ended the year with a bang by issuing a number of notifications on December 31, including the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2018 (PIT Amendment Regulations). The PIT Amendment Regulations come into force on April 1, 2019 and will have significant impact on the manner in which listed companies and intermediaries navigate the market conduct framework.
Though the SEBI (Prohibition of Insider Trading) Regulations, 2015 (PIT Regulations) are not very dated, there existed a need to review and tweak certain aspects of the law. Accordingly, in 2017, SEBI constituted the Committee on Fair Market Conduct under the chairmanship of Mr. T.K. Viswanathan (FMC Committee) to, amongst other things, identify opportunities to improve the PIT Regulations. A copy of the report is available here.
The PIT Amendment Regulations have incorporated almost all of the recommendations made by the FMC Committee in mid-2018 relating to the legal framework, as well as compliances. The key changes introduced by the PIT Amendment Regulations are briefly discussed below. These changes will become effective from April 1, 2019.
Greater Clarity on Key Concepts
In line with the FMC Committee Report, the PIT Amendment Regulations seek to bring clarity by defining a number of terms, such as ‘financially literate’, ‘proposed to be listed’, etc., whose meaning had hitherto been gleaned from other regulations or judicial precedents. The principle that all material information may not necessarily be price sensitive has also been confirmed through an amendment to the definition of ‘unpublished price sensitive information’ (UPSI) in the PIT Regulations.
Specifically, the PIT Amendment Regulations have taken an important step towards determining the contours of the amorphous concept of ‘legitimate purpose’, as a valid ground for communication of UPSI. Currently, the PIT Regulations prohibit communication of UPSI other than in furtherance of legitimate purpose, performance of duties or discharge of legal obligations. None of these phrases have been defined and the scope of ‘legitimate purpose’, in particular, has been the subject of a fair amount of debate over the years. While the onus of circumscribing what would constitute legitimate purpose has been put on the boards of listed companies, this development is crucial, in that it recognises that companies should have the ability to determine the manner and contours within which, they share their information.
Disclosure During Due Diligence
Regulation 3(3) of the PIT Regulations, which dealt with disclosure of UPSI during due diligence exercises, has been amended to clarify that the board of the listed company should approve such disclosure after assessing whether the sharing of UPSI is in the best interests of the company. This provision has caused some difficulty in the past, since the requirement for the board to assess the viability and impact of the transaction at the preliminary stage of information sharing, was felt to be unviable. The amendment, therefore, should enable boards to breathe easier since it realigns the basis on which communication of UPSI may be permitted.
Additional Defences to Insider Trading
This is, undoubtedly, the headline-making change in the PIT Amendment Regulations. A number of additional defences to insider trading have been introduced. Illustratively, a safe harbour has been extended to (i) off-market trades between insiders with the same UPSI (earlier limited only to promoters); (ii) trades executed on the block trade window, between persons who possess the same UPSI; (iii) trades undertaken pursuant to exercise of stock options at a pre-determined exercise price, etc.
While an explanation has been added to reiterate that trades by a person in possession of UPSI would be presumed to have been motivated by such information, the inclusion of the varied defences provides multiple channels to rebut such a presumption and will certainly grant relief to employees exercising stock options as well as facilitate big boy transactions.
Code of Conduct and Institutional Compliances
In addition to altering substantive features of the PIT Regulations, the compliance obligations of listed companies and intermediaries have also undergone a change. For instance, the PIT Amendment Regulations require the board of a listed company to ensure that a structured digital database is maintained with details of persons who receive UPSI pursuant to a due diligence exercise. Also, periodic shareholding disclosures have been limited to designated employees only.
The primary change from a compliance standpoint is the prescription of separate codes for listed companies and intermediaries. The introduction of a unified model code in the PIT Regulations in 2015, had led to a number of challenges and difficulties for market participants, such as maintenance of a restricted/grey list by listed companies, and the applicability of the trading window to intermediaries, etc. Consequently, the PIT Amendment Regulations reverts to the pre-2015 practice of stipulating two separate codes for listed companied and intermediaries and also outlines the categories of persons who would qualify as ‘designated persons’.
Additionally, in what may be an outcome of the furore around leaks of UPSI using social media and messaging platforms, the PIT Amendment Regulations places a great deal of focus on institutional responsibility for implementing and periodically reviewing internal controls and processes to prevent insider trading. Listed companies are specifically required to formulate written policies to ensure inquiry in the case of leaks of UPSI and also put in place a whistle-blower policy. Responsibility has also been placed on the boards and audit committees to ensure compliance and verify the systems and controls implemented by the entity.
An incremental compliance introduced by the PIT Amendment Regulations is the requirement for designated persons to provide details of persons with whom they share a ‘material financial relationship’, i.e., where one person is a recipient of any kind of payment (other than arms’ length transactions) in the preceding 12 months, equivalent to at least 25% of the payer’s annual income.
In this context, it is also relevant to refer to another notification issued by SEBI on December 31, amending the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (FUTP Regulations). The amendments to the FUTP Regulations (which shall come into force on February 1, 2019) also emanate from the FMC Committee Report. Primarily, the amendments seek to expand the scope of ‘dealing in securities’ to include any acts that are knowingly designed to influence trading decisions and clarify the scope of actions that are presumed to be fraudulent or manipulative as per Regulation 4(2) of the FUTP Regulations.
An Encouraging Start to the New Year
As it is with all regulatory changes, the PIT Amendment Regulations are also likely to cause some upheaval, specifically in respect of the compliance obligations that it seeks to cast on listed companies and intermediaries. The heightened focus on individual rights and privacy in current times may also require organisations to put in place balanced, workable solutions in order to implement the requirement for designated persons to provide details of ‘material financial relationship’.
However, these amendments coming in within months of the committee’s recommendations reinforce the importance placed by the regulator on a consultative law-making process. It is indeed inspiring to see SEBI keep pace with the market and gives us a lot to work on and think about, just a week into the new year.