SEBI’s Latest Discussion Paper on Insider Trading Regulations

Prosecuting insider trading cases has always been a challenge for the Securities Exchange Board of India (SEBI). Primary evidence is difficult to come by, which impacts success rates as well as investigation timelines.

On June 10, 2019, SEBI released a discussion paper (Discussion Paper) proposing amendments to the SEBI (Prohibition of Insider Trading) Regulations, 2015 (Insider Trading Regulations) to establish systems and processes (both within listed companies, as well as, at SEBI) that incentivise individuals to report insider trading violations, if they come to their knowledge. In terms of the Discussion Paper, the informant may be rewarded up to INR 1 crore (approx. USD 150,000) if SEBI undertakes disgorgement of at least INR 5 crores (approx. USD 0.72 million) as a result of any action taken on the basis of true, credible and original information.

The informant mechanism is proposed to be implemented through amendments to the Insider Trading Regulations. Some of its key features are as follows:

  • Any individual who has knowledge or reasonable basis to believe that an insider trading violation has or is about to occur, whether through trading or communication, can voluntarily inform SEBI through the Voluntary Information Disclosure Form (Form). The informant must also provide the source of the information.
  • The Discussion Paper also envisages submission of information anonymously, acting through a practising advocate. In such cases, the representative advocate would also have to adhere to certain obligations vis-à-vis the informant, such as verifying their identity and maintaining confidentiality.
  • The Office of Informant Protection (OIP), would be set up as an independent wing (separate from SEBI’s investigation and inspection wings), to act as the liaison with the informant. The OIP would be responsible for putting in place a policy for processing the Form, including a mechanism to assess the veracity of the information received. Once the information is processed by the OIP, it would be transferred to the relevant department, which would recommend suitable enforcement action. Subsequently, the OIP would also make a decision regarding the grant of reward to the Informant upon completion of the enforcement action by SEBI.
  • Under the framework, the identity of the informant, as well as that of the information provided would be kept confidential by the OIP, including through any proceedings initiated by SEBI, except in cases where the informant’s evidence is required to be relied on.
  • Listed companies, intermediaries, etc., would be required to revise their internal codes to ensure that employees are not penalised merely on account of filing a Form or assisting SEBI.
  • An amnesty scheme may also be offered to informants facing enforcement action, where they choose to co-operate with the regulatory investigation.

On the face of it, this Discussion Paper draws heavily from the US Security Exchange Commission’s (SEC) whistle-blower protection framework, institutionalised under the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010, and its three pillars of whistle-blower protection policy, viz., anonymity, bounties and job protection.

While the whistle-blower mechanism has been fairly successful in the US, replicating the model for the Indian market, though well – intentioned, may not be an automatic guarantee for success. Some of the concerns that could arise have been discussed below:

  • At the outset, the Discussion Paper, as currently formulated, has potential for misuse as persons can file false and intentionally misleading complaints or simply result in tip – offs that prove to be red herrings; SEBI will need to demonstrate the tools at their disposal to prevent such misuse and remain discerning about the complaints.
  • Deploying additional resources and time to establish a new division within SEBI that investigates the veracity of such complaints is not just logistically challenging, but also likely to make the main insider trading investigations even more protracted.
  • The Discussion Paper cursorily states that frivolous and vexatious complaints would trigger regulatory action, but this will need more nuanced consideration. Insider trading, as SEBI itself acknowledges, is difficult to prove and conclusive evidence may not be available, even to an informant. Therefore, considerable thought needs to be given to the manner in which the bona fides of the informant should be established.
  • Confidentiality of the complainant will be the fundamental measure of the success of such an initiative. The Discussion Paper states that the identity of the complainant remains anonymous unless their evidence needs to be relied on in proceedings. Such an exception may dilute the number of takers for this, especially in cases where the whistleblower is in a position to furnish primary evidence and hence is likely to be required for the enforcement process as well.
  • Anonymous complaints can also be filed through lawyers who are charged with the responsibility of maintaining the confidentiality of the identity of the complainant. SEBI is, as yet, silent on the liability standards that legal advisors will be held to if such confidentiality is compromised, despite their best measures and efforts.
  • In terms of the Discussion Paper, reporting to the internal compliance committee of a company is not considered for a reward. Given that the Insider Trading Regulations require listed companies to draft their whistle blower policy, SEBI may consider combining both. For example, if an employee were to report to the internal compliance committee of the company and within a prescribed time period, follow up with a SEBI complaint, then the individual should be able to avail of both protection and reward.

Bounty-hunting in the corporate world fosters a rather unique form of vigilantism; one that can benefit regulators and create greater awareness but also, simultaneously, clutter the regulator’s attention with misleading or irrelevant issues. If and when this becomes law, SEBI will have to maintain a fine balance between encouraging proxy regulators within organisations and creating a more institutionalized, reward-based framework for whistleblowers. Also, if indeed implemented, SEBI must consider extending its application to fraudulent and unfair trade practices within companies as well. Many of the recent concerns surrounding governance practices and market conduct issues in Indian companies are, in theory, equally amenable to such a framework, given the similar set of constraints faced by SEBI in the course of investigations.