In our previous blog post, dated June 12, 2019, we discussed the Securities Exchange Board of India’s (SEBI) efforts to institutionalise an informant mechanism for insider trading, through its discussion paper released in June 2019 (Discussion Paper).
The regulator has now formalised this into law through a recent amendment to the Insider Trading Regulations, which came after a SEBI board meeting approved the informant mechanism scheme on August 21 of last month. Interestingly, while the publicly available agenda of the SEBI board meeting states that it had received comments from certain entities on the Discussion Paper, these comments are not publicly available and are stated to have been excised for reasons of confidentiality.
The SEBI board approved the introduction of a new chapter in the Insider Trading Regulations, viz., Chapter IIIA (Amendment). The salient features are as follows:
- A format has been prescribed for informants to confidentially submit ‘original information’, either directly or through their legal representatives, to a SEBI division that would be designated as the Office of Informant Protection of SEBI. Such ‘original information’ is required to be credible, sufficiently specific and not known to SEBI from any other source.
- The amount of reward payable to the informant has been capped at INR One Crore and the Investor Protection and Education Fund shall be utilised for such payments. Generally, individuals who acquire information through positions held in regulatory agencies, self-regulatory organisations or who are under an obligation to report such information (such as, compliance officers) would not be eligible for a reward, though SEBI has retained the ability to review such cases.
- Listed companies, intermediaries and fiduciaries are now required to incorporate a specific clause in their internal Code of Conduct stipulating that no adverse action would be taken against employees who make a reporting to SEBI.
The benefits of introducing this mechanism, at least for the regulator, are obvious. First and foremost, it gives the regulator a platform to widen the net insofar as insider trading convictions are concerned and increase the quality of evidence and investigative processes, both of which currently suffer from a number of infirmities. In the past two years alone, for instance, where almost 85 insider trading cases have been taken up by SEBI, only 25 investigations have been completed. Having an informant’s cooperation will definitely increase the regulator’s success rates and help it in bringing to a close many more transgressions than it can identify when using a top-down approach only. As a corollary, therefore, rewarding whistle-blowers also disincentivises deviant behaviour within organisations and makes employees more cautious about their own conduct, now that the regulator has its ears on their doors.
While weighing the potential pitfalls of this Amendment, though, a number of issues emerge for immediate consideration. While straightforward cases of exploitative trading behaviour will (and should) get picked up quite easily, there will undoubtedly be more complex variations of alleged insider-trading transgressions that are brought to SEBI’s attention through this window. For instance, a given situation is bound to get more complex for both SEBI, as well as private parties, where there are intermediaries involved, and the employee of, say a broker-dealer or an investment bank, chooses to escalate the details of a complex transaction or trade, due to his/her own individual perception of the insider trading risks involved, de hors of the institutional view on the overall legality of the structure.
Whilst this loose cannon risk can technically be said to have always existed, incentivising and legitimising it will undoubtedly give rise to a new set of challenges to market players. Even where the entity eventually emerges with a clean chit from the ensuing SEBI investigation, the immediate impact on on-going transactions, client confidentiality, reputation as well as market perception etc., will surely be a critical practical concern, despite the discretion with which SEBI promises to embark on such investigations.
Another critical feature that merits some review is the approach to a cooperating offender, who is willing to adduce evidence as an informant in terms of this scheme. Under Regulation 7K, no amnesty is proposed to be granted to such parties, but they may be permitted to settle the matter confidentially, i.e., so that the identity of such person is not disclosed. Much like the debate that has raged over the years around the consent mechanism, this provision is bound to spawn another round of fervent discourse around the ethical dilemma that such actions pose. While Regulation 7K does not provide immunity, it permits SEBI to evaluate the extent of cooperation rendered at the time of the final determination of penalty, settlement or any other sanctions. But does providing culpable parties with an opportunity to convert their participation in an offence, into currency for a trade-off with the regulator, ring well for a regulator?
This classic exploitation of the prisoner’s dilemma is an age-old law-enforcement gambit. The US Securities and Exchange Commission (SEC) has, over the years, utilised this exceedingly well as an investigative tool. In fact, this entire informant mechanism structure is admittedly inspired by the SEC’s decade old Whistleblower Program. Their enforcement regime is beset with such examples, the most popular one being the entire SAC Capital insider-trading investigation, where the SEC benefitted immensely from the cooperation of one of the portfolio managers of the fund and helped him avoid a prison term in exchange.
However, in contrast to the US, given the administrative and quasi-judicial framework within which this is contemplated in India, SEBI will have to internally frame specific guidelines on how to objectively handle such cases, in a manner that incentivises and elicits genuine cooperation by abettors while at the same time, not granting them unwarranted clemency. Towing this fine line and ensuring that a cooperating whistleblower does not treat the informant mechanism almost akin to a golden parachute, will be an uphill task for the regulator, but one that will pay rich dividends if they are able to adopt a methodology that is predictable and objective.
The dynamics between the integrity that regulated markets must foster and the settlement and informant mechanisms that they are compelled to incentivise, have always been a rather complex one. Therefore, administering this Amendment and putting in place a systematic governance framework will be critical for its success, not just in sharpening the watchdog’s bite in terms of convictions and evidence collection, but also for maintaining the trust and legitimacy of this route in the mind of market participants.