Challenges in implementation of the SEBI (Prohibition of Insider Trading) (Amendment)Regulations, 2018
“One cannot govern with ‘buts’.” - Charles de Gaulle
Listed companies, intermediaries and fiduciaries associated with the securities market seem to have started off the financial year 2019 – 2020 with lots of ifs and buts, attributed to amendments in the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015 (“PIT Regulations”), which came into effect from April 01, 2019.
The Securities and Exchange Board of India (“SEBI”) had notified amendments to the PIT Regulations on December 31, 2018, which provided a window of three months, to SEBI as well as listed companies, intermediaries and fiduciaries, to provide and / or seek clarifications / guidance with respect to certain difficulties which may be faced by such entities from compliance perspective and / or otherwise.
Such clarifications may inter – alia relate to:
a) the manner in which the digital database for recording the information of the persons with whom unpublished price information is shared (“UPSI”) is to be maintained;
b) the authority within the listed company who shall determine the question as to what shall constitute a legitimate purpose pursuant to which the UPSI may be shared, etc.
Merely by notifying amendments to the PIT Regulations, SEBI seems to be misconceived of having done its job as a market watchdog, leaving the listed companies, intermediaries and fiduciaries helpless.
It may be noted that the PIT Regulations are one of the recently introduced regulations, having come into force in 2015; however taking into consideration the cases investigated by SEBI under the PIT Regulations, difficulties faced therein, as well as the instances of leak of UPSI on ever-growing social networking sites, a need to review and tweak the existing regulations was realised.
SEBI constituted the Committee on Fair Market Conduct in August 2017 under the chairmanship of Mr. T.K. Viswanathan (FMC Committee) to, amongst other things, identify opportunities to improve the then existing PIT Regulations.
In August 2018, the FMC Committee submitted its report and sought public comments and opinion. Majority of the recommendations provided by the FMC Committee inter – alia relating to separate code of conduct for listed companies and intermediaries, compliance requirements, etc. have been accepted by SEBI and accordingly notified.
Significant changes to the PIT Regulations which may require further clarity are discussed briefly below:
Definition of UPSI
The FMC Committee observed that events which are material as per the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”) may or may not be UPSI under the PIT Regulations and may also not have an impact upon the price of the security. Events such as appointment or discontinuation of share transfer agent, change in auditor of the company, though are material events according to LODR Regulations; however the same may not impact the price of the securities of a listed company. Therefore, the specific inclusion of ‘material events in accordance with the listing agreement’ from the definition of UPSI has been deleted.
Accordingly, as per the PIT Regulations, only information relating to financial results, dividends, change in capital structure, mergers, de-mergers, acquisitions, delistings, disposals and expansion of business and such other transactions and changes in key managerial personnel are considered to be UPSI.
In the current scenario, one cannot ignore the fact that the PIT Regulations nowhere state or explain or even lay down any guidance as to when does information relating to mergers and / or acquisitions comes into existence and therefore can be considered as UPSI.
Whether UPSI comes into existence from the date of entering into a non-disclosure and standstill agreement (before conducting due diligence) with the opposite party or from the date when the final proposal is placed before the board of directors of the listed company for its approval.
This leads to further questions, for example, when is the trading window required to be closed? The answers to these questions remain elusive.
One may state that the reason for SEBI not settling these questions till date may be due to the fact that closure of trading window is left to the discretion of the board of directors or of the compliance officer and they may, by exercising such discretion, close the trading window.
However, since such transactions are usually negotiated over 6 – 12 months on an average, it is observed that SEBI has always raised questions about the UPSI coming into existence as well as the date of closure of trading window.
Another issue in the definition of UPSI which necessitates clarification from SEBI is the question as to what is meant by change in key managerial personnel. Will it mean when a notice of resignation is served by such key managerial personnel upon his / her senior / human resource head or will it mean once such notice of resignation is accepted by the board of directors of such listed company?
Sharing of UPSI pursuant to a legitimate purpose
The PIT Regulations permit sharing of UPSI for a legitimate purpose and requires the listed company to have in place a policy for determination of ‘legitimate purpose’. For illustrative purposes, ‘legitimate purposes’ is defined as including sharing of UPSI in the ordinary course of business inter alia with lenders, customers and legal advisors. It is pertinent to note here that ‘promoters’ are nowhere included in this illustrative list.
An October 2017 report by the Committee on Corporate Governance stated that strategic transactions often require the support of promoters, who are generally subject to greater responsibility under the law, and significant shareholders (such as PE investors), who are permitted information rights through nominee directors. While it is recognized that promoters are akin to perpetual insiders, information flow to promoters and significant shareholders “occurs in the ‘shadows’ in the absence of a green channel” legitimizing it.
Therefore, the committee proposed amendments to the LODR Regulations to enable sharing of information with promoters and shareholders with nominee directors, including execution of an “access to information agreement” setting out confidentiality obligations and undertakings by the recipient and the rights of the company to withhold access to material information under specified circumstances.
SEBI, however, rejected the said proposal stating, “Giving any shareholder preferential treatment compared to other shareholders for getting access to information has far-reaching implications and therefore may not be desirable”.
Considering the ambiguous drafting and absence of clarity, in order to exercise abundant caution, listed companies may not share the UPSI at all with its promoters / substantial shareholders, even if such sharing of UPSI is required pursuant to a legitimate purpose and on a need-to-know basis. The PIT Regulations gives discretion to the listed companies to share the UPSI for legitimate purposes. Accordingly, certain listed companies may share the UPSI with its promoters / substantial investors as and when required in accordance with its policy for sharing of information for legitimate purpose, however, in absence of clarity on the same, going forward such sharing may invite inquiry, investigation and questioning by SEBI.
Further, whenever any UPSI is shared for a legitimate purpose, the PIT Regulations require a notice to be served upon the recipient of UPSI, to maintain the confidentiality of UPSI. However, the PIT Regulations do not cast this responsibility upon any specific person. The question that then arises is whether it shall be the responsibility of the person sharing such UPSI or shall it be the responsibility of the Company Secretary or of the Compliance Officer or any other person.
This may lead to instances wherein the notice is not served at all upon the recipient of UPSI and such person, without any knowledge of PIT Regulations trades on the basis of such UPSI. This may further lead to more instances wherein the recipient of the UPSI is hauled up for trading on the basis of UPSI (in absence of notice being served) and the listed company, its board of directors, Compliance Officer / Company Secretary being questioned for not serving a notice in this regard upon the recipient of UPSI.
Investment Companies as designated person
The PIT Regulations state ‘All promoters of listed companies and promoters who are individuals or investment companies for intermediaries or fiduciaries’ shall be designated persons. Accordingly, promoters who are investment companies in relation to intermediaries or fiduciaries are to be categorised as ‘designated persons’ and therefore the code of conduct adopted by such entity shall be applicable to such investment company.
However, the term ‘investment company’ is nowhere defined in the PIT Regulations, nor is it defined in the SEBI Act, 1992, the Securities Contracts (Regulation) Act, 1956, the Depositories Act, 1996 or the Companies Act, 2013. The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 while laying down the list of deemed to be persons acting in concert makes reference to an investment company, however it leaves the term ‘investment company’ undefined and unexplained.
In absence of guidance in this regard, the explanation to Section 186 (13) of the Companies Act, 2013 may be referred, which explains investment company for the purposes of section 186 as ‘Explanation.—For the purposes of this section,— (a) the expression “investment company” means a company whose principal business is the acquisition of shares, debentures or other securities and a company will be deemed to be principally engaged in the business of acquisition of shares, debentures or other securities, if its assets in the form of investment in shares, debentures or other securities constitute not less than fifty per cent. of its total assets, or if its income derived from investment business constitutes not less than fifty per cent. as a proportion of its gross income.’
Therefore, although the definition provided in the above explanation may be referred by such intermediaries or fiduciaries to determine the entities that shall be investment companies and accordingly categorize them as designated person(s) however, to enable such intermediaries to implement the PIT Regulations in letter and spirit, SEBI should lay down a specific definition in this regard.
As discussed above, once such investment companies are categorized as designated persons for the intermediary, the code of conduct adopted by the intermediary will become applicable to the investment company and accordingly the restrictions and compliances in respect of contra-trades and obtaining pre-clearance shall be required to be followed.
For example, an Asset Management Company (“AMC”) being a recognized intermediary is required to formulate a code of conduct in accordance with PIT Regulations and categorize entities/ persons as ‘designated persons’ in accordance with Regulation 9(4) of the PIT Regulations. It is pertinent to note here that ‘investment companies’ who are promoters are also required to be categorized as designated persons and accordingly the code of conduct shall be applicable to such investment companies as well. This categorization is so required irrespective of the role, function and access to UPSI by such investment company.
This being so, every trade proposed to be executed by such investment company shall require pre-clearance from such AMC (since AMCs deals with N-Number of securities). This may in fact lead to a situation of such AMCs being privy to the confidential information of such investment company.
Investment companies being categorized as designated persons may not even be comfortable and open to sharing such trading decisions with the AMCs, as the same may also lead to prejudicing the interest of the stakeholders of the investment company and may also lead to cases of front-running.
However, this doesn’t seem to be the spirit of the PIT Regulations and accordingly, the provision in this regard needs to be reconsidered and relooked at by SEBI.
Conclusion
Amendments to the PIT Regulations are a welcome move but given the ambiguity still prevailing, with a view of implementing the PIT Regulations in its true letter and spirit, SEBI should focus on providing greater clarity and guidance in this regard rather than hauling up the listed companies, intermediaries, its board of directors and compliance officers, wherein non-compliance with the PIT Regulations are attributed to ambiguous drafting of such provisions.
Disclaimer: The views expressed here are strictly personal.