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20 April, 2019
On December 31, 2018, the Securities and Exchange Board of India (‘SEBI‘) issued the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2018 (‘Amendment Regulations‘) amending certain provisions of the SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’) with effect from April 1, 2019. These Amendment Regulations are broadly based on the recommendations in the Report of the Committee on Fair Market Conduct issued on August 8, 2018. Some of the key highlights of the Amendment Regulations are set out below.
- Communication of UPSI for “Legitimate Purposes”
Regulation 3 of the PIT Regulations prohibits, inter alia, communication and procurement of ‘Unpublished Price Sensitive Information’ (‘UPSI’), except for legitimate purposes, performance of duties or discharge of legal obligations. However, the PIT Regulations did not define the term ‘legitimate purposes’. The Amendment Regulations have introduced a new sub-regulation 3(2A) which requires the board of directors of every listed company (‘Board’) to make a policy for determination of ‘legitimate purposes’ as a part of their Codes of Fair Disclosure and Conduct. Further, an explanation has also been added, which provides that the term ‘legitimate purposes’ includes sharing of UPSI in the ordinary course of business by an insider with partners, collaborators, lenders, customers, suppliers, merchant bankers, legal advisors, auditors, insolvency professionals or other advisors or consultants, provided that such sharing has not been carried out to evade or circumvent the prohibitions of the PIT Regulations.
The Amendment Regulations have also introduced a new sub-regulation 3(2B) which provides that any person in receipt of UPSI pursuant to such a ‘legitimate purpose’ would be considered an ‘insider’, and due notice must be given to these ‘insiders’ to maintain confidentiality of such UPSI in compliance with the PIT Regulations.
- Communication of UPSI for Due-diligence
Regulation 3(3) of the PIT Regulations has been amended to provide that in case of sharing of UPSI for transactions involving listed companies (whether or not the transaction attracts open offer obligations under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011), the Board must form an informed opinion that the sharing of such information (and not the proposed transaction, as was the case earlier) is in the best interests of the company.
Further, in case of transactions not attracting open offer obligations, Regulation 3(3) has been amended to provide that cleansing disclosures (i.e. disclosure of UPSI shared in connection with the transaction, that is required to be made at least two trading days prior to the proposed transaction being effected) is to be in such form as the Board of the listed company may determine to be adequate and fair to cover all relevant and material facts.
- Communication of UPSI – Maintenance of Structured Digital Database
The Amendment Regulations have introduced a new Regulation 3(5), which provides that the Board of listed companies must ensure that a structured digital database is maintained containing the names of such persons or entities with whom information is shared under Regulation 3, along with the Permanent Account Number (or any other identifier authorized by law where the Permanent Account Number is not available). Such databases are required to be maintained with adequate internal controls and checks, such as time stamping and audit trails to ensure non-tampering of the database.
- Insider Trading – Presumption based on Possession of UPSI
Regulation 4(1) of the PIT Regulations has been amended to include an explanation stating that when a person who has traded while in possession of UPSI, such trades would be presumed to have been motivated by the knowledge and awareness of such information. This presumption was earlier included in the legislative note to Regulation 4(1), but has now been added as an explanation by SEBI.
- New Defences to Trading while in Possession of UPSI
The off-market inter-se promoter trade defence in the PIT Regulations has been amended to apply to trades inter-se any insiders (i.e. whether promoters or otherwise). Further, the following three defences have been added: (i) block deal window trades between persons possessing identical UPSI; (ii) bona fide transactions pursuant to statutory or regulatory obligations; and (iii) exercise of stock options at a pre-determined price.
However, SEBI has not offered clarity in relation to what transactions would be considered ‘bona fide’ for statutory or regulatory purposes. In this regard, it would be relevant to consider factors such as the timing of the transaction, the nature of the obligation and whether the transaction was the only option available to achieve the obligation. For instance, bona fide trades to ensure compliance with minimum public shareholding requirements may potentially avail of this defence. However, what is not clear is whether such defence is available through the 12 month window provided to achieve minimum public shareholding requirements.
- Trading Plans
Regulation 5(3) has been amended to clarify that pre-clearance of trades is not required for a trade executed as per an approved trading plan, and trading window norms and restrictions on contra trades do not apply to trades carried out in accordance with an approved trading plan.
- Disclosures by Designated Persons
Regulation 7(2) originally required promoters, employees and directors of listed companies to make certain continual disclosures to the company (which were to be passed onward by the companies to the stock exchanges). Regulation 7(2) has been amended to make such requirements applicable to ‘designated persons’ (instead of ‘employees’) and to members of the promoter group (pursuant to a further amendment to the PIT Regulations[1]).
- Code of Conduct – Formulation and Scope
Prior to the Amendment Regulations, the PIT Regulations required the Board of every company and every other person required to handle UPSI in the course of business operations to formulate a Code of Conduct and imposed common minimum standards for all such codes.
The Amendment Regulations have amended Regulation 9(1) to provide that the Board or head(s) of the organisation of every listed company and intermediary must ensure that the Chief Executive Officer or Managing Director formulates such Codes of Conduct adopting the minimum standards in Schedule B (in case of a listed company) and Schedule C (in case of a intermediary). Prior to the Amendment Regulations, the same standards applied in case of listed companies and intermediaries. Separately, Regulation 9(2) requires the Board or head(s) of the organisation of every other person (i.e. other than listed companies and intermediaries) who is required to handle UPSI in the course of business operations to formulate a Code of Conduct governing trading in securities by their designated persons (as identified by the Code of Conduct), adopting the minimum standards set out in Schedule C.[2]
- Code of Conduct – Designated Persons
The Amendment Regulations now require the Board (or analogous authority as the case may be) to, in consultation with the Compliance Officer, specify the persons designated as ‘Designated Persons’ based on their role and function in the organisation and resulting access to UPSI. It further provides that Designated Persons must include, inter alia, promoters of listed companies and promoters who are individuals or investment companies for intermediaries or fiduciaries and the Chief Executive Officer and employees up to two levels below Chief Executive Officer of such listed company, intermediary, fiduciary and its material subsidiaries irrespective of their functional role in the company or ability to have access to UPSI.
- Code of Conduct – Amendments to Minimum Standards
In relation to Codes of Conduct of listed companies, Schedule B (in case of listed companies) has been amended to, inter alia, provide that Designated Persons and their immediate relatives would be governed by the Code of Conduct. Additionally, the minimum standards set out in Schedule B have been amended to provide that:
(i) contra trade restrictions do not apply to exercise of stock options;
(ii) the trading restriction period can be made applicable from the end of every quarter till 48 hours after the declaration of financial results (while this seems to be a recommendation and not a mandatory requirement, the National Stock Exchange of India Limited (NSE) has clarified that, pursuant to discussions with SEBI, in any case, the trading restriction period is required to commence not later than the end of every quarter till 48 hours after the declaration of financial results)[3]; and
(iii) the gap between clearance of accounts by the Audit Committee and the Board meeting should be as narrow as possible and preferably on the same day to avoid leakage of material information.
The Amendment Regulations further removed the following requirements from Schedule B:
(i) that trading window restrictions also apply to persons having contractual or fiduciary relation with the listed company (such as auditors, accountancy firms, law firms, analysts, consultants etc. assisting or advising the company);
(ii) the restriction on Designated Persons applying for preclearance if such Designated Person is in possession of UPSI (even if the trading window is not closed); and
(iii) the requirement to maintain a restricted list of securities (to be used as the basis for approving or rejecting preclearance applications).
In relation to Codes of Conduct of intermediaries and fiduciaries, the new Schedule C provides minimum standards which removes the trading window requirements provided for in Schedule B and provides for restricted lists.
Additionally, both Schedule B and C provide for certain incremental compliance requirements, including requiring Designated Persons to disclose to the listed company, intermediary of fiduciary, as the case may be, the names and Permanent Account Number (or any other identifier authorized by law) of (i) immediate relatives; and (ii) persons with whom such Designated Persons share a ‘material financial relationship’.[4]
- Institutional Mechanism for Prevention of Insider trading
The Amendment Regulations have introduced a new Regulation 9A, which provides that the Chief Executive Officer, Managing Director or such other analogous person of a listed company, intermediary or fiduciary must put in place an adequate and effective system of internal controls to ensure compliance with the PIT Regulations.
These internal controls include: (i) all employees with access to UPSI to be identified as “designated employees”; (ii) UPSI to be identified and confidentiality to be maintained; (iii) adequate restrictions on communication or procurement of UPSI; (iv) maintenance of a list of employees with UPSI and execution of confidentiality agreements or notice to be served on all such employees and persons; and (vi) periodic process review to evaluate effectiveness of such internal controls should be conducted.
The Board or head(s) of the organisation of every relevant entity must ensure that the Chief Executive Officer, Managing Director or other analogous person ensure compliance with Regulation 9 and Regulation 9A and the Audit Committee or other analogous body, as the case may be, must review compliance at least once every financial year and verify that the systems for internal control are adequate and are operating effectively.
Every listed company is also required to formulate written policies and procedures for inquiry in case of leaks or suspected leaks of UPSI and to formulate a whistle-blower policy to enable employees to report instances of leak of UPSI. In case of an inquiry initiated by a listed company in case of leaks or suspected leaks of UPSI, the relevant intermediaries and fiduciaries are required to co-operate with the listed company in connection with such an inquiry.
- Additional Obligations on Boards under the PIT Regulations (Pre and Post-Amendment)
| Particulars | Pre-Amendment | Post-Amendment |
| Legitimate purposes | – | The Board of a listed company is required to formulate a policy for determination of legitimate purposes (for communication of UPSI under Regulation 3) as part of the Code of Fair Disclosure and Conduct. |
| Communication of UPSI for due-diligence | UPSI may be shared in relation to a transaction that would (a) attract an obligation to make an open offer; or (b) not attract the obligation to make an open offer, if the Board is of the informed opinion that the proposed transaction is in the best interests of the company.
In case of a transaction that would not attract the obligation to make an open offer, the cleansing disclosure is required to be made in such form as the Board may determine. |
UPSI may be shared in relation to a transaction that would (a) attract an obligation to make an open offer; or (b) not attract the obligation to make an open offer, if the Board is of the informed opinion that the sharing of such information is in the best interests of the company.
In case of a transaction that would not attract the obligation to make an open offer, the cleansing disclosure is required to be made in such form as the Board may determine to be adequate and fair to cover all relevant and material facts. |
| Structured Digital Database | – | The Board to ensure that a structured digital database is maintained containing the names of such persons or entities, as the case may be, with which information is shared (under Regulation 3) along with the Permanent Account Number or any other identifier authorized by law. |
| Formulation of Code of Conduct – Listed companies and market intermediaries | The Board of every listed company and market intermediary must formulate a Code of Conduct in accordance with Schedule B of the PIT Regulations. | The Board of every listed company and the Board or heads of organization of every intermediary must ensure that the Chief Executive Officer or Managing Director must formulate a Code of Conduct with their approval in accordance with Schedule B and Schedule C of the PIT Regulations, respectively. |
| Formulation of Code of Conduct – Persons required to handle UPSI | Every person required to handle UPSI in the course of business operations must formulate a Code of Conduct in accordance with Schedule B of the PIT Regulations. | The Board or heads of organization of every person required to handle UPSI in the course of business operations must formulate a Code of Conduct in accordance with Schedule C of the PIT Regulations. |
| Ensuring compliance with Code of Conduct and Institutional Mechanism for Prevention of Insider Trading | – | The Board of every listed company, and the Board or heads of the organization of intermediaries and fiduciaries must ensure that the Chief Executive Officer or the Managing Director or such other analogous person ensures compliance with Regulation 9 (Code of Conduct) and sub-regulations (1) and (2) of Regulation 9A (Institutional Mechanism for Prevention of Insider Trading) of the PIT Regulations. |
| Policy for inquiries into UPSI leaks | – | The Board is required to approve the written policies formulated by every listed company with respect to inquiries to be initiated in case of a leak or suspected leak of UPSI. |
- Compliance Officer – Eligibility Criteria
The definition of ‘compliance officer’ in the PIT Regulations provided that such an officer must be ‘financially literate’, but did not explain the meaning of the term. In line with the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, the Amendment Regulations have introduced an explanation to the definition of ‘compliance officer’, which states that ‘financially literate’ means a person who “has the ability to read and understand basic financial statements i.e. balance sheet, profit and loss account, and statement of cash flows.”
- New Definition of “Proposed to be Listed”
The prohibitions and restrictions on insider trading and communication of UPSI apply to securities of companies that are listed or “proposed to be listed”. However, the PIT Regulations, as originally enacted, did not define the term “proposed to be listed”. For clarity, the Amendment Regulations have defined “proposed to be listed” to include securities of an unlisted company: (i) if such unlisted company has filed offer documents or other documents, as the case may be, with SEBI, stock exchange(s) or registrar of companies in connection with the listing; or (ii) if such unlisted company is getting listed pursuant to any merger or amalgamation and has filed a copy of such scheme of merger or amalgamation under the Companies Act, 2013.
- Definition of UPSI – Delinked from “Material events”
The illustrations of information that constitute UPSI, as provided in the PIT Regulations, included “material events” in accordance with the listing agreement. The above illustration has been deleted since many of these events might not be price sensitive.
For further information, please contact:
Zia Mody, Partner, AZB & Partners
zia.mody@azbpartners.com
[1] Securities and Exchange Board of India (Prohibition of Insider Trading) (Amendment) Regulations, 2019.
[2] An explanation has been added to Regulation 9(2) which provides that professional firms such as auditors, accountancy firms, law firms, analysts, insolvency professional entities, consultants, banks etc., assisting or advising listed companies shall be collectively referred to as “fiduciaries” for the purpose of the PIT Regulations.
[3] NSE Circular Ref No: NSE/CML/2019/11 dated April 2, 2019.
[4] For this purpose, an explanation has been added to define “material financial relationship” as a relationship in which one person is a recipient of any kind of payment such as by way of a loan or gift during the immediately preceding twelve months, equivalent to at least 25% of such payer’s annual income, but shall exclude relationships in which the payment is based on arm’s length transactions.
