Executive summary: The following article discusses the introduction of the 2015 Regulations to overhaul the legal regime to address challenges posed by the 1992 Regulations. Such challenges included limited scope of definition of ‘insider’ or ‘connected person’, no clear guidance on due diligence in listed company transactions and over regulation by prescribing detailed disclosure requirements and internal compliance processes to be followed by listed companies.  This article provides a background of insider trading related concepts in India, and the practical challenges that companies doing business in India may encounter pursuant to the 2015 Regulations becoming effective.

Main Article:

1. INTRODUCTIONAcross jurisdictions, insider trading has garnered a lot of attention within the realm of market conduct, not only as a scholarly analysis of (occasionally conflicting) economic theories but also as a distinctive type of market conduct, which has necessitated continuously evolving jurisprudence and critical regulatory scrutiny. The very essence of the prohibition on insider trading has been the impetus to maintain a level playing field in the marketplace and the dynamic nature of the legal framework has, therefore had the underlying objective of casting a wider net, in light of complex securities market products and increased access to information in this age of technology.

   With an aim to ensure information symmetry and integrity of price discovery mechanism in the securities market, the insider trading regime in India was first crystallised by the Securities and Exchange Board of India (“SEBI”), the securities market regulator, in the form of SEBI (Prohibition of Insider Trading) Regulations, 1992 (“1992 Regulations”). This was followed by significant amendments in the years 2002 and 2008 to address the evolving needs of the market and to plug certain loopholes. Subsequently, a High Level Committee under the Chairmanship of Justice N. K. Sodhi (“Sodhi Committee”) was constituted to review and strengthen the existing framework, which released its recommendations vide a report dated December 7, 2013 along with draft of the proposed regulations. This report formed the basis for introduction of the SEBI (Prohibition of Insider Trading) Regulations, 2015 (“2015 Regulations”) which will take effect from May 14, 2015. The 2015 Regulations, coupled with the provisions introduced by the Companies Act, 2013 (“Companies Act”) on insider trading and the amendments to the SEBI Act, 1992 (“SEBI Act”) conferring enhanced enforcement powers on SEBI, will now determine the extent and implementation of insider trading liability to business dealings in India.

   The introduction of the 2015 Regulations is certainly a laudable effort by SEBI in overhauling the legal regime to address challenges posed by the 1992 Regulations. Such challenges included limited scope of definition of ‘insider’ or ‘connected person’, no clear guidance on due diligence in listed company transactions and over regulation by prescribing detailed disclosure requirements and internal compliance processes to be followed by listed companies.

   This article aims to trace the development of some insider trading related concepts in India, and the practical challenges that companies doing business in India may encounter pursuant to the 2015 Regulations becoming effective.

2. JURISPRUDENTIAL UNDERPINNINGSSecurities market laws in India often find their jurisprudential basis in off-shore jurisdictions especially the United States (“U.S.”), where prohibition of insider trading emerged as a central feature of securities laws since the 1960s.

   The “classical theory” of insider trading, based on the anti-fraud provisions, i.e. Section 10(b) of the Securities Exchange Act^[1] and Rule 10b-5 of the Securities Exchange Commission Rules^[2], makes it unlawful for ‘corporate insiders’ to trade in securities on the basis of material non-public information in breach of the fiduciary obligations owed to the company and its shareholders. A complementary theory to the classical theory which aims to cover ‘corporate outsiders’, known as the “misappropriation theory”, deals with misappropriation of confidential information by corporate outsiders for securities trading purposes, in breach of a duty of trust and confidence owed to the source of the information and with expectation of a personal benefit.

   Interestingly, recent caselaws[3] in the U.S. are indicative of efforts to go beyond these theories and de-link the insider trading offence from breach of fiduciary or similar duty owed to the company. The basis for insider trading, instead, has been deemed to lie in “affirmative misrepresentation” which gets triggered upon misappropriation of confidential information by corporate outsiders, resulting from a breach of private contracts or confidentiality agreements, irrespective of the existence of a fiduciary or similar relationship.

   On the other hand, the insider trading laws in other jurisdictions such as United Kingdom (“U.K.”), Australia and Hong Kong are broader and already cover scenarios that do not necessarily require existence of a fiduciary or fiduciary like relationship to levy an insider trading allegation. The other elements required to determine culpability may, however, vary in these jurisdictions depending upon factors such as inter alia: (i) knowledge of the information recipient that the information is material and price sensitive; (ii) the ambit of material non public information or unpublished price sensitive information (“UPSI”); (iii) derivative liability of information provider vis-a-vis trader; (iv) profit motive; and (v) exonerating circumstances.

   In India, the insider trading jurisprudence places significant reliance on these jurisdictions and the 2015 Regulations, in principle, cover corporate insiders under the broad head of ‘connected persons’ and corporate outsiders get roped in by virtue of the residual clause in definition of an ‘insider’ which covers all persons in possession of or having access to UPSI. The distinction between these two categories, as they exist in India, is that the burden of rebutting the presumption of possession of UPSI lies on the corporate insiders, whereas, for corporate outsiders who are not deemed to be connected to the company, the onus of furnishing proof remains with the regulator.

3. KEY CONCERNS WITH THE NEW REGIME IN INDIAThe press release accompanying the 2015 Regulations states that the primary objective for the introduction of the new regulations has been to strengthen the legal and enforcement framework, align Indian regime with international practices, provide clarity with respect to the definitions and concepts, and facilitate legitimate business transactions.

   One of the most noticeable and distinguishing feature of the 2015 Regulations is the inclusion of specific ‘notes’ in some of the provisions, which set out the legislative intent and rationale behind the formulation of the particular legal requirement. Whilst the Sodhi Committee report specifically noted that the ‘notes’ are an integral and operative part of the regulations, this clarification does not form a part of the 2015 Regulations, which may impact the enforceability and reliability of these additions. A case in point is the definition of “trading” in securities which includes dealing and agreeing to deal, in addition to subscription, purchase and sale of securities. The relevant note however extends the scope of the definition to cover pledging of securities. Such inclusion, being outside the purview of the legislation, not only expands the scope of the legislated definition beyond the interpretative limits, it also leads to adversely impacting standard financing transactions in India where promoters are usually expected to pledge their shares to lenders of listed companies. Therefore, to the extent ‘interpretative notes’ undermine or broaden the plain meaning of the 2015 Regulations, it will be interesting to see how courts will resolve any conflicting interplay between the notes and the regulations.

   Set out below are some key conceptual changes introduced by the 2015 Regulations and the analysis of the expected impact these may have on dealings in the Indian securities markets:

   1. UPSI – now a misnomer?In relation to unpublished price sensitive information, the 1992 Regulations interpreted the term ‘unpublished’ literally and prescribed that only information published by the company would be outside the purview of UPSI. However, under the new regime, there is no longer a specific requirement for the company itself to publish or authenticate the information and this renders the continuous usage of the term “UPSI” in the 2015 Regulations a misnomer.

      The 2015 Regulations recognize two specific categories of information that are potentially available in relation to a company and its securities: (i) generally available; and (ii) UPSI. The term UPSI has been defined to mean any information relating to a company or its securities, directly or indirectly, that is not generally available, and which upon becoming generally available is likely to materially impact the price of securities. The phrase generally available information has been defined to mean information that is accessible to the public on a non-discriminatory basis. The note to the definition states that information published on the stock exchanges’ websites would ordinarily be considered as generally available information.

      To assess the practical implication of the new definition, it is important to delve into the legislative and judicial developments which shaped the understanding of UPSI in the previous regime. Prior to 2002, ‘unpublished price sensitive information’ was defined as ‘any information which relates to…a company, and is not generally known or published by such company for general information…’. Consequently, in the case of HLL v. SEBI (July 1998), it was observed by the Appellate Authority that for information to be ‘generally known’ it was not required for such information to be authenticated or confirmed by the company. However, subsequently, in 2002, the definition of ‘unpublished’ was amended in the 1992 Regulations to mean ‘information which is not published by the company or its agents..’, with the specific intent to exclude information which is ‘generally available’, such as speculative reports, etc., and which had not been authenticated by the company, from the scope of ‘unpublished price sensitive information. However, the 2015 Regulations now seem to revert to the pre-2002 position by creating a carve-out for generally available information.

      Interestingly, the term ‘non-discriminatory’ has not been defined in the 2015 Regulations, and therefore the extent to which such information should be disseminated in the public domain, for it to be considered as available on a non-discriminatory basis, remains uncertain. Given the geographical spread of India and the various tools of communication available across different investor classes, terms such as ‘non discriminatory’ and issues concerning whether information available in research reports or in newspapers with limited circulation, will be considered to fall within this definition, remain open to interpretation. While several jurisdictions such as Australia, Singapore and Malaysia use the phrase ‘generally available’ to refer to non-public information in the context of insider trading laws, unlike India, none of these jurisdictions qualify such information with ‘non-discriminatory’ accessibility. Whilst the meaning and scope of the phrase ‘generally available information’ is interpreted by their courts and applied depending upon the facts and circumstances of each case, it will be interesting to see the parameters developed by SEBI to consider information as ‘generally available’ or ‘available on a non-discriminatory basis’.

   2. Communication for PIPE deals & Impact on M & A in IndiaThe 2015 Regulations prohibit communication to any person of UPSI in relation to a company or securities, listed or proposed to be listed. However, an exception has been carved out for communications for all legitimate purposes, performance of duties or discharge of legal obligations. The relevant note states that the rationale for this carve-out is to ensure that organisations develop practices based on ‘need to know’ principle for treatment of information in their possession. Although intended to provide greater flexibility in communication while conducting business such as evaluation of a deal, or communication with promoters etc, it may be difficult to draw the contours of what would constitute such legitimate purpose, in the absence of guidance from SEBI.

      In this regard, the 1992 Regulations only exempted communication of UPSI required in the ordinary course of business or profession or employment. The wider exception in 2015 Regulations is based on international experience, where regulators have acknowledged and recognised that UPSI may in certain circumstances have to be shared selectively, including with major shareholders and other persons requiring such information to fulfil their duty.

      Specifically in the context of deal making, the 2015 Regulations permit sharing of UPSI in connection with potential transactions, subject to compliance with certain prescribed conditions set out below.

      • Mandated disclosures: In relation to a transaction that would not entail an obligation to make an open offer under the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 (“Takeover Regulations”), any UPSI shared with the prospective acquirer is required to be made generally available two trading days prior to the proposed transaction being effected, in a form determined by the board of directors (“Mandated UPSI Disclosure”). In SEBI’s view (a) the Mandated UPSI Disclosure will ensure ruling out of any information asymmetry before any transaction that has involved sharing of UPSI on a selective basis; and (b) non-applicability of this requirement to an open offer under the Takeover Regulations is acceptable as the open offer process itself requires disclosure of such UPSI.[4] However, it is not clear if SEBI has considered whether the Mandated UPSI Disclosure will lead to speculative trading and if so, this is an acceptable consequence. From deal making perspective, such Mandated UPSI Disclosure is bound to impact the stock price, which consequently will also impact the commercials of the underlying transaction, as under Indian law, the floor price for acquisition of shares of listed companies is linked to the trading price over a specific look back period from the date of signing.
      • Involvement of the Board: The 2015 Regulations cast an obligation on the board of directors to (i) form an informed opinion that the transaction is in the ‘best interests’ of the company (“Upfront Board Approval”); and (ii) ensure that confidentiality and non-disclosure contracts are duly executed between the parties and that such parties keep the information received as confidential and do not indulge in insider trading. It is pertinent to note that the 1992 Regulations provided an unconditional white wash for disclosing UPSI to an acquirer if an open offer was made and the requirement of seeking the Upfront Board Approval has been introduced for the first time by the 2015 Regulations.
      • Impact on deal making: The requirement of seeking an Upfront Board Approval significantly impacts the dynamics of deal making in India as usually the management of companies are empowered to negotiate and take all steps necessary (including disclosure of information to counter parties as part of due diligence) to finalise the terms of the transaction, including transaction documents. The board of directors then, in a meeting held usually a day or two in advance of the execution, reviews the finalised terms and the agreed drafts of the transaction documents for a final sign off and for granting its approval for execution. Therefore, the Upfront Board Approval will modify the usual process of deal making and is not just a procedural hurdle, given that at this stage, it is unclear how the board of directors will form an ‘informed opinion’ on the proposed transaction, without having had the management negotiate the terms of the transaction and finalise the transaction documents, which in turn will depend upon the management having allowed the counter party to undertake due diligence.
      • Secondary market transactions: The requirement of the Upfront Board Approval may become a road block especially for secondary market transactions where the acquirer chooses to undertake due diligence. This is because not only will such a transaction require approval of the board of directors of the company (which ordinarily is not required) but the board approval may also not be forthcoming unless strong commercial/ strategic rationale is set out by the acquirer to convince the board of directors of the transaction being in the interest of the company even when there is no direct/ obvious benefit from such a secondary transaction.
      • Independent Directors: The challenges of seeking the Upfront Board Approval are compounded by the liability attached to the responsibilities of directors under Indian law. It is not clear what standards SEBI will adopt to verify if the decisions of the board of directors stand the test of ‘informed opinion’ and whether SEBI will sit in judgment over the commercial wisdom of the board of directors.
4. DEFENCESThe Chinese wall arrangements implemented by companies continue to be recognized as a defence to an insider trading charge under the new regime. Interestingly, the 2015 Regulations provide a broad defence mechanism whereby an “insider may prove his innocence by demonstrating the circumstances”. Some instances of such circumstances have been expressly provided in the 2015 Regulations and include the following situations:
   1. Information ParityThe parity of information defense is available for inter-se transfers between promoters off the exchange, when such promoters are in possession of same UPSI. Whilst the Sodhi Committee report had provided parity of information as a valid defense generally, this has been significantly curtailed in the 2015 Regulations and limited to off-market deals between promoters only.
   2. Trading planThe 2015 Regulations permit trading undertaken on the basis of a trading plan formulated for a one year period, commencing from the expiry of a six month period post the public disclosure of such plan. This concept is followed in several jurisdictions including U.S. and U.K. to allow large stockholders, directors, officers and other insiders who regularly possess material non public information but who nonetheless wish to buy or sell stock to establish an affirmative defence to an illegal insider trading charge by adopting a written plan to buy or sell, at a time when they are not in possession of such information.

      The Indian regime on this issue is relatively less flexible, on comparison with other jurisdictions, and viability of trading plans in India is likely to be significantly impacted due to the onerous requirements set out in the 2015 Regulations, which inter alia include:

      1. the trading plan, once approved, cannot be revoked or amended, and would have to be mandatorily followed;
      2. the insider cannot deviate from it or undertake additional trades on account of corporate actions or even if market conditions or prospects of a company undergo significant change;
      3. the trading plan will have to be disclosed to the compliance officer of each of the companies in whose securities the person seeks to trade, for approval and regular monitoring of implementation if approved; and
      4. once approved, the compliance officer will notify the trading plan to the exchanges and such public disclosure may impact the trading of such securities leading to artificial movement in price and volume.

      In addition to the above, the trading plan will come into force only once the UPSI in possession of the insider at the time of formulation of the trading plan becomes generally available. This requirement therefore renders the trading plan concept implausible for perpetual insiders who are always in possession of UPSI. The regulations also provide that these plans would not grant absolute immunity to the insiders and they will still be open to proceedings for market abuse, resulting in no real incremental benefit or exemption to the user of a trading plan.

   3. Other Safe Harbors- Is the Mens Rea defence back?Due to the broad ended and inclusive nature of the provision, the 2015 Regulations arguably provide for a blue sky defence and permit an insider to prove his innocence by demonstrating the attendant circumstances surrounding the trade. Several jurisdictions such as Singapore, Malaysia, Australia determine the culpability of a person on the basis of his knowledge of the nature of the information in his possession. In this regard, the relevant note in the 2015 Regulations states that trades undertaken by a person in possession of UPSI would be presumed to have been motivated by the knowledge and awareness of such information in possession. Although this would be sufficient to bring a charge of insider trading, it would be open to the insider to prove his innocence by demonstrating the extenuating circumstances. Similarly, other  exonerating circumstances like undertaking trades contrary to the nature of the UPSI, although discussed in Sodhi Committee report but not specifically mentioned in the 2015 Regulations, may still be available to an insider to justify his conduct.

      In view of the above, it will also be interesting to evaluate if the corporate purpose defence, based on the decision of Securities Appellate Tribunal in Rakesh Agrawal vs. SEBI (November 2003) wherein it was held that genuine transactions undertaken to achieve a legitimate corporate purpose are valid, continues to remain available.

5. ENFORCEMENT- What to expect in the coming years?In terms of the 2015 Regulations read with the SEBI Act, SEBI is empowered with the enforcement of these regulations. As under the old regime, SEBI can continue to utilize the following enforcement mechanisms to deal with instances of insider trading:
   1. SEBI Board orders under the SEBI Act;
   2. Enquiry proceedings under the SEBI (Intermediaries) Regulation, 2008;
   3. Adjudication proceedings under the SEBI Act;
   4. Criminal prosecution under the SEBI Act and the Companies Act.

   Given the gravity of insider trading offences, the consent mechanism is not available in these cases. Also, going forward, the investigation and enforcement of the insider trading cases by SEBI is expected to significantly intensify in view of the powers conferred upon SEBI in terms of the amendments to the SEBI Act. The key powers include search and seizure of records, including call records, as well as the power to call for any information that may be relevant from any person. Historically, regulatory action and prosecution in most of the insider trading cases has relied upon circumstantial evidence but with these brand new powers, SEBI will be able to speed up the investigations and proceedings and discharge its onus of proof effectively.

6. CONCLUSIONThe 2015 Regulations, with an objective to further strengthen the regulatory framework and facilitate transactions (both from the perspective of perpetual insiders and acquisitions), are certainly a big step towards making the markets more business friendly.

   However, the 2015 Regulations, in their present form, do appear to go beyond the scope and objective it initially set out to achieve and is likely to have a number of unintended consequences that have been discussed in the preceding paragraphs. For instance, it remains to be evaluated what best practices the Indian securities market will adopt in light of the international concepts and practices (viz. trading plan etc.) incorporated in the Indian regulations. Further, the manner in which certain provisions have been drafted, read with interpretive notes that have now been introduced as legislative guides, are fraught with the risk of causing a fair amount of collateral impact on public M&A in India. This will require some careful and complex legal manoeuvring around the regulations to facilitate transactions with minimal impact commercially.

   It will also be important to reconcile the provisions of the 2015 Regulations with the Companies Act, which, in its current form, penalises insider trading in the context of unlisted private and public companies, in order to ensure standards are consistently applied across companies. Notwithstanding the above, the introduction of the 2015 Regulations, coupled with the enhanced enforcement powers of SEBI are a recipe for interesting times ahead, in terms of evolving market practice, as well as jurisprudence in India.

[1]     Section 10(b) of the Securities Exchange Act prohibits the use of any deceptive device in connection with the purchase or sale of securities

[2]     Rule 10b-5 prohibits both affirmative misrepresentations and nondisclosure of material information in connection with the purchase or sale of any security.

[3]     SEC v. Cuban 634 F. Supp. 2d 713 (N.D. Tex. 2009); SEC v. Dorozhko 574F.3d 42 (2d Cir. 2009).

[4]     Note to Regulation 3(3)(i) of the 2015 Regulations: In an open offer under the takeover regulations, not only would the same price be made available to all shareholders of the company but also all information necessary to enable an informed divestment or retention decision by the public shareholders is required be to made available to all shareholders in the letter of offer under those regulations.