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Insider trading curbs needs fine-tuning

Shishir Vayttaden
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SEBI should limit its trading embargo to individuals with presumptive access to insider information. — A. Roy Chowdhury
SEBI should limit its trading embargo to individuals with presumptive access to insider information. — A. Roy Chowdhury

SEBI has gone overboard in placing trading curbs.

Every once a while, a statute will become so incomprehensible under layers of conflicting amendments and poor drafting that the only sensible thing is to repeal it and bring in a wholly new law.

Committees are then constituted, public comments invited, established conventions shaken up and a (hopefully better) legislation created. Like a surgery that is clumsily executed on the good knee while the gangrenous foot festers, these motions happened for SEBI’s takeover regulations (twice, mind). Its regulations on insider trading, which have cried louder and longer for reform, continue to fester.

To be fair, the amendments to SEBI’s regulations on insider trading have kept good pace with international best practice in essential respects. However, on critical points of detail, they either make no sense or create over-zealous policy.

REgulatory apparatus

Examples include the amendments of 2002 and 2008, which brought SEBI’s regulations closer to the public-friendly “parity of information” theory. The 2002 amendments made it irrelevant, whether unpublished price sensitive information (UPSI) is obtained by virtue of a connection with the company, or independently of the company. The 2008 amendments made it irrelevant whether the accused was actually an insider or a rank outsider.

Both these movements were in line with the English (and now the EU) position, but vary considerably from US law. To understand the difference, contrast Rajat Gupta who was an insider of Goldman Sachs in the classical sense, with Ranbaxy director V. K. Kaul who held no office in Orchid, whose shares his wife unlawfully dealt in.

This is problematic even without regard to the (somewhat hackneyed) debate on the fairness of making “insiders” out of persons who don’t draw paycheques from the company, and therefore owe no duty to its shareholders. It is problematic because SEBI’s exceptions have lagged behind the aggressive strides that its prohibitions made in 2002 and 2008. For example, if the provenance of UPSI is irrelevant (as it has been since 2002), how are clients to ever act on analyst reports?

If even self-generated UPSI has to be disclosed before securities can be dealt in, how does any price-sensitive share purchase transaction itself ever take place?

Again, SEBI’s regulations do not recognise the international best practice of permitting selective disclosures of UPSI when they are backed by standstill and non-disclosure covenants. For this reason, due diligence exercises in listed companies remain of doubtful legality and are frequently undertaken in a less than transparent manner.

IMMEDIATE DISCLOSURE

Another instance of SEBI’s refusal to embrace internationally accepted exceptions is its insistence on immediate disclosure of all UPSI. Both, SEC’s fair disclosure regulation and EU’s Market Abuse Directive (MAD) recognise circumstances in which disclosures may be deferred and stipulate precautions that must accompany such deferral. In fact, MAD’s disclosure provision was one of the laws that the Governor of the Bank of England, Mervyn King, had famously blamed for not making a covert loan to Northern Rock in his testimony to the House of Commons.

It is to the deferred disclosure exception to that provision that economists had pointed when they trashed that testimony.

SEBI’s unqualified insistence on immediate disclosures also sits ill with its rule on trading windows. Almost every event that obliges a closure of trading windows is also UPSI. If all UPSI is disclosed immediately, there should never be any occasion to close the trading window!

TRADING EMBARGO

This absurdity arises because of SEBI’s refusal to recognise that there are circumstances when UPSI may exist and yet a public disclosure may not be appropriate for some time. The appropriate policy response to this would be to permit the deferral of disclosures while ensuring that UPSI is isolated among persons who are barred from trading.

Instead, in the recent order against Satyam’s compliance officer (for not closing the trading window on the very day when Ramalinga Raju first mooted the infamous merger with Maytas), SEBI’s adjudicating officer held that every price-sensitive proposal triggers a public disclosure even before it attains finality. As practitioners know too well, this makes business with listed companies impossible.

Price-sensitive proposals are made every day — but in every one of them, the slips between the cup and the lip are so many that it is imprudent to make public disclosures until parties have reached an agreement on essential aspects.

SEBI’s rules on trading windows have their own problems, as SAT’s decisions in the recent MAN Industries and Hindustan Dorr Oliver cases demonstrate. When a company approaches certain price-sensitive matters, it becomes obliged to close its trading window. Since the window is common to all employees and directors (and not restricted to those involved with the matter), if every UPSI triggered a closure of the trading window, it would remain closed throughout the year for several companies.

Given this, SAT held that it is not all UPSI, but only seven matters specifically enumerated in SEBI’s regulations, that necessitate a closure of trading windows. This is sub-optimal and clearly begs legislative intervention. Indeed, if SEBI’s past with appellate reverses is anything to go by, either an amendment or an appeal to the Supreme Court is on its way.

If SEBI goes down the amendment route (as it should, in this writer’s view), one only hopes it limits its trading embargo to individuals with presumptive access to UPSI.

Another problem is that the sheer English of the regulations is incomprehensible in several crucial respects. Consider the provision on “tipper’s liability” (liability for passing on UPSI, independent of whether its recipient trades or not). While the SEBI Act retains this in unequivocal terms, SEBI’s regulations have been unintelligible on this point since 2002.

On the one hand, a 2002 press release of SEBI suggested that the intent of the amendment was to decriminalise the act of tipping per se. On the other hand, a 2008 SEBI report suggests (correctly, in this writer’s view) that tipper’s liability survived 2002.

Another bizarre provision, apparently imported from Europe, provides that an act of insider trading is permissible provided the acquirer complies with takeover regulations. This simply makes no sense! Why should an act of insider trading be legal simply because the acquirer discloses his shareholding under the takeover regulations? Presumably, the intent was that acquirers who disclose UPSI in their open offer documents should be allowed to acquire shares tendered in the open offer.

Even assuming that this mysterious defence is restricted to open offers (which it is not), it still makes no sense because if UPSI is disclosed in the open offer documents, it ceases to be UPSI and there could, to begin with, be no insider trading!

The essence of all these problems is obvious. SEBI’s insider trading regulations are an internally inconsistent regime that even legitimate businesses will find hard to comply with. The solution is equally obvious. SEBI needs to re-think fundamental aspects of its insider trading regulations and completely overhaul them.

The Takeover Regulations Advisory Committee did a splendid (albeit needless!) job with SEBI’s takeover regulations. It’s time for SEBI to put together a similar team for its insider trading regulations.

(The author is Partner, Luthra & Luthra Law Offices Mumbai. The views are personal.)

(This article was published on November 6, 2012)
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