SEBI plugs the loophole in insider trading regulations: Promoters to disclose more often

Readers must be aware that under regulation 13(1) of the SEBI (Prohibition of Insider Trading) Regulations, 1992 (PIT Regulations), any person holding more than 5% shares or voting rights of a listed company is required to make an initial disclosure of his holding in terms of PIT Regulations. Under regulation 13(3), such a person is also required to make continuous disclosures about number of shares or voting rights held and any change therein from the last disclosure, if such change exceeds 2% of total shareholding or voting rights in the company. This disclosure is required to be made within two working days of receipt of intimation of allotment of shares or acquisition or sale of shares or voting rights, as the case may be.

Clause 35 of the Equity Listing Agreement, listed companies are inter alia required to make disclosures about the shareholding of promoter and promoter group of such company, on quarterly basis within 21 days from the end of each quarter. The Takeover Code also states that promoter or every person having control over a company is required to disclose the number and percentage of shares or voting rights held by such person(s), within 21 days of financial year ending on 31st March as well as the record date.

Issue

As explained above, under the past regulatory framework, the information about shareholding of promoter and promoter group comes in public domain at the end of each financial year and at the end of each quarter. There was no mechanism in place which ensured that the promoter and persons who are part of promoter group immediately disclosed to the market as and when a change (beyond certain threshold) occurs in their shareholding pattern unless such promoter/ person held more than 5% of the shares of the company (in such a case he would be liable to disclose under 13(1) of the PIT Regulations). Thus any person who is promoter and does not hold more than 5% of the shares of a company was not required to inform immediately any change in his shareholding even when such change is beyond the thresholds specified in PIT Regulations. Thus 'in a given case if shareholding of promoter and promoter group has been disclosed at the end of a quarter at say 40%, and promoter and promoter group is consisting of 10 persons so that none of them is holding more than 5% of the shares then information about any change in the shareholding of the promoter and promoter group comes in public domain within 21 days of the end of the relevant quarter. In such a case all the promoters and persons who are part of promoter group can exit from a company within a quarter without any information to the market regarding such change till the next quarterly filing'.

Amendment

By issuing the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2011, SEBI has made it mandatory for a promoter or member of promoter group to disclose all changes in their shareholding or voting rights from the immediate previous disclosure made under the PIT Regulations or the Equity Listing Agreement if such change exceeds Rs. 5 lakh in value or 25,000 shares or 1% of total shareholding or voting rights, whichever is lower. This disclosure has to be made within 2 working days of the receipts of intimation of allotment of shares, or the acquisition or sale of shares or voting rights, as the case may be. Also any person who is a promoter or part of promoter group of a listed company should disclose the number of shares or voting rights held by such person, within two working days of becoming such promoter or person belonging to promoter group.

A copy of the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2011 is available here.

A copy of the SEBI Board minutes in this regard is available here.

The concept of Chinese wall in financial institutions – Part II (SEBI regulations)

The Chinese wall policy, in the context of financial institutions, was introduced in India by the Securities and Exchange Board of India (Insider Trading) (Amendment) Regulations, 2002. These regulations made it mandatory for (i) all listed companies and (ii) other organizations associated with securities markets (financial institutions), to have a Chinese wall policy as a part of their code of internal procedures and conduct (“Internal Code”). It also recognized implementation of a Chinese wall policy as a valid defense against insider trading allegations.

Chinese wall policy as a part of Internal Code

Financial institutions, by virtue of being organizations associated with securities market (broker/ sub-broker, depository participant, clearing/ trading member, merchant banker, custodian etc.) are under an obligation to implement an Internal Code which contains provisions of Chinese wall framework. Regulation 12 of the SEBI (Prohibition of Insider Trading) Regulations, 1992 (“Regulations”) requires such organizations to frame an Internal Code in accordance with the ‘model code’ specified in Schedule I of the Regulations (“Model Code”). The Internal Code should be framed ‘without diluting’ the Model Code prescribed by SEBI and the organizations should adopt appropriate mechanisms and procedure to enforce such Internal Code. Apart from the entities mentioned above, other entities like public financial institutions, all intermediaries registered with SEBI, asset management companies, trustees of mutual fund, self regulatory organizations, stock exchanges and professional firms who assist or advise listed companies are also under the obligation to frame such Internal Code.

The Model Code acts as the basic framework of Chinese wall policy in India, in the context of financial institutions. It contains two parts namely, (i) Part A which contains the model code for listed companies (the title reads as ‘Model code of conduct for prevention of insider trading for listed companies’) and (ii) Part B which contains the model code for organizations associated with securities markets (the title reads as ‘Model code of conduct for prevention of insider trading for other entities’). It appears from the Regulations that if the entity is associated with securities market and is listed, such an entity should implement an Internal Code which is a combination of Part A and Part B.

Part A (Model Code for listed companies)

Clause 2.1 of the Model Code (Part A) for listed companies requires the employees/ directors of such organisations to maintain confidentiality of all price sensitive information. They are prohibited from passing on such information to any person directly or indirectly by way of making a recommendation for the purchase or sale of securities. Clause 2.2.1 states that price sensitive information should be handled on a “need to know” basis. This means that such information should be disclosed only to those within the company who need the information to discharge their duty. Clause 2.3.1 mandates that the files containing confidential information should be kept secure and should have adequate security of login and pass word etc.

Part B (Model Code for other entities)

The Model Code for other entities (Part B) contains, in addition to the above mentioned restrictions under Part A, certain other requirements which details out Chinese wall policy, in further. Clause 2.4 and 4 require the organisation to adopt a "Chinese Wall" policy which separates “inside areas” from “public areas” for preventing the misuse of confidential information. The “inside areas” are defined as those areas of the organization which routinely have access to confidential information and “public areas” are defined as those areas which deal with sales, marketing, investment advise or other departments providing support services. The Regulations stipulates the following measures to be adopted by organizations for separating “inside areas” from “public areas”.

• The employees in the “inside area” should not communicate any price sensitive information to anyone in “public area”.
• The employees in “inside area” may be physically segregated from employees in “public area”.
• Demarcation of the various departments as “inside areas”
• Only in exceptional circumstances, employees from the public areas may be brought "over the wall" and be given access to confidential information on the basis of "need to know" criteria.

The Model Code for other entities (Part B) also requires that securities or shares of a listed company should be put on a “restricted/grey list” while the organization is handling any assignment for such listed company or while preparing appraisal report or while handling credit rating assignments and is privy to price sensitive information. Additionally, any security which is being purchased or sold or is being considered for purchase or sale by the organisation on behalf of its clients/schemes of mutual funds, etc. should also be put on the “restricted / grey list”. The effect of putting/ adding a security on the “restricted / grey list”’ is that any trading in such securities by employees/directors/partners of the organization would require the pre-clearance of trade by compliance officer. As a result of this, trading in these securities may be blocked or may be disallowed at the time of pre-clearance by the compliance officer after taking into account, all the relevant circumstances. This can be explained by way of simple example. If ‘Company A’ (a listed company), appoints ‘Only profit’ (an investment banker/ merchant banker) to find out an investor in ‘Company A’ to fund its new projects. This would be followed by ‘Company A’ sharing confidential information (which may be price sensitive) with ‘Only profit’ for preperation of IM, financial projections etc. In such a case ‘Company A’ would be added to the “restricted/grey list” maintained by the compliance officer of ‘Only profit’ and henceforth any trade made by employees/directors/partners of ‘Only profit’ would require pre-clearance of such trade by compliance officer of ‘Only profit’. The compliance officer would also have the option to restrict such trades, taking into account ‘relevant circumstances’.

In the next post, I will discuss the scope of “Chinese wall policy” as a defense to insider trading.

“The concept of Chinese wall in financial institutions – Part I (origin & mechanisms)” is available here.

SEBI issues clarifications on insider trading amendments

A brief history

Earlier, SEBI had amended certain provisions of SEBI (Prohibition of Insider Trading) Regulations, 1992 vide notification dated November 19, 2008 (covered in this blog here). One of the major changes it introduced was that the directors/officers/designated employees, who buy or sell shares, cannot carry out a reverse transaction for six months. In the case of subscription in the primary market (initial public offers), the above mentioned entities should hold their investments for a minimum period of 30 days. The holding period would commence when the securities are actually allotted. Earlier there existed no restriction on entering into an opposite transaction in six months. The only restriction, which existed before, required that the security should be held for a minimum period of 30 days. This amendment tried to introduce the “Short-Swing Profit Rule” in India. SEC’s “Short-Swing Profit Rule” requires company insiders to return any profits made from the purchase and sale of company stock if both transactions occur within a six-month period. In India, as per the terms of the present amendment, the insider is not required to return profits to company but it just prohibit such transactions.  

The Clarifications

SEBI had received a few queries on the amended regulations and it has now issued clarifications in form of an FAQ. They are as follows: -

1. Does the six month restriction also apply to the exercise of ESOPs and the sale of shares received?

2. If an employee has sold shares on 10th February 2009, can he subscribe to ESOPs on 11th March 2009?

Clarification: Restriction in Clause 4.2 is intended for transactions in the secondary market and hence is not applicable for the exercise of ESOPs and sale of these shares. In the above example, the employee can subscribe to the ESPOs even if he has sold shares during the previous six months. However, it may be noted that once shares acquired through ESOPs are sold in the market, the restriction on buying would become applicable for next six months. Also, while exercising ESOPs, the code of conduct framed by the company and the fundamental principles for prohibition of insider trading as specified in the Regulations must be complied with.

 
3. If an employee has purchased 100 shares on 1st February 2009 and then again purchased 400 shares on 15th March 2009, when will he be able to sell the shares purchased on 1st February 2009? Will it be after 1st August or 15th September?

Clarification: The restriction of six months on sale of shares would apply from the date of the last purchase and not the first purchase. In the above example he can sell the shares after 15th September. The same is true in case of sale of shares on two different dates i.e. the restriction of six months on purchase of shares would apply from the date of the last sale.

 
4. The clause 4.2 stipulates that, no opposite transaction can be entered into for a period of 6 months from the date of prior transaction by a designated employee. Whether the same shall be applicable for shares held on the date of the notification. For example, a designated person has purchased 100 shares on 01.11.2008. Can he sell these shares on 22.12.2008?

Clarification: As the shares were acquired before the amendments to the Regulations were notified, the designated person may be allowed to sell the shares if it is permitted under the code of conduct of the company 

 
5. Clause 4.2 of Part A, Schedule I of the Regulations, provides for holding period of 30 days in case of acquiring shares through IPO. Can the company apply the minimum holding period of 30 days as applicable to IPOs even for bonus issues, ESOPs, rights issues etc.?

Clarification: Under the existing Regulations, 30 day holding period restriction is applicable for IPOs. In case of issues as referred to above, the company may decide about the holding period as specified in its code of conduct.

 
6. Clause 4.3 of Part A, Schedule I of the Regulations provides that in case the sale of securities is necessitated by personal emergency, the holding period may be waived by the compliance officer after recording in writing his / her reasons in this regard. Can the Compliance Officer extend the waiver clause to the restrictions on opposite transactions?

Clarification: Yes. The waiver may be applied for sale of shares by personal emergencies after recording the reasons in writing and ensuring that there is no element of insider trading.


7. Can a designated employee continue to deal in NIFTY / SENSEX index futures?

Clarification: There is no restriction under the Regulations for dealing in NIFTY / SENSEX index futures by the designated employees subject to their compliance of code of conduct.


8. For a designated employee already holding derivative positions in the company’s shares, is it required for them to liquidate the positions before maturity or it necessary to hold till maturity?

Clarification: As the position in derivatives was taken before the notification of Regulations, the company may take a view about liquidating the derivative position or holding it till maturity.

A copy of the communication from SEBI is available here.

Summary of the SEBI (PROHIBITION OF INSIDER TRADING) (AMENDMENT) REGULATIONS, 2008

The changes brought out by the SECURITIES AND EXCHANGE BOARD OF INDIA (PROHIBITION OF INSIDER TRADING) (AMENDMENT) REGULATIONS, 2008 are as follows: -



“Insider” definition has been changed and its scope is widened. Now any person who has received or has had access to such unpublished price sensitive information will be considered to be an “Insider”. It is not necessary that he should be a connected person (subject to interpretation).


The “code of internal procedures and conduct” framed by the intermediary should not only be as near thereto the Model Code specified in Schedule I of these Regulations but it should also: -
· be without diluting it in any manner and

· the concerned intermediary should ensure the compliance of the same.



Any person who holds more than 5% shares or voting rights in any listed company shall disclose to the company, the number of shares or voting rights held by such person, on becoming such holder, within 2 working days of:-
· the receipt of intimation of allotment of shares; or

· the acquisition of shares or voting rights, as the case may be.

Earlier the time limit was 4 working days.



Any person who is a director or officer of a listed company shall disclose to the company in Form B the number of shares or voting rights held and positions taken in derivatives by such person and his dependents (as defined by the company), within two working days of becoming a director or officer of the company.
Earlier it was not necessary to disclose the positions taken by such persons in derivatives and the time limit was 4 working days.



Any person who is a director or officer of a listed company, shall disclose to the company and the stock exchange where the securities are listed in Form D, the total number of shares or voting rights held and change in shareholding or voting rights, if there has been a change in such holdings of such person and his dependents (as defined by the company) from the last disclosure made under sub-regulation (2) or under this sub-regulation, and the change exceeds Rs. 5 lakh in value or 25,000 shares or 1% of total shareholding or voting rights, whichever is lower.
Earlier the person was not under an obligation to disclose the shares of his dependant.



In Regulations 13 (5) and (6) the time limit prescribed for submission of the documents has been reduced to 2 working days.
Earlier the time limit was 4 and 5 days respectively.



A new provision for filing disclosures, required under regulation 13, through ‘electronic filing system devised by the stock exchange’ has also been inserted.
A person who violates regulation 11 he shall be liable for appropriate action under Sections 11, 11B, 11D, Chapter VIA and Section 24 of the Act.
Earlier the action was limited to 11, 11B and 24 of the Regulation.



In the model code (for listed companies): - All directors/officers /designated employees of the company and their dependents who intend to deal in the securities of the company (above a minimum threshold limit to be decided by the company) should pre-clear the transactions as per the pre-dealing procedure.
Earlier the dependents were not included. ‘Dependents’ have to be defined by the company.



In the model code (for listed companies): - All directors/officers /designated employees and their dependents shall execute their order in respect of securities of the company within one week after the approval of pre-clearance is given.
Earlier the dependents were not included. ‘Dependents’ have to be defined by the company.



In the model code (for listed companies): - All directors/ officers/ designated employees who buy or sell any number of shares of the company shall not enter into an opposite transaction i.e. sell or buy any number of shares during the next six months following the prior transaction. All directors/ officers/ designated employees shall also not take positions in derivative transactions in the shares of the company at any time. In the case of subscription in the primary market (initial public offers), the above mentioned entities shall hold their investments for a minimum period of 30 days. The holding period would commence when the securities are actually allotted.
Earlier there was no restriction entering into an opposite transaction in six months. There was also no restriction for taking derivative positions. The only restriction that existed was that the security should be held for a minimum period of 30 days.