Since the introduction of the new insider trading regime in 2015, India’s securities market has seen a number of changes in terms of processes and controls for transactions and also with regard to routine compliances and reporting requirements. The Securities and Exchange Board of India (SEBI) has provided additional clarity by way of a guidance note and through an informal guidance regime. While several processes have been simplified, some practical constraints arise out of the requirements prescribed under the SEBI (Prohibition of Insider Trading) Regulations, 2015.
1. One of the primary compliances for listed companies and market intermediaries is to regulate and monitor trading of their employees and designated persons through a code of conduct (CoC). The CoC must adhere to the principle-based minimum standards set out under Schedule B of the regulations. This approach was welcomed as a step forward from the prescriptive nature of the previous model codes. However, applying these minimum standards across both financial institutions and listed companies has had some unintended consequences.
For instance, previously only market intermediaries were obliged to maintain a restricted list. Although SEBI, in an informal guidance, has suggested that this obligation applies only to intermediaries, from a plain reading of the regulations, it appears to extend to listed companies as well. As a result, employees not only have to obtain pre-clearance of trades in securities of the listed company which employs them, but also in respect of their trades in all other securities. The same informal guidance also appears to expand scope of applicability of the CoC to “all connected persons and not only to designated persons”, while the regulations specifically state that “employees and connected persons designated on the basis of their functional role … in the organization shall be governed by an internal code of conduct”.
2. Employee stock options are typically granted as part of compensation packages (especially to employees who hold senior management or key positions), which are exercisable post satisfaction of rigorous performance conditions. Such holders of options are likely to be in possession of unpublished price sensitive information (UPSI) on a regular basis and therefore to be construed as perpetual insiders.
Although SEBI’s clarification on non-applicability of six months’ trade restriction when shares are acquired upon exercise of employee stock options provided respite, the restriction on sale of such shares by perpetual insiders continues to be a cause of concern. Given the current regime, employees have little room to liquidate their holdings during their tenure in a key position, even to meet exigencies or routine expenses. For a variety of reasons (including the length of the implementation and waiting periods) trading plans may not provide need-based liquidity. Stakeholders need to suggest to SEBI a viable mechanism to implement trading plans without compromising investor confidence.
3. A discretionary portfolio manager (DPM), licensed with SEBI, is understood to be an entity which independently manages funds and securities portfolios of its clients based on their risk profile and investment objectives. Given the complete transfer of decision-making, globally most organizations exempt this route of investment adopted by designated “insiders”. However, SEBI has recently clarified in an informal guidance that trades of an insider, whether direct or indirect, including through a DPM, will be assumed to be motivated by knowledge and awareness of UPSI. Being an informal guidance, SEBI’s view is neither conclusive nor binding. However, it reflects the regulatory mindset on this issue and has disrupted practices that most organizations have adopted for their employees. It remains to be seen whether SEBI will consider exempting transactions through DPMs, if checks and balances are put in place to the satisfaction of SEBI.
Board members and compliance officers have not only been entrusted with effective compliance, the scope of their obligations has also expanded under the regulations. In an informal guidance issued in February 2017, SEBI also said that the actions of the board and the compliance officer would be scrutinized from the standpoint of any “ulterior motive”. These legal requirements, coupled with regulatory expectations, will raise the cost of compliance.
SEBI has been open to concerns of market participants and it will be interesting to see how it can simplify these complexities, while still ensuring a robust regulatory framework that can effectively deter market abuse.
Cyril Amarchand Mangaldas is India’s largest full-service law firm. Shruti Rajan is a partner and Gazal Rawal is a principal associate at the firm.
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