SEBI

An Overview of Insider Dealing Regulations

What is Insider Dealing?

The term insider dealing is also known as insider trading in India. Insider dealing or insider trading has been present since the twentieth century. Insider trading is understood as taking undue advantage of unpublished price sensitive information related to stocks, shares, and securities. Information is exploited by developing a friendly or privileged relationship with the individual or institution dealing with securities. This privileged agreement is called as insider dealing as the individual would have an unfair advantage when selling the securities in comparison to the public. The price of securities is altered due to the fact of the disclosure of information.

Thus insider dealing or insider trading is defined as the practice where corporate agents deal and act in buying and selling securities. Such securities are bought and sold without disclosing any form of price-sensitive information. Divulging information related to price-sensitive information would be prohibited.

Insider Trading in the USA and the UK

Scenario in USA

The main regulatory authority dealing with insider dealing in the USA is the Securities Exchange Commission (SEC). USA was the first country to enact the law for insider trading. The Securities and Exchange Act, 1934 was enacted to regulate insider trading in the country. Strict penalties are enforced for insider dealing in the USA. During the 2001 global crisis, Enron one of the largest energy companies in the USA filed a bankruptcy petition for misleading investor’s money.

One of the issues which led to the downfall of the energy giant is insider dealing. Insider dealing was not only present between the employees, but also present in the senior management. The Securities Exchange Commission looked into this problem and imposed a heavy penalty. Due to this the Sarbanes Oxley Act, 2002 was enacted to have a framework for corporate governance and insider dealing.

Scenario in the UK

The main regulation dealing with insider trading in the UK is the Financial Services and Markets Act 2000 (FSMA 2000) which regulates financial transactions in the country. Apart from this, the Criminal Justice Act, 1993 provides the legal framework for insider dealing in the UK. None of the acts provide a specific definition of insider trading.

The FSMA helps in preventing market abuse related to insider dealing of securities. The main regulatory authority for the securities market in the UK is the Financial Services Authority (FSA). The FSMA defined market abuse as committing any of the seven activities as per the act.

The following activities would come under the meaning of market abuse:

The above activities would be considered as market abuse. Therefore, if any of the above activities are conducted which leads to disclosure of information, then it would be considered as insider trading in the UK. USA and the UK have specific regulations dealing with insider trading.  Non Compliance with the above regulations would attract strict penalties.

Insider trading in India

The securities market in India evolved after the 1990s. In 1992, the Securities and Exchange Board of India (SEBI) was formed to regulate the securities market in India. This regulator also looks into unlawful activities such as misleading the public about securities and insider trading activities. Apart from the SEBI rules on insider trading, the Companies Act 1956 also deals with provisions related to insider trading. With the enactment of the Companies Act 2013, the provision for insider trading has been included in section 195. Section 195 of the Companies Act 2013, speaks about insider trading by a shareholder, director, or key management personnel in the company.

The following is included in the section:

• A director or shareholder cannot get into any form of insider trading. However, if the form of communication or divulging of information is carried out in the normal course of business dealings, then there is no form of insider trading.
• According to the Companies Act, insider trading is understood as the process of buying, selling, and dealing in securities or an agreement to buy or sell or deal in securities by a director, key management personnel, or the shareholder of the company. The above officers have direct access to information that is not public. Such information would be price sensitive.
  
• Insider trading would also include the act of communicating, procuring, or informing directly or indirectly any form of information that is not present in the public to any individual or company.
  

Contravention of the above provision would lead to imprisonment for a term which may extend to five years. Apart from this, the authority can impose a fine of Rs 5 lakh rupees. This may extend to Rs 25 Crore or three times the amount of money secured from insider trading. The authority has the right to impose either one of the penalties or both.

Apart from the Companies Act 2013, the Securities Exchange Board of India Act 1992 also regulates the law related to insider trading. The SEBI has brought out insider trading regulations during the formation of the securities exchange board of India. These regulations have been amended from time to time with the increase of insider trading in India.

Under the SEBI Act, the SEBI (Prohibition of Insider Trading) Regulations^[1], 1992 (‘1992 Regulations’) have been brought out by the SEBI. This has been amended in the year 2015 with few amendments in 2019. However, the 2015 regulation is the current law that deals with insider dealing. There is a strict penalty for non-compliance with these provisions.

What are the features of the 2015 regulation?

The 2015 regulations have brought about many changes in the working of the act.

The following are the changes related to insider trading:

• An informant is an individual who brings about the information to the board. The information would be brought to the board using the Voluntary Information Disclosure Form^[2]. This information would be related to violation of insider trading regulation.
• An insider is an individual or associated with the connected person who has unpublished price sensitive information related to a particular stock or security. The persons connected in a company would also be considered as an insider. Therefore, under the provisions of the contract, parties form a fiduciary relationship with each other would also come under the definition of an insider.
• UPSI is considered to measure and test price-sensitive information as per the agreement related to the listing of securities in a particular stock exchange.
  

Under Section 3, an individual is prohibited to communicate price sensitive information to the public. Price sensitive information would only relate to securities that are listed and traded in the stock exchange.

The information which is price sensitive must not be communicated to any other individual in the company. There is an exception to this. If the communication is made in furtherance of the business or made for a legitimate purpose, then such communication is allowed.

The regulations also state that no individual shall collect such information from an insider of the company. Such information will include any security that is proposed to be listed in a stock exchange or any other form of revelation regarding the security.

Exceptions to Disclosing Price Sensitive Information related to Insider Dealing

The following are the exceptions under the 2015 Regulations:

• If price sensitive information is prima facie disclosed for legitimate business reasons.
• Under the takeover regulations in India, if the company is subjected to an open offer and the board of directors believes that the takeover would be in the best interests of the company. For this purpose, it is crucial to provide the UPSI when transactions such as takeovers, mergers and acquisitions, divestment of information. This would be important, if there is a change of control in dealing with the securities of the company.
• When there is any form of open offer for the company and the board of directors in the best interests of the company that this transaction occurs. The disclosure of such price-sensitive information must take place before two business days (trading days) from the transaction taking place.
  

 Requirement of Sign Confidentiality Agreements

When entering into a takeover or an open offer, the board of directors of the company would require all employees to enter and execute confidentiality undertakings and non-disclosure agreements with the company for not divulging any form of price-sensitive information that affects the company. The confidentiality agreements would not include the above exceptions for disclosure of confidential information by the company.

Circumstances where unpublished price sensitive information is received

According to the regulations, no insider is allowed to trade in securities upon possessing any form of price-sensitive information. However, there are various defences regarding the possession of price-sensitive information.

The following are the defences that can be used in insider dealing:

• The information is present with the promoters of the company. The transaction happened as an off-market inter se transfer between promoters. All the promoters had similar information related to unpublished price sensitive information.
• For non-individual insiders- When an individual who has information about the price-sensitive matter and these individuals were different from people taking decisions related to the trading of securities. The people trading securities do not have such information when deciding to trade the security.
• If there are systems in place to make sure that such price-sensitive information is not disclosed to any other party. Apart from this, if there are arrangements in place not to violate any such regulations related to the disclosure of price-sensitive information. In such circumstances, the individuals having information related to price-sensitive securities have not disclosed the same to other individuals and there is no form of proof regarding this.
• Trading was conducted according to the plan under the regulation.

In case the insider has to take a defence under these regulations then the burden of proof would be on the connected persons for such insider information. In other such cases, the burden of proof would be on the directors of the company. The board has to maintain certain standards under the regulations for compliance.

Plans related to Trading- Insider Dealing

An insider of the company must formulate a trading plan under the provisions related to the regulations. This trading plan has to be shared with the compliance officer of the company for approval.

The trading plan will have the following:

• No trading can be undertaken earlier than 6 months from the public disclosure of the plan
• No trading can take place between the twentieth trading day before the last day of any financial period for which results are required to be announced by the issuer of the securities. Also, the second trading day after the disclosure of financial results would be considered for trading not to take place.
• Trading should not take place for a period of lesser than 12 months.
• Trading should not overlap any other period of trading.
• The trading plan should set out the values of the trade.
• The trading plan should not have securities for market abuse.

The compliance officer has to review and assess the plan whether it complies with the insider dealing regulations related to SEBI. Non Compliance with the insider dealing regulations would attract strict penalties to the individual and the company.

Conclusion for Insider Dealing Regulations

Insider Dealing is understood as taking advantage of unpublished market information related to the trading of securities. Information is extracted from the insider of the company to deal with securities. Insider dealing in the USA is regulated by the Securities Exchange Commission. In the UK, insider dealing regulated by the financial services authority. In India, insider dealing is regulated by the SEBI and Companies Act 2013. Both the laws impose strict penalties related to insider dealing. Specific defences can be used against insider dealing.