Introduction

On July 1, 2023 (see here), the Securities and Exchange Board of India (SEBI) took action against Cyquator Media Services, a promoter entity of ZEE Entertainment Enterprises Ltd (ZEEL), for non-compliance with disclosure requirements, and as a result of certain lapses in disclosing specific trades involving ZEEL shares, Cyquator has been fined Rs 4 lakh by SEBI. During the examination conducted by SEBI, the trading activities of Cyquator in ZEEL shares were scrutinized for potential violations of insider trading regulations.

Insider trading is a practice that has garnered significant attention and concern in financial markets worldwide and involves the buying or selling of securities based on non-public and material information, hence, giving certain individuals an unfair advantage over other market participants. The consequences of insider trading extend beyond financial loss for individual investors as this practice undermines market integrity and disrupts the investor’s confidence. Therefore, understanding the legal framework surrounding insider trading is crucial for comprehending its implications and the measures in place to combat this unethical behaviour.

Recognizing the potential harm caused by insider trading, governments and regulatory bodies have implemented the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015 (“Insider Trading Regulations or Regulations”) to combat this practice. These regulations aim to deter insider trading, punish wrongdoers, and safeguard the interests of investors and the overall integrity of the financial markets.

The Background

In India, the journey towards regulating insider trading began in 1948 with the establishment of a committee led by Mr. P.J. Thomas. The Thomas Committee's recommendations resulted in the introduction of Sections 307 and 308 under the Companies Act, 1956. These sections mandated certain disclosures by directors and managers, but they proved ineffective in preventing insider trading. Subsequent committees, including the Sachar Committee in 1978 and the Patel Committee in 1989, along with the Abid Hussain Committee in 1989, were formed to address the issue.

Drawing on the suggestions put forth by these committees, the SEBI introduced the SEBI (Insider Trading) Regulations, 1992. However, after revealing loopholes in cases like Hindustan Lever Ltd. v. SEBI [(1998) 18 S.C.L. 311AA] and Rakesh Agarwal v. SEBI [(2004) 1 CompLJ 193 SAT, 2004 49 SCL 351 SAT], the regulations were amended in 2002 and renamed as SEBI (Prohibition of Insider Trading) Regulations, 1992 (1992 Regulations).

In 2015, SEBI further revised the regulations and introduced the SEBI (Prohibition of Insider Trading) Regulations, 2015 (Insider Trading Regulations). In 2018, another committee under the chairmanship of Shri T.K. Viswanathan was formed, leading to further amendments to the Insider Trading Regulations in 2019, and the latest amendment was made on November 24, 2022.

Key Terms

Insider Trading:

Neither the Insider Trading Regulations nor the 1992 Regulations provide a specific definition for the term ‘Insider Trading’. However, insider trading generally refers to the buying or selling of securities by individuals, including company management or connected persons, using non-public, sensitive information about the company's financial condition or other significant developments. This information, if known to the public, could affect the securities' value. Engaging in such trading activities based on unpublished sensitive information is considered illegal.

Insider:

As per the Insider Trading Regulations, an individual is classified as an insider if they fall into either of two categories: a connected person or someone with access to UPSI (Unpublished Price Sensitive Information) [Reg. 2(1)(g) of the Insider Trading Regulations]. The regulations make it evident that possession or access to UPSI qualifies an individual as an 'insider,' regardless of how they obtained such information.

Connected Person:

According to the Insider Trading Regulation, a connected person is defined as follows [Reg. 2(1)(d) of the Insider Trading Regulations]:

• Any individual who is directly or indirectly associated with a company or has been associated with the company within the last six (06) months before the concerned act.
• Such association can take various forms, including:
  • Communication with the company's officers from time to time,
  • Engagement in any contractual, fiduciary, or employment relationship with the company,
  • Being a director of the company,
  • Being an employee of the company, or
  • Holding any professional or business relationship with the company.
• The considerations mentioned above provide such individuals with direct or indirect access to unpublished price-sensitive information. Reg. 2(1)(d)(ii) of the Insider Trading Regulation specifies the categories of persons deemed to be connected persons.

Unpublished Price Sensitive Information:

As per the Insider Trading Regulation, unpublished price-sensitive information (UPSI) refers to any information, directly or indirectly related to a company or its securities, which is not publicly available and, upon becoming public, is likely to significantly impact the securities' price. Such information includes details about:

1. The financial results of the company,
2. Dividends declared by the company,
3. Changes in the company's capital structure,
4. Any mergers, demergers, acquisitions, delistings, disposals, or business expansions,
5. Changes in key managerial personnel, and
6. Material events specified under the listing agreement.

Prohibitions & Exceptions

Prohibitions:

The Insider Trading Regulations impose several restrictions and prohibitions related to the communication, procurement, and trading of UPSI:

• Insiders are prohibited from communicating, providing, or allowing access to any UPSI, which pertains to a listed company or its securities, to any person, including other insiders. [Reg. 3(1)]
• It is restricted for any person to obtain UPSI from an insider, related to a listed company or its securities, and share it with others, including fellow insiders. [Reg. 3(2)]
• Insiders, when in possession of UPSI, are prohibited from trading in securities that are listed or proposed to be listed on a recognized stock exchange. [Reg. 4(1)]

In the case of Samir C. Arora v. SEBI (see here), Samir Arora faced insider trading charges and was banned from participating in the securities market for five (05) years by SEBI. However, the Securities Appellate Tribunal (SAT) overturned SEBI's order, stating that since the information was false, it could not be classified as UPSI, and the provisions of insider trading would not apply. SAT emphasized that the information must be true to qualify as UPSI and trigger insider trading regulations. SEBI then appealed to the Supreme Court, but the Apex Court dismissed SEBI's appeal, noting that Samir Arora did not engage in trading during the period he was banned from the securities market

Exceptions:

• Under Reg. 3(1) and 3(2), UPSI can only be communicated or procured for lawful purposes, performing duties, or fulfilling legal obligations.
• UPSI may be communicated or procured in the following circumstances:
  • If the UPSI requires an obligation to make an open offer under the Takeover Code, and the company's board of directors believes the proposed transaction is in the company's best interest.
  • If the UPSI does not mandate an open offer under the Takeover Code, but the company's board of directors believes the proposed transaction is in the company's best interest, and the UPSI is made generally available to the public at least two (02) trading days before the transaction.
• Exceptions to Reg. 4(1):
  • Off-market transfers among promoters possessing the same UPSI, where both parties made an informed trade decision, resulting in no unlawful gains.
• In cases involving non-individual insiders:
  • The individuals making trading decisions did not possess the UPSI at the time of the trade, and
  • Adequate arrangements were in place to prevent the communication of UPSI to those making trading decisions, and no evidence indicates a breach of these arrangements.

Fair Disclosure & Code of Conduct

Code of Fair Disclosure:

• As per Reg. 8(1), listed companies must develop a code of practices and procedures for fair disclosure of UPSI, adhering to the principles outlined in the regulations. This code should be published on the company's official website.
• Additionally, the company must inform the stock exchanges [Reg. 8(2)]  where its securities are listed in the code of fair disclosure, ensuring transparent disclosure of the policy formulated under [Reg. 8(1)].

Code of Conduct:

• Reg. 9(1) requires the listed companies and market intermediaries to create a code of conduct to regulate and report trading activities by their employees and connected persons in accordance with the regulations. The board of directors must adopt the minimum standards set out in the Insider Trading Regulations.
• As per Reg. 9(2), other entities handling UPSI must also establish a code of conduct to regulate and report trading by employees and connected persons, complying with the principles mentioned in the regulations.
• Reg. 9(3) states that every listed company, market intermediary, and other entity formulating a code of conduct should appoint a compliance officer.

Examples of companies implementing these codes are:

• Birlasoft (see here)
• Power Finance Corporation Ltd. (see here)
• BEML Ltd. (see here)