[Rishabh Sharma is a student at NALSAR University of Law.]
The Securities and Exchange Board of India (SEBI) has always been faced with formidable challenges in prosecution of insider trading cases. The success rate of solving such cases and the investigation timelines are tremendously impacted by the difficulties encountered in procuring primary evidence.
On August 21, 2019, SEBI approved the SEBI (Prohibition of Insider Trading) (Third Amendment) Regulations, 2019 (Amendment) to bring amendments in the SEBI (Prohibition of Insider Trading) Regulations, 2015 (Insider Trading Regulations) for the purpose of introducing an informant mechanism for limiting insider trading and safeguarding the interests of the investors. In the pursuance of this object, systems and processes shall be put in place for incentivizing individuals to blow the whistle on insider trading violations. If the action taken on the basis of the information supplied by an informant leads to a disgorgement of at least INR 1 crore, the concerned individual shall be entitled to a reward of 10% of the disgorged monies up to INR 1 crore.
Key features
Some of the key features of the notified amendments to the Insider Trading Regulations are as follows:
Any individual possessing knowledge or a reasonable basis suggesting that an insider trading violation has occurred/is occurring/is about to occur can voluntarily notify the SEBI by submission of a original information using the Voluntary Information Disclosure Form (VIDF). The source of the information must also be disclosed by the informant.
The informant can also act through a practising advocate and furnish information to the SEBI anonymously. Such a legal representative would be under an obligation to verify the whistle-blower’s identity / contact details and maintain their confidentiality.
An independent wing (distinct from investigation / inspection wings at the SEBI or any other concerned departments) called the Office of Informant Protection (OIP) would be set up for acting in close liaison with the informant. The OIP shall oversee receiving and registering the VIDF in addition to instituting a mechanism for assessing the authenticity of the acquired information. As soon as the OIP processes the information, it will be transmitted to the SEBI for recommendation of the appropriate enforcement action. Thereafter, upon completion of the enforcement action, the SEBI shall determine the amount of the reward to be granted to the informant.
In the notified framework, the OIP would be obligated to maintain confidentiality of the informant’s identity as well as the information supplied. Such confidentiality is expected to be maintained even during the SEBI’s ongoing proceedings except when there is a requirement for producing evidence of the informant.
By revising their internal codes of conduct, everyone associated with the securities market, including listed companies as well as intermediaries, will have to ensure that their whistle-blowing employees are not faced with any penalty, demotion, harassment, suspension, or termination, directly or indirectly, on account of filing the VIDF / assisting the SEBI.
If it is determined by the OIP that the informant has furnished vexatious or frivolous information, appropriate action can be initiated against the concerned individual by the SEBI under the laws applicable.
No amnesty / immunity shall be deemed to be provided to informants in violation of the securities laws. The SEBI may choose to offer an amnesty scheme to the informants facing the enforcement action wherein they would be eligible for a reward and settlement with confidentiality if they show voluntary cooperation.
Critical considerations
Prima facie, the Amendment considerably draws inspiration from the United States Security Exchange Commission’s framework for protection of whistle-blowers, put in place under the Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010[1] and the three foundational pillars (anonymity, bounty, and protection of job) of its whistle-blower protection policy. While this mechanism has been reasonably effective in the United States, a replication of the model in the Indian securities market, albeit benign, might not guarantee automatic success.
Some of the concerns that will have tremendous bearing on its efficacy are discussed below:
To begin with, the Amendment, in its present formulation, is capable of being misused since individuals can intentionally file misleading and false complaints or provide tip-offs that merely prove to be red herrings. Does the SEBI have the necessary tools at its disposal for prevention of such misuse? Unless the SEBI demonstrates its competence to remain discerning about the complaints, it remains a huge concern.
A large proportion of insider trading cases will remain outside the purview of the Amendment, as the threshold for cases to be within the fold of the new framework is quite high. Only those informants which blow the whistle on cases where disgorgement of monies occurs to the tune of INR 1 crore or more shall be entitled to a reward. In effect, this will disincentivize, or provide no incentive to, individuals with insight on insider trading involving smaller transactions to share their insight with the SEBI.
Deployment of additional resources for setting up a new unit within SEBI, i.e., the Office of Informant Protection, which will operate separately from the investigation / inspection wings to device policies in relation to receipt of VIDF will not only prove to be logistically challenging but would also possibly protract the main insider trading investigations.
As per the Amendment, vexatious or frivolous complaints will attract appropriate regulatory action against the informant, however, such a proposal requires more nuanced consideration. As is acknowledged by the SEBI itself, it is a herculean task to prove insider trading, with tremendous possibility of lack of conclusive evidence even at the informant’s disposal. Therefore, establishing the bona fides of the informant would require careful thought and furnishing of any information which is insufficient to result in a conviction would not be enough to initiate regulatory action against the concerned informant.
The measure of success of such a framework is fundamentally dependant on the confidentiality of the informant. The Amendment states that the anonymity of the informant’s identity will be maintained except when their evidence is required to be recorded in the proceedings. It needs to be factored into consideration that such an exception is detrimental to the success of the initiative as it might dilute the number of individuals who are ready to blow the whistle regarding any knowledge on insider trading violations. This would be true especially for cases wherein the whistle-blower is aware that he might be required during the enforcement proceedings by virtue of being in a position to provide primary evidence.
Anonymous complaints may be filed through legal representatives who are obligated with the responsibility to maintain the informant’s identity confidential. However, the Amendment remains silent with respect to the standards of liability against which these representatives will be held in case the confidentiality is compromised, despite taking proper care to maintain anonymity.
Conclusion
In the corporate world, bounty-hunting is a rather peculiar vigilantism mechanism, one that fosters the potential to benefit regulators and increase awareness, while concomitantly is capable of channelling the attention of the regulators on issues which are irrelevant and misleading. When the Amendment comes into force 100 days after its notification, the SEBI will be faced with the responsibility to encourage proxy regulators within organizations and to institute a more institutionalized, reward-based setup for the whistle-blowers. However, a successful implementation of the new framework will open the doors to considering extension of the framework’s application to unfair and fraudulent trade practices inside companies as well. In theory, many recent concerns with respect to the market conduct issues and governance practices in the Indian companies have been equally amenable to introduction of such a framework, as the SEBI encounters with an analogous set of predicaments in the course of investigating such matters.
[1] Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010.
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