[Prerna Raturi is a student at Symbiosis Law School, Pune.]
Due to its liberalization, the Indian economy has become one of the most alluring economies around the globe. As a result, the Indian stock market has seen an increment in investments by foreign institutional investors which, in turn, has invigorated the country’s market structure. To its dismay, there exist various vices and irregularities in the Indian securities market which clog its development, one of them being the practice of insider trading.
Insider trading is a malpractice involving trading in securities by a person having access to or knowledge of unpublished price sensitive information of a company which is likely to adversely affect the price of its securities. The person trading in the securities is known as an insider, as he has the knowledge of such price sensitive information by virtue of either his position in the company or his connection or relation to any other person associated with the company. Insider trading jeopardizes the position of other stakeholders (actual or potential) in the market since such information is unavailable to them.
On 15th January, 2015, the Securities and Exchange Board of India (SEBI) introduced the SEBI (Prohibition of Insider Trading) Regulations, 2015, which provides a framework to prevent insider trading and thwart any laxity towards the same. These regulations provide for penalty in case of its contravention, which is to be decided by SEBI in accordance with the SEBI Act, 1992 (15 of 1992).[1]
Revamping Insider Trading Regulations through SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2018
On 31st December, 2018, the SEBI introduced the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2018 in order to amend the existing principal regulations. These amended regulations were introduced on the recommendations given by the Free Market Committee, which was set up under the chairmanship of Shri T.K. Viswanathan to suggest measures to curtail manipulative and unfair practices in the securities market.
One of the most important aspects of these amended regulations is the inclusion of the concept of material financial relationships. The provision in this regard has been added as clause 14 of Schedule B of the principal regulations. Schedule B lays down minimum standards for code of conduct to regulate, monitor and report trading by insiders. Initially, these standards were aimed at prevention of trading by insiders. The amended regulations see a substitution of the word ‘insiders’ with the words ‘designated persons’.
Concept of Material Financial Relationship
Clause 14 of Schedule B of the amended regulations states that all the designated persons in a company are necessarily required to reveal the personal details of those persons with whom they share a material financial relationship including the immediate relatives of such designated persons. Personal details encompass PAN details, phone numbers and any other means of identifier of such persons as authorized by law. These details are to be provided to the company on an annual basis and as and when there is any change in the information provided. Apart from this, designated persons are required to submit details of their educational institutions as well as the names and details of the designated person’s past employers. For the purpose of this clause, a material financial relationship is one where a person receives any payment from the other which is equivalent to at least 25% of the payer’s annual income.
It is pertinent to note that material financial relationship would include those transactions as well where the payment made by a party to a designated person is more or equivalent to 25% of the annual income of the party even if such payment is not more or equivalent to designated person’s annual income. Therefore, in such cases it becomes significant for the designated person to have knowledge of the annual income of any person he is involved in a monetary transaction with. Such transaction must be made during the immediate preceding 12 months. It is to be noted that such transactions do not include any transaction taking place on an arm’s length basis. An arm’s length transaction is one where there is no collusion between the parties to the transaction, thus giving an assurance to any third party that both the parties are acting independently and in the ordinary course of business.[2]
A new Schedule C has also been inserted which lays down minimum standards for code of conduct for intermediaries and fiduciaries to regulate, monitor and report trading by insiders. Clause 12 of Schedule C of the amended regulations deals with the concept of material financial relationship as regards intermediaries and fiduciaries.
Importance of Material Financial Relationship
It is important to know the rationale behind the inclusion of the concept of material financial relationship in SEBI (Prohibition of Insider Trading Regulations), 2015. Through this, the market regulator aims to discover those cases where insiders or designated people fund any other person to deal or trade in securities of the company on their behalf. In such case, even though there is misappropriation of the unpublished price sensitive information, the same is difficult to identify as it is not being directly executed by any designated person, Therefore, it becomes necessary to figure out such instances where insider trading is effected by insiders or designated persons by funding any independent or unrelated third party.
Challenges to Implementation
The amended regulations have been introduced with an intent to clamp down on the malpractice of insider trading by designated persons of a company, but the foremost concern is the implementation of the changes so introduced. One must not forget that the concept of material financial relationships is solely based on the designated persons providing private information not only of themselves but also of their relatives, friends and family members. Even if, for once, designated persons provide their own personal information with respect to their annual income and transactions with other people, it is difficult for them to dispense the personal information (such as PAN details, annual income, etc.) of other people they are associated with due to privacy concerns. Not everyone can provide the designated people with their personal details for the purpose of these regulations. Furthermore, there is no assurance that the information provided to the designated people is true and authentic. Thus, there are high chances of such personal details being unreliable, thereby defeating the whole purpose of introducing the concept of material financial relationships in the amended regulations.
Moreover, the amended regulations are silent on the liability of designated persons in case the personal details provided by them are inaccurate. As a result, the provision of material financial relationships is one which comes with its own struggle of implementation.
[1] Clause 10, Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015.
[2] Explanation (b) to Section 188(1) of the Companies Act, 2013.