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Decoding the recent amendments to SEBI's insider trading framework

Finsec Law Advisors

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In order to further enhance the standards of surveillance on flow of unpublished price sensitive information (UPSI), the SEBI board had recently approved certain changes to the insider trading framework in its meeting on June 25, 2020. While some of these changes were notified by SEBI through an amendment to the SEBI (Prohibition of Insider Trading) Regulations, 2015 (PIT Regulations) on July 17, 2020, the remaining were notified through two separate circulars issued by SEBI on July 23, 2020.

Revised norms for maintenance of Structured Digital Database

Through an earlier amendment, with effect from April 01, 2019, SEBI had mandated every listed entity, intermediary and fiduciary, to maintain a structured digital database containing the name and PAN details of persons with whom any UPSI is shared. As per the PIT Regulations, this database must be secured through adequate internal controls such as time stamping and audit trails so as to prevent any kind of tampering. The above mandate was primarily introduced with a view to maintain a trail of information and aid SEBI in investigations pertaining to insider trading by establishing a link between insiders and persons who communicate and trade on the basis of such UPSI.

Now, through the recent amendments notified on July 17, SEBI has prescribed that along with the above information, the database shall also contain details such as the nature of UPSI and the details of the person who shared such UPSI. Additionally, SEBI has mandated that such database shall be maintained internally and cannot be outsourced, and that the database is required to be preserved for minimum eight years. In the event any proceedings have been initiated by SEBI, the relevant information in the database shall be maintained till the completion of such proceedings.

In investigations pertaining to insider trading, identifying the insider who communicated the UPSI in the first place becomes increasingly relevant for narrowing down potential offenders and to trace the trail of information, more so in the backdrop of the recent ‘WhatsApp leak’ case wherein after long investigations, SEBI had recently penalized certain individuals for leaking information related to financial results of certain listed entities on the popular instant messaging application. Interestingly, since WhatsApp messages are usually protected through end-to-end encryption, in the abovementioned case, neither the origin or source of the information was traced nor any connection was established by SEBI between the promoter or management of the listed entities and the persons who circulated such UPSI, thus setting an alarmingly low standard of proof in such cases. It is hoped that the new structured database may assist and prevent such cases in future.

Further, for complying with the above mandate of SEBI, many entities provide dedicated services such as automated compliance software and platforms which ensure the maintenance of such structured digital database. However, with the recent amendment restricting listed entities, intermediaries and fiduciaries from outsourcing the maintenance of such database, it is unclear whether the services provided by such entities would also fall within the purview of such restriction.

Trading Window restrictions not applicable for OFS and RE

Schedule B of the PIT Regulations mandates closure of trading window for designated persons and their immediate relatives who can be reasonably expected to possess UPSI, during which such persons are not permitted to trade in securities to which such UPSI relates. However, certain exceptions had been carved out; for instance, off-market inter se transfers between insiders, transactions through block deal mechanism, exercise of stock options, pledge of shares for bonafide reasons, etc.

Through its circular dated July 23, SEBI has also permitted selling of promoters’ holding by way of offer for sale (OFS) and exercising to rights entitlement (RE) during the period of closure of trading window. One would recall that through prior amendments, the requirement of closure of trading window was extended, specifically during the period of declaration of financial results; thus, reducing the time period for listed entities to undertake OFS or REs. In light of the recent efforts by SEBI to ease the norms with respect to fund raising, this is a good move and will give more opportunities to listed entities to generate quick cash flow for effectively operating their businesses, especially during the ongoing pandemic.

Reporting of violations of the Code of Conduct

Further, through a separate circular issued on July 23, SEBI has specified that listed entities, intermediaries and fiduciaries are required to promptly report any violation of the Code of Conduct under the PIT Regulations in the prescribed format to the stock exchanges and any amount recovered from the defaulter shall be deposited in the Investor Protection and Education Fund. Prior to this, such reporting was required to be made to SEBI, as per the circular issued on July 19, 2019 which now stands repealed.