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Portfolio Managers Beware

Finsec Law Advisors

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SEBI recently clarified that trades executed by entities in possession of unpublished price sensitive information, even if done indirectly through discretionary portfolio management schemes (DPMS), will be in violation of the SEBI (Prohibition of Insider Trading) Regulations, 2015.

HDFC Bank had sought SEBI's views on (i) whether an employee of the bank or his relatives, who might be in possession of UPSI, can deal in shares of the bank or listed companies with which the bank deals through DPMS; and (ii) whether an employee of the bank or his relatives can deal in shares of the bank or the company with which bank deals, through DPMS, when their trading window is closed. Under DPMS, day to day investment discretion for the accounts is fully delegated to the portfolio manager and is not shared with the investor. The investor does not make suggestions regarding specific investments/ disinvestments and the portfolio manager does not advise the investor regarding trades prior to their execution.

SEBI, while replying to HDFC's query, observed that the insider trading regulations unambiguously states that no insider shall trade in securities whenin possession of UPSI. SEBI stated that dealing in securities, whether it is direct or indirect, is not relevant, and any insider when in possession of UPSIshould not deal in securities of the company to which the UPSI pertains. Even while dealing in such securities through a DPMS, the trades of an insider shall be assumed to be motivated by the knowledge and awareness about the UPSI. Similarly, in relation to trading during closure of the trading window, SEBI stated that dealing, even if through a DPMS, during the closure of the trading window shall be assumed to be motivated by the knowledge of UPSI.

This interpretation by SEBI is contrary to the N. K. Sodhi Committee report, which had recommended that trades undertaken by insiders through DPMS would be a valid defence in relation to violation of insider trading regulations, since the discretionary portfolio manager may not be in possession of UPSI. The stand taken by SEBI in the present informal guidance has widened the scope of the regulations, as UPSI in possession of the clients has been treated as being held by the portfolio manager, irrespective of it being a discretionary or non-discretionary portfolio management scheme. This may be a concern for portfolio managers as it would impose an unnecessary and additional burden on them, and for insiders as it restricts their avenues for investment in the securities market. Such an approach by SEBI may lead to a potential drop in equity participation by investors.