Insider Trading: Will the Informant Mechanism be Effective?

The Securities and Exchange Board of India (SEBI) on 10 June 2019 proposed an ‘informant mechanism’ to safeguard the interests of the investors and limit insider trading. In light of the difficulty in tracking illegal transactions, SEBI has released a discussion paper, which could be operationalized by amending the SEBI (Prohibition of Insider Trading) Regulations, 2015 (the 2015 Regulations). The mechanism provides ‘near absolute confidentiality along with appropriate surveillance.’ Genuine whistleblowers would get a monetary reward of up to 1 crore rupees as well as amnesty from regulatory action. This post aims to analyze the evolution of insider trading laws in India, their applicability and the details of the informant mechanism proposed by the SEBI.What is Insider Trading?Regulation 2(1)(g) of the 2015 Regulations defines ‘insider’ as a person who is a connected person or one who is in possession of or has access to unpublished price sensitive information (UPSI). Regulation 2(1)(d) interprets a ‘connected person’ as one who has been associated with a company, directly or indirectly, for a continuous period of six months prior to the commission of the act. UPSI is that price related information that is not in the public domain. Regulation 3 prohibits the transmission of such price sensitive information to any person except for a legitimate purpose. Thus, these regulations have been designed to prohibit insider trading violations.Evolution of the Laws Relating to Insider TradingIn 1948, the Thomas Committee Report pointed out instances of directors, agents, officers possessing strategic economic information regarding the size of dividends, issue of bonus shares or the conclusion of a favorable contract, prior to its public disclosure. The Sachar Committee in 1979 proposed a separate statue to regulate insider trading. Consequently, in 1992, SEBI (Insider Trading) Regulations came into force. The Regulations were amended and renamed SEBI (Prohibition of Insider Trading) Regulations in 2002. The 2015 Regulations, presently in operation, came into force on 15 May 2015. The same has been amended since.ApplicabilityRegulation 9 requires the board of directors of listed companies and market intermediaries to draw up a code of conduct to regulate, monitor and report trading by their employees or connected persons towards achieving compliance with the regulations. The Companies Act, 2013 under section 195 provides that no person including a director or key managerial person shall enter into insider trading.Penalty for Non-compliance separate punishment for defying these provisions is not prescribed under the 2015 Regulations. The penalty for insider trading under Section 15G of the Securities and Exchange Board of India Act, 1992 would be applicable. The penalty shall not be less than 10 lakh rupees but may extend to 25 crore rupees or three times the amount of profits made out of insider trading, whichever is higher.SEBI’s Informant MechanismSEBI, on 10 June 2019, issued the discussion paper to devise an amnesty and protection policy for informants who provide information on insider trading violation. SEBI’s whistleblower policy proposes to reward genuine whistleblowers with a monetary sum of up to 1 crore rupees. The reward shall be paid from the Investor Protection and Education Fund (IPEF). The ‘informant mechanism’ proposed by the SEBI will enable early detection of insider trading cases. It will also seek to prevent victimization of the informant. It provides ‘near absolute confidentiality along with appropriate surveillance.’ The move comes in response to a SEBI consultation paper on ‘insider trading activities’ which recommended the institution of a process to set up timely reporting of insider trading violations. The consultations also came up with the need for a grant of reward with adequate checks and balances to incentivize such reporting. The policy would be implemented by amending the 2015 Regulations.The salient features of the discussion paper are as follows:1. Voluntary Information Disclosure Form: The mechanism would consist of a dedicated reporting window and a voluntary information disclosure form. The informant will have to submit the details of complete information on the act of communication of the UPSI or trading in violation of the code of conduct.2. Office of Informant Protection (OIP): An independent office within SEBI that is separate from the investigation and inspection wings may be established to device the policy relating to the receipt of VIDF.3. Confidentiality of the informant: The confidentiality regarding the identity of the informant and the information provided shall be protected through the OIP.4. Reporting and Hotline: The OIP has to submit a report of its functioning on an annual basis to the SEBI board. A hotline to guide persons to file information shall also be set up.5. Reward: The total amount of reward shall be ten percent of the monies collected but shall not exceed 1 crore rupees or such higher amount as may be specified. For instance, a reward to the tune of 1 crore rupees would be for cases where disgorgement has been 5 crore rupees or more.6. Quantum of Reward: An interim reward not exceeding Rs 10 lakh may be given at the stage of issuance of the final order by the SEBI against the person directed to disgorge. The final reward shall be issued after collection or recovery of the monies disgorged equal at least twice the final reward.7. Exemption under RTI: Information provided for the purpose of law enforcement is exempted from disclosure under section 8(1)(g)  and  8(1)(h) of the Right to Information  Act, DrawbacksThe promulgated policy can be counterproductive. Firstly, it seems to resolve the issue of ‘vested and frivolous complaints’ and reward whistleblowers for voluntarily disclosing information; however, it completely excludes individuals who wish to share information anonymously. Secondly, only cases where disgorgement has been to the tune of 5 crore rupees or more shall be covered. This minimum threshold excludes the majority of smaller transactions from coming within its purview. Thirdly, it discourages complainants, as the consequences of a wrong complaint are comprehensive and pernicious.ConclusionSEBI’s discussion paper illustrates the zeal with which SEBI desires to curb insider trading transactions and punish the offenders. However, the practical effectiveness of the policy and the orbit of its operation is yet to be seen.

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