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If we analyse the orders of SEBI / SAT, the penalty levied for violation of Insider Trading is fairly high as compared to the amounts involved in the transactions. It needs to be considered whether the disproportionate penalties levied as compared to the transaction amounts are necessary for punishing the violators of Insider Trading or in order to deter others in the future. This article gives a snapshot of the types of transactions and Acts which are covered under the Insider Trading Regulations and how SEBI imposes penalty disproportionate to the profit earned through violation of Insider Trading.
1. An insider may be a director, officer or even auditor etc., who has close relations with the company. These persons are occupying position of trust and as such can access inside information. Such information if made public, would result in the price of the shares going up or down. He can thus earn profit from such information. Since this profit is earned through abuse of such trust and position and is also violative of the Regulations which prohibit Insider Trading, it will attract penalty prescribed by SEBI for violation of Insider Trading Regulations. SEBI has got wide powers and if we analyse the recent orders passed for violation of Insider Trading, it can be seen that the punishment is severe and the penalty imposed is in crores. This article gives a snapshot of the types of transactions and Acts which are covered under the Insider Trading Regulations and how SEBI imposes penalty disproportionate to the profit earned through violation of Insider Trading.
2. SEBI replaced the two decade old SEBI (Prohibition of Insider Trading) Regulations, 1992 with the SEBI (Prohibition of Insider Trading) Regulations, 2015 (PIT Regulation) which are much more extensive in the outreach and scope.
3. In respect of a listed company (or a company that is proposed to be listed), the PIT Regulations prohibit:-
Not closing Trading Window -Action against the Company Secretary and Directors
4. One of the important compliances with regard to Insider Trading Regulations is that the companies are required to adopt, provide for closure of trading window when price sensitive information is expected to be generated. It is also embedded in the Code of Conduct. It is for this reason that there is a regulation called closure of trading window. For example, while the Audited Accounts are being approved by the Board, there may be persons in the company who may have access to such information and if they deal in the shares of the company, then it is likely that they would take into consideration such information and thus enter into trades favourable to them. It is for this reason that the company should prohibit trading during such period by specified insiders and such prohibition is called "Closure of Trading Window". It is the responsibility of the Compliance Officer /Company Secretary to notify such closure of the trading window.
Case of G. Jayaraman v. SEBI  42 taxmann.com 383/124 SCL 177 (SAT - Mum.) – Order by Securities Appellate Tribunal (SAT)
"In the aforesaid matter, it was held that the Model Code contained regulations which require the Compliance Officer to keep the trading window closed during the period when information referred to in para 3.2.3 is unpublished. Object of keeping the trading window closed under para 3.2.3 of the Model Code in addition to prohibition contained in Regulation 3 of Insider Trading Regulations is to doubly ensure that directors /officers and designated employees of the Company do not misuse "price sensitive information" and trade in securities of the Company while in possession of such unpublished price sensitive information. Therefore, Compliance Officer is mandatorily obliged under Model Code to keep the trading window closed when in possession of price sensitive information specified in para 3.2.3 of Model Code. If Compliance Officer fails to close the trading window inspite of being in possession of price sensitive information, then he would be violating the Insider Trading Regulations. In such a case, whether any employee / director by taking undue advantage has traded in securities of that company or not, Compliance Officer would be liable for violating Insider Trading Regulations. In other words, Compliance Officer would be liable for penalty if he fails to close trading window when in possession of unpublished price sensitive information even if no employee has traded in shares of that company when in possession of unpublished price sensitive information."
When the directors can be absolved from the liability
5. In one of the case, SEBI initiated action against the Company Secretary and directors of the company as the trading window was not closed during the time when the sale of controlling interest was being decided upon. Before taking any action on this matter, the Company Secretary had passed away. In this case, SEBI noted that the obligation for initiating closure of the trading window under the Regulations and Code of Conduct was on the Company Secretary. Upon death of the Company Secretary, the proceedings against him abated and the directors were also absolved from the liability.
When did the Unpublished Price Sensitive Information (UPSI) arise
6. As regards dissemination of UPSI, it is really from the commencement of this that the insiders are prohibited from dealing in the shares of the company. Mere developments will not be taken into account and there would be a particular stage after which the development must have turned into such definitive information that if made known to the public would materially affect the price of the shares of the Company. The requirement is that before dissemination of UPSI, the trading window should be closed. E.g. if any decision is taken to finalise a particular transaction which is UPSI in a Board Meeting then it is considered that the UPSI has commenced from the date of the Board Meeting.
When Price Sensitive Information ceases
7. Particular information may not be price sensitive in perpetuity and the timing of the information and the time of trade are very important to arrive at a conclusion that any information was price sensitive especially at the time of trading. Thus, it can be safely concluded that Price Sensitive Information will cease to be so after it is in the public domain.
8. Section 195 of the Companies Act, 2013 prohibits all persons including any director or Key Managerial Personnel of a company from engaging in insider trading.
However, communication required in the ordinary course of business or profession or employment or under any law are an exception. This Section does not distinguish between a listed or unlisted company or even between private or a public company whereas SEBI Insider Regulations are applicable only on the listed public companies. It is interesting to see how this section will be applied to a private company which is usually run by the founder shareholders and where there is no market determined price of shares readily available.
SEBI in various cases found that directors purchased shares during presence of the price sensitive information. In some cases, it was found that the directors were also held to have shared the information with their relatives who dealt in the shares. In these cases, the directors were penalised separately for sharing information and for dealing in shares.
Similarly in one of the case, a director was held to have shared the information with a group he was associated with, which group in turn dealt in the shares of the Company. SEBI investigated the matter and levied a penalty of one crore on such director. In fact, for the persons to whom such UPSI was shared and who dealt in such shares, a penalty of two crores was levied for such persons put together. From these, it is clear that the PIT Regulations are wide in scope and SEBI's penalty is more severe than one may commonly expect. In some cases, though the profit earned through Insider Trading was in thousands, the penalty may be in lakhs or even in crores. Thus, it can be seen that the orders of SEBI are stringent and punishment are severe, which in most of the cases also been confirmed by the Securities Appellate Tribunal (SAT) with some changes.
In cases of Open Offer
9. If the information is price sensitive and not made public, then the PIT Regulations require that insiders should not deal on basis of such information, which is called UPSI. The regulations rightly bar them from dealing in the shares of the company till such information is not shared with public. However, it is to be seen that whether even information that does not directly relate to activities of companies can also be inside information. For example, the Promoters of a company would have entered into an agreement to sell their stake (part) to an acquirer, whether such information would also be inside information under these Regulations. Here, the information does not really relate to the operations of the company but it is a peculiar nature of information. Such an acquisition would have to result in an open offer from the public by the acquirer under the SEBI Takeover Regulations. In case the open offer price is higher than the current ruling market price, the public shareholders would be benefitted. However, if the promoters, being aware of such information and the deal with the acquirer, acquire the shares from the market at the ruling price, then they may profit from such purchases.
The PIT Regulations contain a specific carve out for communication and procurement of information (Due Diligence conducted) in connection with transactions involving merger and acquisition. Therefore, based on whether or not a transaction entails making an open offer under SEBI ( Substantial Acquisition of Shares & Takeovers) Regulations, 2011 (Takeover Code)information may be communicated, provided, allowed access to or procured on the following conditions:-
(a) Open offer obligation under Takeover Code :
Where the Board of Directors of the company is of the informed opinion that the proposed transaction is in the best interest of the company.
(b) No open offer obligation under Takeover Code
Where the Board of Directors of the company is of the informed opinion that the proposed transaction is in the best interest of the company. Information that constitutes UPSI is disseminated to be made generally available at least 2 trading days prior to the proposed transaction being effected in such form as the Board of Directors may determine.
Therefore, as long as the Board is of the informed opinion that the transaction is in the best interest of the company, due diligence may be lawfully conducted. In case, a particular transaction does not entail making an open offer to the public shareholders the Board of Directors would be required to cause public disclosures of the UPSI prior to the proposed transaction to rule out any information asymmetry in the market. Additionally, a duty has been cast on the Board of the company to cause the parties to execute confidentiality and non-disclosure agreements for the purpose of this provision. Therefore, introduction of this provision under the Regulations has amply clarified that the communication or procurement of UPSI for the purposes of due diligence shall be permitted, subject to the conditions set out in the Regulations.
10. UPSI - SAT fixes the commencement period :
Case of Mrs Chandra Mukherji & Shelter Infra Projects (P.) Ltd. v. SEBI [Appeal No: 126 of 2014 & 121 of 2014]
The facts of the case is that Shelter Infra and its promoters had entered into a Share Purchase Agreement (Spa) on 31st July, 2009 with one Ramayana Promoters Pvt. Ltd (RPL) for sale of 35% shareholding of the promoters to RPL thereby triggering the open offer obligations under the Takeover Regulations, 1997. The SPA was approved by the Board of Shelter Infra on 30.7.2009. However, the discussions pertaining to the SPA had commenced from May 21, 2009 and the first draft of the SPA was shared with the Board of Shelter Infra on 20th June, 2009. As per SEBI's investigation, it was observed that the Board of Shelter Infra had decided to complete the takeover formalities within a week from the Board meeting held on 19th June, 2009. As per SEBI, Shelter Infra was bound to intimate its Board meeting decision approving the SPA within 15 minutes of the conclusion of the Board Meeting held on 30th July, 2009. But Shelter Infra did not comply the same and thus violated the provisions of Listing Agreement as well as PIT Regulations, 1992. Also Shelter Infra was legally required to close the trading window w.e.f. 21st May, 2009, when discussions pertaining to the SPA had commenced and were within the knowledge of the Board of Shelter. However, Trading window was closed only after 30th July, 2009, thereby enabling the promoters and relatives of the promoters to trade in the shares of Shelter Infra during 20th June, 2009 to 30th June, 2009 (UPSI period), thereby violating the provisions of PIT Regulations, 1992.
SAT held that even assuming that the first draft of the SPA was shared with the Board of Directors of Shelter Infra on 20th June, 2016, the Board had already taken decision pertaining to the SPA on 19th June, 2009 and thus UPSI came into existence on 19th June, 2009. Accordingly, the Trades executed by directors and relatives of directors and other connected entities during the UPSI period was in violation of PIT Regulations, 1992. As regards violation with regard to closing of trading window, SAT reversed the order of SEBI holding the compliance officer liable for non-compliance with the PIT Regulations, 1992 and exonerating the directors from the liability by holding that it is the overall responsibility of the Company and the Board of the Company to ensure compliance with PIT Regulations, 1992 in the letter and spirit.
Informing Stock Exchanges regarding decision of Takeover and making the public announcement as required by the Takeover Regulations – Penalty levied by SEBI
11. In the aforesaid case, the Company did not comply regarding intimation to the Stock Exchange as required by the Listing Agreement. Further, a public announcement was required to be made under the Takeover Regulations within 4 working days of having entered into the agreement for sale of shares/control. The public announcement was made, however, after 5 working days, which incidentally came to 7 days. A penalty of Rs. 50 lakh was levied by SEBI for not intimating the Stock Exchange under the Listing Agreement and a further Rs. 50 lakh for not releasing the public announcement in the prescribed time. The Company argued that the information was provided through the public announcement in 7 days and even otherwise, the penalty comes to only Rs 7 lakhs being Rs. 1 lakh per day. But SAT however took a practical view and accepted the contention that the public announcement also effectively released the required information. Hence the delay was limited to 7 days. SAT also applied the penalty of Rs. 1 lakh per day under section 23(a) of the Securities Contracts (Regulation) Act, 1956 and limited the penalty to Rs. 7 lakh.
12. If we analyse the orders of SEBI / SAT, the penalty levied are fairly high as compared to the amounts involved in the transactions. It needs to be considered whether the disproportionate penalties levied as compared to the transaction amounts are necessary for punishing the violators of Insider Trading or in order to deter others in the future. In most of the cases, the adjudicating officer has not given any detailed working how the penalty has been calculated according to the Regulations. Hope the stringent penalties imposed by SEBI/SAT will deter both the insiders as well as any person (outsider)/third party who has inside information from dealing in the securities of the company as the definition of "Insider" under the Regulations includes any person who received such information.