WHO IS AN “INSIDER” UNDER THE INDIAN LEGAL FRAMEWORK GOVERNING INSIDER TRADING?

by Pritika Kumar and Moksh Roy

An introduction to insider trading

Insider trading essentially refers to trades in the securities of a company made by individuals who have access to certain inside information about the company which, when made public, will have a significant effect on the price of the company’s securities. Such information can include the financial results of the company, or any proposed change in the capital structure of the company.     

The regulatory framework to tackle insider trading.

In India, the securities market regulator is the Securities Exchange Board of India (“SEBI”). SEBI is empowered to govern all major aspects of the Indian securities market, including regulation of matters of insider trading, by way of its parent act, which is the SEBI Act, 1992. The SEBI (Prohibition of Insider Trading) Regulations, 2015 (“Insider Trading Regulations”) lay down the mechanism to check for instances of insider trading.

The Insider Trading Regulations delve into defining several important terms such as “Unpublished Price Sensitive Information” or “UPSI”, “trading”, and “insider”.

In this article we will be focusing on the definition of “insider” under the Insider Trading Regulations as well the decisional practice of SEBI and the courts in this regard.

“Insider” under the Insider Trading Regulations

An “insider” according to the Insider Trading Regulations includes: -

1.        Anyone who has access to UPSI[1]; or

2.        A connected person.   

It can be understood that an individual does not necessarily have to be part of the company or associated with it in any capacity to fall under the ambit of the definition of an “insider”. Merely having access to UPSI through any source will be enough for a person to be classified as an insider.

A “connected person” is defined by the Insider Trading Regulations as a person who has been associated with a company during 6 months prior the commission of the act in question, either directly or indirectly in any capacity, including by reason of frequent communication with the company’s officers.

It can be said that employees and other officers of the company as well as persons having contractual, professional or business relations with the company can fall under the definition of a “connected person” and consequently an “insider.”

It should be noted that a person who falls under the definition of a connected person will be deemed to have had access to UPSI, and it will be upon the connected person to disprove the presumption that they had access to UPSI.  

On the other hand, if a person is alleged to be an insider due to them having access to UPSI, the onus to prove that they had access to such information will lie on SEBI.

“Connected person” under the Insider Trading Regulations

As mentioned earlier, employees and other officers of the company as well as persons having contractual, professional or business relations with the company can fall under the definition of a “connected person.”

The insider trading regulations lay down the classes of persons that are deemed to be connected persons and as a result it will be presumed that they had access to UPSI.

These persons are: -

·      immediate relative of connected person;

·      holding company or associate company or subsidiary company;

·      intermediary as specified in S.12 of the SEBI Act or employee or director thereof;

·      investment company, trustee company, AMC or employee or director thereof;

·      official of a stock exchange or of clearing house or corporation;

·      member of board of trustees of a mutual fund or a member of the board of directors of the AMC of a mutual fund or is an employee thereof;

·      member of the board of directors or an employee, of a public financial institution as defined in S.2 (72) of Companies Act, 2013;

·      official or an employee of a self-regulatory organization recognised or authorized by SEBI;

·      banker of the company;

·      concern, firm, trust, HUF, company or association of persons wherein a director of a company or his immediate relative or banker of the company, has more than 10% of the holding or interest.

One should note that frequent communication with any officer of the company can also lead a person to be classified as a “connected person.”

While frequent communication has not been defined under the SEBI Act or the Insider Trading Regulations, a reasonable interpretation would be to assume that any person who has a track record of frequently meeting, calling, or messaging an official of a company would be a connected person.

The High Level Committee chaired by Mr. N.K. Sodhi in its report from 2013 reviewing the insider trading regulations from 1992, stated that frequent communication is a question of fact and evidence would have to be brought in to show close contact between the parties.

Interestingly, SEBI has widened the scope of frequent communication by a great margin with its decision in the case of Deep Industries. In this instance the persons accused of insider trading were held to be connected person by virtue of frequent communication with the Managing Director of the company.

However, frequent communication was proven by highlighting the fact that the accused persons had “liked” several pictures of the MD on Facebook and the MD had also liked several pictures of the accused persons. SEBI stated that they were connected persons by virtue of frequent social interaction.

This matter was settled and therefore, the appellate forums were not able to comment on the validity and viability of the position adopted by SEBI in this case.

Conclusion

To sum it up, insiders can either be those people who are in possession of UPSI and such possession can be proved by SEBI, or those who fall under the definition of a connected person, in which case such person will have to prove their innocence by establishing that they did not have access to UPSI.

A person who does not squarely fall into the definition of connected person by virtue of being an officer of the company or having a contractual relationship with it can be said to be a connected person due to frequent communication with any officer of the company. And after SEBI’s decision in Deep Industries the scope of frequent communication has increased significantly which has resultantly widened the ambit of “connected person” as well.   

[1] UPSI is any information that is not yet publicly known and that could have a significant impact on the price of a company's securities.