This post has been authored by Sanya Suman, a 4th year law student at Chanakya National Law University, Patna.
Introduction
Insider trading is loosely defined as "the wrong of trading in securities with the advantage of having asymmetrical access to Unpublished Price-Sensitive Information (UPSI), which, when published, would affect the price of securities in the market."[1] Recently, the insider trading regulations underwent a major alteration when the Securities and Exchange Board of India (“SEBI”) amended the SEBI (Prohibition of Insider Trading) Regulations, 2015 (“PIT Regulations”) in June 2024 intending to strike a balance between compliance and flexibility.
The key changes introduced by the amendment include the elimination of the minimum 12-month trading period requirement, the period for commencement of trading under trading plan being reduced from six months to 120 calendar days, the addition of trade splitting guidelines, and permission for trading plan deviations under specified extraordinary circumstances. These changes demonstrate SEBI's commitment to adapting rules to meet market demands along with upholding strong safeguards against the improper use of unpublished price sensitive information (“UPSI”). The effectiveness of these measures in tackling the problems of insider trading in the Indian securities market needs an assessment. This post examines the major changes been made and their efficacy in the Indian market.
Minimised Waiting Period
Regulation 2(1)(g) of the PIT Regulations defines an ‘insider’ as any person who is connected or in possession of or has access to UPSI. Regulation 5(1) requires an insider to formulate a trading plan and present it to a compliance officer which then will be approved and publicly disclosed. In terms of Regulation 5(2), such trading plan did not entail commencement of trading earlier than 6 months of the public disclosure. This period has now been reduced to 120 calendar days.
This is a notable modification. It will allow insiders to have more freedom to carry out their trading strategies while still ensuring safeguards against any abuse of UPSI. This amendment aims to achieve a better balance between permitting lawful trading activity and preserving market integrity. At the same time, the reduced waiting period, also begs the question of whether it indeed gives UPSI enough time to gain market acceptance and become widely known.
Flexible Trading Period
Another noteworthy development that will give insiders more flexibility in their trading methods is the elimination of the minimum 12-month trading duration limitation. Prior to the amendment, regulation 5(2)(iii) of the PIT Regulations specified that a trading plan must involve trading for at least 12 months. This has been omitted to enable insiders to adapt to shifting market conditions due to the dynamic nature of financial markets.
The removal of this restriction displays that SEBI considers long-term, tight trading plans unfavourable. However, this change may also further difficulties for the oversight and control of insider trading operations. The shorter trading periods may make it more challenging for authorities to discern between trading actions that are based on UPSI and those that are not. Thus, while this change shows SEBI's proactive approach, it also highlights certain possible weaknesses and areas of concern that need to be carefully considered.
Specified Price Range for trading
The amendment also introduced a 20% price range for purchasing or selling shares in a trading plan under Regulation 5(2)(v), affording corporate insiders a break from the price restriction only under specified circumstances. The price range may represent an upper limit for a buy trade and a lower limit for a sell trade, depending on the scrip price at the time the trading plan is created.
Though the 20% trading range is promising in its objective of providing clarity and transparency, it needs to be seen whether it rules out any abuse by insiders with access to UPSI by establishing favorable ceilings. Furthermore, the absence of setting upper limit on the duration of trade splitting, may be misused if it enables insiders to extend deals. The efficacy of the regulatory structure may be jeopardized by the two-day approval window that compliance officers have to review trading plans. [2] This window may not be long enough to allow for a comprehensive analysis of trade strategies.
Further, Regulation 5(2)(v) also clarifies permissibility of ‘trade splitting’, which refers to the practice of an insider breaking down a substantial transaction involving the purchase or sale of shares into smaller sections that are carried out across many dates or periods.[3] SEBI has clarified that insiders can their trades over different dates but there ought to be an outer limit to this duration to prevent misuse.[4]
Addition of Exit Clause
A practical addition to the regulations is the provision for departures from approved trading plans under special conditions, such as permanent disability, bankruptcy, or operation of law. As per Regulation 5(4) of the amended regulations, insiders are now obligated to follow their trading plans without deviation or trading outside the plan, except in instances of permanent disability, insolvency, or operation of law.
This clause acknowledges that an insider's financial status or capacity to carry out a trading plan may be considerably impacted by unanticipated circumstances. It does, however, also present a possible channel for misuse if not closely supervised.
Critical Analysis
It is a double-edged sword to impose explicit price limits on trades executed by trading programs. On the one hand, it provides insiders with a clear framework within which to operate, perhaps reducing the likelihood of manipulation. Additionally, to avoid large price swings, buy trades have an upper limit of 20% above the closing price, whereas sell trades have lower limit of 20% below the closing price.. Meanwhile, the 20% range remains relatively big and might be leveraged by insiders with access to UPSI. Given that they anticipate information that could influence the market, they may set price limits at the extremes of this range. This highlights the ongoing challenge of establishing a compromise between stringent controls to prevent market manipulation.
To mitigate these issues and improve the effectiveness of insider trading laws, several regulatory improvements may be taken into consideration. An option to limit the abuse of sensitive information that is more nuanced than a fixed 120-day term could be applied to implement a waiting period that is based on the insider's position and probable access to UPSI. The chances of manipulation may be decreased by creating an AI-driven system that establishes price restrictions depending on market conditions and past volatility. The regulatory system might be strengthened even more by mandating more thorough disclosures of the reasoning behind trading strategies and any modifications to insider access to information or roles.
Further, determining and confirming the requirement of unusual circumstances like permanent disability, or bankruptcy could be the difficult part of making sure that the clause isn't used as a way to get around trade prohibitions. To preserve the integrity of the departure clause and allow for the necessary flexibility in legitimate circumstances, SEBI will need to set up precise guidelines and strong verification procedures.
Conclusion
These changes are a major step in the direction of more adaptable but reliable market governance. They solve some important issues, but they also present new difficulties and possible weaknesses that will need to be continuously evaluated and improved. We have to look at the key factors like the regulations' execution and enforcement to asses market's ability to adjust to these new standards in order to determine how effective they are. Maintaining a flexible regulatory framework that successfully discourages insider trading while fostering fair and efficient markets will be essential.
The viability of India's insider trading regulatory framework largely depends on SEBI's ability to strike a balance between these conflicting interests and remain responsive to market realities. To conclude, the recent changes introduced to the PIT Regulations show a laudable attempt to adjust to changing market conditions, but they also underscore the continued difficulties in policing this complex field. These adjustments also highlight the need to strike a careful balance between stopping market manipulation and creating an atmosphere that is not unnecessarily harsh. Maintaining investor trust and upholding market integrity will be greatly dependent on how well these laws work as India's financial markets develop and thrive.
The views expressed in this Blog Post are solely of the Guest Author.
[1] https://www.scconline.com/blog/post/2024/05/14/the-need-to-strip-profit-motive-off-of-insider-trading/
[2] Regulation 5(4), SEBI (Prohibition of Insider Trading Regulations), 2015.
[4] Regulation 5(2)(v), SEBI (Prohibition of Insider Trading Regulations), 2015.
Comentarios