[By Gauravi Talwar]
The author is a student of Gujarat National Law University.
INTRODUCTION
The Securities and Exchange Board of India (SEBI), in its Consultation Paper dated July 29, 2024, has initiated a pivotal reform in its regulatory approach to insider trading. This proposed amendment to the SEBI (Prohibition of Insider Trading) Regulations, 2015, signals a decisive effort to strengthen the regulatory landscape in response to the growing sophistication of financial markets and insider trading practices. By focusing on closing historical loopholes and enhancing market integrity, SEBI aims to create a more comprehensive framework by revising key definitions, such as “connected persons” and “relatives.”
By aligning the definition of “connected persons” with the “related party” concept in the Companies Act, 2013, and expanding the definition of “relative” under Section 56(2) of the Income Tax Act, 1961, these amendments are designed to capture a broader spectrum of individuals and entities with access to Unpublished Price Sensitive Information (UPSI). This article conducts a comparative analysis of the proposed amendments and evaluates their potential impact on insider trading regulations in India.
EXPANDING THE DEFINITION OF “CONNECTED PERSON”
The SEBI (Prohibition of Insider Trading) Regulations, 2015, define an “insider” as any individual who either is a connected person or has access to Unpublished Price Sensitive Information (UPSI). However, the current definition of “connected person” is insufficient in covering individuals with indirect access to UPSI through their associations with such persons. SEBI’s proposed amendments seek to remedy this by aligning the term “connected person” with the “related party” concept under Section 2(76) of the Companies Act, 2013. This alignment expands accountability, casting a wider regulatory net to capture those with indirect ties to companies and recognising the complex relationships that can facilitate insider trading. Additionally, amendments to Regulation 2(1)(d)(ii) broaden the scope of “deemed connected persons,” acknowledging that insider trading networks often extend beyond formal company roles.
A pivotal change is the expanded definition of “relatives,” now modelled on Section 56(2) of the Income Tax Act, of 1961. This revision includes a broader array of familial connections—spouses, siblings, and lineal ascendants—closing loopholes that previously enabled insiders to exploit indirect access to UPSI through family members. These amendments reinforce SEBI’s efforts to ensure comprehensive regulatory scrutiny and prevent circumvention of insider trading laws through intermediaries.
COMPARATIVE MODELS: UNITED STATES AND UNITED KINGDOM
United States
In the United States, insider trading is regulated under a broad legal framework, anchored in the Securities Exchange Act of 1934, the Insider Trading Sanctions Act of 1984, and the Insider Trading and Securities Fraud Enforcement Act of 1988. The U.S. Securities and Exchange Commission (SEC) treats insider trading as securities fraud, focusing on the improper use of non-public, material information rather than the individual’s formal association with the company. This ideology has been reinforced by the landmark U.S. v. O’Hagan case which introduced the “misappropriation theory”. The idea behind the theory is to extend liability beyond corporate insiders to include any individual who improperly uses confidential information for personal gain. U.S. regulations also emphasize flexible enforcement through civil penalties, disgorgement of profits, and criminal charges, allowing the SEC to adapt to evolving market practices, such as high-frequency trading.
United Kingdom
The United Kingdom’s regulatory framework, governed by the Criminal Justice Act of 2003 and the Financial Services and Markets Act (FSMA), adopts a broad and inclusive definition of insider trading. It focuses on the misuse of non-public information, regardless of the insider’s relationship with the company, and places significant emphasis on the intent behind trading activities. The UK regulators impose both criminal and civil penalties, providing flexibility in enforcement. Notably, the UK’s approach is less focused on fraud and instead prioritizes preventing the unfair exploitation of confidential information. This is exemplified by the R v. McQuoid and Melbourne case, which emphasized possession and misuse of inside information over intent to commit fraud.
This concept of evaluating insider trading has not yet been explored by the Indian regime which only looks at the use of Unpublished price sensitive information from a unidimensional lens that does not evaluate the improper use of UPSI extensively, thereby increasing bureaucracy in the segment as most of the cases get overturned by SAT due to incorrect evaluation of an insider in possession of UPSI in general or lack of conclusive proof of improper use.
IMPACT OF SEBI’S PROPOSED INSIDER TRADING AMENDMENTS
SEBI’s proposed amendments to the SEBI (Prohibition of Insider Trading) Regulations, 2015, mark a pivotal shift toward aligning India’s insider trading laws with global standards. By broadening the definition of “connected person,” these changes aim to enhance market fairness and investor protection, by encompassing a broader range of individuals with potential access to unpublished price-sensitive information (UPSI).
This will increase accountability, subject more individuals and businesses to regulatory oversight, and reduce opportunities for gaining unfair advantages. Drawing inspiration from U.S. and UK regulatory models, SEBI’s approach strikes a balance by expanding coverage while maintaining a focus on preventing unfair practices. These changes are expected to significantly bolster market integrity, foster greater compliance, and enhance investor trust, ultimately promoting a fairer, more transparent financial market.
LIMITATIONS OF THE PROPOSED AMENDMENTS:
SEBI’s proposed amendments to the definition of “relatives” in insider trading regulations may have significant implications, particularly in high-profile cases akin to the Adani-Hindenburg affair. By expanding the scope to include a wider array of familial ties, SEBI acknowledges that insider trading frequently involves not just immediate associates but also extended family members. However, this expanded definition risks regulatory overreach, as seen in the SEBI ruling against Deep Industries. In that case, social media interactions were deemed sufficient to establish insider trading connections, a decision later overturned by the Securities Appellate Tribunal (SAT), highlighting the risk of overreach in interpreting personal relationships. The proposed amendments could significantly increase the number of insider-trading cases, potentially deterring legitimate market activities. Investors, fearful of being wrongfully accused, may curtail their trading activities, thereby dampening market liquidity and impeding growth. Additionally, the inclusion of extended familial relationships could pose challenges for multinational companies and foreign investors, who may face undue scrutiny due to their connections within the Indian market.
To mitigate these risks, SEBI should supplement the expanded definitions with clearer insider trading guidelines and more precise disclosure requirements for each stakeholder to ensure that the trades happen in a regularised fashion. These guidelines could also include periodic disclosures to include a different trading plan regime for relatives so that they can carry out trades easily while complying with the requirements prescribed by SEBI and not deter or disincentivise them from accessing the market in general. A balanced approach is essential to ensure that regulatory efforts do not inadvertently stifle market participation or hinder the growth of India’s financial markets, especially in a globalized financial environment.
CONNECTED PERSONS AND THE ADANI-HINDENBURG SAGA
The Adani-Hindenburg saga vividly exposes the complexities of insider trading and regulatory oversight. The Hindenburg report, authored by a notable short seller, alleged dubious connections between the Adani family and offshore entities, including funds purportedly linked to SEBI Chairperson Madhabi Puri Buch. These claims involve potential misuse of funds and over-invoicing, raising serious questions about insider trading and regulatory lapses. SEBI has refuted claims of negligence, citing Supreme Court approval of most investigative reports and issuing a show-cause notice to Hindenburg for potential securities law violations. Chairman Madhabi Puri Buch has defended her compliance with regulatory standards. This controversy highlights the urgent need for stringent regulatory measures and scrutiny of market practices, reflecting similar challenges faced by the SEC in the U.S.
CONCLUSION
SEBI’s proposed expansion of the “relatives” definition in its insider trading regulations may have profound implications for regulatory enforcement, as evidenced by high-profile cases like the Adani-Hindenburg saga. By expanding the scope to include a wider range of familial relationships, SEBI aims to address the reality that insider trading often involves extended family members beyond immediate connections.
In the current landscape, where social media interactions are increasingly scrutinized, this expanded definition could result in a notable rise in insider trading cases. The SEBI order against Deep Industries illustrates potential pitfalls, as reliance on social media connections led to controversy and was later overturned by the Securities Appellate Tribunal, raising concerns about possible regulatory overreach.
This broader definition may introduce a chilling effect, potentially deterring legitimate market activities due to fears of wrongful allegations. Including extended family members as “connected persons” could also dampen market liquidity and hinder new market participants. While the amendments represent a significant step forward in enhancing regulatory oversight, they underscore the need for a nuanced approach. SEBI should consider implementing clearer enforcement guidelines and detailed disclosure requirements to balance regulatory rigor with market vitality. Additionally, careful attention must be given to the global implications of these changes to ensure, that SEBI’s framework remains adaptable and effective within the international financial landscape.