Fiscal Solutions Powered by Law…

The Inside of Trading

- An Industry PerspectiveBy

Suresh Viswanathan

Founder Director & Chief Consultant

Finteglaw Knowledge Solutions Private Limited

“Divergence of perception”

May 6, 2015

The Regulatory View - Globally

A company's confidential information– Qualifies as property to which the company has a right of

exclusive use.

Divulging UPSI by an insider is violation of a fiduciary duty – Constitutes fraud akin to embezzlement– Has criminal implications

Misappropriation of UPSI amounts to theft– Use of UPSI for ones benefit amounts to dishonesty and

cheating– Has criminal implications

May 6, 2015

Insider trading a crime in US

U.S. insider trading prohibitions are based on English and American common law– Governed by prohibitions against fraud

A director, who bought his company’s stock when he knew it was about to jump up in price, committed fraud by buying while not disclosing his inside information– The US Supreme Court ruling in 1909

– Well before the SEC Act, 1934,

May 6, 2015

On the lighter side!

May 6, 2015

Corrupting Effects

Corrupts the ‘Level Playing Field’

Profit made out of the loss of other investors

Leads to loss of confidence in stock market

Easier to identify the beneficiaries– Extent of losses suffered

impossible to calculate.

May 6, 2015

SEBI Investigations

3

11

12

43

86

2

14

10

52

41

6

13

16

6

67

6

13

16

12

73

0 10 20 30 40 50 60 70 80 90 100

Takeovers

Insider Trading

Miscellaneous

Issue Related Manipulations

Market Manipulations

2013-14 Investigations Completed

2013-14 Investigations Taken up

2012-13 Investigations Completed

2012-13 Investigations Taken up

May 6, 2015

Penalties Skyrocket

184

2040

1009

0

500

1000

1500

2000

2500

2012-13 (Rs. Lakhs) 2013-14 (Rs. Lakhs) Increase %

Penalty under SEBI (PIT) Regulations, 1992

May 6, 2015

‘The Unwinnable War’

A.M. Louis in his book ‘The Unwinnable War on Insider Trading,’ asserts that:

– Of all the issues that have confronted regulators of the securities markets, the regulation of insider dealing has proved among the most intractable’

Very true of Indian stock market

– The Indian stock market practically runs on unpublished price sensitive information

May 6, 2015

Challenges Ahead

May 6, 2015

New Powers

Section11(2)(ia) - Calling for information and records from any – person

– Including any bank or any other authority or board or corporation

• established or constituted by or under any Central or State Act

Relevant to any investigation or inquiry by SEBI in respect of any transaction in securities– In the opinion of SEBI

Implications

Enables collection of call recording data from any Telecom provider

Enjoys courts’ powers for– discovery and production of

books of account and other documents

– Summoning and enforcing attendance

The provisions have powers over-riding other laws

SEBI Act Amended - 2014

May 6, 2015

Search and Seizure

Power to search – Places and Buildings

– Vessel, vehicle or aircraft

– Persons

– Computers

Powers to– Inspect

– Seize

– Place identification mark

– Make copy

– Record statement

May 6, 2015

On the lighter side!

May 6, 2015

SEBI’s Tentacles

SEBI has installed an advanced surveillance software– This monitors abnormal patterns of

trading in all scrips– Detailed information sought from

Exchanges on such trades– Exchange in turns to the Members

for client information

Surveillance systems still not able to cope with the malpractices– HDFC Mutual Fund case, the

information was voluntarily shared with SEBI

May 6, 2015

The Odds

Very wide definition of connected persons

Onus on the Connected Person to prove innocence – Guilty unless proved innocent– Contrary to established principles of law

New powers acquired by SEBI– Search & Seizure powers– Power to procure Call records data

Heavy penalties (Rs. 10 Lakh to 25 Crore) and disgorgement

Unlisted intermediaries could face prosecution under Companies Act also

PIT violations outside Settlement process

May 6, 2015

S 447 of Companies Act 2013

“any person who is found to be guilty of fraud, shall be punishable with imprisonment for

a term which shall not be less than six months but which may extend to ten years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud”

– Provided that where the fraud in question involves public interest, the term of

imprisonment shall not be less than three years.

“fraud” includes any act, omission, concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with

intent to deceive, to gain undue advantage from, or to injure the interests of,

the company or its shareholders or its creditors or any other person, whether or not

there is any wrongful gain or wrongful loss

– “wrongful gain” means the gain by unlawful means of property to which the person gaining is not legally entitled

May 6, 2015

S 195 of Companies Act 2013 “No person including any director or key managerial personnel of a company

shall enter into insider trading” “insider trading” means—

– an act of subscribing, buying, selling, dealing or agreeing to subscribe, buy, sell or deal in any securities by any director or key managerial personnel or any other officer of a company

either as principal or agent if such director or key managerial personnel or

any other officer of the company is reasonably expected to have access to any non-public price sensitive information in respect of securities of company

– an act of counselling about procuring or communicating directly or indirectly any non-public price-sensitive information to any person;

Contravention punishable with imprisonment for a term which may extend to

five years five years or with fine which shall not be less than five lakh rupees but which may extend to twenty-five crore rupees or three times the

amount of profits made out of insider trading, whichever is higher, or with both.

S 458 delegates the prosecution powers to SEBI

May 6, 2015

Connected Persons (Non Intermediaries)

The Issuer Company

Director,

Immediate Relative

Company, Firm,

HUF, AOP

Officer, Employee, Professional or

Business Partner

Immediate Relative

Holding, Associate & Subsidiary

Investment, Trustee & Asset Management

Companies

Banker of the Company

Public Financial Institution, its

Directors & Employees

If a Director, immediate Relative or Banker has more than 10% interest

May 6, 2015

Connected Persons (Intermediaries)

The Issuer Company

Any Dealing Intermediary u/s

12 of SEBI Act

Employees & Directors of the

Intermediary

Officials of Stock Exchange &

Clearing House

Immediate Relative

Member of Board of Trustees of MF

Director & Employee of the AMC of the MF

SEBI Authorised Self regulatory Organisations

Officials & Employees

May 6, 2015

“Fig Leaf Cover” for Stock Brokers

Segregate and demonstrate– Prop dealing from client dealing

desk– Sales staff from client dealing desk– Research team from dealing and

sales teams

Maintain documented evidence– NDA with all concerned including

professionals and business partners– Rationale for prop trade decisions– Basis (sources) of research reports– Authenticated order book/deal

tickets • even for prop trades

– Call records of the dealer

May 6, 2015

Taboo for Stock Brokers

Never ever– Prop trade

• on stocks of group companies

• based on any insider information from anyone

– Undertake trades of AMCs, PMS, AIF etc., belonging to your group

– Allow staff to trade through other brokers

– Provide unsolicited trading advise to clients

• other than through an authenticated published document

May 6, 2015

Research Vs. Insider - Wafer thin…

To ask a Maruti employee about footfall at his location

To have lunch with an ex CFO of a software company

To talk to doctors who have worked on past clinical trials of a pharmaceutical company

To appoint an automobile industry veteran as a 'source'

To pay a Maruti employee to get a printout of a sales data

To have lunch with a current CFO of a software company - on your boat

To pose as a doctor to gain access to a clinical trial in progress in a pharmaceutical company

To appoint the brother in law of Maruti VP as an industry 'source'

May 6, 2015

Internal Trade Controls

Effective Employee Securities Dealing Policy– To regulate, monitor & report trades

• Automation suggested

– Adherence to Schedule B– Applicable to Auditors, consultants,

vendors etc. who may have access to UPSI

– Everyone to appoint a Compliance Officer

Address Insider Trading as an Enterprise Risk– Make this part of corporate culture

Conduct periodic awareness sessions to all employees

May 6, 2015

Trading Plan – An EntitlementTrading

Plan

Listed Company

Connected Person

Deemed Connected

Person

SEBI Intermediary

Person Possessing UPSI

Person having access to UPSI

No trading during 10th

March, June, September & December till 2 days

after declaration of results

Minimum Plan period for 12 months

Value of trades or no. of securities, nature of

trades and intervals, or dates to be disclosed

No parallel plans allowed.

No scope for market abuse to be provided

Once approved, cannot be revoked

Trading not to commence before 6 months of disclosure to Stock

Exchange(s)

To be formulated by the insider

To be reviewed & approved by the

Compliance Officer

Disclosure to the Stock Exchange(s)

Plan shall not be implemented if any UPSI is in the possession of the Insider

May 6, 2015

Daunting Tasks for Listed Companies

To maintain the dynamic list of connected persons– Acting in contractual or fiduciary

relationship– Professionals – Business partners

To ensure that UPSI is not shared with the aforesaid except under permitted circumstances

To document and prove that UPSI was not shared with the aforesaid

To enter into NDA with all the aforesaid

To approve and operate Trading Plans

May 6, 2015

Utopian!

May 6, 2015

Role of Compliance Officer Defined!

SEBI Adjudication Order dated July 27, 2012 in respect of Mr. G Jayaraman in the matter of Satyam Computer Services Ltd. – SEBI held the erstwhile compliance officer of

Satyam is liable for not enforcing the safeguards under the Model Code during the period of December 2008 – January 2009

– Trading window was not closed after becoming aware of certain “price sensitive information”

The order further said – “The duty weighs even more on a person like

Compliance Officer, who is conferred upon with key responsibilities in a company. Hence, the violation by the Noticee needs to be viewed seriously.”

SEBI imposed a penalty of Rs.5,00,000/-(Rupees Five Lakh only) on Mr. G Jayaraman.

May 6, 2015

Onerous role of Compliance Officer

Responsible for Trading Plans and Employee Security Dealing Policy– Means he should ensure that nobody is

front running– Trades by relatives is more onerous to

monitor

Responsible for scrip related rumours floated by other employees

Bound to report all cases of Insider trading to SEBI

Responsible for all reporting to Exchanges

May 6, 2015

Brace up …

Install– Robust internal control systems for

complying with regulatory requirements

– Proper Chinese Wall mechanisms

Strengthen– The ambit of internal audit– The standards in regulatory

compliance

Automate– Compliance processes– Internal controls– Back up mechanisms

May 6, 2015

Insider regulations fully enforced…

May 6, 2015

Awaiting Clarification

Companies whose debt securities are listed also come under the ambit of SEBI as a Listed Company, even though they are closely held– Will PIT apply to these companies

also?

Does a Trading Plan apply to an Intermediary also?– What will happen if an insider goes

bankrupt and not able to continue trades under the Plan

Post FMC Merger, will commodities derivatives also come under the ambit PIT Regulations?

May 6, 2015

Finteglaw Knowledge Solutions Private LimitedCIN: U74140MH2008PTC186787

Registered Office: A – 403, Kukreja Centre, Sector 11, CBD Belapur, Navi Mumbai – 400614.Zonal Office (South) : ‘Reglog’, New No. 17/1, Playground View Road, Nandanam, Chennai – 600 035.

Phone: +91 22 27577315, Website: www.finteglaw.com, email: contact@finteglaw.com

May 6, 2015