Miligram Inc. has made a groundbreaking discovery—a new drug to combat cancer. However, Amish, a director at Miligram Inc., gains knowledge of this breakthrough and swiftly purchases a substantial number of company shares. Shortly thereafter, the news regarding the drug becomes public.
As anticipated, the price of Miligram Inc.'s shares skyrockets in the stock market. Amish, who was privy to the drug's potential benefits and the resulting increase in the company's share value, reaps significant profits. Meanwhile, it is possible that others, unaware of the impending announcement, may have sold their shares beforehand, while some are now purchasing shares at a much higher price following the announcement.
Conversely, let's assume that Miligram Inc. fails to develop the drug. Upon receiving this information, Amish promptly sells his shares in the company. Subsequently, when news of the failed drug becomes public, the company's share prices plummet. However, Amish has already profited from the trade by selling his shares based on his prior knowledge, unlike the public who were unaware of the outcome of Miligram Inc.'s experiment.
The underlying theme across the examples above revolves around Amish possessing privileged information about the company that could significantly impact its position in the securities market. This information, commonly called Unpublished Price Sensitive Information (UPSI), served as the basis for Amish’s actions, enabling him to gain profits and avoid potential losses before the information became public.
Is making profits through trading a criminal offense? No, but utilizing UPSI to generate profits is unequivocally prohibited by law. This practice is commonly known as ‘Insider Trading’. Insiders can include individuals from the C-suite, managerial officers, employees, and anyone connected to the company by certain criteria.
As evident from the examples above, this blog aims to shed light on the concept of insider trading and the legal framework established by the country’s capital market regulator, the Securities and Exchange Board of India (SEBI), to address such cases. Therefore, to facilitate understanding, we have carefully selected 5 (five) fundamental concepts of insider trading that are crucial for individuals to be well-informed and proactive in combating this form of misconduct. Without further ado, let us begin.
What is UPSI?
UPSI, as defined in Section 2(1)(n) of the SEBI (Prohibition of Insider Trading) Regulations, 2015 the “Regulations”), encompasses unpublished information pertaining to a company’s securities or the company itself. This information, when disclosed, would have a substantial impact on the price of the securities. The scope of UPSI extends to various material events, including those outlined in the listing agreement, such as financial results, dividends, changes in capital structure, mergers, de-mergers, acquisitions, delistings, disposals, business expansions, and key managerial personnel changes. UPSI is comprehensive in its coverage and allows for interpretation, encompassing even the smallest details. This is because any information that is not known to the public or has not been disclosed to the relevant authorities or the general public, but has the potential to significantly affect the price of a listed company’s securities, can be classified as UPSI. For instance, sharing financial statements on social media before formally notifying the public.
2.Can UPSI be disclosed?
Disclosure of UPSI is permissible under specific circumstances where it serves legitimate purposes, fulfils job responsibilities, or complies with lawful obligations. However, such disclosure of UPSI requires approval from the Board of Directors (“BOD”) of the listed company. The BOD must hold an informed opinion that the sharing of UPSI is in the best interests of the company.
3.What is the significance of Regulation 3 in the SEBI (Prohibition of Insider Trading) Regulations, 2015 and why is it important?
Regulation 3 is a critical provision that addresses the dissemination and acquisition of UPSI. Its significance lies in restricting the communication, provision, or access to a company's UPSI or listed/securitized securities by any person, including other insiders. However, there are exceptions to this prohibition when sharing UPSI is necessary for legitimate purposes, legal obligations, or official duties. Regulation 3(2) echoes 3(1) in that it forbids the unlawful procurement of UPSI, thereby preventing any unauthorized access to such information.
There are circumstances where the procurement of UPSI is permissible. For example, in cases involving transactions subject to open offer requirements under takeover regulations, if the BOD holds an informed opinion that sharing the UPSI is in the company's best interests. Additionally, according to Regulation 3(3), if the transaction does not require an open offer but the BOD believes that sharing the UPSI is beneficial to the company, the UPSI can be made available two trading days before the transaction takes effect. In such instances, the sharing of UPSI must be conducted in a fair and comprehensive manner, ensuring all material facts are disclosed.
Regulation 3(4) mandates that the involved parties must sign a confidentiality agreement specified by the BOD. They are required to maintain the information as private and confidential, except as outlined in Regulation 3(3). Additionally, individuals or entities in possession of UPSI are prohibited from engaging in securities trading until they no longer possess the UPSI.
In accordance with Regulation 3(5), a structured Digital Database must be maintained to track such individuals or entities. This database will include their names, PAN (Permanent Account Number), or any other authorized unique identifier if PAN is unavailable. The database must be internally maintained and should not be outsourced, as it will contain sensitive information regarding the nature of the UPSI. To ensure data integrity, necessary measures such as time stamping and audit trails must be implemented to detect any tampering with the data contained in the database.
4.Can you trade while in possession of UPSI?
An individual who has access to UPSI is prohibited from trading securities that are listed or intended to be listed in the market. However, there are certain exceptions to this rule. Trading while in possession of UPSI is allowed in specific circumstances. For example, it is permissible when there is an off-market inter-se transfer between insiders who possess the same UPSI. Additionally, trading can occur through the block deal window mechanism between individuals who have knowledge of the same UPSI, as long as informed trading decisions are made and the information was not obtained in violation of Regulation 3.
It is important for these insiders to notify the company within two working days after conducting the trade. Subsequently, the company must disclose this information to the stock exchange within two working days after receiving the notification.
5.What are the penalties for engaging in insider trading?
SEBI can impose a penalty of up to INR 25 crore or three times the amount of profits obtained from insider trading, whichever is higher, on individuals found guilty of committing insider trading.
Additionally, SEBI has the authority to order the disgorgement of profits derived from insider trading and can impose a ban on the offender from trading in securities for a specific duration.
Further, non-monetary penalties can also be imposed, which include:
- Debarring the violator from trading in securities for a certain period
- Directing the violator to provide restitution to the victims affected by the insider trading
Recent insider trading cases prosecuted by SEBI:
- In 2019, SEBI imposed a penalty of INR 22.7 crore on the promoters of Aurobindo Pharma for insider trading . The penalty was levied on its promoters for violations of provisions of insider trading in relation to a licensing deal it had entered with Pfizer in 2009.
- In 2023, SEBI banned 3 (three) individuals from the securities market for a period of 2 (two) years and imposed a penalty of INR 90 Lakhs for insider trading in scrip of Zee Entertainment Enterprises Ltd. The case pertains to insider trading activities by certain entities in the scrip of ZEEL, while in possession of UPSI. The information related to the audited financial results of the media company for the quarter ended June 30, 2020 as well as the launch of ZEEPLEX by the company on September 1, 2020.
Having a thorough understanding of insider trading and being familiar with SEBI's regulatory framework is essential for organizations that are listed or planning to list on the stock exchange. It is crucial for individuals to be aware of the provisions and consequences of these regulations in order to protect themselves from potential legal and reputational risks. Through these FAQs, we have endeavored to provide a comprehensive understanding of the subject and the corresponding laws. Our aim is to assist organizations and more specifically their employees in maintaining compliance with the regulations and mitigating their exposure to unethical practices.
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