In a move aimed at revolutionizing the mutual funds industry, SEBI published a Consultation Paper with a proposal on the applicability of SEBI's Prohibition of Insider Trading Regulations to Mutual Fund (MF) units, in July 2022. SEBI thereafter introduced the PIT (Prohibition of Insider Trading) Framework for Mutual Funds through an amendment to its Insider Trading Regulations of 2015 on November 24, 2022, by way of an official gazette notification.

This amendment incorporated a new chapter, "Restrictions on Communication in Relation to and Trading by Insiders in the Units of Mutual Funds." Moreover, it extended the applicability of Chapter IIIA (concerning the Informant Mechanism) and Chapter V (covering miscellaneous provisions) of the PIT Regulations to Mutual Fund units.

SEBI's decision was a response to cases where senior officials in the mutual fund industry sold their units upon sensing trouble within their own fund houses. While the SEBI (Prohibition of Insider Trading) Regulations, 2015 already prohibited fund managers, portfolio managers, and senior industry executives from trading based on inside information, there was no specific restriction on them selling mutual fund units.

Apart from a few conditions outlined in the industry's code of conduct, fund managers and senior officials were only required to report their mutual fund unit sales.

Notably, this amendment revised the definition of "securities" to eliminate the exemption of mutual fund units. Unlisted units are redeemed by the fund, while listed Mutual Fund units are generally sold in the open market. The definition of "trading" has been updated to include terms like "redeeming," highlighting the intention to apply the Mutual Funds PIT Framework to unlisted Mutual Fund units as well. However, it is worth mentioning that this framework excludes exchange-traded funds (ETFs) and eases restrictions on Systematic Investment Plans (SIPs), both of which are considered crucial investment modes for many individuals.

Within the context of mutual funds, "unpublished price-sensitive information" (UPSI) refers to any information that can impact the net asset value or materially affect the interests of unit holders once it becomes generally available. Examples of such information include changes in accounting policies, restrictions on redemption, the winding up of schemes, alterations in the valuation of assets, the liquidity position of the concerned mutual fund scheme, and defaults in the underlying securities, provided they are material to the concerned Mutual Fund schemes.

It's essential to note that the determination of UPSI should be made at the level of each Mutual Fund scheme, not at the level of the mutual fund as a whole. However, Regulation 5(1)(f) on UPSI does not include changes in the investment objective of the concerned Mutual Fund scheme or the conversion of a close-ended scheme to an open-ended scheme or vice versa.

The Mutual Fund PIT framework applies to all insiders who have access to unpublished price-sensitive information related to a scheme or are connected persons, as specified under Regulation 5B(1)(d). This broadens the definition of an insider, encompassing even outsiders who illicitly receive UPSI. For instance, an audit firm with access to UPSI of a Mutual Fund scheme during an AMC audit, even though it is an outsider, is considered an insider. Asset Management Companies (AMCs) are SEBI-registered firms that manage mutual fund assets.

Additionally, the amendment revised the meaning of "connected person" under Regulation 5B(1)(b), expanding it to include individuals deemed to be connected. This includes, but is not limited to, sponsors of Mutual Funds or their holdings, board of directors and key managerial personnel of the sponsor of Mutual Funds, individuals associated through contractual, fiduciary, professional, business, or employment relationships that expose them to UPSI, immediate relatives of such individuals, officials of self-regulatory organizations and stock exchanges, and entities where a director of an AMC, trustee, or their immediate relative, or a banker of the company, holds more than 10% interest, among others.

With certain exceptions in place, there is a complete ban on trading in Mutual Fund units when in possession of UPSI or during the closure period. An insider can claim the defense of not possessing UPSI during the trading period, but the burden of proof lies with SEBI.

UPSI can be obtained for legitimate purposes as outlined in Regulation 5C(3), including activities within the ordinary course of business with Valuation Agencies, Fund Accountants, the Association of Mutual Funds of India, and other advisors or consultants. This excludes sharing information for the purpose of evading PIT regulations. Procurement of UPSI for legitimate purposes should follow procedures established by the AMC to bring individuals within the framework. This includes providing notice of confidentiality, along with agreements and NDAs, to recipients. Information about the provider and receiver of the UPSI should be entered into the Structured Digital Database, maintained by the Board of Directors, and containing details about the nature of UPSI, the names and PANs of sharers and receivers. This database should be tamper-proof and internally managed, with checks such as time stamping and audit trails, for a period of up to 8 years from the transaction date.

While this amendment represents a legal milestone, compliance with its provisions necessitates a well-structured framework to ensure enforcement and prevent violations. Under Regulation 5H(3) of the amended PIT framework, compliance with the provisions should be reviewed at least once a financial year, including the verification of adequately operating internal control systems by the Audit committee of AMCs and trustees or a similar body of an intermediary or fiduciary. AMCs should establish written policies, including whistleblower mechanisms, to be followed during suspected or actual incidents of the leak of unpublished price-sensitive information, promptly informing the Board of such occurrences, inquiries, and their outcomes. Relevant intermediaries and fiduciaries should cooperate with AMCs and trustees when inquiries are conducted in cases of suspected leaks. This amendment is expected to be a significant step in the mutual fund industry, helping to avoid complexities and unintended consequences resulting from insider trading.

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