INSIDER TRADING AND FRONT RUNNING LAWS IN INDIA AND ROLE OF COMPLIANCE OFFICERS

1. INSIDER TRADING AND FRONT RUNNING LAWS IN INDIA AND ROLE OF COMPLIANCE OFFICERS Ashish Ahuja Managing Partner Wadia Ghandy and Co. ashish.ahuja@wadiaghandy.com

2. Insider trading – Brief introduction • Insider trading is basically the buying or selling of the securities of a listed public company by a person who has unpublished price sensitive information relating to that company. • Insider trading, as a securities crime in India, is defined as such and governed by the SEBI (Prohibition of Insider Trading) Regulations, 1992 (“Insider Trading Regulations”). While we must analyze the law relating to insider trading in the context of the Indian regulatory regime, we shall for the purpose of a comparative analysis also refer to certain American regulations/ laws. • The important definitions to be taken note of in order to understand the ambit and scope of the Insider Trading Regulations are the definitions of who is an “insider” and of what constitutes “price sensitive information”. • Basically, when an “insider” is in possession of “ unpublished price sensitive information”, that insider is prohibited under Regulation 3 from directly or indirectly dealing in the securities of the company in respect of which the insider possesses “price sensitive information”. • The scheme of the Insider Trading Regulations contemplates that listed public companies and other specified entities should create an internal governance code and procedure which is intended to ensure a self governing mechanism to prevent instances of insider trading. For this purpose, SEBI has prescribed a Model Code of Conduct for prevention of Insider Trading for other Entities (under Schedule I to the Insider Trading Regulations) (“Model Code”) which is to be adopted by the listed companies/ entities

3. Insider trading – Brief introduction • As per the Model Code, a compliance officer (“Compliance Officer”) is to be appointed by the listed company/ entity. This Compliance Officer is to be a senior level employee and is to perform certain stated and defined functions. He is, however to function under the overall supervision of the Board. • The role of the compliance officer under the Model code is • Responsibility for setting forth policies, procedures, monitoring adherence to the rules for the preservation of “Price Sensitive Information”, pre-clearing of trades of designated employees and their dependent relatives (directly or through respective department heads as decided by the Company) monitoring of trades and the implementation of the code of conduct under the overall supervision of the Board of the listed company.

4. SEBI’s VIEW ON THE ROLE OF THE COMPLIANCE OFFICER IN CASE OF INSIDER TRADING • SEBI Adjudication Order dated 27th July 2012 in respect of Mr. G Jayaraman in the matter of Satyam Computer Services Ltd. (“Satyam”) • Vide the aforesaid Order, SEBI has held the erstwhile compliance officer of Satyam Computer Services Ltd, Mr. G Jayaraman, liable for not enforcing the safeguards under the Model Code during the period of December 2008 – January 2009. It may be noted that Mr. G Jayaraman was the Company Secretary of Satyam. • The particular safeguard which the said Compliance Officer had failed to enforce was to close the trading window after becoming aware of certain “price sensitive information” relating to Satyam, i.e. The potential merger of Maytas with Satyam, which was not yet confirmed by the Board of Satyam. • In the context of the facts of the case, under paragraph 20 of the said Order, SEBI has stated that despite the Compliance Officer being under the overall supervision of the board of directors of the company, he should have closed the trading window even without obtaining prior approval of the board. • At paragraph 29 of the said Order, SEBI summarised the role that a Compliance Officer is expected to play in the securities market. An extract is given below:- • “For orderly and fair functioning of the securities market, it is essential for every market player to fulfil the requirements mandated in the law. 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 Lakhs only) on Mr. G Jayaraman.

5. Front Running - Meaning • Front running as a securities malpractice/ crime is recognised and regulated by SEBI under the SEBI (Prohibition of Fraudulent and Unfair Trading Practices Relating to Securities Market) Regulations, 2003. • Front Running has not been defined by SEBI in a uniform manner, however, the concept has been elaborated upon vide various regulations, circulars and judgments of SEBI. • One such example is the SEBI Circular on Consent Orders as amended by Circular CIR/EFD/1/2012) dated 25th May 2012 (“Consent Order Circular”) which has defined “front running” as under: • “Front running; for the purpose of this circular, means usage of non-public information to directly or indirectly, buy or sell securities or enter into options or futures contracts, in advance of a substantial order, on an impending transaction, in the same or related securities or futures or options contracts, in anticipation that when the information becomes public; the price of such securities or contracts may change;”

6. Front Running - Meaning • What does this mean? I want to buy 3000 kgs of Gold. The order being substantial would mean that the prices of the metal would shoot up. Someone who knows what I want to do, takes position in Gold or silver or any other metal whose price may get impacted by the price movement in gold before my order is placed and usually sells once the price moves up • Goldman Sachs has 90% of its revenues in the US from trading in the prop book. Merchant banking accounts only for 10% of its revenues. There were allegations in the US that they were front running as they had non public information based on which they were trading • Front running can also be a situation where a broker releases a research report, which would have an impact on the prices of a scrip, but has directly or indirectly taken positions before that report is made public • Front running can also happen when huge orders are placed by mutual funds and FIIs with brokers. Brokers may directly or indirectly take positions in the scrips before inputting the order in the system

7. Front Running - Meaning • SEBI has taken a strong stand against front running in Re: ShriSujitKarkera, ShriPurushottamKarkera and SmtShilpaKotak and Trading Activity of SujitKarkera and Group (MANU/SB/0115/2012) (in paragraph 26) whereby it has considered the evils of front running on the investor community and elaborated on the same as follows: • “Front running is one of the most heinous crimes in the securities markets. It has the potential of eroding the faith of the investors in the securities market. It amounts to defrauding an innocent and unsuspecting investor who blindly repose trust in the entity to transact on his behalf in the securities market. Once this trust is played truant with, one would run the risk of losing the investor, not only for the loss it would have suffered but also for the loss of confidence. It is of utmost importance that a sense of fair play be maintained in the market so that innocent investors do not find themselves at the receiving end of irregular conduct by entities in the market. Thus, I have considered it critical that the penalty in the matter should be seen not only disgorgement in nature but also deterrent in effect. Given this consideration I am imposing a penalty with a multiple of 3 of the profit made for deterrent effect. With regard to repetitive nature, I find that the default was repetitive in nature.”

8. Front Running -Touchpoints • The touch point for front running is the place where non public information is confided and shared. • Employees in mutual fund organisations and FIIs – consent orders in case of l and t mutual funds and hdfc mutual fund • Brokers with whom huge orders are placed. UTI Securities and FMO matter in Ballapur Industries matter • Merchant bankers during potential transactions

9. Front Running – Role of Compliance Officers • In all touchpoint – intermediary regulations, including broker regulations, merchant banker regulations, • “..shall appoint a compliance officer who shall be responsible for monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions, etc., issued by the Board or the Central Government and for redressal of investors’ grievance.” • “The Compliance officer shall immediately and independently report to the Board any non-compliance observed by him.” • Under the Master Circular for Mutual Funds dated 31st March 2012, SEBI which makes reference to the Circular for Investment/ Trading in Securities by Employees of Asset Management Companies and Mutual Fund Trustee Companies- dated 08-05-2001 provides for a meaning of the term “front running” as under: • “Any transaction of front running by any employee directly or indirectly is strictly prohibited. For this purpose,   ‘front running' means any transaction of purchase /sale of a security carried by any employee whether for self or for any other person, knowing fully well that the AMC also intends to purchase/sell the same security for its mutual fund operations. For the purpose of ascertaining that the employee had no prior knowledge of the Mutual Fund's intended transactions, the Compliance Officer may take a declaration in this regard from the employee. Such declaration may be included in the application form itself.”

10. Onerous role of the Compliance Officer • To monitor the compliance • That means to watch and check and conduct scrutinies to see that nobody is front running • Would that mean random listening to conversations? • Would than mean checking relative trades every now and then • Would that mean watching the movement of prices before big trades and executed in the market • Would that mean conducting researches and ensuring that heavy technology is implemented to ensure that front running does not happen?

11. But who is the Compliance Officer? • Always an employee, at times the company secretary, who may have no knowledge of trades and markets, if it is a compliance officer in a non intermediary. • What does he do? If someone asks him to close the trading window, he closes the trading window. If someone asks him to pre clear trades, he pre clears trades. If nobody asks him anything, he does nothing • In intermediaries, the most feared man. Transactions are shot down on the basis of the compliance officer not agreeing. We have even seen merchant bankers refusing to lend their names to issues, if the compliance officer does not agree. • But has anyone seen any compliance officer complaining to the regulator? Why? Because he is still after all an employee. If he blows the whistle once, will he ever get a job with any other corporate,?

12. US Protection to Whistle Blowers • If anyone acts as a whistle blower in the US, pursuant to the Dodd Frank Wall Street Reforms Act in 2010, two key protections were afforded to him • You cant throw him out of his job • You must incentivise him. 10% to 30% of the penalty is shared with the Whistle Blower

13. SEBI’s inabilities • Why does SEBI have to chase the compliance officer? • SEBI is not yet recognised as an organisation that has the power to tap phones. It is still seeking a notification that empowers it to do so under the Indian Telegraph laws. • Surveillance systems are not sufficient to discover front running except on a prima facie basis • Even in HDFC Mutual Fund case, because information was voluntarily shared with SEBI that SEBI was able to investigate. • How many mutual funds would keep or share records? • Therefore the over reliance on compliance oficers

14. Need for removal of dependence on Compliance Officers • The Compliance officers of all organisations are employees, who are doing their best within what the contours of the organisation permit • Need to recognise this and remove the onerous burden on compliance officers • Every solution needs to be practical. SEBI cant guarantee jobs for compliance officers in India, neither can it reward them in India

15. What Solutions to the problem of insider trading and front running • SEBI gets notified for the purpose of phone tapping, which the government ought to do • SEBI has huge surveillance information and knows on a prima facie basis where front running has occurred • Shift the burden of proof in such cases on the organisation to prove that there was no insider trading or front running. Create a presumed guilty until proved innocent • Create a separate whistle blower framework that ensures secrecy and rewards. Of course how SEBI will ensure secrecy in such a porous organisation is anybody’s guess. Don’t mandate a compliance officer to act as a whistle blower. Incentivise him.

16. In other words • Battles are fought between equals • SEBI should therefore not search for the “bakra” to sacrifice when you cant catch the kingpin

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