SEBI’s informal guidance blurs distinction; covers discretionary portfolio manager within insider regulations
Market regulator Securities and Exchange Board of India (SEBI) in their order dated 4 February 2016
regarded ‘Facebook’ account as evidence to prove charges against an individual under the SEBI (Prohibition of Insider Trading) Regulations, 1992. SEBI continues interpreting this in a wider sense, now on the investment made by an insider through a discretionary portfolio manager (DPM) while the insider is in possession of any unpublished price sensitive information (UPSI) vide an informal guidance dated 25 July 2016 given to HDFC Bank Ltd
DPMs make investment in the securities market independent of their clients’ advice, i.e., the client does not have any influence or control over the investment decisions.
There exists two types of portfolio management services like discretionary and non-discretionary. The classification is based on the extent of control a client has over the investment made by the portfolio manager. There is absence of client’s control over the investing decisions in the case of the former and the presence of the same in the latter one. In the light of the same, the market participant investing through a DPMS is absolutely said to have no control or awareness of the investments that are made out of his funds by the DPMS. In such a case, the assumption and stand taken by SEBI that even a trade by DPMS for the insider’s account while in possession of UPSI will amount to insider trading, blurs the distinction.
The informal guidance infers that Regulation 4(1) of SEBI (Prohibition of Insider Trading) Regulations, 2015 (Regulations, 2015) which reads as follows, gets attracted even if the dealing in securities is through a DPM. Such a trade shall be assumed to be motivated by the awareness and knowledge of UPSI:
“No insider shall trade in securities that are listed or proposed to be listed on a stock exchange when in possession of unpublished price sensitive information:”
However, the possibility of such a motivation to the market participant is highly circumstantial, but generalizing the assumption to all cases will be a reason to worry for the DPMs. The investment made by DPM qualifies as one of the exonerating circumstance for insider trading. The portfolios managed by these DPMs are standard in most of the cases and are not specifically altered for an investor. Further, the investments made through DPMs are easily identifiable as they are mandatorily held in separate demat account with power of attorney in favor of the DPM.
Clause (ii) of proviso to Regulation 4 (1) provides for an exemption in case of non-individual insiders if the following conditions are met:
“(a) the individuals who were in possession of such unpublished price sensitive information were different from the individuals taking trading decisions and such decision-making individuals were not in possession of such unpublished price sensitive information when they took the decision to trade; and
(b) appropriate and adequate arrangements were in place to ensure that these regulations are not violated and no unpublished price sensitive information was communicated by the individuals possessing the information to the individuals taking trading decisions and there is no evidence of such arrangements having been breached.”
Such exemption should hold good in case of DPMs too. This was very well discussed in the NK Sodhi committee report, reproduced as under:
“Non-insider decision-maker for trades
59. While trading to take advantage of the possession of UPSI should be outlawed, it is equally important to make provision for the ability to disconnect the two aspects of the matter i.e. the possession of UPSI and the decision to trade at a certain price. In any business group comprising multiple entities discharging multiple roles, if it is possible to ring-fence the persons who are in possession of UPSI from those who are responsible for the decision-making necessary for the trades, the rationale underlying the prohibition of insider trading would not be attracted. In situations where the person in possession of the UPSI is different from the person who takes the trading decisions and the two are segregated by effective arrangements, the purpose of the prohibition would not be attracted. Consequently, if it can be established that adequate arrangements were in place to ensure that the persons taking decisions on the trade are different from the persons having possession of the UPSI and there is no evidence of such arrangements breaking down, a valid defence ought to be available. Likewise, if the trades are made by a duly authorised person other than the insider without any reference to or prior knowledge of the insider although the trades may have been made on behalf of the insider, the defence ought to be available. This is the principle on which the concept of “blind trust” is adopted worldwide i.e. where a person is given complete authority to trade – say, a discretionary portfolio manager who is himself not in possession of UPSI. In such a fact situation, the Committee believes that a valid defence should be provided.”
The market regulator has specified that its views should not be construed as decision of the Board on the question. However, such informal guidance depicts the interpretation of the SEBI to some extent and accordingly influences the actions of the companies.
(Vignesh Iyer works at Vinod Kothari and Company)