The advisory committee for the review of the Sebi (Prohibition of Insider Trading) Regulations, 1992, constituted under the chairmanship of Justice NK Sodhi has submitted its report to Sebi. This is an overdue overhaul of the insider trading norms. In my column here yesterday, I had discussed the need for the overhaul proposed and some of the significant additions and changes which will help the regulator and market participants focus on the right issues. The current formless, vague and amoeba-like development of the law which confuses the market participants and sometimes harms legitimate conduct required an overhaul.
There are many well-thought and sophisticated defences provided in the draft regulations. This column seeks to discuss a few. These include defences like trading against the insider’s interest. Thus, a person who has good news—before the good news is publicly available—and sells in the market would not be charged with insider trading. While this may be somewhat obvious, providing a clear framework giving such a defence provides clarity even to non-experts in the field.
Another significant defence against the charge of illegal insider trading is the one relating to due diligence, which caused heartburn to institutional and private equity investors under the current regulations. The current regulations virtually deem illegal all due diligence of a company before making significant investments. This occurs because due diligence gives access to unpublished price-sensitive information. Since investment is partly made on the basis of the due diligence, this falls under the informational advantage definition of insider trading. This is, of course, wrong and hurts India without providing any benefit to the investors.
Any strategic investor or even a large passive investor in a company will want to conduct due diligence before investing—the purpose of which is never to get access to inside information, but to make sure the representations made to them are correct and accurate. While reviewing the information, the person conducting the diligence—and there are many areas where due diligence is needed, such as legal or financial—may chance across a fair amount of confidential information. After all, information doesn't sit in one room with the label 'legal documents' and in another with the label 'financial documents'! In this task, there will rarely be undiscovered happy news. More likely will be the discovery of undisclosed contracts which may create legal liability or litigation or other bad news. This is, of course, the purpose of due diligence.