Outsiders cannot be insiders

The new insider trading regulations notified by the Securities and Exchange Board of India (Sebi) took effect last weekend. While the regulations are largely based on draft regulations made by the N K Sodhi Committee, they do deviate on some material issues. (Disclosure: the author was a part of the Sodhi Committee and any critique should be taken with a pinch of salt.) This column will not dwell on the deviations in what is covered by the regulations but would pick up one element of something that has been left out.

One of the recommendations in the draft regulations was to treat "any person who is a public servant or occupies a statutory position that allows such person access" to unpublished price sensitive information of companies (colloquially, "inside information"), as a "connected person". This was an explicit definition that would have brought this category of persons within the ambit of "insiders". This element has been dropped. It is argued by some that such language is unnecessary because the definition of the term "insider" covers apart from "connected persons", any person who has access to inside information. Clearly, that would not be a complete answer.

Insider trading regulations are all about prohibiting someone with asymmetrical access to inside information of an issuer of securities from monetising the access ahead of the rest of the market. The access to the workings of the business and the financial position of the issuer would enable access to information that could impact price discovery of such securities but is not generally available. Therefore, it necessarily has to emanate from inside the issuer, which it is even necessary to define a connection as one to the insides of an issuer. For example, a chief financial officer of a company that is listed on the stock market is clearly privy to the draft financial statements way before the information becomes generally available.

On the other hand, take a judge who is writing a judgement on a material tax dispute. All the information presented to him is generally available - anyone sitting in the court room would see exactly what is being argued before him. Now, his decision on which way to rule in the dispute is price-sensitive information, will impact the price of securities of the company involved in the dispute, but would be known only to him because it is he who would take the decision and until he makes the decision public, no one would know which way the fortunes of the price of those securities is headed. The staff in his office, his fellow judges who may get wind of which way his decision is headed, and his relatives who may discern his views from his views on the dining table, would all be "outsiders" and not "insiders". The information relating to the final decision in the judgment would emerge from outside the company and not from inside.

Such persons would be connected to the outsider judge and not to those inside the company who would be eagerly awaiting the outcome themselves. If they were to trade ahead of the market, there would be no legal basis for treating such "outsiders" to listed companies as "insiders". Unless, of course, there is an explicit definitional coverage of such a person as a "connected person", which is precisely what has been deleted. Replace the judge with a bureaucrat who determines government policy that can have an impact on price discovery for securities in the market, and the picture remains the same. Replace the bureaucrat with a lawmaker in Parliament who gets to decide on policy and the effect would be the same. Indeed one could argue that an income-tax official who gets to see advance tax data filed by various listed companies or an investigator, who conducts a search and seizure into a listed company and gets access to inside information, would be covered as a recipient of information from an insider. The information they would get, would not be information that they generate but information generated from the insides of the company they are assessing or raiding. Trades by them when being privy to such information could indeed be covered by the regulations since they were recipients of information from insiders.

Given the stakes involved - of whom the law would protect against rather than who would be protected - this is not an easy piece of reform to implement. Every piece of law protects someone from someone else. It is not surprising that this piece of reform did not come through.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)