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Sebi’s fair market conduct committee sidesteps vital points on fraud and insider trading

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The committee has missed a golden opportunity to rectify several problems in the market.

Sebi’s fair market conduct committee sidesteps vital points on fraud and insider trading
In the backdrop of leakage of crucial financial numbers over WhatsApp and increasing instances of insider trading and financial frauds in the securities market, a committee was set-up by market regulator Securities and Exchange Board of India (Sebi) under the chairmanship of TK Viswanathan.
The committee submitted its report on ‘Fair Market Conduct’ on August 9, 2018, suggesting amendments in Sebi (Prevention of Insider Trading) Regulations, 2015 and Sebi (Prohibition of Fraudulent and Unfair Trade Practises relating to Securities Market) Regulations, 2003. The report is divided into four parts. Some of the recommendations are as follows:
Market Manipulation and Fraud
: The major proposals for amendment in PFUTP Regulations includes changes in Regulation 4(2) which provides for various kinds of dealing in securities which are deemed to be fraudulent or unfair trade practice.
The recommendations are essentially incremental to the existing framework but do not address the poorly defined description of fraud. This leaves what constitutes fraud as inchoate and unclear.
Further, the committee has recommended the inclusion of ‘market manipulation’ under Regulation 4(2). This is in line with recent orders of the Supreme Court wherein the court has laid down various principles to determine fraudulent and unfair conduct, including market manipulation and non-intermediary front running.
Due to increasing financial frauds in the listed entities and repeated question on Sebi’s powers to look into the matters related with manipulation of books of accounts and siphoning of funds, another important suggestion has been made wherein it is recommended that fraud related with financial statements and misutilisation of issue proceeds may be included in the purview of PFUTP Regulations.
Although such an explicit inclusion in PFUTP Regulations would settle this issue once for all, however, considering that another central government body, Serious Fraud Investigation Office (SFIO), is already entrusted with the powers to look into the issues related with financial frauds. It would be interesting to see how will the issue of conflict between Sebi and SFIO be resolved.
Moreover, in a number of matters involving accounting issues and understanding of financial statements, Sebi has sought assistance from external auditors. Should the proposed amendment gets notified, Sebi might be required to form a separate internal department consisting of experts possessing sufficient technical expertise and experience in the field of accountancy and finance.
Insider Trading: With regard to the Insider Trading Regulations, the committee has recommended removing ‘material events’ under the Listing Regulations from the list of deemed price sensitive information. Considering that a number of material events are more from the compliance perspective, they may not have a bearing on the price of the securities.
Further, the report recommends that the requirement of pre-clearance and application of contra-trade related restrictions should be removed from the trading undertaken in accordance with the trading plans. Application of the same set of laws differently on the same persons may create more confusion and an open door for interpretation and litigation.
It seems that the committee’s approach is a legalistic analysis of existing regulatory framework with little reference to corresponding international practices, International Organization of Securities Commissions (IOSCO) principles and effectiveness of Sebi in enforcing past violations.
In addition, on a bigger canvas, the committee has missed a golden opportunity to redefine insider trading so as to catch only dishonest conduct. The current wording of the prohibition includes all kinds of honest trades and even due diligence as not being fully kosher. A clearly defined definition excluding honest conduct through special safe harbour rules would have been very helpful.
Code of Conduct under Insider Trading Regulations: The committee has recommended that there should be a separate code of conduct for listed entities and intermediaries, as was present in the erstwhile Insider Trading Regulations of 1992.
Further, the report provides for the inclusion of a broad definition of ‘designated person’, instead of leaving it to the discretion of the listed entities. Although providing an indicative list is a welcome move, however, to implement such changes, the definitions of certain terms will need to be reconsidered. For instance, the term ‘promoter’ includes ‘promoter group’; however, all members of a promoter group should not be considered as designated persons.
Surveillance, Investigation and Enforcement: One of the recommendations under this chapter is to expand the existing powers of Sebi from seeking call records to intercepting conversations. In the light of the recent judgment of the Supreme Court holding ‘Right to Privacy’ as a fundamental right and the pending Personal Data Protection Bill of 2018, it will be interesting to see as to whether this recommendation will see the light of the day.
We believe, this power should not be given to Sebi, as it would cause insurmountable privacy problems.
Sandeep Parekh is the managing partner and Deepika Goyal is an Associate at Finsec Law Advisors

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