[Kabir is a student at OP Jindal Global University.]
Through its consultation paper dated 29 July 2024, the Securities and Exchange Board of India (SEBI) proposed significant changes to the SEBI (Prohibition of Insider Trading) Regulations 2015 (PIT Regulations). These proposed amendments have now been officially adopted, reflecting SEBI’s commitment to addressing the growing sophistication of financial markets and the rise in insider trading. Approved at SEBI’s board meeting on 30 September 2024, and incorporated into the regulatory framework through the 11 December 2024 amendment regulations, these changes aim to fill historical gaps and strengthen the market structure by redefining principal terms such as ‘connected persons’ and ‘relatives’.
The changes made in the ‘connected persons’ definition to match the ‘related party’ definition employing the Companies Act 2013, and the widening in the meaning of ‘relative’ in Section 56(2) of the Income Tax Act 1961, were done to cover the larger circle of people and entities including possible access to UPSI. In this article, these amendments are compared and their possible effects on insider trading laws in India are also discussed.
Expanding the Definition of 'Connected Person'
Any individual affiliated with unpublished price sensitive information (UPSI) as well as a related party is an insider under the PIT Regulations. However, the previous definition of 'connected person' did not sufficiently capture persons with indirect access to UPSI through their connections. SEBI’s amendments address this issue by defining the 'connected person' in the same way as the term 'related party' in Section 2(76) in the Companies Act 2013. This adjustment increases the coverage of the regulations to persons connected with companies, even in an indirect manner, as it is sometimes possible to manipulate the stock markets through connections. The amendments also expressly include a firm or its partner or employee if a connected person is also a partner, as well as any person sharing a household or residence with a connected person.
The amendments replace the term ‘immediate relative’ with ‘relative’. Additionally, the modification broadens the meaning of 'relative' in Section 56(2) in the Income Tax Act 1961 to a family relation. Such modifications work to incorporate certain additional relatives – that is, spouses, siblings, and lineal ascendants – to the extent that these changes plugged prior holes that allowed indirect exploitation of UPSI via family members.
Comparative Models: United States and United Kingdom
United States
In the US, insider trading is governed by the Securities Exchange Act of 1934, the Insider Trading Sanctions Act of 1984 and Insider Trading and Securities Fraud Enforcement Act of 1988. Insider trading is defined by the United States Security and Exchange Commission (SEC) as a breach of securities laws that focuses on the inappropriate use of material non-public knowledge rather than the insider's employment status. The ruling by the US Supreme Court in the case US v. O’Hagan brought the ‘misappropriation theory’, which makes any person using information which is known to be confidential for some private advantage a law-breaker. The SEC uses a number of discretionary measures, including fines, forfeiture of gains and criminal prosecution, in order to adapt to new market strategies like high frequency trading.
United Kingdom
The Financial Services and Markets Act as well as the Criminal Justice Act of 2003 both establish legal measures to curb insider trading throughout the UK. The UK opts to have an all-encompassing approach by encompassing all insider executives regardless of their position in a certain company and regardless of whether the non-public data misused was acquired for trading purposes or not, but with a lot of emphasis on trading intent. The enforcement involves a civil penalty and a criminal penalty. Rather than categorizing insider trading as fraud, as in the United States, the United Kingdom focuses on the unfair use of confidential information. The R v. McQuoid and Melbourne case, for instance, showed that insider trading mainly focuses on possession of material non-public information as well as misuse of the same.
The exploitation of unpublished price-sensitive information has not been thoroughly investigated in the current framework for analyzing insider trading regulations in India. At the moment, it is only unidimensional, meaning that while it investigates the misuse of UPSI, it does not deeply analyze the phenomenon itself. This results in a higher level of bureaucracy especially because most cases are overturned by the Securities Appellate Tribunal (SAT) for wrong evaluation of insiders having UPSI or inadequate proof of using such UPSI.
Impact of SEBI’s Insider Trading Amendments
The amendments to PIT Regulations by SEBI indicate a paradigm shift in compliance with global standards. These amendments seek to increase accountability and market efficiency and provide investors with protection by expanding on the idea of a connected individual. The expanded definitions are designed to eliminate sources of exploitation by broadening the category of persons who might gain access to UPSI. This would be in keeping with SEBI’s long-term goal of creating an efficient and competitive market structure where all stakeholders including long-time shareholders and new players can compete with each other effectively without feeling that they are being taken advantage of or manipulated by the others.
Informed by the US and the UK’s regulatory models, SEBI’s approach achieves both the goals of increasing coverage while not losing sight of eliminating unfair practices.
Limitations of the Amendments
The extension of the list of ‘relatives’ according to SEBI’s insider trading rules may have implications in future cases of insider trading, especially where high profile firms, such as the Adani group and Hindenburg research, are involved. The reason is that most of the time, insider trading involves insiders and their close relatives, so SEBI includes extended family members. However, this expansion, much like what happened in the Deep Industries case, presents the danger of using regulatory functions beyond their purview because SEBI used social media interactions to arrive at contentious rulings that were later overturned by the SAT.
These wider definitions might result in adverse effects related to the legal trading process, and likely cause market illiquidity and stagnation, as they will be associated with fraud. For instance, companies may not engage new parties like shareholders or partners because compliance requirements will slow down the business and also limit the formation of new ideas and partnerships that are necessary for an economy to thrive. Nations and groups of multinational corporations and foreign investors could also tear this important garment with undue scrutiny making it difficult for them to enter into the Indian markets.
Connected Persons and the Adani-Hindenburg Saga
This is why the Adani-Hindenburg issue is a vivid example of insiders’ use of manipulation and the need for appropriate legislation and supervision. The Hindenburg report alleged that the Adani family had improper linkages with offshore entities, including the Cook Island based AP Investment Ltd., or the Cayman Island based Crestwood Ltd., and equity offerings had been made for misuse of funds and for insider trading. SEBI has taken up the investigation of such claims, prompting discussion on regulatory failure, and increased vigilance. This is an obvious episode that explains why SEBI undertook these reforms and also reveals an obvious problem with the market practices, reflecting similar challenges faced by the SEC in the US.
Conclusion
SEBI’s amendments to the definitions of the terms 'relative' and 'connected person' have gone a long way toward improving insider trading regulation. This is laudable for simplification, in cases such as the Adani-Hindenburg one, but at the same time, it comes with a drawback of over regulation and disturbance of efficient markets.
Finally, SEBI’s reforms represent a bold but essential first step to rehabilitating insider trading rules, but their success is subject to whether the amendments strike the right balance between high regulatory standards and free market. These overly stringent rules might deter legitimate market activities as well as discourage innovation; alternatively, too much flexibility could leave room for exploitation.
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