| Sebi ruling on Samir Arora case has far-reaching implications
|
| |
| The mutual fund industry and foreign institutional
investors are perturbed by the Securities and Exchange
Board of India’s (Sebi’s) interpretation of the term“insider.”
|
| |
| Fund managers at 30-odd domestic mutual funds, 500-odd
foreign institutional investors, over 100 banks, numerous
brokers and large stakeholders could henceforth qualify
as “insiders” to various companies if Sebi’s interpretation
of the term “insider”, as defined in the Samir Arora
case, were to be applied across the board. |
| |
| The regulator used Sections 2(e) and 2(h) of the Insider
Trading Regulations to nail the former chief investment
officer and head of Asian emerging markets of Alliance
Capital in a case relating to Digital GlobalSoft. |
| |
| On March 31, 2004, Sebi’s wholetime director T M Nagarajan
passed final orders banning Arora from dealing in securities
on Indian bourses for five years on three key charges:
thwarting Alliance Capital’s plans to sell its India
operations, making inadequate disclosure and violation
of insider trading regulations. |
| |
| A Sebi spokesperson declined to comment on the issue,
pointing out that “the order is a judicial document
which has gone through the legal process and, hence,
no further clarification can be provided”. |
| |
| Section 2 (e) defines an insider as any person who
is (or was) connected with a company, or is deemed to
have been connected with the company and is reasonably
expected to have access to unpublished price-sensitive
information about the company. |
| |
| The enumeration of persons deemed to be connected
with the company, as given in Section 2 (h), includes
intermediaries, investment companies, trustee and asset
management companies or employees of stock exchanges
and clearing corporations. This clearly means that mutual
funds and their executives are indeed covered by the
definition. |
| |
| However, till recently it was assumed that the wider
ambit of the definition of “insider” would be applied
less in practice, with the focus being on direct insiders
— those who work for the company in various capacities,
and their relatives. |
| |
| The Arora case is the first instance of a fund manager
being hauled up for insider trading violations despite
not having a board seat or any direct official connection
with its management. |
| |
| If Samir Arora or Alliance Capital did indeed have
access to any inside information on Digital GlobalSoft,
it was not because of any official position in the company.
|
| |
| Normally, if insider trading has to be proved, Sebi
would have had to prove how Arora got price-sensitive
information, and how his use of it was mala fide. But
an amendment made to the insider trading regulations
in February 2002 dropped some crucial words in Section
2(e). |
| |
| Earlier, an “insider” not only had to be connected
or deemed to be connected with a company, but also had
to have access to price-sensitive information “by virtue
of such connection”. The dropping of the words “by virtue
of such connection” makes it easier for Sebi to level
charges without a higher degree of proof. |
| |
| Observes Siddharth Shah, senior
associate, M&A and funds practice, Nishith Desai
Associates: "Legally, all persons mentioned in Sebi
regulations 2 (e) and 2 (h) qualify as insiders and
Sebi can charge them with violation of insider trading
regulations in case they leverage unpublished price-sensitive
information. The burden of proof, in such cases, would
rest with the fund managers or any other affected party."
|
| |
| Para 9.15 of Sebi's final order in the Arora case
says as much. "It is not material whether Shri Arora
was providing any service to DGL (Digital GlobalSoft).
The factual position was that the entities managed by
Shri Arora, at some time or other, held as much as 10
per cent of the paid-up capital of the equity capital
of DGL which was next only to that of the controlling
holder, viz. Compaq. He and his analysts were maintaining
contact and close interaction with the management of
DGL. I find that Arora was indeed an insider within
the meaning of insider trading regulations." |
| |
| And further, clause 9.17 of the final order, says:
"The requirement for Sebi to show that any other insider
has shared unpublished price-sensitive information with
Shri Arora does not arise." |
| |
| Industry players, academics and some lawyers believe
that Sebi's logic may be flawed. "This is a way to circumvent
the idea of having to prove violation of insider trading
because it is difficult to prove," says Jayant S Varma,
a former Sebi executive director and professor at the
Indian Institute of Management, Ahmedabad. |
| |
| An official of a leading law firm in the country,
who preferred anonymity, said that Sebi's definition
of 'insider' was not in consonance with regulations
in some foreign countries. |
| |
| A representation to Sebi regarding this was made a
year-and-a-half ago, but no alterations were made in
this respect, the official added. |
| |
| The interpretation of Section 2 (e) and 2 (h) may
have far-reaching implications for institutional investors
and large individual shareholders, who tend to have
frequent interactions with company managements. |
| |
| Some legal eagles believe that any fund manager buying
or selling shares ahead of a material event, including
quarterly result announcements, can be hauled up for
violation of insider trading regulations without establishing
that he did indeed have access to unpublished price-sensitive
information. |
| |
Even prudent buy or sell decisions based on judgements
could be termed insider trading, if they happened to
be timed before a material event. "This could even hamper
FII flows into the country," a fund manager pointed
out.
Packing a punch
- According to Section 2(h) of the Insider Trading
Regulations, “intermediaries, investment companies,
trustee and asset management companies or employees
of stock exchanges and clearing corporations” are
insiders
- An amendment made to Section 2(e), in February
2002, shift burden of proof from the regulator to
the accused
|
