K S O Joseph, retired employee of a leading consumer goods company, couldn’t believe his bad luck when he was slapped with a Rs 2-lakh fine for a stock transaction of Rs 1 lakh. He sold some stocks of a pharmaceutical company in which he was a board member during its silent period (the specified periods when a publicly listed company cannot make any announcements about anything that could cause a normal investor to change their position on the company’s stock).
When officials of the regulator, Securities and Exchange Board of India (Sebi), came to his house to enquire about the transaction, he explained that as the company’s shares weren’t doing so well, he sold these to buy other stocks. He was fined. Employees or board members often wish to participate in their company’s fortunes. After all, they believe they are best equipped to know whether the company will do well or not. But buying or selling the company’s stock during certain periods or passing on sensitive information, even during a casual conversation, has hurt badly.
If you are an employee …
Tejesh Chitlangi, partner at law firm IC Legal, says irrespective of whether there is mala fide intention, a transaction by a designated employee in a company’s shares will violate insider trading norms if it breaches a company’s model code of conduct. “Anyone who is a designated employee under the listed company’s model code of conduct is expected to know the permissible windows and manner in which such an employee can transact in his employer’s shares. In case of doubt, such an employee should check with the company’s compliance officer,” he says.
Designated employees refer to all employees at the top three tiers (directors, associate directors and other staff) of a company’s management in the finance and secretarial departments, as well as those who might have access to any ‘price-sensitive information’.
According to the Sebi Prohibition of Insider Trading Regulations, 1992, an ‘insider’ means any person who, is or was connected with the company and is expected to have access to unpublished price sensitive information of the company’s securities, or has received or has had access to such unpublished information. They further explain, “The words ‘connected person’ shall mean any person who was connected even six months prior to an act of insider trading.”
Says Sajid Mohamed, partner at law firm PDS and Associates, “Violation of insider trading rules as mentioned in the example above is common. Directors who are not active with the company management often tend to commit such mistakes and are penalised heavily, sometimes even for such mistakes by their family members.”
He says while the engagement letters of senior employees of most firms mention these norms, firms do not always have these clauses included for junior employees. It ought to be made a rule to include such rules for employees across levels. More so as trading or transacting in stocks have become easier after dematerialised accounts and smartphones came into existence. Now, anyone can transact from anywhere at the click of a button.
Hence, individuals in a listed firm and owning shares of their employer have to adhere by the code of Corporate Disclosure Practices laid down by Sebi. It says: “Any person who holds more than five per cent shares or voting rights in any listed company shall disclose the same to the company, within two working days of (a) the receipt of intimation of share allotment; or (b) the acquisition of shares or voting rights. This applies to even a promoter/ director/officer of a listed company, and if their dependents own such stocks.
That’s why Ameet Hariani, managing partner of law firm Hariani and Company, suggests employees or connected persons of a company should not trade or transact in shares during the ‘black-out periods’ or ‘no transaction period’ that precedes events such as quarterly results and annual general meetings (see box). Additionally, they should give a disclosure to their employer and the stock exchanges if they trade in these shares in the non-blackout period, too. The employer should also give a disclosure about this to the exchange from his side.
The penalty for violating insider trading norms can be a wage freeze, suspension, denial of future participation in employee stock options and so on. Since designated employees who buy or sell shares of their company are not permitted to enter into opposite transactions for the specified time period under the Company’s Code of Conduct, hence in case of an urgent need of funds, such an employee is required to take prior consent from the Compliance Officer, says Chitlangi.
Designated employees need pre-clearance even before indulging in share transaction in non-black-out periods from the Compliance Officer, says Mohamed. “But there is no need for them to give a reason for transaction(s) during a non-blackout period despite being privy to important informations. Senior employees, many times, take advantage of this. Of course, companies with high level of corporate governance do not allow such practices,” he says.
Sebi also asks for continual disclosure. “A person holding more than five per cent voting rights in any listed company shall disclose (to the company) the number of shares or voting rights held and change in shareholding or voting rights, if there has been change from the last disclosure made or such change exceeds two per cent of total shareholding or voting rights in the company.”
If you pass on information casually
“A client made a profit of Rs 1 lakh after a fellow traveller in the local train asked him to sell his holding in an information technology stock,” says a financial planner. While in this case one might not be caught for letting out sensitive information, there are many other times when one could be pulled up.
Recalls the financial planner that a client once was called for interrogation by Sebi for helping his brother earn Rs 30 lakh from shares of the company he worked for. He was at a senior level but had not passed any information. But this individual was interrogated for three or four days before he was let off, as it was later found the brother had got a tip from some other employee. There is no leniency for such acts. There is no room for being pardoned for unintentional passing on of information. The law presumes information was let out wilfully and, hence, is punishable with wage freeze, suspension and so on.
If an intermediary
“Roughly the same rules apply even for intermediaries. They are blocked from trading in clients’ shares for a fixed period before and after an event is to be announced,” says Hirani. Many law and tax consultancy firms do not allow partner-level employees to own shares of listed client firms. They are made to sign an undertaking on engagement. Many others ask for shareholding disclosures at the time of joining a firm (see box).
An individual can be a ‘connected person’, if he is a merchant banker, share transfer agent, registrar to an issue, debenture trustee, broker, portfolio manager, investment advisor, sub-broker, investment company, members of a board of trustees of a mutual fund or a member of the board of directors of an asset management company or is a relative of any of the mentioned persons, banker of the company, relatives of the connected person, a concern, firm, trust, Hindu Undivided Family, company or association of persons who have more than 10 per cent of the holding or interest, says Sebi.
“Designated employees of an intermediary handling assignments for listed companies, may not be allowed to trade in stocks of such listed client company, they being in the grey list,” says Chitlangi. Security of a listed company shall be put on the restricted/grey list if the organisation is handling any assignment for the listed company or is preparing appraisal report or is handling a credit rating assignment and is privy to price-sensitive information, says Sebi. Security being bought or sold, even on behalf of clients or mutual funds, shall be put on the restricted/grey list.
Price-sensitive information is to be handled on a need-to-know basis, even within the organisation and only for discharge of duty. Files containing confidential information are to be kept secure, with a high level of security and restricted access. Sebi asks intermediaries to maintain a policy which separates those areas of the organisation routinely accessed or public areas and the ‘inside areas’.
There are reporting requirements for securities transactions by intermediaries. They are supposed to disclose all holdings in securities at the time of joining the organisation, periodic statement of securities transactions and annual statement of all holdings in securities.
WHAT IS NO-TRANSACTION PERIOD?
- Declaration of financial results (quarterly, half-yearly and annual)
- Declaration of dividends (interim and final)
- Issue of securities by way of public/rights/bonus and so on
- Any major expansion plans or execution of new projects
- Amalgamation, mergers, takeovers and buybacks
- Disposal of whole or substantially whole of the undertaking
- Any changes in policies, plans or operations of the company
RESTRICTIONS FOR INTERMEDIARIES:
- Restrict trading in certain securities and designate such list as restricted/grey list
- Restricted list itself not be communicated to anyone outside the organisation
- If trading, execute order in one week of pre-clearance
- Hold investments (in client shares) for minimum 30 days for consideration as investment; also applicable for IPOs
- No holding period constraint for emergency securities sale after adequate reasoning
- Stock analysts preparing research reports shall disclose their shareholdings/interest in companies. Will also not trade in such securities for 30 days from preparation of a report