SEBI Informant Mechanism

Introduction

The Securities and Exchange Board of India (SEBI) monitors, governs and regulates insider trading activities and other instances of market abuse through the SEBI (Prohibition of Insider Trading) Regulations, 2015 (PIT Regulations).

An insider (Insider) means a connected person or any person who is in possession of or has access to unpublished price sensitive information[1] (UPSI). A connected person is, one who is or has been associated with the company, directly or indirectly, during the 6 (six) months prior to the concerned act and has access to UPSI by virtue of such association.[2] UPSI means any information relating to a company or its securities, directly or indirectly, that is not generally available and which upon becoming available, is likely to materially affect the price of the securities…[3]

In the general parlance, insider trading is taken to mean trading of and/or dealing with securities by any person while being in possession of UPSI (Insider Trading).

Challenges

The evidence of violations in cases of and instances relating to Insider Trading is usually completely circumstantial, which pose the following challenges for SEBI:

• Establishing an information trail and transmission of UPSI;
   
• Details relating to the precise time when the UPSI was generated and when the information became public and the persons who had access to such UPSI before it became public or was published;
   
• Establishing a connection / relation between the Insiders and those persons who have made trades based on the UPSI and acquiring evidence of such connection / relation; and
   
• Establishing and proving that securities were traded while being in possession of UPSI.

In light of the complexities surrounding Insider Trading violations and with a view to establish a system of checks and balances to deal with such violations in a prompt, efficient and timely manner, SEBI has, through a discussion paper published on June 10, 2019, proposed to amend the PIT Regulations to include an informant mechanism whereby any person or employee (Informant) may report to SEBI, instances / occurrences of Insider Trading. Subject to certain conditions, an Informant will be eligible to receive a monetary reward from SEBI for the information being provided.

Key Highlights of the proposed Informant Mechanism

• The Informant would be required to fill out a Voluntary Information Disclosure Form (VIDF) setting out credible, complete and original information of Insider Trading, including communication of UPSI. Further, the Informant shall mandatorily disclose the source of original information and provide an undertaking and indemnity to the effect that such information has not been acquired from any person employed with SEBI.
   
• At the time of submission of the VIDF, the Informant should disclose his / her identity or may submit the VIDF anonymously. In the latter case, the VIDF is to be submitted by an authorized representative who must be a practising advocate.
   
• SEBI has also proposed to establish an Office of Informant Protection (OIP) for: (i) administering the informant mechanism; (ii) processing and authenticating the information received; (iii) maintaining confidentiality of information and protecting the identity of the Informant; (iv) maintaining a hotline to facilitate submission of information; (v) deciding upon the grant of reward to the Informant; (vi) dealing with other departments of SEBI and reporting to SEBI on an annual basis; (vii) acting as a medium of exchange between the Informant and SEBI; and (viii) initiating appropriate action in cases of frivolous or vexatious information.
   
• An Informant would be eligible to receive a monetary reward only in cases where the disgorgement of monies amounts to INR 50,000,000 (Indian Rupees Fifty Million). The monetary reward shall be an amount equal to 10% (ten per cent) of the monies collected and shall be capped at INR 10,000,000 (Indian Rupees Ten Million). Such monetary reward is to be paid out of Investor Protection and Education Fund maintained by the Central Government.
   
• Every person associated with the securities market, including listed companies and intermediaries, shall incorporate, in their Code of Conduct, provisions for safeguarding the employees and shall ensure that no employee is terminated, demoted, threatened or harassed for filing a VIDF.
   
• Information provided under this informant mechanism would be exempted from disclosure under sections 8(1)(g) and 8(1)(h) of the Right to Information Act, 2005.

Mechanism in other Jurisdictions

USA

The informant mechanism proposed by SEBI draws heavily from the Securities and Exchange Commission’s (SEC) whistle-blower program promulgated under Section 992 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2011 (Dodd Frank Act), and Section 21F Securities Exchange Act of 1934.

An informant has been described as a whistle-blower, being any person providing information about a possible violation which has already been committed, is ongoing or is about to be committed. To be considered for an award, the SEC’s rules require that a whistle-blower must voluntarily provide the SEC with original information that leads to the successful enforcement by the SEC of a federal court or administrative action in which the SEC obtains monetary sanctions totalling more than USD 1 million[4].

If a genuine whistle-blower provides information leading to the successful enforcement of proceedings, the SEC shall grant a reward to the tune of 10% to 30% of the total monetary sanctions collected in such proceedings, there being no cap on the disbursement of such monetary reward. The highest reward granted by SEC to two joint whistle-blowers amounted to USD 50 million and another whistle-blower received more than USD 33 million in 2018. The SEC has awarded more than USD 262 million to 53 whistle-blowers since issuing its first award in 2012[5].

In addition, it is unlawful to intervene or interfere with a whistle-blower’s attempts to provide information to the SEC, including any confidentiality agreement to which such whistle-blower may have been a party to. The whistle-blowers are also protected against any retaliation from employers in case of both internal whistle-blowing and whistleblowing to the SEC under Section 806 of the Sarbanes-Oxley Act of 2002.

The Dodd-Frank Act sets out categories of people, along with exceptions, who shall not be eligible for the whistle-blower awards. Further, the SEC specifically refrains from granting awards to culpable whistle-blowers “to prevent wrongdoers from benefiting by, in effect, blowing the whistle on themselves”[6]. In stark contrast to this rule, under SEBI’s proposed mechanism, a culpable informant may be eligible for a reward under this scheme and shall also be eligible for a reward after the Informant has paid the monetary sanctions ordered against him and shall also be eligible for settlement with confidentiality in the proceedings initiated against him.

UK

The Financial Conduct Authority (FCA), along with the Prudential Regulation Authority (PRA), regulates the financial markets in the United Kingdom (UK) and prevents and detects offences relating to market abuse in accordance with the Market Abuse Regulation (MAR) of 2016. While insider dealing, unlawful disclosure, market manipulation and attempted manipulation are civil offences under the MAR, insider dealing and market manipulation are also criminal offences under the Criminal Justice Act of 1993 and Financial Services Act of 2012, respectively.

Although UK has a robust whistle-blower system in place and was the second largest source of international whistle-blower tips received by the SEC in the financial year of 2018[7], the whistle-blowers do not receive any incentives or monetary rewards for providing information of market abuse. Further, barring the UK employment laws, there are no specific provisions for the protection against any retaliation or victimization and maintenance of confidentiality of the whistle-blowers.

In a report published by the FCA in July 2014, the FCA and PRA compared their mechanisms with those existing in the USA upon conducting thorough research of the SEC’s Whistle-blower Program and have also listed several drawbacks in providing rewards to whistle-blowers. T

he research showed that introducing financial incentives for whistle-blowers would be unlikely to increase the number or quality of the disclosures we receive from them[8]. The FCA and PRA opined that: (i) incentives in the USA are provided only to a few whistle-blowers whose information results in regulatory proceedings and not to each of the whistle-blowers; (ii) the system of incentives and rewards requires a complex and costly governance structure; (iii) monetary rewards sabotage and weaken the internal whistleblowing mechanism of companies; and (iv) may lead to malicious reporting of information, Insider Trading conspiracies, whistle-blowing for personal financial gain and negative public perception towards and victimization of whistle-blowers.

Conclusion

• This proposed mechanism is a tool in the hands of employees and any other persons for instant reporting of Insider Trading violations to SEBI while providing for protection and confidentiality of such employees and other persons, provides for ease of access in reporting of violations to SEBI and may act as a deterrent thereby reducing the number of Insider Trading instances and violations.
   
• SEBI has not chalked out a clear plan of action to be adopted by OIP while screening the information and as a result, the source, authenticity and credibility of the information can still fall into grey areas, which could potentially lead to frivolous claims.
   
• SEBI is of the opinion that the evidence in cases of Insider Trading is almost completely circumstantial. Although this proposed mechanism aims to identify the original source of information, it does not completely aid in the procurement of direct evidence as it relies on an Informant who may not always be able to provide a clear and direct link to the original source. In such a situation, credible and authentic information may also be taken to be frivolous and the Informant will be subject to “appropriate action” by OIP under the securities law and any other applicable law despite providing information in good faith, thereby rendering this informant mechanism to be counterproductive.

The views and opinions expressed in this article belong solely to the author and do not reflect the position of Tatva Legal Hyderabad.

[1] Regulation 2(1)(g) of the PIT Regulations.

[2] Regulation 2(1)(d) of the PIT Regulations.

[3] Regulation 2(1)(n) of the PIT Regulations.

[4] https://www.sec.gov/news/press/2011/2011-116.htm

[5] https://www.sec.gov/news/press-release/2018-44

[6] Supra note 3.

[7] Appendix C, 2018 Annual Report to Congress on the Whistleblower Program (SEC, November 2018).

[8] Financial Incentives for Whistleblowers: Note by Financial Conduct Authority and Prudential Regulation Authority for the Treasury Select Committee (FCA, July 2014.)