Short-term profits not for insiders, Sebi proposes US-style legislation

Sebi plans to introduce short-swing insider trading regulations in India too. The draft note put up on its website traces its origins to US securities’ law. The proposal seeks to define insiders for the purpose of this regulation.

Sebi has raised a question on whether a narrower definition of an insider should be made, to include all key management, all directors, all ‘officers’ of the company who are the beneficial owners directly or indirectly of 10% or more of any class of equity shares. Alternatively, it can be a broader definition to include all insiders, including employees who hold less than 10% too. The latter seems more sensible, how many employees are there, who are not promoters, who can own more than 10% of a company’s shareholding.

The proposed rule is that insiders are not supposed to sell shares within six months of buying them. If they do, they will have to surrender the profits to the company. The logic, according to Sebi, is to ensure that insiders cannot profit from inside knowledge by indulging in short term transactions in securities. The rule does not get into whether the insider had some material information or not while making the trades, just being an insider imposes on him a moral commitment not to indulge in short term transactions.

If it works, it will level the playing field for minority shareholders. Sebi has proposed the LIFO or last-in-first-out method for calculating the six-month period between trades. Some transactions are exempted, transactions approved by a regulatory authority, employee benefit plans meaning ESOPs, gifts and inheritances and shares acquired due to a M&A transaction. The framing of rules, definition of insider, deciding who will implement these rules, will all determine to what extent it benefits minority shareholders. Insiders need to be very careful once these proposals become law.

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