On July 29, 2024, the Securities and Exchange Board of India (“SEBI”) issued a Consultation Paper, wherein it proposed certain amendments to broaden the scope of “connected persons” under the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015 (“PIT Regulations”).
· Broadening the definition of “Connected Person” and introducing new categories of “Deemed Connected Persons”
Under the existing provisions, Regulation 2(1)(d) which provides the definition of “connected person” as anyone who has been associated with a company in any capacity during the six months before a relevant act. The definition also covers those holding any position that gives them access to UPSI or is reasonably expected to allow such access. The regulation also specifies certain categories of persons who are “deemed to be connected persons,” such as immediate relative, holding companies, subsidiaries, intermediaries, and more.
Under the proposed amendments, the term “immediate relative” in sub-clause (a) is proposed to be replaced by “relative” (inline with the Income Tax Act, 1961).
Additional categories of “deemed connected persons” have been introduced, including:
1. Firms or partners where a connected person is also a partner.
2. Persons whose advice or directions a connected person is accustomed to act upon.
3. Body corporates with boards or managers acting on the instructions of a connected person.
4. Persons sharing residence with a connected person.
5. Persons having material financial relationships with a connected person, including those dependent on or frequently transacting financially with the connected person.
6. Hindu Undivided Families (“HUF”) where the Karta or any member/coparcener is a connected person or relative of a connected person.
It is pertinent to note that when a charge under Regulation 4(1) of the PIT Regulations is brought against these deemed connected persons, they will bear the burden of proving that they were not in possession of UPSI, as specified in Regulation 4(2) of the PIT Regulations.
· Redefining the terms “Immediate Relative” and “Relative”
Further, the existing Regulation 2(1)(f) provides the definition of “immediate relative” which includes a spouse, parent, sibling, and child of a person or of the spouse, who are financially dependent on the person or consult the person in trading decisions.
The “Note” related to the definition of “immediate relative” is proposed to be removed, as the term “relative” will replace“ immediate relative” in the context of determining connected persons, but the definition itself will be retained for disclosure purposes.
A new definition of the term “relative” is proposed to be included under Regulation 2(1)(hc) which shall include spouse, siblings, sibling’s spouse, siblings of parents, lineal ascendants or descendants of the individual or spouse, and the spouse of any of these persons.
Our view:
While these amendments aim to enhance regulatory oversight, they may have several negative implications. The Consultation Paper aims to rationalize the definitions of ‘relative’ and ‘related party’ with those in the Income Tax Act and Companies Act, 2013, but it fails to explain the necessity for this rationalization.
Further, the expanded definition of ‘connected person’ and the replacement of ‘immediate relative’ with ‘relative’ could unnecessarily increase the number of individuals implicated in insider trading. There exists a rebuttable presumption that connected persons possess UPSI, as noted in Regulation 2(1)(d)of the SEBI (Prohibition of Insider Trading) Regulations, 2015. The proposed amendments aim to expand the number and scope of persons presumed to have access to UPSI without SEBI needing to establish this access definitively. This amendment places a heavy burden on many individuals, requiring them to disprove the allegation.
Further, the proposed expansion significantly broadens the scope, imposing this burden on many who may not be reasonably considered to possess UPSI based solely on their relationship to a connected person.
Similar to the proposed SEBI (Prohibition of Unexplained Suspicious Trading Activities in the Securities Market) Regulations 2023 (“PUSTA Regulations”) outlined in the consultation paper dated May 18, 2023, this consultation paper seeks to shift the burden of proof from SEBI to the accused individuals. Granting SEBI, the power to designate individuals as connected persons without needing to establish actual communication of UPSI could lead to potential misuse and overreach. What is required is an enhancement of SEBI’s investigative abilities and powers, enabling it to build a stronger case when alleging violations, rather than shifting the burden of proving innocence onto individuals.
The proposed amendments could negatively impact business operations. The fear of being implicated in insider trading investigations might deter individuals from assuming roles that could expose them to such risks, thereby affecting business decisions and operations. Skilled professionals might avoid joining entities or firms with known connected persons to mitigate the risk of being deemed connected themselves. Furthermore, the inclusion of individuals with ‘material financial relationships’ with connected persons might discourage legitimate business relationships, adversely affecting investment and partnership decisions. Given these concerns, SEBI should reconsider the proposed amendments.
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