A major omission in insider trading rules

The SEBI (Prohibition of Insider Trading) Regulations, 2015 (“New Insider Regulations”) have come into force from May 15. These allow a potential acquirer to conduct due diligence before acquiring a listed company. Due diligence is conducted to determine if the target listed company is a good buy for the acquirer, the potential pitfalls, liabilities and risks involved in the acquisition, and the acquisition price. An ambiguity,

however, arises over whether the acquirer and the company will fall on the wrong side of the law if the deal is aborted.
Dealing with insider knowledge

As part of the due diligence, the acquirer gets to know “unpublished price sensitive information” (“UPSI”) about the target listed company, which is not generally available to public.

This makes the acquirer an “insider” in terms of the New Insider Regulations. Unlike the earlier SEBI (Prohibition of Insider Trading) Regulations, 1992, the New Insider Regulations now specifically allow UPSI to be communicated, provided, allowed access to or procured by the acquirer in relation to a transaction.

However, before such UPSI is shared with the acquirer, a confidentiality and non-disclosure agreement needs to be signed. The acquirer is not allowed to trade in securities of the target listed company while in possession of UPSI.

These provisions are covered in Regulation 3(3) and 3(4) of the New Insider Regulations. Regulation 3 (3) which permits communication, provision, allowing access to or procuring UPSI to the acquirer, covers only two situations for a transaction: one, when the transaction results in an “open offer” under the SEBI takeover regulations and second when the transaction does not result in an “open offer”.

When a transaction results in an “open offer”, the UPSI which is necessary to enable the public shareholders to decide whether to retain or to sell their shares in an open offer, is made available to the public shareholders of the target listed company in the letter of offer sent to them. In case the transaction does not result in an “open offer”, the Regulations provide that UPSI should be disseminated to the public at least two days prior to the proposed acquisition by the acquirer.

In both these situations, the UPSI is made generally available prior to completing the transaction with the acquirer, thereby ruling out any information asymmetry in the market.

That means everyone possesses the same level of information and no one can be said to be better placed than others. But Regulation 3(3) only provides for two situations, both resulting in acquisition. It is silent on a situation where no acquisition is made after the due diligence.

Loud silence

It is usual in M&A transactions for the acquirer not to proceed further with the acquisition. So, what happens to the UPSI already shared with the acquirer for such aborted transactions?

As far as the acquirer is concerned, it will continue to be an “insider” and therefore should not trade in the securities of the target listed company while in possession of the UPSI, until the UPSI is generally made available to the public.

But how are company’s management and promoters placed in the eyes of the law, by virtue of sharing information as “insiders” with the acquirer? Regulation 3(1) of the New Insider Regulations provides that no insider will allow access to any UPSI relating to a company, or securities listed or proposed to be listed, to any person except under three circumstances: when the communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.

It is not absolutely clear if due diligence in an aborted transaction will fall under any of these three exceptions. Probably, it could fall within the category of furtherance of legitimate purposes.

Although the New Insider Regulations are silent on this issue, it cannot be the intention that due diligence for aborted deals is not permitted. A line of clarification from Sebi will set the issue at rest.