India: A Compliance Officer Doesn't Need Prying Eyes

In a recent ruling¹, the Hon'ble Securities Appellate Tribunal ("SAT") has absolved a company and its compliance officer for wrongful disclosure made to the stock exchanges. The ruling was based on the argument that the misinformation originated from a Key Managerial Personnel (KMP) within the company.

The matter also concerned an allegation against the KMP for trading when in possession of Unpublished Price Sensitive Information ("UPSI"). The UPSI in question was the financial results for the quarter ending 31 March 2016. Also in contention was the date on which the alleged UPSI came into existence.

Summary

The KMP was the Managing Director (MD) of the company and an 'insider'. He transferred shares of the company on 04 May 2016 to another entity, for which he received consideration almost a year later. He disclosed this to the company and the compliance officer on 09 May 2016 as an encumbrance upon these shares and not a sale, and consequently a disclosure was made to the stock exchanges.

This declaration was made under Regulation 31 of the SAST Regulations², whereas it ought to have been under Regulation 7(2)(a) of the PIT Regulations³. The consequent disclosure made by the company and its compliance officer therefore, suffered from the same vice.

The Securities and Exchange Board of India (SEBI) imposed penalties on the KMP for trading while in possession of UPSI and for wrong disclosure. It imposed a penalty against the company and its compliance officer as well, for failing to make the correct disclosures of these trades.

SEBI substantiated such an onerous burden on the compliance officer by stating that there is a high degree of responsibility on compliance officers to ensure that all the rules and regulations applicable over a company are complied with and that being a compliance officer, she had the statutory duty to go into the nitty-gritty of the said transaction undertaken by Noticee No. 1 (the KMP) and to guide the company and management of the company accordingly.⁴

The company contended that it diligently adhered to the disclosure provided by the Key Managerial Personnel (KMP) in good faith. The Securities and Exchange Board of India (SEBI) attempted to place the onus on the company to validate the KMP's disclosure against the report of its Registrar and Transfer Agent (RTA), which captures alterations in shareholding. SEBI argued that an encumbrance might not register as a change in shareholding, whereas a transfer would.

The Hon'ble SAT's Order:

The KMP did not trade while in possession of UPSI as the UPSI came into existence later - on 18 May 2016, when the draft financial accounts was submitted to the management. SEBI's treatment of 15 April 2016 as the start date for the UPSI period on the basis that this was the date on which finalization of the accounts began was therefore, erroneous.

The KMP was held to have made a wrong disclosure. However, the company and the compliance officer were not at fault for relying on the KMP's disclosure. While setting aside the penalty imposed on the company and the compliance officer, the Hon'ble SAT held, that "it is not necessary for the company or the compliance officer to go into the correctness of the transaction (as disclosed by the KMP) and verify whether the transactions had actually been done or not."

Consequently, the Hon'ble SAT set aside the penalty for insider trading under Section 15G of the SEBI Act and substituted it with a penalty under Section 15A(b) for non-disclosure.

Analysis

The Order has clarified that the company's and the compliance officer's duties under the PIT Regulations end with the disclosure made to it by the KMP. They are not required to investigate the nitty-gritty of the said transaction undertaken. That would be an onerous expectation, requiring the compliance officer and the company to pry into business of its KMPs to an unreasonable extent.

Additionally, the ruling provides valuable guidance for the determination of when UPSI comes into existence. This is essential for the purposes of accurate maintenance of the Structured Digital Database ("SDD").

In this case, various dates were considered for the beginning of the UPSI period. The Hon'ble SAT noted that SEBI had not substantiated the reason to consider 15 April 2016 as the date on which the UPSI came into existence. In the absence of any other material dates on the record, it chose 18 May 2016, the date on which the draft financial results were communicated to the management as the date on which UPSI, if any, came into existence.

Essentially, the Hon'ble SAT held that the beginning of internal finalization of accounts prior to its communication to the management would not give rise to UPSI; the underlying logic being that specific details of the information are required to be crystalised with reasonable probability before it can be termed UPSI. Any information before this stage could be imprecise and therefore, would likely not be UPSI. For UPSI to come into existence the veracity of the information has to be concretized.⁵ This fundamental principle has been eruditely explained by the Ld. Whole Time Member (as she then was; and present Chairperson, SEBI) as far back as 30 June 2021 in the order in respect of Shreehas P Tambe.⁶

Key Take-Aways in this matter:

• The duty of the company and compliance officer to disclose a KMP's transactions does not exceed the duty of the KMP.
• The determination of the UPSI period is a mixed question of fact and law which requires analysis of when the information crystallized to a reasonable degree of certainty/precision.

Footnotes

1. Order of the Securities Appellate Tribunal dated 06 November 2023 in Appeal No. 709 of 2022

2. Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011

3. Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015

4. SEBI Adjudication Order No.: Order/GR/HK/2022-23/18165-18169 dated 29 July 2022, [56], [59]

5. SEBI WTM Order No.: WTM/GM/EFD/29 /2019-20 dated 13 August 2019, [16]

6. SEBI WTM Order No.: WTM/MB/IVD/ID3/12407/2021-22 dated 30 June 2021, [28], [30]

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