By Ravindra Bhandhakavi and Parnika Malhotra
Private Investments in Public Equity, commonly known as PIPEs, have become a preferred source for raising capital by public listed companies in India. From the issuer’s perspective, PIPE transactions are time efficient and provide access to capital at a lower cost as compared to public offerings. While financial investors find PIPE deals attractive for various reasons, there are a number of legal and regulatory restrictions under Indian law that need to be taken into account for structuring a PIPE transaction in India. Of particular significance are the restrictions laid out in the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 (Insider Trading Regulations).
Since their enactment in 1992, the Insider Trading Regulations have undergone extensive changes which have been focused on broadening the scope of the offence of insider trading and addressing the difficulties faced by SEBI in securing convictions. Some of these amendments actually dis-incentivize investors from undertaking PIPE investments in companies listed in India.
Restrictions on due diligence for PIPE investments
The definition of an “insider” under the Insider Trading Regulations is very broadly worded and extends to a financial investor who has received or has had access to such unpublished price sensitive information any time prior to its investment in the listed company. By virtue of this definition, the Insider Trading Regulations affect the ability of a financial investor to conduct a detailed due diligence on the listed company before proceeding with the investment if, as a part of such due diligence, the financial investor is provided or gains access to unpublished price sensitive information. Any “dealing in securities” while in the possession of “unpublished price sensitive information” is prohibited under the Insider Trading Regulations and the term “dealing in securities” covers the act of subscribing, buying, selling or even agreeing to subscribe, buy or sell securities. Therefore, if the financial investor has been provided or gained access to unpublished price sensitive information during the due diligence process or at the negotiations stage and subsequently decides to invest in the listed company, then such financial investor can be held liable for the offence of insider trading under Indian law.
The above mentioned restrictions pose a significant legal risk and deter financial investors from pursuing PIPE deals in India. The only relaxation set forth in the regulations is with respect to potential acquisitions that trigger the open offer obligations under the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, (Takeover Regulations). Therefore, with respect to investments that do not trigger the open offer obligations under the Takeover Regulations, the safest option that is currently available to investors is to opt for a limited due diligence which is based on information available in the public domain. But investors view this as a commercially unattractive option as it results in an inadequate assessment of the risks associated with the potential investment.
In order to facilitate PIPE investments, the Securities and Exchange Board of India (SEBI) needs to acknowledge that immediate dissemination of unpublished price sensitive information by listed companies to the public may not be feasible at all times. The SEBI must take cues from the insider trading regulations in jurisdictions such as the United States which acknowledge the above fact and further permit selective disclosures of such information. In the United States, Regulation FD promulgated by the Securities and Exchange Commission (SEC) on August 15, 2000 under the Securities Exchange Act of 1934, requires that an intentional disclosure of material non-public information must be accompanied with simultaneous public dissemination of such information. However, persons who expressly agree to maintain the confidentiality of material non-public information are excluded from the coverage of Regulation FD. By virtue of this exclusion, the listed companies can make a selective disclosure of unpublished price sensitive information to prospective financial investors if the prospective investors execute confidentiality agreements. Such confidentiality agreements typically contain standstill provisions and the prospective investors who sign these agreements cannot trade in securities of the company until the information is made public. Under Regulation FD, the listed company also has the flexibility of obtaining the executed confidentiality agreement from the prospective investor even after the material non-public information is disclosed to such prospective investor, as long as the confidentiality agreement is executed before the prospective investor trades in securities or communicates with other persons. This helps listed companies in rectifying any inadvertent disclosures of material non-public information.
Specific areas of concern under Insider Trading Regulations
In addition to the above-mentioned restrictions on due diligence, one of the issues that needs to be examined from the perspective of PIPE investments is the “use” versus “possession” criteria under the Insider Trading Regulations. Until the year 2002, the offence of insider trading was made out only if the insider dealt in securities on the basis of unpublished price sensitive information. This wording required SEBI to prove that the trade in securities by a person was motivated by the unpublished price sensitive information that was in its possession. The amendment to the Insider Trading Regulations in the year 2002 changed the requirement from “on the basis of” to “while in possession of” unpublished price sensitive information. However, section 15G of the Securities and Exchange Board of India Act, 1992 (SEBI Act) still retains the erstwhile language which states that trading must be “on the basis” of unpublished price sensitive information. The above provisions are conflicting and create ambiguity in interpretation especially since the Securities Appellate Tribunal (SAT) has ruled in recent cases that “prohibition contained in regulation 3 of the Insider Trading Regulations will apply only when an insider trades or deals on the basis of any unpublished price sensitive information and not otherwise”. It is interesting to note that in these cases the SAT’s approach was to evaluate the trading pattern of the insider, examine the nature of unpublished price sensitive information and consequently determine if the trading took place on the basis of such information. If the insider information was positive in nature, then the insider should be buying securities prior to the public disclosure and if the information is negative in nature, then the insider should be selling securities prior to the information being made public.
Another issue which is relevant to PIPE investments is the interpretation of the term “price sensitive information” under the Insider Trading Regulations. Although the Insider Trading Regulations define “price sensitive information” as any information which relates directly or indirectly to a company and which if published is likely to materially affect the price of securities of the company, there is no bright line test to determine what kinds of information will “materially affect” the price of securities of a company and this aspect is usually examined on a case by case basis. In a recent ruling, the SAT ruled that every decision by an investment company to buy or sell its investments would be considered to be an “activity in the ordinary course of its business” which does not have a material effect on the price of its own securities and therefore not amount to “price sensitive information” in terms of the Insider Trading Regulations. In view of this ruling, it has become important to ascertain the nature of business of the listed company in question and also examine if the action in question may be considered to be “in the ordinary course of business”. If the answer to the above is in the affirmative, then information in respect of such action would not be considered as price sensitive information and would not result in a breach of the Insider Trading Regulations.
On March 5, 2013, SEBI constituted a high level committee under the chairmanship of Hon’ble Justice N.K. Sodhi to review the Insider Trading Regulations. There has been a long felt need for a review of the Insider Trading Regulations and this development marks a positive step forward.
The policy rationale behind Insider Trading Regulations is that it creates an unfair advantage in favour of certain investors, undermines the confidence of the larger investing public and impacts the foundations of our capital markets. Recent insider trading convictions for prominent investors such as Raj Rajaratnam and bankers such as Rajat Gupta in the United States clearly highlight the impact of such information asymmetry in the markets and underscore the need for having a stricter insider trading enforcement regime. However, the regulator should not lose sight of the fact that the purpose of insider trading regulations is not to impose absolute curbs on negotiating and undertaking investments in listed securities but to restrain trading on the basis of unpublished price sensitive information. One of the prominent features of a developed capital market is to provide companies, particularly listed companies, with access to various avenues for capital. In light of the same, SEBI should consider providing certain relaxations under the Insider Trading Regulations to make PIPE investments more attractive for financial investors.
Ravindra Bandhakavi is a Partner and Parnika Malhotra is an Associate at the Delhi office of Amarchand Mangaldas.
 Mrs. Chandrakala v. the Adjudicating Officer, SEBI (Appeal no. 209 of 2011 decided on 31.01.2012); Mr. Manoj Gaur v. SEBI (Appeal no. 64 of 2012 decided on 3.10. 2012)
 Gujarat NRE Mineral Resources Limited v. SEBI (Appeal no. 207 of 2010 decided on 18.11. 2011)