The Securities and Exchange Board of India’s (Sebi) enforcement action against a Hong Kong hedge fund has emphasised the regulator’s focus on insider trading and its international reach. It should also cause market participants to review their handling of confidential information.
On June 5 Sebi issued an interim order against Hong Kong hedge fund Factorial Master Fund. It cited the fund’s aggressively short position in L&T Finance Holdings immediately before its March offer for sale (OFS) to comply with India’s free float rules. The investor was one of more than 70 sounded by Credit Suisse to gauge interest in the deal.
Sebi’s enforcement action is a rare citation of a foreign firm. It also calls attention to the regulator’s focus on insider trading in India, especially since proposed new regulations are still in the consultation phase.
“This is not the first time in which Indian regulators have gone after an offshore investor, but it’s the first time they have in an insider trading context,” said Sandeep Parekh of Finsec Law Advisors and former head of enforcement at Sebi.
Banks must be prepared too. “This is a big warning for a lot of banks to have their house in order,” said Ajay Vaiya, head of legal and compliance at Kotak Mahindra Securities.
KEY TAKEAWAYS
Sebi’s interim order against Factorial Master Fund is a rare action against a foreign institutional investor;
Banks must ensure that they are not distributing price-sensitive information to their clients by developing appropriate systems and training programmes;
Sebi is expected to continue focusing on disclosure, with a consultation on its insider trading regulations expected. It will also look into secondary market disclosure.
Market sounding
Over 70 investors were sounded before L&T Finance Holdings’ OFS, although it’s unclear what information they were given and whether they were wall-crossed.
In its order Sebi inferred that Factorial was in possession of information about the likely floor price of the OFS, although it did not implicate the broker.
There is no set regulatory guidance on market sounding or wall crossing, said Sandip Bhagat of S&R Associates, who added that banks should be reasonably prudent. “There’s nothing that says that brokers should not or cannot approach investors, but Sebi also hasn’t set anything in stone to say that this is the preferred way that banks should be behaving,” he added.
Instead banks must strengthen their own internal guidelines on how they should tackle trades, and the insider trading regulations and the code of conduct must be kept in mind.
Vaidya added that two things are important: one is establishing procedures and the second is training employees. “That’s very important: you must keep recirculating and retraining employees on your policies regarding confidential information,” he said.
He noted that India’s market participants don’t yet have established practice on market sounding, and terms are still developing from a regulatory perspective. “In the meantime, this is a signal to take the most conservative approach to go forward,” he added.
Future regulations
In December of last year a Sebi panel chaired by Justice NK Sodhi submitted its report on new insider trading regulations; these were much stricter than existing rules. Sebi has not yet released a consultation paper based on these recommendations because they’ve encountered significant market resistance.
The proposed rules do not include guidance on market sounding and wall-crossing. But banks must be conscious of the fact that insider trading can be very broadly interpreted: “A lot of jurisdictions today depend on parity of information versus the standard of the fraud,” said Parekh.
He believed that Sebi will provide some broad guidance on market sounding, although he doubted that the regulator would introduce a set of new regulations. “It has enough to do with the draft regulations on insider trading,” he added.
But Bhagat wasn’t sure whether the regulator would act. “I’m sure people have informally discussed this with Sebi but I haven’t seen the regulator issue guidance on how one can wall-cross,” he said.
He agreed that the insider trading regulations will form the basis for most investigations on market sounding. Sebi will go back to the insider trading regulations and the defences available there, focusing on whether a bank is compliant, whether there were Chinese wall in place and whether it had a set process for these soundings.”
Disclosure will remain an important issue for the regulator, especially in the secondary market. It may also next consider regulations issued to the stock exchanges.
Generally ongoing disclosure is poorer in India than in the US, he added. “I believe there should be more detail such as that required under the 10K and 10Q annual and quarterly reports in the US, including more continuous, immediate and detailed disclosure of material transactions and public filing of material agreements.”
See also
India private placement changes to broaden market
India block trades: underwriting clarifications needed