Part 2: Trading While in Possession | CSL Module 5

2.1 The Trading Prohibition

Regulation 4 contains the central prohibition of the PIT Regulations -- no insider shall trade in securities when in possession of UPSI. This "possession-based" test is stricter than the "use-based" test in some other jurisdictions.

4(1) - Trading Prohibition

"No insider shall trade in securities that are listed or proposed to be listed on a stock exchange when in possession of unpublished price sensitive information."

Key Elements of the Prohibition

Insider Status: Person must be an "insider" as defined
Trading: Buying, selling, or agreeing to buy/sell securities
Listed Securities: Securities listed or proposed to be listed
Possession of UPSI: Having access to or possessing UPSI

!Possession vs. Use

India follows a "possession-based" test, not a "use-based" test. The prosecution need not prove that the insider actually used UPSI to trade -- mere possession while trading is sufficient. The burden shifts to the insider to prove the trade was not influenced by UPSI.

What Constitutes "Trading"?

2(1)(l) - Trading

"Trading" means and includes subscribing, buying, selling, dealing, or agreeing to subscribe, buy, sell, deal in any securities, and "trade" shall be construed accordingly.

The definition is deliberately broad and includes:

Market purchases and sales
Off-market transfers
Subscription to rights issues, FPOs, OFS
Exercise of ESOPs and stock options
Pledging of securities (in certain cases)
Agreement to trade (even if not executed)

!ESOP Exercise

Exercise of ESOPs while in possession of UPSI can constitute insider trading. Companies must ensure trading windows are open and designated persons do not possess UPSI before allowing ESOP exercises.

2.2 Communication of UPSI

Regulation 3 prohibits the communication of UPSI except for legitimate purposes. This provision targets the "tipper" in insider trading cases and is critical for understanding liability chains.

3(1) - Communication Prohibition

"No insider shall communicate, provide, or allow access to any unpublished price sensitive information, relating to a company or securities listed or proposed to be listed, to any person including other insiders except where such communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations."

Legitimate Purposes

UPSI may be shared for "legitimate purposes" which include:

Due Diligence: In connection with mergers, acquisitions, takeovers
Professional Services: To lawyers, auditors, investment bankers
Statutory Compliance: Regulatory filings and disclosures
Board Meetings: Preparation of agenda and board materials
Credit Rating: Sharing with rating agencies

TIPBest Practice

When sharing UPSI for legitimate purposes, always: (1) Execute confidentiality agreements, (2) Record details in the digital database, (3) Obtain acknowledgment of insider trading restrictions, and (4) Document the legitimate purpose.

2019 Amendment: Board Approval

The 2019 amendment requires that for sharing UPSI for legitimate purposes:

Board of directors must approve a policy for legitimate purposes
Such sharing must be recorded in the structured digital database
Recipients must be informed that they are insiders and bound by restrictions
For certain purposes, prior approval of the Compliance Officer may be required

2.3 Procurement of UPSI

Regulation 3(2) prohibits procuring UPSI from insiders. This provision targets the "tippee" who actively seeks UPSI rather than passively receiving it.

3(2) - Procurement Prohibition

"No person shall procure from or cause the communication by any insider of unpublished price sensitive information, relating to a company or securities listed or proposed to be listed, except in furtherance of legitimate purposes, performance of duties or discharge of legal obligations."

Active vs. Passive Receipt

Scenario	Liability	Regulation
Actively seeking UPSI from insider	Procurement violation + insider if trades	Reg. 3(2) + Reg. 4
Passively receiving UPSI	Insider if trades; no procurement violation	Reg. 4 only
Inducing insider to share UPSI	Procurement + aiding/abetting	Reg. 3(2) + SEBI Act

Procurement Scenario

A journalist contacts a company's CFO asking detailed questions about upcoming quarterly results. The CFO inadvertently confirms certain numbers. The journalist then trades on this information.

Analysis: The journalist violated Reg. 3(2) (procurement) and Reg. 4 (trading while in possession). The CFO violated Reg. 3(1) (communication). Both face liability.

2.4 Tipping Liability

Tipping liability creates accountability for those who communicate UPSI even if they do not trade themselves. The tipper becomes liable when the tippee trades, creating a chain of responsibility.

Elements of Tipping Liability

Insider Status: Tipper must be an insider or connected person
Communication: UPSI was communicated to another person
Not for Legitimate Purpose: Communication was not for permitted purposes
Trading by Tippee: Recipient traded on the information

!Remote Tippee Liability

Liability can extend through multiple levels of tipping. If A tips B, B tips C, and C trades -- all three can be liable. A as original tipper, B as secondary tipper and procurer, C as trader.

Tipper-Tippee Relationship

Tipper	Tippee	Tipper Liability	Tippee Liability
Director shares results with spouse	Spouse trades	Reg. 3(1) violation	Reg. 4 violation
Employee tells friend about merger	Friend trades	Reg. 3(1) violation	Reg. 4 violation
Banker shares deal info at party	Acquaintance trades	Reg. 3(1) violation	Reg. 4 violation

"The prohibition on communication exists precisely because the law recognizes that sharing UPSI creates an unfair advantage that corrupts market integrity, regardless of whether the tipper personally profits."SEBI Adjudication Order, 2019

2.5 Penalty Provisions

Violations of PIT Regulations attract severe penalties under the SEBI Act, including monetary penalties, disgorgement, and market bans. Understanding the penalty framework is essential for advising clients on risk.

Penalty Framework

Violation	Penalty (SEBI Act Section)	Maximum Quantum
Insider Trading	Section 15G	Rs. 25 crore OR 3x profit, whichever is higher
Communication of UPSI	Section 15G	Rs. 25 crore OR 3x profit, whichever is higher
Failure to disclose	Section 15A(b)	Rs. 1 crore
Code of Conduct violations	Section 15HB	Rs. 1 crore per day

Types of Orders

Monetary Penalty: Civil penalty imposed by Adjudicating Officer
Disgorgement: Return of ill-gotten gains with interest
Debarment: Ban from securities market for specified period
Directions: Cease and desist, restrictions on future conduct
Criminal Prosecution: For serious violations (rare)

!Disgorgement Interest

SEBI can order disgorgement of profits with interest at 12% per annum from the date of violation. In some cases, total disgorgement plus interest can exceed the actual profit made.

Factors Considered in Penalty

Disproportionate gain/unfair advantage: Quantum of profit/loss avoided
Repetitive nature: Past violations, if any
Market impact: Effect on market integrity and investor confidence
Cooperation: Level of cooperation with investigation
Voluntary disclosure: Self-reporting of violations

PRACTICESettlement Option

SEBI allows settlement of insider trading cases under the Settlement Regulations. Settlement typically involves payment of settlement amount without admission of guilt. Consider this option for clients where evidence is strong but quantum is manageable.

Key Takeaways

India follows a "possession-based" test -- trading while possessing UPSI is prohibited
Communication of UPSI is allowed only for "legitimate purposes"
Procurement (actively seeking UPSI) is separately prohibited
Tipping liability extends through chains of communication
Penalties can reach Rs. 25 crore OR 3x profit, whichever is higher
Settlement is available as an alternative to adjudication