SEBI Proposes Insider Trading Norms for Mutual Funds. Is It Practical to Implement?

July 27, 2022 Mutual Fund

The Securities and Exchange Board of India (SEBI) recently released a consultation paper in which it has proposed covering dealings in mutual fund units under the SEBI (Prohibition of Insider Trading) Regulations, 2015 (PIT Regulations). Currently, the PIT norms govern dealings in securities (stocks and bonds) of a listed or proposed to be listed company by any person in possession of unpublished price-sensitive information (UPSI). However, the units of mutual funds are specifically excluded from the purview of PIT Regulations.

The development came after SEBI observed that a Registrar and Transfer Agent of a Mutual Fund had redeemed all its units from a scheme, being privy to certain sensitive information pertaining to a scheme of Mutual Fund, which was not yet communicated to the unit holders of that particular scheme. Similarly, in another instance, a few key personnel of a Mutual Fund were found to have redeemed their holdings in the schemes while in possession of certain sensitive information not communicated to the unit holders of the schemes.

Therefore, SEBI felt the need to harmonise the provisions in PIT Regulations to initiate serious enforcement actions against those who misuse the sensitive non-public information pertaining to mutual fund schemes, directly or indirectly, to which they have access by virtue of their fiduciary capacity.

At the same time, SEBI is of the view that the regulatory approach should not be onerous. For instance, though a person may possess an UPSI pertaining to a security, he/she may not have knowledge of the existing portfolio of the Mutual Fund scheme or have any control over the fund manager’s decision. Accordingly, SEBI is considering including a separate chapter in PIT Regulations, specifically to cover transactions in the units of Mutual Fund schemes, both close-ended and open-ended, so as to avoid complexities and unintended consequences.

Just like in the case of securities, there can be certain material events which can affect the NAV of the schemes in a big way in the near future. Such events can arise due to various situations such as a scheme facing liquidity issues in its underlying securities, default/downgrade risk of issuers, merger/winding up of schemes, unusual redemption pressure in a scheme/s, the exit of a star fund manager, proposed change in investment objective/mandate of a scheme/s. In such cases, insiders who have access to such information that has not been made public yet, can make an unfair profit or avoid losses.

Are there existing guidelines in place to prevent insider trading in mutual funds?

There are already several SEBI guidelines in place that prevent employees of AMC, including Board members of AMC, Board members of Trustees, and other key employees, from transacting in the concerned scheme while in possession of certain sensitive information which has not been communicated to the unit holders of the scheme and which could materially impact the NAV or interest of unit holders.

In addition, SEBI provisions require concerned employees to seek prior approval from the Compliance officer to trade in units of mutual funds even if there is no unpublished information relating to a scheme. Furthermore, SEBI has taken various steps in the last couple of years to improve transparency related to mutual fund transactions.

Now, by bringing mutual funds within the purview of PIT Regulations, SEBI is looking to widen the ambit, thus making it easier to enforce the regulations.

The SEBI has outlined the definition of connected persons who may have direct or indirect access to UPSI or is reasonably expected to allow such access. It has also outlined reporting of transactions by designated persons, the code of conduct for designated persons and other persons, and defences available to an insider, among other provisions.

Are SEBI’s PIT norms for mutual funds practical to implement?

While SEBI’s move is well-intended, the proposed norms are easier said than done. The norms could prove to be too difficult to implement in practicality.

SEBI has proposed a long list of ‘connected persons’ who are directly or indirectly associated with the AMC and Trustees that will be brought under the definition of an insider, including but not limited to immediate relatives of key employees of the mutual fund/AMC, RTAs, an official or employee of Association of Mutual Funds in India, an auditor, legal Advisor or consultants of the Mutual Fund or Asset Management Company, an official or employee of the credit rating agency, a banker of the mutual fund or AMC, among others.

Considering the long list of connected persons, SEBI might find it challenging to prove who was in possession of inside information and at the same time has carried out the transaction to evade or circumvent the prohibitions of PIT regulations. It could also become difficult for connected persons to prove their innocence, if the need arises, since they are connected with AMC/mutual fund in one way or another.

This article first appeared on PersonalFN here