SEBI’s Insider Trading Combat: Navigating the Terrain of the Structured Digital Database. - MMJC

In the dynamic landscape of financial markets, integrity and transparency stand as linchpins. Guarding against unethical practices like insider trading remains a top priority for regulatory bodies worldwide. In India, the Securities and Exchange Board (SEBI) embarked on a transformative journey five years ago, unleashing a Structural Digital Database (SDD) aimed at severing the threads of insider trading—a move that redefined market surveillance and integrity.  Since the establishment of the Prevention of Insider Trading (PIT) framework, SEBI as the primary overseer of securities markets, has consistently refined its arsenal to fulfil its responsibility of ensuring market integrity, preventing malpractices, and safeguarding investor interests.

A notable addition to SEBI’s digital surveillance toolkit as stated above is the ‘Structured Digital Database’ (SDD), incorporated through the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2018, effective from April 1, 2019. The implementation of the structural digital database streamlines the process of tracing the flow of Unpublished Price Sensitive Information (UPSI). With this innovative system, seamlessly tracking the origination of UPSI, monitoring its flow, and ascertaining its destination, ensures a robust mechanism for maintaining confidentiality and integrity in sensitive information transactions. The introduction of SDD into the PIT landscape is spread over last five years. However, its implementation still presents occasional challenges for market participants.

This piece offers a concise overview of SDD, which is increasingly emerging as a potent tool for SEBI in investigating matters related to suspected insider trading. There have been various cases where SEBI has sought extracts of SDD as a part of adjudication process. Infosys, Zee Telefilms, are some popular names where SDD extracts were sought for investigation purpose. Stock Exchanges have also been actively asking for SDD extracts for general inspection purpose and when there is some highly material information having significant impact on price is a standpoint that SDD is here to stay for long.

Decoding Structural Digital Database (SDD)

The Structured Digital Database (SDD) is a mandated electronic repository established under the SEBI (Prohibition of Insider Trading) Regulations, 2015, subject to periodic amendments. According to these regulations, entities entrusted with UPSI are obligated to maintain this digital database. It serves as a comprehensive record, encompassing details of individuals involved in sharing UPSI, including both the parties disclosing the information and those receiving it. This requirement extends beyond listed companies to include intermediaries such as merchant bankers, asset management companies, stockbrokers, as well as fiduciaries like auditors, transaction advisors, law firms and consultants. It functions as an electronic ledger, cataloguing individuals with access to UPSI, thereby enhancing transparency and regulatory compliance.

https://www.sebi.gov.in/enforcement/orders/may-2021/interim-order-in-the-matter-of-insider-trading-in-shares-of-infosys-limited_50378.html

https://www.sebi.gov.in/enforcement/orders/aug-2021/interim-order-in-the-matter-of-insider-trading-in-shares-of-zee-entertainment-enterprises-ltd_51820.html

Having said the same, anyone and everyone who is in the periphery, dealing and engaging with listed entities are to ensure that SDD is maintained.Top of Form

Why SDD?

The introduction of the Structured Digital Database (SDD) stems from the imperative to create a transparent and traceable record of the legitimate flow of Unpublished Price Sensitive Information (UPSI). The Committee on Fair Market Conduct emphasized on the challenges faced by companies when UPSI, shared for legitimate reasons, potentially gets misused for insider trading. In such cases, establishing a clear link between the company and the recipient becomes challenging, hindering effective regulatory action.

In response to these concerns, SEBI amended PIT regulations and bought into effect provisions relating to SDD that establishes an information trail. This trail serves as a valuable tool for SEBI and stock exchanges during investigations into insider trading matters, enabling a more thorough and efficient examination of information flows. Some prerequisites mandated for maintaining SDD security and compliance include having systematic internal servers secure enough and password protected, timestamps as to when is the entry made by the person first having access to UPSI, tamper proofs – evidence that SDD cannot be tampered with, and access rights limited to authorized personnel only.

For listed entities, SDD compliance forms an integral part of the Annual Secretarial Compliance Report, which is prepared by an independent practicing company secretary and submitted to stock exchanges. This comprehensive adherence to SDD requirements underscores the commitment to data security, regulatory compliance, and the integrity of information sharing practices.

Key Challenges in Implementing the Structured Digital Database (SDD)

The Dilemma: 

The expansion of entities required to comply with SDD regulations, as codified in the amendment to the PIT Regulations, has led to uncertainties regarding applicability. Entities, especially those not regularly handling Unpublished Price Sensitive Information (UPSI), grapple with whether maintaining an SDD is necessary based on their exposure to listed entities or if relying on the data held by listed companies is sufficient.

Recognizing details: 

The definitional conundrum i.e., differentiating confidential information from UPSI is a hardship.  Having said this determining what information should be entered into the SDD poses as another common challenge. The subjective nature of identifying UPSI and its linkage to the maintenance of SDD prompts questions about the scope of confidential information that qualifies. For instance, during corporate actions, entities face dilemmas such as when to commence SDD

  Para 2.3 of the Report of the Committee on Fair Market Conduct dated August 8, 2018

https://www.bseindia.com/markets/MarketInfo/DispNewNoticesCirculars.aspx?page=20230316-14

maintenance and whether every stage requires data entry. The origin of corporate action ideas from external consultants adds another layer of complexity.

Frequency of Occurrence: 

The frequency and timeline for entering information into SDD present ongoing questions for entities. While the PIT Regulations lack specific timelines, regulatory expectations favour real-time and immediate updates upon information sharing. Determining the optimal time to enter information into the SDD and making entries is critical. Designated persons till date see it as an obstacle as to when and how many times the entry should be made in SDD. The determination of the start date of UPSI often poses challenges.

Awareness:

Creating awareness and ensuring the entry into SDD is a significant challenge, accompanied by the percolation of data throughout the system. For individuals unfamiliar with the legal intricacies or those who are not well-versed in the regulations, the consequences of omitting their entry in SDD can be severe. According to the established code of conduct, the penalty meter is set in motion, and the repercussions are unforgiving. It underscores the critical importance of adherence to protocol, emphasizing the need for vigilance and compliance in order to avoid the potentially brutal consequences that may follow.

Reach: 

All individuals, whether designated or not, internal, or external, with access to UPSI must be included in the SDD. This invites procedural constraints for entities, raising challenges in recording information for all relevant persons. Ensuring comprehensive coverage of individuals within or outside an organization is a complex task. Because once the name is entered in SDD, measure is enacted – i.e., PAN frozen. With this freeze, designated persons are restricted from trading as they possess and have access to UPSI. Complications arise, particularly in joint ventures or collaborations, where sharing PAN data might be challenging. However, the significance of providing accurate information cannot be overstated, as non-compliance with this protocol brings about stringent consequences, reinforcing the necessity for comprehensive tracking and adherence to regulatory guidelines.

Concord/Synchronization: 

The necessity for both information providers and recipients to maintain SDDs introduces a requirement for clear alignment. Any disparity in the SDD during regulatory scrutiny could lead to reputational risks for the involved entities. Having quoted this the responsibility of maintaining the SDD extends beyond individual companies to encompass group entities. Having the individual companies and group companies being in sync is a daunting task.

Heightened Regulatory Oversight

SDD compliance has gained regulatory attention, with stock exchanges inspecting systems maintained by listed entities. Non-compliance led to entities being flagged as SDD non-compliant on exchange websites. Regulatory requests, often seeking SDD extracts, have become routine for listed companies, intermediaries, and investors associated with listed entities. This heightened regulatory focus makes SDD compliance a critical aspect of capital markets and M&A transactions involving listed entities.

Important decisions taken by promoter and not necessarily by management: 

SDD should not be limited to management decisions alone; it should also encompass significant decisions taken by promoters. This inclusive approach ensures a comprehensive record of pivotal decisions that influence the company’s trajectory. This as well becomes a challenge as promoters may take decisions which shall lead to significant material change in company’s share price but entry in SDD may be a miss shot.

The Impact Unveiled

Unprecedented Transparency

SEBI’s database revolution brought forth an era of unparalleled transparency. Tracking market movements, trade patterns, and investor behaviour became seamless, fostering an environment where suspicious activities could be swiftly identified and investigated.

Statistics from the inaugural year showcased a marked increase in the detection of irregularities. Reports indicated a staggering 50% surge in flagged transactions, underscoring the system’s efficacy in unearthing potential instances of insider trading.

Dismantling Insider Trading Networks

Insider trading, once veiled in obscurity, faced a formidable adversary in the digital database. Notorious instances of confidential information misuse, which previously slipped under the radar, now met swift intervention. SEBI’s data-driven approach dismantled several clandestine networks, leading to high-profile convictions and deterrent penalties.

Notable cases include Suumaya Industries, where real-time analysis of trading patterns exposed coordinated insider trading. This revelation led to landmark convictions, instilling a sense of accountability, and dissuading future malpractices.

Looking Ahead: Continual Evolution and Challenges

While the digital database heralded a paradigm shift, the journey toward fortifying market integrity is an ongoing endeavour. SEBI continues to refine its systems, embracing emerging technologies like artificial intelligence and blockchain to bolster surveillance capabilities further.

However, challenges persist, including adapting to rapid technological advancements and addressing data privacy concerns. Striking a delicate balance between surveillance and individual privacy remains a focal point in the regulatory landscape.

Conclusion: 

SEBI’s directive for maintaining an SDD underscores its commitment to transparency and integrity in India’s securities markets. By enforcing accountability and ensuring a traceable record of UPSI dissemination, SEBI aims to regulate the flow of information within and outside organizations. However, the looming risk of regulatory action due to challenges in SDD compliance necessitates a thoughtful and nuanced approach for entities involved in handling information related to listed securities. Navigating these challenges demands careful consideration and strategic planning.Top of Form

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This article is published in Taxman. The link to the same is as follows: –

https://www.sebi.gov.in/enforcement/orders/oct-2023/adjudication-order-in-the-matter-of-suumaya-industries-limited_78629.html

https://www.taxmann.com/research/company-and-sebi/top-story/105010000000023689/sebis-insider-trading-combat-navigating-the-terrain-of-the-structured-digital-database-experts-opinion

This article is written by: –

CS Vallabh M Joshi – Senior Manager – RND Team – vallabhjoshi@mmjc.in

CS Hasti Vora – Research Associate – RND Team – hastivora@mmjc.in