Facts of the case
A Ltd, an unlisted company, is going for Initial Public Offer [‘IPO’] of equity shares. Its IPO will open in two days. There is one individual [‘Mr. A’] who is a designated person of A Ltd. This designated person wants to subscribe to equity shares in the IPO. SEBI (Prohibition of Insider Trading) Regulations, 2015 [‘SEBI PIT’] states that if you have access to UPSI you cannot trade in shares of a company that is listed on a recognized stock exchange. Ideally this is applicable to trading in equity shares capital of companies which are listed. [1]As mentioned above, IPO of A Ltd will open in two days. So, can the designated person subscribe to equity shares in the IPO of the company?
I. Background: Proposed to Be Listed under the purview of SEBI PIT
Proposed to be Listed companies were brought under the purview of SEBI PIT on the recommendation of The High-Level Committee to Review the SEBI (Prohibition of Insider Trading) Regulations, 1992 [Sodhi Committee]. Sodhi Committee stated that ICDR Regulation provides for disclosure of material information necessary for making an informed decision in an IPO and hence insider trading could occur in the process of book building. It was further stated that in case of offer for sale an insider could take advantage of his access to UPSI and trade with investors in IPO without making such UPSI generally available in the prospectus of company.
II. Analysis – Literal rule of interpretation.
Regulation 4(1) of SEBI PIT states: “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insider shall trade in securities that are listed or proposed to be listed on a stock exchange when in possession of unpublished price sensitive information.” This prohibition applies universally to all insiders, not just designated persons. An insider is defined as any person who is a connected person or who possesses or has access to UPSI[2]. As per regulation 4(1) of SEBI PIT an insider cannot trade in securities of a proposed to be listed entity. Reg. 2(1)(l) defines ‘Trading’ under SEBI PIT[3]. Trading includes subscribing or agreeing to subscribe to securities. So, subscription or agreeing to subscribe to IPOs is also considered as Trading. Hence reading reg. 4(1) jointly with reg. 2(1)(l) an Insider cannot subscribe to IPO of a proposed to be listed entity.
Regulation 3(5) of SEBI PIT states that any entity required to handle UPSI shall a structured digital database in place. Structured Digital Database [‘SDD’] is record of persons having access to USPI. If any insider has access to UPSI then he cannot trade in securities of any company. So, if an insider has access to UPSI, his name would be entered in SDD then he cannot trade in securities of proposed to be listed entity. Further entities that are proposed to be listed are required to maintain SDD from the date of filing of prospectus.[4]
Now the question arises is whether this prohibition is still relevant in SEBI PIT? It also raises the question whether subscription to IPO by designated person is allowed in spirit of law?
III. Analysis – Purposive Interpretation.
Regulatory framework for a proposed to be listed entity
A Proposed to be Listed Company also follows the procedure/provision prescribed for listing under SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. A proposed to be listed entity files its DRHP with SEBI or stock exchange as the case may be. In case of proposed to be listed entity, SEBI (Issue of Capital and Disclosure Requirement) Regulations, 2018 [SEBI ICDR] mandates disclosure of updated material information in the draft offer document[5].
SEBI or stock exchange then gives its observation which are to be incorporated in DRHP. DRHP is also made available in public domain for comments. After incorporating observation and public comments the proposed to be listed entity files updated offer document/ RHP[6] with SEBI / SE. SEBI ICDR states that all the material information should be made available to proposed investors through RHP[7]. Accordingly, all material information is made available in public domain.
SEBI ICDR provides for reservation on competitive basis for employees of IPO bound companies[8]. SEBI ICDR states that retail investors can apply in IPO only at cut off price and hence they are not allowed to bid on price of shares[9]. As the shares are not listed on a recognized stock exchange and all material information is available in public domain, the purpose of SEBI PIT is not defeated in case an insider subscribes to IPO (i.e. trades in securities).
Conclusion
The current intersection of SEBI (PIT) and SEBI (ICDR) Regulations creates a unique regulatory paradox for “proposed to be listed” entities. While a literal reading of Regulation 4(1) of the PIT Regulations suggests an absolute embargo on insiders subscribing to an IPO, a purposive analysis reveals that the safeguards intended by the Sodhi Committee are now largely subsumed within the robust disclosure mandates of the ICDR framework. The regulator may consider re-evaluating the absolute prohibition of IPO subscriptions by Designated Persons (DPs) who are not in possession of UPSI. Just as the law has evolved to mandate the Structured Digital Database (SDD) to track the flow of information, the enforcement of PIT could shift from a blanket ban on the “act” of subscription to a compliance-based approach.
[1] If securities are not listed, they would not be amenable to price discovery – pg 19 Sodhi Committee report
[2] Reg. 2(1)(g)
[3] Trading” means and includes subscribing, 10[redeeming, switching,] buying, selling, dealing, or agreeing to subscribe, 11[redeem, switch,]buy, sell, deal in any securities, and “trade” shall be construed accordingly
[4] BSE and NSE circular October 18, 2024 – Certification of SDD maintenance
[5] Reg 24(5) of ICDR : Lead manager shall ensure that the information contained in DRHP and offer document and particulars as per restated audited financial statements in the offer document are not more than six months old from the issue opening date.
[6] Regulation 25(5), Regulation 26(3) of ICDR
[7] Regulation 24(1) of ICDR
[8] Reg. 33(1)(a) read with Reg. 33(2) of ICDR.
[9] Schedule XIII, Part A, Clause 12(o)
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