[Opinion] Mutual Fund units now under the net of Insider Trading Regulations

[2022] 145 taxmann.com 178 (Article)

Numerous actionable for Asset Management Companies

Background

Investment in MFs are very common these days. As on March 31, 2022 there were about 1120 open ended schemes and 354 close ended schemes. Presently, in terms of Reg. 32 of SEBI (Mutual Funds) Regulations, 1996 every close ended scheme, other than equity linked savings scheme, are required to be listed on stock exchanges.

Until, the present amendment, SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’) were applicable in case of dealing in securities that are listed or proposed to be listed while in possession of Unpublished Price Sensitive Information (‘UPSI’). Units of mutual funds were excluded from the definition of securities under PIT Regulations and therefore, remained outside the purview of the said regulations.

The erstwhile PIT Regulations of 1992 was amended in 2002 to mandate Asset management Companies (AMCs) and Mutual Fund (‘MF’) Trustees to frame internal procedures and conduct for prevention of insider trading, pursuant to which any security which was purchased or sold or was considered for purchase or sale by the organization on behalf of its clients/ schemes of MFs was required to be put on the restricted/ grey list. Thereafter, at the time of finalization of PIT Regulations, the committee led by Mr. N. K. Sodhi felt that there is no longer a special need for a special or separate circular for a specific class of market intermediaries and therefore, the said circulars be withdrawn to ensure consistency. The definition of securities in the proposed draft of PIT Regulations forming part of the said report provided for the meaning assigned to it under the Securities Contract (Regulation) Act, 1956 (‘SCRA’) without any exclusion. It was also explained that an MF set up as a trust, that can issue units of close-ended schemes which are traded in the market would also be a ‘company’ for purposes of the proposed regulations. However, the PIT Regulations as approved by SEBI in its meeting held on November 19, 2014 excluded MF units from the definition of securities. The thought process, as indicated in a news piece, was that even if a person has inside information regarding one company, he cannot possibly take advantage on that information by investing in a scheme, which is a diversified pool of securities of various companies and that there existed strict and transparent norms of NAV (net asset value) calculations and offence of front-running was already covered under SEBI (Fraudulent and Unfair Trade Practices) Regulations, 2003.

Scope of SEBI Circular issued for employees of AMCs and MF Trustees

SEBI continued to regulate by way of issue of circulars for ‘Investment/ trading in securities by employees and Board members of AMC(s) and Trustees of Mutual Funds’, last compiled circular being issued on October 28, 2021. The guidelines are applicable to all employees of AMCs and MF Trustees and cover sale or purchase of securities made in the name of employees, either individually or jointly, or in the name of spouse or as member of HUF or in the name of immediate relatives, of any securities such as shares, debentures, bonds, warrants, derivatives and units of schemes floated by MFs/AMCs where the concerned persons are employed. The purpose of the guidelines is to ensure that employees and Board members of AMC, Board of MF Trustees, including Access Persons are not be able to take undue advantage of any sensitive information that may have about any company or its securities or about the AMC’s schemes or its units.

However, the circular only provided for prohibition in dealing while in possession of UPSI and disclosure requirements, and did not provide the entire framework to be followed with respect to communication, sharing, controls, internal reporting etc. This article discusses how the present amendment make all of these applicable on the AMCs and further actionable, in this regard. Detailed comparison of the amendments made with corresponding requirements under SEBI Circular is provided in Annexure A.

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