SEBI's attempts to improve corporate governance are also an unending battle against tech smokescreens, business complexity and rogue elements

SEBI says both unusual trading patterns and material non-public information will be challenged.

Perhaps a fallout of the recent controversies, SEBI has released a flurry of consultation papers, three of which relate to corporate governance in securities markets - suspicious trading activities, review of Unpublished Price Sensitive Information (UPSI) definition, and regulation of Foreign Venture Capital Investors (FVCIs).

The first one is the most ambitious. While its new alert generation models picked up around 5,000 alerts during the year 2022 (involving 3,588 unique entities) with as many as 97 entities appearing repetitively for five or more times, it could not act on many as it was unable to gather evidence to establish “preponderance of probability”.

Changing Tack On Suspicious Actions

Modern tech that violators deployed (encrypted technologies, disappearing messages) made it extremely tough. Besides, the differing evidence requirements of different laws also posed a challenge. It therefore seems to have taken a different approach now proposing a new regulation that would establish presumptive guilt based on suspicious actions that are not satisfactorily rebutted, quite like the Income Tax department.

It sums up the approach in a neat equation STA = UTP + Existence of MNPI. What this means is if Unusual Trading Patterns (UTP) co-exist with Material Non Public information (MNPI) that would amount to suspicious trading activity (STA), which if not rebutted satisfactorily will attract prosecution.

To be sure, SEBI says both unusual trading patterns and material non-public information will be challenged, but it hopes to win the battle by shifting the burden of proof on the accused, instead of itself chasing evidence. This is bound to be challenged in courts as this reverses the generally accepted innocent-until-proven guilty principle, but nevertheless marks a new approach in the battle against bad practices.

Dealing With Price Sensitive Information

The second paper is about reviewing the definition of Unpublished Price Sensitive Information (UPSI) under the SEBI (Prohibition of Insider Trading) Act. The definition has had a longish history. Based on a SEBI committee recommendation in 2017, the insider trading material disclosure requirements were pruned by leaving out the disclosures under the Listing Obligations and Disclosure Requirements (LODR) as they were seen as excessive.

But now, with the benefit of its actual experience with UPSI disclosures of listed entities, SEBI feels that companies failed to live up to expectations. Out of the 1,100 press releases made by the top 100 listed companies between January 2021 and September 2022, only 18 were categorised by them as UPSI (price-sensitive) while SEBI believes the number to be far higher at 227, based on a 2 percent price movement criterion post-release.

The fallout of under-reporting was that SEBI’s surveillance alerts on suspected insider trading transactions also failed to go further because MNPI (material disclosure) was supposed to work in tandem with the UTP that its surveillance system throws up – the equation in the earlier paper. But SEBI’s solution to fix the non-disclosure problem seems to be more disclosures, which is what the paper proposes by including the Regulation 30 disclosures of LODR also under this framework.

The point is that the onus of disclosure is still on the entities, but SEBI perhaps believes that by sufficiently widening the ambit of materiality, entities will find it difficult to escape disclosure. Whether this will work is a moot question, but SEBI also needs to tweak its surveillance systems alongside legal reforms. If it is any comfort, insider-trading cases are the hardest to establish everywhere in the world.

Ensuring Genuine Foreign VC Fund Flows

The third paper on streamlining regulatory framework for Foreign Venture Capital Investors (FVCIs) seems more benign as all it seeks to do is to align the registration requirements of FVCIs with those of Foreign Portfolio Investors (FPI). But the norms for FPIs are very stringent (for instance, controlling investors only from permitted foreign jurisdictions and from countries that have strategic anti-money laundering measures).

With FVCI being one of the three routes for inward foreign capital, the intent is unmistakable. There are already restrictions in place for eligible sectors and the tightening of investor criteria is only to ensure that genuine venture capital funds flow in.

There are two other important changes: One, the responsibility of scrutiny and registration shifts from SEBI to designated depository participants (who already do the job for FPIs); and two, RBI approval is being done away with. Whether all of this would impact FVCI flows remains to be seen, but as of March 2023 there were only 269 FVCIs with a cumulative investment of Rs 48,286 crore.

SEBI has travelled a long way in making markets safe for investors, but this is an unending battle as the pressure from the forces of technology, business complexity and rogue elements will be relentless.

SA Raghu is a columnist who writes on economics, banking and finance. Views are personal and do not represent the stand of this publication.