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Nearly two years after they were first notified, insider trading regulations for mutual funds (MF) will finally come into force from November 1 this year. Such rules currently apply only to securities of listed companies or those proposed to be listed.
SEBI had issued a consultation paper on applying insider norms to mutual funds units in July 2022, followed by a notification in November. The delays in enforcing the law were mainly due to the industry pushback and operational hurdles in setting up common standards.
The new norms will require MFs to create a structured digital database (SDD) containing the nature of unpublished price sensitive information, a separate code of conduct for employees and additional disclosures -- increasing compliance burden significantly.
Scope of Insiders
No “insider” can trade in units of a mutual fund scheme when in possession of unpublished price sensitive information (UPSI), which may have a material impact on the net asset value of a scheme or on the interest of the unit holders.
“Insider” means a connected person or someone in possession of UPSI. The definition of a ‘’connected person” is very broad and includes any person who was associated with the mutual fund in the preceding two months in any capacity, even contractual or fiduciary. Auditors, accountancy firms, law firms, analysts, consultants, banks, valuation agencies, registrars and share transfer agents, custodians and credit rating agencies come under the ambit.
“Given the involvement of retail investors/public participation in mutual fund schemes and the recent front running cases, separate regulations to curb insider trading practices in the mutual fund industry was the need of the hour. While the proposed regulations would certainly help in curbing the insider trading, the compliance burden for the asset management companies would increase tremendously,” said Harish Kumar, Partner, Luthra and Luthra Law Offices India.
The Chief Executive Officer or Managing Director has to formulate a Code of Conduct to regulate, monitor and report dealings in mutual fund units by the designated persons and immediate relatives of such persons towards achieving compliance with these regulations. The SDD will be maintained internally and preserved for eight years after the transaction.
Defences against insider trading gains
The insider can prove his innocence by demonstrating that the transaction was an off-market inter-se transfer, or was carried out pursuant to a statutory or regulatory obligation or was triggered by systematic transactions or irrevocable trading plans.
Anil Choudhary, Partner, Finsec Law Advisors said, the new rules were excessive give the industry was already heavily regulated. “There has been exactly one single case in the MF history of over two decades where AMC senior officials misused the news that redemptions would be frozen soon. It’s like using a cannon to kill a bug,” he said.
Choudhary was referring to the Franklin Templeton episode, in which a few fund officials were accused of redeeming holdings in schemes that were about to be wound down.
The insider proposals for MFs had faced a pushback when they were first mooted, especially given the broad definition of ‘connected person’.
Experts still maintain that there is no need for separate insider regulations as the SEBI master circular for MFs already prohibits employees and directors from trading in MF units when in possession of UPSI.
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