Connected person

Insider trading law has to settle one question before it can settle anything else: was this person close enough to the company to have known?

The SEBI (Prohibition of Insider Trading) Regulations, 2015 answer it with the idea of a connected person, and deliberately not with a list of job titles. Anyone who is, or has been during the six months prior to the concerned act, associated with a company in any capacity — directly or indirectly — is a connected person, provided that association allows, or is reasonably expected to allow, access to unpublished price sensitive information.

Frequent communication with the company's officers is enough. So is a contractual, fiduciary or employment relationship, a directorship, or any professional or business relationship, whether temporary or permanent. The test is access, not designation — the definition is written to catch people who occupy no position in the company at all but are in regular touch with it and know how it is running.

The definition works in two limbs.

Limb one — the association test. A six-month look-back, any capacity, direct or indirect. Whoever alleges the connection has to establish it, and the connection has to be one that puts the person in the way of price sensitive information.

Limb two — the deeming list. Twelve categories are deemed to be connected persons unless the contrary is established:

• a relative of a connected person;
• a holding, associate or subsidiary company;
• an intermediary specified in section 12 of the SEBI Act, or its employee or director;
• an investment company, trustee company or asset management company, or its employee or director;
• an official of a stock exchange, clearing house or clearing corporation;
• a member of the board of trustees of a mutual fund, or of the board of directors of its AMC, or an employee thereof;
• a director or employee of a public financial institution as defined in section 2(72) of the Companies Act, 2013;
• an official or employee of a self-regulatory organisation recognised or authorised by SEBI;
• a banker of the company;
• a concern, firm, trust, Hindu undivided family, company or association of persons in which a director of the company, his relative, or the company's banker holds more than ten per cent of the holding or interest;
• a firm, or its partner or employee, in which a connected person is also a partner;
• a person sharing a household or residence with a connected person.

The deeming is described in the regulations as a rebuttable legal fiction. It does not decide the case; it moves the burden.

Sunrise Pharma Ltd, a listed company, engages the law firm Kothari & Co in January to paper an acquisition. The board approves the deal on 10 May and the company announces it on 12 May. The share price moves from Rs 620 to Rs 790.

Who is connected?

Rekha buys 40,000 shares at Rs 620 on 2 May — an outlay of Rs 2.48 crore — and sells on 15 May at Rs 790 for Rs 3.16 crore. Profit: Rs 68 lakh.

SEBI does not have to prove that Anil told her anything. She is deemed connected, and therefore an insider; Regulation 4 then presumes her trade was motivated by the information in her possession. She has to rebut both the deeming and the presumption.

If she cannot, section 15G of the SEBI Act provides a penalty of not less than Rs 10 lakh, extending to Rs 25 crore or three times the profit made, whichever is higher. Three times Rs 68 lakh is Rs 2.04 crore, so that is the ceiling that actually bites here — the Rs 25 crore figure only governs where the profits are very large.

Chapter 7 (SEBI (Prohibition of Insider Trading) Regulations, 2015) opens with this definition, and it is the most heavily examined definition in the chapter. Expect questions that name a relationship — the company's banker, a stock exchange official, a flatmate, a firm in which the banker holds 12% — and ask whether that person is a connected person, and whether the status is established or merely deemed. The six months prior look-back and the more than ten per cent holding test are the two numbers tested directly.

• Connected person and insider are not the same word. Every connected person is an insider, but so is anyone in possession of or having access to UPSI, connected or not. The WhatsApp results-leak appeals turned on precisely that distinction.
• The deeming list is rebuttable, not conclusive. "Unless the contrary is established" is in the text; an option saying a relative is conclusively connected is wrong.
• It is six months prior to the concerned act, not six months before detection and not twelve months. A director who resigned five months ago is still connected.
• The clause (j) test is more than ten per cent, and the holding must be that of a director of the company, his relative, or the company's banker — not of any shareholder.
• Being connected establishes access, not guilt. Regulation 4 still allows the person to demonstrate an exonerating circumstance, such as a trade under an approved trading plan.
• Immediate relative — spouse, and a parent, sibling or child who is financially dependent or who consults the person on trading decisions — is a narrower, separate defined term used for the code of conduct. Do not substitute it for "relative" in the deeming list.