Legitimate purposes
Also written Legitimate purpose
Sharing UPSI in the ordinary course of business with partners, lenders, advisers and similar parties — permitted under the PIT Regulations if not done to evade them; the recipient becomes an insider.
In plain language
A listed company cannot run its business without sharing some secret information. A bank lending money for a takeover needs to see the numbers. The merchant banker needs the deal terms. The auditor needs results that are not yet public. If every such talk were a crime, no deal could happen.
So the PIT Regulations ban sharing unpublished price sensitive information (UPSI), with three exceptions:
- to further legitimate purposes;
- to carry out duties;
- to meet legal duties.
"Legitimate purposes" is the exception for normal business. The rules also make sure it cannot be stretched into a back door.
How it works
The prohibitions it qualifies.
- Regulation 3(1): an insider shall not communicate, provide or allow access to UPSI to any person, including other insiders, except in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.
- Regulation 3(2): no person shall procure from or cause the communication by any insider of UPSI, except for the same three reasons.
The policy (Regulation 3(2A)). The board of directors of a listed company shall make a policy for determination of "legitimate purposes" as part of the Codes of Fair Disclosure and Conduct under Regulation 8.
What it includes. Sharing UPSI in the ordinary course of business by an insider with partners, collaborators, lenders, customers, suppliers, merchant bankers, legal advisors, auditors, insolvency professionals or other advisors or consultants — provided that such sharing has not been carried out to evade or circumvent the prohibitions of the regulations.
What happens to the recipient (Regulation 3(2B)). Any person in receipt of UPSI pursuant to a legitimate purpose shall be considered an "insider", and due notice shall be given to such persons to maintain confidentiality.
The paper trail (Regulation 3(5) and 3(6)). The board or head of every person handling UPSI must maintain a structured digital database of the nature of the UPSI, who shared it and with whom it was shared, with PAN (or another identifier where PAN is unavailable). It may not be outsourced, must have time-stamping and audit trails, and must be preserved for not less than 8 years after completion of the transaction. Information not emanating from within the organisation may be entered not later than 2 calendar days from receipt.
Deal-related sharing is a separate route (Regulation 3(3)). Sharing in connection with a transaction that triggers an open offer under the takeover regulations is allowed where the board is of informed opinion that it is in the company's best interests; for a transaction that does not trigger an open offer, the UPSI must also be made generally available at least two trading days before the transaction is effected. Parties must sign confidentiality and non-disclosure agreements (Regulation 3(4)).
A worked example
Illustrative facts. Godavari Agro Ltd (listed) is negotiating to buy a rival for Rs 1,200 crore. The CFO shares the draft terms and unaudited results with four parties.
| Recipient | Purpose | Legitimate purpose? | Consequence |
|---|---|---|---|
| Lead bank arranging Rs 800 crore acquisition finance | Credit appraisal | Yes — lender, ordinary course | Becomes an insider; gets a confidentiality notice; logged in the structured digital database with PAN |
| Merchant banker on the deal | Valuation and structuring | Yes — merchant banker | Same |
| Statutory auditor | Review of unaudited results | Yes — auditor | Same |
| CFO's brother-in-law, a "sounding board" | None | No | Communication in breach of Regulation 3(1); the brother-in-law is an insider in possession of UPSI |
Now the bank's credit officer mentions the deal to a friend, who buys 30,000 shares at Rs 540. After announcement the stock trades at Rs 610.
Profit = 30,000 × (610 − 540) = Rs 21,00,000
Section 15G ceiling = higher of Rs 25 crore and 3 × Rs 21 lakh (Rs 63 lakh) = Rs 25 crore
Section 15G floor = Rs 10 lakh
The company's sharing with the bank was legitimate — and the database entry proves who received what and when. The bank officer's onward disclosure was not, and because the bank received UPSI for a legitimate purpose, it and its officer were insiders from the moment of receipt.
Why NISM asks about it
Chapter 7 (SEBI (Prohibition of Insider Trading) Regulations, 2015), 6% of the paper, sets out Regulations 3(1) to 3(6); the phrase recurs in Schedules B and C, which require that no UPSI be communicated "except in furtherance of legitimate purposes, the performance of duties or discharge of legal obligations".
Expect a list question ("which of these is covered as a legitimate purpose"), the recipient-becomes-insider rule, and the database numbers — 8 years, 2 calendar days, not outsourced.
Common exam traps
- Legitimate purpose does not make the recipient an outsider. Regulation 3(2B) makes every recipient an insider, with a notice to keep the information confidential.
- The listed categories are ordinary-course business counterparts — partners, collaborators, lenders, customers, suppliers, merchant bankers, legal advisors, auditors, insolvency professionals, other advisors or consultants. A relative or friend is not on the list.
- The proviso bites: sharing "carried out to evade or circumvent" the prohibitions is not legitimate, whoever the recipient is.
- The board makes the legitimate-purposes policy, as part of the Codes of Fair Disclosure and Conduct.
- Procurement is prohibited too. Asking for UPSI without a legitimate purpose breaches Regulation 3(2), even if the asker never trades.
- Two trading days is the advance general disclosure required only for transactions that do not attract an open offer.
- The structured digital database is kept internally for not less than 8 years — not outsourced.
Check yourself
1.The objective of the SEBI (Prohibition of Insider Trading) Regulations is to prohibit insiders from ___________ on matters relating to insider trading.
- a)Dealing, communicating and counselling — all of these
- b)Dealing only
- c)Communicating only
- d)Counselling only
Show the answer
Answer: (a) Dealing, communicating and counselling — all of these
All three are prohibited, in separate provisions.
Communicating — Regulation 3(1): an insider shall not communicate, provide, or allow access to any unpublished price sensitive information, relating to a company or securities listed or proposed to be listed, to any person including other insiders except where such communication is in furtherance of legitimate purposes, the performance of duties or discharge of legal obligations.
Procuring — Regulation 3(2): no person shall procure from or cause the communication by any insider of unpublished price sensitive information... except in furtherance of legitimate purposes.
Trading — Regulation 4: 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.
You can breach these regulations without buying a share.
Section 15G of the SEBI Act penalises the same three — an insider who deals in securities... on the basis of any unpublished price-sensitive information, who communicates any unpublished price-sensitive information to any person, with or without his request, or who counsels or procures for any other person to deal.
Why the regulations exist: any dealing/trading done by an insider based on information which is not available in the public domain gives an undue advantage to insiders and affects market integrity. This is not in line with the principle of fair and equitable markets.
And the systemic answer: organisations must develop practices based on "need-to-know" principles for treatment of confidential information in their possession, backed by a structured digital database, a Code of Fair Disclosure under Schedule A and a Code of Conduct under Schedules B and C.
One exception runs through all three prohibitions — legitimate purposes, the performance of duties or discharge of legal obligations.
2.Organisations are required to develop practices for treatment of confidential information based on a _______________ basis.
- a)Need to know
- b)Ought to know
- c)Need not know
- d)May know
Show the answer
Answer: (a) Need to know
The phrase appears twice in the chapter.
Regulation 3(1) is intended to ensure that organisations develop practices based on "need-to-know" principles for treatment of confidential information in their possession, casting an obligation on all insiders who are essentially persons in possession of unpublished price sensitive information to handle such information with care and to deal with the information with them when transacting their business strictly on a need-to-know basis.
And it appears as the last of the Schedule A principles: handling of all unpublished price sensitive information on a need-to-know basis.
Both Schedule B and Schedule C repeat it: all information shall be handled within the organisation on a need-to-know basis and no unpublished price sensitive information shall be communicated to any person except in furtherance of legitimate purposes, the performance of duties or discharge of legal obligations.
Options B, C and D are not terms the regulations use.
What the principle means in practice. Information travels only to those whose work actually requires it — which is why the codes must contain norms for appropriate Chinese Walls procedures and processes for permitting any designated person to "cross the wall".
And why the movement of information must be recorded. Regulation 3(5) requires a structured digital database... containing the nature of unpublished price sensitive information and the names of such persons who have shared the information and also the names of such persons with whom information is shared.
The Piramal case turned on this test. SAT found that information about the sale of a healthcare division was given to Shri Anand Piramal and others only on a 'need to know' basis, because as a promoter he had to give an undertaking relating to multiple Clauses in the BTA like non-compete provision for 8 years.
He needed to know, so telling him was lawful.
3.What is a "legitimate purpose", and what follows for the recipient of UPSI shared for one?
- a)Any business reason, and the recipient has no obligations
- b)Sharing in the ordinary course of business with partners, collaborators, lenders, customers, suppliers, merchant bankers, legal advisers, auditors, insolvency professionals or other advisers or consultants — provided it is not to evade the regulations; and the recipient is himself considered an insider and must be given due notice to maintain confidentiality
- c)Only sharing with regulators
- d)Only sharing approved by SEBI in advance
Show the answer
Answer: (b) Sharing in the ordinary course of business with partners, collaborators, lenders, customers, suppliers, merchant bankers, legal advisers, auditors, insolvency professionals or other advisers or consultants — provided it is not to evade the regulations; and the recipient is himself considered an insider and must be given due notice to maintain confidentiality
Regulation 3(2A) states that the board of directors of a listed company shall make a policy for the determination of "legitimate purposes" as a part of "Codes of Fair Disclosure and Conduct" formulated under regulation 8. The term "legitimate purpose" shall include sharing of unpublished price sensitive information in the ordinary course of business by an insider with partners, collaborators, lenders, customers, suppliers, merchant bankers, legal advisors, auditors, insolvency professionals or other advisors or consultants, provided that such sharing has not been carried out to evade or circumvent the prohibitions of these regulations.
The proviso is the safeguard, which disposes of option A — a purpose invented to justify a leak is not legitimate.
Options C and D are far too narrow. The list expressly extends to commercial counterparties.
And on the recipient — Regulation 3(2B): any person in receipt of unpublished price sensitive information pursuant to a "legitimate purpose" shall be considered an "insider" for purposes of these regulations and due notice shall be given to such persons to maintain the confidentiality of such unpublished price sensitive information in compliance with these regulations.
Lawful receipt still makes you an insider — with all that follows, including the bar on trading under Regulation 4.
And it must be recorded. The structured digital database must contain the names of such persons with whom information is shared under this regulation along with the Permanent Account Number (PAN), entered within 2 calendar days where the information came from outside.
The concept links to the need-to-know principle — Regulation 3(1) permits communication only in furtherance of legitimate purposes, the performance of duties or discharge of legal obligations.
Piramal is the worked example. Information was given to a promoter who had to give an undertaking relating to multiple Clauses in the BTA like non-compete provision for 8 years, and SAT accepted it was shared only on a 'need to know' basis — the penalty for that charge being unsustainable.
Where this is taught
Free preparation for NISM Series III-ARelated terms
- Connected personA person whose association with a company in the six months before the act put them, or could reasonably be expected to put them, in a position to access unpublished price sensitive information.
- InsiderAnyone who is a connected person, or who simply possesses or has access to unpublished price sensitive information — possession alone is enough, with no relationship to the company required.
- Unpublished price sensitive informationInformation about a company or its securities that is not generally available and that would, on becoming available, be likely to materially affect the price of the security.
- Code of Fair DisclosureThe code every listed company's board must formulate and publish on its website under Regulation 8 of the PIT Regulations, setting out how it will disclose price sensitive information fairly and promptly.
- Exonerating circumstancesThe circumstances listed in Regulation 4 of the PIT Regulations that an insider who traded while holding UPSI may demonstrate to rebut the presumption that the trade was motivated by that information.
- Structured digital databaseThe tamper-evident internal register every handler of unpublished price sensitive information must maintain, recording the nature of the information and the PAN of everyone who shared it and received it.