SEBI alerts banks to realize fiduciary duties for insider information

Fiduciary duties of banks in maintaining insider trading controls for shares of borrower companies 

– Pammy Jaiswal and Payal Agarwal | Partner | corplaw@vinodkothari.com 

Background

The SEBI Insider Trading Regulations (‘PIT Regulations’) explicitly rolled out the responsibilities for fiduciaries by amending the regulations in 2015. Subsequrently a separate Schedule C was inserted vide the SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2018 effective from April 01, 2019 which further outlined the responsibilities for fiduciaries. In the context of PIT Regulations, the term ‘fiduciaries’ refers to all such persons who are  get to handle clients’ unpublished information (UPSI) in course of their business operations, such as  bankers, merchant bankers, auditors, ,  law  firms, analysts and consultants [refer Para 3.1. of the Report of Committee on Fair Market Conduct]. 

While banks, because of their role and functions, are likely to have access to UPSI of borrower listed entities, listed banks have two distinct strands of responsibility when it comes to curbing and eliminating insider trading practices. In the first place, since their own securities are listed, the requirements of drawing up internal controls for their Designated Person(s) (‘DPs’) become applicable beside the framing of Code of Fair Disclosure for any sharing of UPSI in a fair and symmetrical manner. The second responsibility comes up as being fiduciaries for other listed entities, being their borrowers. In the course of its dealings with other listed entities, several price sensitive information are shared with a concerned group of employees of a bank which may be price sensitive and unpublished and hence, the list of such borrower entities, and the list of the bank’s officers dealing with such entities,  needs to be drawn up for maintaining the restricted list.

In this article, we have pointed out the unique position of listed banks when it comes to handling UPSI of other listed clients, its relevance, global scenario, judicial precedents and what should be the take and approach for such listed banks while handling UPSI for other such clients.

Uniqueness for banks to have access to UPSI

Banks would usually have a more regular, frequent access of such information about its clients, which may likely be in the nature of UPSI. These may include, for instance, :

1. Details of all major cash inflows or outflows of the listed entity, since the bank account through which such dealings are done is maintained with such banker
2. Monthly turnover or performance data is usually shared 
3. Business projections are shared at the time of sanctioning, monitoring and renewal of financing facilities 
4. Any stress conditions in the financial position of the listed entity etc.  

The dealing officer for the listed clients would have an early access to such information, and hence, may be considered as ‘insider’, pending a public disclosure of such information by the listed entity. 

The Chairperson of SEBI in his recent speech has also highlighted some purposes for which unpublished information may be shared with banks such as: 

• Sanctioning credit facilities – Before such financial entities sanction the credit facilities, it generally gets access to UPSI in the category of financial projections or any other relevant financial data.
• Debt restructuring & Settlements – During debt restructuring negotiations or repayment settlements, sensitive data on a company’s liquidity position becomes available to the listed financial institutions.
• Participation in the Committee of Creditors – When such financial institutions participate in the discussion of the Committee of Creditors for restructuring of stressed assets of other listed entities, they become aware of the strategic corporate decisions while they are unpublished.

The information asymmetry and access of UPSI with banks has also been indicated by the Sodhi Committee in the context of setting out principles for sharing of UPSI for due diligence purpose: 

“45. In an ideal world, the information that is generally available about any listed company in the public domain ought to be adequate for any and every investment in its securities. However, that is neither a true position nor a correct expectation is evidenced by even listed companies having to write detailed offer documents and prospectuses for securities offerings such as rights issues and follow-on public offerings. Banks that lend for acquisitions would need to conduct due diligence on a company’s operations…”

While such sharing of UPSI is expected to be for legitimate purposes, however, having access to such information makes it imperative for the listed banks to have concrete and conscious lines of internal control so as to avoid any undue usage of UPSI of listed clients for the gain of such DPs in any manner. 

Identification of Designated Persons while acting as fiduciary 

The identification of DPs in a fiduciary capacity requires designating such persons, who may, on the basis of their function and role in the organization, may be considered to have the ability to or have access to UPSI in relation to the clients of such fiduciary. In the context of a bank in a fiduciary relationship with a listed entity, the select group of persons, identified as DPs, based on their relevant role and functions may involve, for instance: 

1. Project finance team 
2. Credit department 
3. Restructuring department
4. Legal team etc. 

This implies that all the DPs of the listed bank as identified in its own Code of Conduct for the purpose of its own internal controls need not be included in the list of DPs maintained by the bank against the securities listed out in the restricted list or the grey list. The latter is expected to be drawn up by the listed bank considering the outreach and access of UPSI by its concerned employees in the specific departments of the listed bank.

Bankers as fiduciaries: judicial precedents of putting liability

There have been a few recent instances of insider trading related adjudication by SEBI on listed banks of the country. However, these largely pertain to dealing in the listed scrips of the banks by their Connected Persons, and not necessarily on the failure of fiduciary duties of the banks. Having said that, much of the insider trading regulations in India are built upon its counterparts in other western countries, including the US, UK, Singapore, Australia, etc. The concept principally remains similar across jurisdictions, although the manner of putting controls may vary.  Thus, in the context of fiduciary duties of bankers towards protection of inside information, reference may be made of the decisions of international courts. 

In one of the orders passed by the Financial Conduct Authority addressed to Mr. Ian Charles Hannan, a senior investment banker at JP Morgan was found to have shared information of its client company which was listed on the London Stock Exchange.

In another matter of the Federal Court of Australia in ASIC v Citigroup Global Markets Australia Pty Ltd [2007] FCA 963, one of the employees of the investment bank was found to have dealt in the securities of its listed clients.

In Affiliated Ute Citizens v. United States, 406 U.S. 128, 146 (1972), the Bank was acting as a transfer agent for the sellers. The Bank employees (Gale and Haslem) induced the sellers of the UDC stock to dispose of their shares without disclosing to them material facts that reasonably could have been expected to influence their decisions to sell. Withholding of such information, used by the employees for their personal gains, was considered to be in violation of Rule 10b-5 of the SEC, which prohibits “any device, scheme, or artifice to defraud” in connection with securities transactions. The Court further held that the liability of the bank, of course, is coextensive with that of Gale and Haslem.

In SEC v. Cherif, 933 F.2d 403, 405 (7th Cir. 1991), the matter pertained to an ex-employee, employed in a department dealing with confidential information of the clients of the Bank, using his access card even post his termination of employment to deal in the securities of the listed clients on the basis of material non-public information. The department was engaged in providing financing for extraordinary business transactions such as tender offers and leveraged buy-outs and hence, in the possession of UPSI pertaining to the listed clients of the Bank. The SEC brought civil charges under Rule 10b-5 against Cherif for insider trading, and such charges were affirmed by the Court on the context that as a former employee, Cherif continued to owe the bank fiduciary duties, even after the Bank terminated his employment.

In United States v. Salman, 137 S. Ct. 420 (2016), the Court of Appeals, Ninth Circuit, affirmed the conviction by the jury trial on the grounds that the disclosure of inside information about the clients to the relatives constituted a breach of the fiduciary duty of the employee of Citigroup, acting as an investment banker for such clients  The Court also cited the US SC in Dirks v. SEC, 463 U.S. 646 (1983), which states that: 

The elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.

Listed banks should get hyper or hiber(nate) over actionables?

Sensitisation of persons responsible for dealing with UPSI

SEBI Chairperson reiterated the importance of sensitizing the employees of listed banks on their roles and responsibilities as fiduciaries which shall give strength to the internal controls in the entity. In the absence of the above, drawing of internal controls by drafting a Code of Conduct or asking the DPs to seek pre-clerance or putting a trading window and a contra trade restriction, all of these will completely lose their relevance. 

The importance of sensitisation and various means by which sensitisation can be done effectively has been discussed in Sensitization: The key to implementation of PIT Regulations. An effective sensitisation framework is not limited to creating awareness through training only, but extends to a follow-up exercise of evaluating the understanding towards such principles. 

Relevance for fiduciaries to have a process for how and when people are brought ‘inside’ on sensitive transactions

As a part of the Code of Conduct, the fiduciaries are required to have a process for how and when people are brought ‘inside’ on sensitive transactions. This requires sensitising the recipients about their duties and responsibilities with respect to receipt of such information, the manner of dealing with the information and the liability that follows upon the misuse of such information. Further, the effective presence of Chinese walls in a bank also helps to restrict flow of information from one department to the other without having any legitimate purpose. 

Concluding Remarks

In view of the far reaching negative impact of a breach of fiduciary’s duties under insider trading regulations on the capital markets, SEBI has tried to send out an alert call for over ambitious listed banks which may not realize the nature of flaws in this regard of failing as a fiduciary The requirement for a fiduciary to protect and uphold the confidentiality of its clients has been there under the PIT Regulations for approximately a decade. It has been seeking  more and more attention by securing and exhibiting an exclusive mention under the PIT Regulations itself and getting listed companies including listed banks to draw up and implement robust internal controls. 

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Read More:

Prohibition of Insider Trading – Resource Centre