In today’s Finshots, we explain how a new consultation paper by the Securities and Exchange Board of India could help company insiders sell stock more easily.

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If you’re a top executive at a listed company, you almost always possess UPSI! Or Unpublished Price Sensitive Information.

For instance, you know when a merger discussion is underway. You know if the company is going to set up a new factory to increase capacity. You know if the sales haven’t been great during a quarter. And this information is exclusive to you. The public isn't aware of this in real-time.

It's called UPSI because when such information becomes public, it can impact the share price. Investors will assess what the news means for the company’s profitability and future. And then they’ll act on it. They’ll trade the stock and it can push the share price higher or lower.

So SEBI has rules in place to ensure that executives like you don’t indulge in ‘insider trading’. That you don’t buy or sell stock in the company if you possess what could be construed as UPSI.

That sounds fair, no? After all, no one should have an undue advantage over other investors and make profits just by virtue of one’s position.

Now here’s the thing. As a top executive, there’s also a high chance that a big chunk of your compensation is in the form of company stock. It’s a way for the company to align incentives — to ensure that your financial fortune is linked to the company’s success. If you take the company to greater heights, more investors will flock to the company, the share price will rise, and everyone wins.

But if you’re always in possession of the UPSI we mentioned, how on earth will you actually sell your stock?

Your financial planner might have told you to use your cash salary for daily needs and retirement planning and they might have asked you to sell your stock at regular intervals in order to fund your lavish holidays. But if the rules say that you can’t sell stock if you’re in possession of UPSI — which can be a perpetual affair — your holiday planning goes for a toss. Now you could still sell the stock and then try to convince SEBI that you didn’t have any other option or that the information you had wasn’t really UPSI, but that’s a cumbersome process. And SEBI could still find you guilty of insider trading at the end of the day. It’s a risky endeavour.

So, SEBI offers some leeway.

And it’s through something called a Trading Plan.

Think of it as an automated selling plan. Say you have 120 shares in your account on the 1st of January. You could create a Trading Plan and tell your company that you will sell 10 shares on the fifth day of every month. And you’ll do this over the next year. Like clockwork.

And because it’s predetermined, SEBI can’t accuse you of insider trading. Ever.

But here’s the thing, the rules can be quite rigid. For instance, imagine a war breaks out in some other part of the world and the markets crash. Ideally, you’d want to hold on to your stock and not sell at a loss. But just because of the automated trading plan, you might be in a bind. You’re forced to sell just to avoid scrutiny later.

That doesn’t seem fair, does it? And it appears that executives haven’t been too pleased with the Target Plan either.

So SEBI’s trying to rework the rules now. Make it a tad bit easier for insiders to sell.

For instance, one suggestion is to work within a price limit that’s set in advance. Let’s assume that the stock price is ₹100 on the day you set up your Target Plan. Now you could tell your broker to hit the pause button if the price is lower by 10% on the day the trade is to be executed. That way, you can wait and protect yourself from a loss. And SEBI’s working group has proposed a price band within +/-20% to solve this problem.

Another problem with the Trading Plan is that it involves a blackout period. By that, we mean that top executives aren’t allowed to buy or sell stock a few days before a company announces its quarterly earnings. It’s a prohibited time. And that’s because the regulator believes that there’s a high chance that insiders will have private and exclusive information, particularly during this period.

Now you have to ask, if there’s an automated selling plan in place, what’s the need for a blackout period?

Think about it this way. Assume that the company decides to announce the results for the January-March quarter on the 7th of May. As an executive, you know the profits have been subdued. And as a consequence, investors will sell and drive the price down. Your Trading Plan mandates that you sell on the 5th. So you get lucky and manage to sell a chunk of stock before the price drops. Doesn’t seem fair, no? But the reverse of this can also happen. The results might’ve been fabulous. But before it was announced, the plan forced you to sell. So you missed out on a possible gain you might’ve made had you waited. So yeah, over multiple periods, these things should average out.

And it seems like that’s how the SEBI working group is thinking too. So they want to do away with these blackout periods for Trading Plans.

Then there was a problem with the minimum duration of a Trading Plan too. Currently, these plans have to run for a minimum period of 12 months. So you can’t wake up one day and say, “I’m feeling spontaneous. I want to buy a holiday home in 6 months. So let me set up a Trading Plan to sell my stock before that.” Your holiday home would have to wait for at least a year. Actually it would have to wait for 18 months because once you propose a Trading Plan, there would be a cool-off period of 6 months. It’s only after this period that the first sale can be executed.

18 months seems like an awful amount of time to just sell shares, doesn’t it?

But now, SEBI proposes to cut this down drastically. It wants to keep the cool-off period to 4 months. And cut down the minimum duration to just 2 months. So this way, you could actually buy that holiday home in 6 months!

So yeah, if SEBI decides to remove these handcuffs and make the tweaks to its rules, it could make ‘insider’ selling much more easier to execute.

Until then…

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