This article has been written by Gunjan Hariramani and Pranjal Kinjawadekar, 5th year law students at Maharashtra National Law University, Mumbai
Introduction
Indian lawmakers have time and again enacted various laws to protect the confidential information of the parties. Several law firms often enter into agreements or form “Chinese wall policies” within their organisations to protect and prevent the leakage of confidential information. Additionally, it has also been observed that when competitors enter into an M&A transaction, there is an exchange of price-sensitive information and parties often use a “clean team agreement” to protect this information from falling into the wrong hands. Information protected under the Chinese wall policies or the clean team agreement can only be disclosed if any authorized body requires such information on a need-to-know basis.
This article delves into the nuances of Chinese walls, exploring their adoption in India, particularly mandated by the Securities and Exchange Board of India. Further, the article discusses the significance of clean teams, highlighting their role in M&A transactions, their absence in specific Indian regulations, and their potential integration into the regulatory framework. Through this post, the authors have attempted to analyse the ways of creating an information barrier in M&A transactions to protect the interests of the concerned parties and ensure the long-term integrity of the Indian corporate sector.
Chinese Wall – an internal information barrier
A Chinese wall is an internal information barrier which is established to prevent the unauthorized exchange of confidential information between different departments and individuals within a company or a firm. It is a virtual barrier within the company meant to prevent any conflict of interest and to ensure fair treatment. Chinese walls are becoming increasingly prevalent across a range of companies including those providing services of accountancy, law, and banking and financial services. To illustrate, for avoiding conflicts of interest, investment banks and brokerages employ Chinese walls in multiple departments such as research and trading. In a similar manner, if a law firm is representing two clients who are competing in a particular market, it may enforce a Chinese wall so as to prohibit the legal counsel representing both the clients from interacting with one another. Law firms, therefore, employ Chinese walls, which require lawyers engaged in different cases to isolate themselves, in order to prevent the exchange of unpublished price-sensitive information.
In India, Chinese walls were regarded by the Securities and Exchange Board of India (SEBI) as an internal tool for controlling information leaks among corporations. The “Minimum Standards for the Code of Conduct to Regulate, Monitor and Report Trading by Insiders” was a set of rules that became effective in 2002 and mandated that all listed companies install and maintain Chinese walls. According to the Schedule B of the SEBI (Prohibition of Insider Trading) Regulations, 2015, companies must implement a “Chinese Wall Policy” that keeps departments which deal with sales, marketing, investment advising, and other support functions apart from those that habitually have access to confidential information. Any price-sensitive information cannot be shared by the personnel in each division with other divisions.
For the companies, Chinese wall policies are regarded as a defence for insider trading under Regulation 4(1)(v) of the SEBI (Prohibition of Insider Trading) Regulations, 2015. These organisations can rely upon the Chinese wall policies instituted by them in order to establish that the members who had unpublished price-sensitive information were not the same as the people who decided to trade on their behalf thereby proving that the transaction was not triggered by the possession of unpublished price-sensitive information.
Moreover, Regulation 3(5) of the SEBI (Prohibition of Insider Trading) Regulations, 2015, mandates that a listed company must maintain an internal digital database that will contain the details of the unpublished price-sensitive information and the people with whom such information is shared. A similar database should be maintained by the intermediary with whom such information is shared under Regulation 9A(2)(d) and the Code of Conduct under Schedule C.
Apart from the Insider Trading regulations, under Regulation 29 and the Fourth Schedule of the SEBI (Depositories and Participants) Regulations, 2018, personnel in regulatory departments are not permitted to disclose any information about its regulatory functions to persons in other departments of the depository. This policy was introduced with the aim of segregating the functions of the regulatory divisions from the rest of the organisation and ensuring autonomy of regulatory departments.
Clean Team: an information barrier between two parties
M&A transactions require an exchange of confidential information between the parties and when the parties involved in the transaction are competitors or when there is a risk of a leak of confidential information, a clean team is used. A clean team is a secured facility where a team of experts review and analyse the sensitive information involved in the transaction and ensure that confidential information is not disclosed to unauthorized personnel.
When two or more companies decide to undergo a merger, due diligence is followed for integration planning, and in order to protect the target company’s trade secrets the merging companies agree to enter into a clean team agreement. The buyer and seller enter into a non-disclosure agreement at an outset of any takeover or merger transaction to protect each other’s information. It is important to note that a clean team agreement is a supplement to a non-disclosure agreement and not a replacement of a non-disclosure agreement. If the trade secrets of the target company were to be compromised, it could have a huge impact on the target company’s purchase price. Therefore, under a clean team agreement, access to the merging parties’ competitively sensitive information is limited to members of a clean team and is protected from getting leaked to any third party.
The use of a clean team in any M&A transaction not only helps in maintaining the confidentiality of the trade secrets and intellectual properties of the parties, but also helps in protecting the interests of the merging parties. Further, it helps in preventing any leaks of the sensitive information of the parties because it restricts access to a few people. A clean team helps in expediting the due diligence process. By bringing together a team of experts in a secure environment, a clean team enables a comprehensive review of sensitive information in a short period of time. Additionally, a clean team helps to evaluate the process of purchasing the target company by analyzing its valuation reports and divesting its assets to remedy any antitrust issues.
Although there are no provisions specifically regulating clean team agreements in India at present, in accordance with the Competition Commission of India’s (CCI) compliance manual, the utilization of a clean team may serve as an effective measure to minimize the risks associated with gun jumping. India’s merger control regime is suspensory in nature, where it does not permit the parties to consummate any step in a transaction if the transaction is above the threshold limit provided under Section 5 of the Competition Act, 2002. If the parties share commercially sensitive information in such a case without the CCI’s approval, it would be termed as gun jumping. By employing a clean team, the parties involved refrain from sharing price-sensitive information with each other, thereby ensuring compliance with relevant Competition Law regulations.
While a clean team agreement is a well-established practice in foreign jurisdictions such as the USA and the UK, it is gradually gaining recognition within the Indian jurisdiction. In 2013, the CCI imposed penalties on two entities for utilizing confidential bid-related information during the acquisition of a target company. This information was acquired to facilitate bid coordination for the procurement of broadcasting services. As a result of this case, it is contended that the implementation of clean teams became essential for two significant purposes: first, to safeguard sensitive information, and second, to avoid potential consequences under Section 3(3) of the Competition Act, 2002.
In the proceedings against Adani Green Energy Ltd., the CCI stated that though the clean team protocols have the potential to protect the sensitive information, it is necessary to follow all the procedures for forming the clean teams. It is significant to check the constitution of the clean team, the rules of engagement and the compliances mentioned in the CCI’s manual.
Further, the regulation of clean team agreements may also fall under the ambit of Regulation 9(2) of the SEBI (Prohibition of Insider Trading) Regulations, 2015. Regulation 9(2) of the aforementioned Regulations states that “The board of directors or head(s) of the organisation, of every other person who is required to handle unpublished price-sensitive information in the course of business operations shall formulate a code of conduct to regulate, monitor and report trading by employees and other connected persons towards achieving compliance with these regulations (emphasis supplied), adopting the minimum standards set out in Schedule B to these regulations, without diluting the provisions of these regulations in any manner.” In a clean room procedure, a group of professionals reviews the sensitive data, and any copies or notes created are disposed of after the review is finished. This prevents private information from being disclosed or exploited for individual gain especially for trading in securities of the concerned parties. Apart from the destruction of notes, a standardised code of conduct as mentioned under Regulation 9(2) could be incorporated to prevent the communication and transmission of unpublished price-sensitive information and the consequent insider trading.
Conclusion
Adopting resilient confidentiality safeguards like clean teams and Chinese walls is crucial for protecting sensitive data and preserving the integrity of business operations. India is a host to several information-heavy industries, including banking, technology, and manufacturing. Thus, there is an increased need for strict measures to prevent unauthorized disclosures and conflicts of interest.
Chinese walls are essential in Indian business environments as these policies clearly define the boundaries between various divisions or departments, stop unauthorized information flow, and adhere to legal standards. In the Indian M&A market, clean teams agreements play a critical role in ensuring secure information transmission during deals, fostering openness, and protecting the interests of concerned parties.
Moreover, after complying with the SEBI (Prohibition of Insider Trading) Regulation, 2015, Chinese walls effectively lower the danger of insiders abusing privileged information for personal advantage by establishing strong controls and information barriers to block the flow of sensitive information to unauthorized individuals. In a manner similar to this, clean teams’ agreements guarantee that confidential information is only accessible to those with a genuine need to know during essential business activities. By restricting the accessibility of potentially market-moving information, this limited access helps reduce the likelihood of insider trading.
The aforementioned measures not only safeguard confidential information but also promote stakeholder trust, assisting in the expansion and stability of the Indian corporate sector. By taking these confidentiality measures organisations in India can strengthen their commitment to transparency, ethics, and long-term value generation.
Keywords: SEBI, Mergers and Acquisitions, Insider Trading, Clean Teams Agreement