Why is Insider trading illegal in India?

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Why is Insider trading illegal in India?

Why is Insider trading illegal in India?:

  • Insider trading is the most unfair practice that is conducted in our country.
  • Anyone can make good money with the help of insider trading.

What is insider trading?

  • Insider trading involves the practice of trading in a public company’s stock by anyone who has non-public or material information about that stock for any reason.
  • Insider trading can be either illegal or legal, depending on the trade that the insider makes.
  • This sort of trading comes with a huge disadvantage and has several harsh consequences.
  • Insider trading in India is governed by the Securities and Exchange Board of India (SEBI) Act, 1992.
Why is Insider trading illegal in India? – Video By, Trading Fuel Team

What is insider trading in SEBI?

  • Insider trading is the malpractice in trading of listed company stocks in the market that is undertaken by individuals who, by virtue of their work, have access to non-public information about the company.
  • This individual can be a corporate officer, from the employees, board of directors, or someone who has received non-public information about the company.

Understanding insider trading:

Insider trading can be both legal as well as illegal.

We have to understand both.

Understanding insider trading
Image Credited: Trading Fuel || Research Lab
  • Insiders are legally permitted to buy or sell the shares of the firm or any subsidiary that employs them.
  • However, it is important to register such transactions with the Securities and Exchange Commission (SEC).
  • This can also be done with advance filings.
examples of legal insider trading
Image Credited: Trading Fuel || Research Lab

#2. Illegal insider trading:

  • The most infamous form of insider trading is illegal insider trading.
  • Here, there is the use of non-public material information for profit.
  • This type of trading can be done by anyone, including the company executives, their relatives, friends, or just a regular person.
  • For example, if the CEO of the company discloses the yearly earnings of the company to the barber, and if the barber with that information trades on it then it is considered as illegal insider trading.
  • The SEC may take action in this regard.
  • The SEC can monitor such trades by looking at the trading volumes of any particular stock.
  • Volumes of the trade increase dramatically after material news is issued to the general public, but when no such news is issued and the volume increases, then this can be considered as a warning sign.
  • The SEC will then determine in detail who is responsible for such trade and whether or not it was legal.

Why is insider trading illegal in India?

In most countries, illegal insider trading is banned as well as prohibited by making all the rules and practices criminalized.

The main reasons behind considering insider trading illegal in India are as follows:

main reasons behind considering insider trading illegal in India
Image Credited: Trading Fuel || Research Lab

#1. Unfair for other investors:

  • Insider trading is considered the most unfair practice to other investors in the stock market because they do not have access to the company’s information.
  • Through illegal insider trade, an investor with non-public information can profit more than a regular investor in the stock market.

#2. Morally wrong and has un-ethical terms:

  • It is morally wrong and is an unethical way to trade in the stock market through illegal means.
  • It is a common fact that all investors should get an equal opportunity to trade with the same piece of information about the company.

#3. Hampers the confidence of the people:

  • Insider trading in the stock market will reduce the confidence of the public in the trading process.
  • If the people who are investing in the stock market think that the market is unfair, they will not enter the market, and this will hurt the market conditions.
  • Stock trading by insiders in the company through its employees is permitted as long as it does not rely on material information, which is also not in the public domain.
  • Many jurisdictions across the globe require that such trading be reported and hence the transactions be monitored.

Most common insider trading cases:

The following are the most common examples of insider trading practices:

#1. Rakesh Jhunjhunwala:

  • Rakesh Jhunjhunwala was probed by SEBI in January 2020 on account of insider trading.
  • These allegations were based on trades he and his family made in the IT education firm Aptech.
  • Aptech is the only firm in his portfolio over which he has managerial control.
  • Here, SEBI questioned his wife, mother-in-law, and brother.
  • This was not the first time he has been questioned about insider trading.
  • It was in 2018 also, when he was questioned about insider trading in the shares of Geometric.
  • Rakesh Jhunjhunwala settled that case through the consent order mechanism.

#2. Rajat Gupta:

  • Rajat Gupta, a former member of the board of directors of Goldman Sachs, has been in the news and was convicted of insider trading charges in 2012.
  • The charges against him were for leaking the board room information about Goldman to Mr. Raj Rajaratnam, the founder of the Galleon group and a hedge fund investor, who in turn traded on that information.
  • The leaked information also included the news about Warren Buffett‘s $5 billion bailout at the height of the crisis, which in turn prompted Mr. Raj Rajaratnam to hedge himself against the fluctuations in the stock price.
  • Though Mr. Rajat Gupta and his friend were discussing the deal in their own position as real investors and had no such financial gain, the timing of the same and the fact that the reveal took place before the public announcement led to the conviction of insider trading.

How to avoid being implicated by insider trading?

After looking at the above cases, we get to know that simply dealing with all the non-public information can be just one step away from being accused of illegal insider trading.

The following are the steps that we need to follow to avoid this crunch:

  1. If you are an employee in an organization that requires you to deal with sensitive information, you have to be careful with whom you share your data.
  2. If you are not directly connected to the organization, you will have to identify the sources and whether they are connected to an insider or not.
  3. Generally, all the employees as well as the third-party players are required to sign a non-disclosure agreement.
  1. If you receive any data that is important to your trade, then you will have to verify whether that data is public or not.
  2. You can do this by checking through reliable public sources and if you find yourself in dilemma then you have to report the same to the authorities.
  1. You should not go looking for non-public information about the company from its personnel or from those who deal with it.
  2. This puts you at risk of being investigated if the information becomes public.

Insider trading vs. insider information:

  • Insider information is the knowledge of material related to a publicly traded company that will provide an unfair advantage to the trader or investor.
  • For example, let us suppose that the vice president of the company overhears the meeting between the CEO and the CFO.
  • One week before the company releases its earnings, the CFO tells the CEO that the company could not meet the sales demand and has lost money over the past quarter.
  • The vice president of the company knows that his friend owns the shares of the company and eventually warns the friend to sell the shares and look forward to opening a short position.
  • This is an example of insider information because the earnings are not yet released to the public.
  • Now let us assume that the friend then sells their shares and then shorts 5000 shares of the stock before the earnings are even released, then it is known as insider trading.
  • However, if the trade is done after the earnings are released, then it cannot be considered as an illegal trade because they did not have any sort of direct advantage over other investors.

If you can find anyone involved in insider trading, then this is considered a very serious consequence and requires legal assistance.

Frequently Asked Questions (FAQs)

Answer: Insider trading is an act of buying, selling, and dealing with the securities of a company with the possession of non-public or price-sensitive information.
Answer: SEBI Act, 1992 governs the insider trading rules.
Answer: An insider is required to submit the details of the holdings of himself and his relatives within 7 days of joining or being categorized as an insider.
Answer: An insider has to formulate a trading plan and also get it approved by the compliance officer. The value of the trades to be affected or the total number of securities purchased must be specified in this trading plan.
Answer: As an employee, you do not have any initial disclosures. However, if your traded value exceeds the threshold limit of Rs. 10 lakhs during the calendar quarter, then continuous disclosure is required.
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