What is Insider Trading?

Have you ever wondered how certain investors consistently seem to have insight into the optimal timing for buying or selling stocks? The answer could lie within a practice known as insider trading. The word may seem intricate initially, but it revolves around a single concept: exploiting undisclosed information to gain an unfair advantage in the market.

In today’s blog, we will explore the basics of insider trading, SEBI’s regulation to curb it, and several Indian instances of Insider Trading.

What is Insider Trading?

Insider Trading involves buying or selling stocks or other financial instruments based on non-public material information that could significantly impact the stock price.

For instance, imagine a company’s CEO who knows they are about to announce a new product that will be a massive success.

If the CEO buys the company’s stock using this information before the announcement, it would be considered insider trading.

Insider trading is illegal because it enables some individuals to benefit from the market unfairly. It disrupts fair competition between investors.

SEBI Regulations for Insider Trading

Earlier, there were no specific regulations for insider trading. The Sachar Committee (1979) found the need to create rules to prevent insider trading.

Later, after establishing the SEBI, it introduced the (Prohibition of Insider Trading) Regulations, 1992, which defined insiders and UPSI (Unpublished Price Sensitive Information) and set restrictions on insider trading activities.

SEBI regulations were amended multiple times throughout the decades for various reasons.

Currently, Insider trading rules in India are explained in the SEBI (prohibition of insider trading) regulations, 2015.

According to regulations, an insider refers to someone who is either a connected person or has possession of or access to UPSI, regardless of how one came in possession of or had access to such information

*UPSI stands for Unpublished Price Sensitive Information, which means any information that is not yet public but could significantly impact a company’s stock price. For example, mergers that will happen in the future, the release of new products, financial results, dividends, change in key managerial personnel, etc.

Restrictions on communication and trading by insiders are as follows,

• Insiders cannot share confidential information about a company’s financial details with others unless necessary for their job or legal requirements.
• An individual cannot obtain or request insider information about a company or its securities unless it is for valid reasons or legal obligations.

Additionally, it is suggested that the company’s board of directors create a policy to determine ‘legitimate purposes’ as a part of the ‘Codes of Fair Disclosure and Conduct’ under regulation 8.

Insiders cannot trade securities listed or planned to be listed on a stock exchange if they have unpublished price-sensitive information unless and until they can prove their innocence by showing that they were involved in a private trade with another insider who had the same secret information and that they did not break any rules. Both parties must have made a deliberate trade decision, and trade should be reported to the company within two days. Companies must inform the stock exchanges where their securities are listed within two days of receiving the information.

Insiders can create a trading plan and submit it to the compliance officer for approval and public disclosure. They can then trade on that plan. The trading plan can be executed six months after its public disclosure. 

Furthermore, trading is not allowed between the 20^th trading day before the last day of a financial period and the second trading day after disclosing the financial results.

Companies should establish a code of conduct that clearly states the rules against insider trading for employees and designate a compliance officer to administer the code of conduct.

Indian Examples

1. Acclaim Industries

Abhishek Mehta, the director of Acclaim Industries and a company insider, sold his shares before a planned merger was called off. He engaged in insider trading by selling his shares before the public disclosure of the decision, which SEBI considers illegal. The SEBI fined him INR 42 lakhs for breaching insider trading regulations.

2. Rajat Gupta Case

Rajat Gupta, a former top McKinsey executive and Goldman Sachs member, was involved in a high-profile case. In 2012, he was convicted in the U.S. for sharing private company information with hedge fund founder Raj Rajaratnam and using the information for illegal trading.

3. Infosys Case

Infosys employees were accused of insider trading during the company’s financial results announcement in July 2020. The SEBI suspected that some Infosys employees traded the company’s stock while accessing UPSI (Unpublished Price price-sensitive information) about the company’s financial results.

Conclusion

To sum it up, insider trading is a serious issue in the Indian stock market, and SEBI has established clear regulations to prevent it. The high-profile cases and strict rules show that the market’s integrity and investor interests are protected. Both companies and investors must understand insider trading regulations to keep the financial markets fair.

FAQs (Frequently Asked Questions)