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What is Insider Trading?
An insider refers to a person who is a part of the company whose stocks they are trading. They may or may not possess confidential non-public knowledge regarding the firm. An insider can also refer to an individual owning more than 10% of the corporation’s equity stocks. Generally, directors, chairpersons and high-level executive members of a firm are insiders of that particular organisation.
In some cases, an insider may not be a part of the company but still hold extensive confidential information regarding stock performance from an actual executive of the firm.
Insider trading can be legal or illegal, based on the kind of material information the insider possesses. If the insider holds non-public information, he/she is legally prohibited from trading their existing equities for that company.
On the other hand, if the information is already public, these individuals can trade safely without invoking any legal action against them.
The Securities and Exchange Board of India or SEBI strictly regulates insider trading in India today. Any trader found in violation of the various regulations enforced by the government body is liable to pay severe penalties.
How Does SEBI Regulate Insider Trading?
SEBI perceives trading by the following groups or individuals as a form of insider trading. Therefore, any person coming under one of these categories should avoid trading equities for the firm for which they are classified as an insider.
- Immediate relatives of connected individuals or insiders
- An associated company or holding firm directly linked with the other corporation
- A high-level executive belonging to such a holding firm of the parent company
- An official working at a clearing house or stock exchange
- Asset management company board members or a trustee in mutual fund management companies
- A Board member or chairman of a public financial organisation
SEBI also restricts the procurement of Unpublished Price Sensitive Information or UPSI, unless required by law or legal proceeding.
Past Instances of Insider Trading in India
Even after several insider trading regulations by SEBI, convictions have been few and far between. For instance, in 2019, the regulatory body investigated as many as 70 instances of alleged insider trading but completed only 19 probes. Between FY15 and FY19, SEBI took up more than 140 of such cases.
Following are some recent instances of charges brought against companies by the SEBI.
- General Insurance Company
In October 2019, SEBI sent a notice to General Insurance Company or GIC informing the firm regarding impending insider trading investigations. In the notice, SEBI also provided a settlement offer to the insurance provider. In December the same year, GIC settled the charges by paying a penalty of around Rs. 1.23 Crore.
The IT company was found in violation of SEBI insider trading regulations when it failed to make public an allegation of a company insider regarding illegal trading. While the original complaint was filed on September 20, 2019, the matter came to light when the whistleblower mailed a copy of the same to the media a month later, in October.
In November, the lead independent director of Infosys, Kiran Mazumdar Shaw, settled the charges by paying a fine of Rs. 3 Lakh to SEBI.
- Rakesh Jhunjhunwala
Independent investor and billionaire Rakesh Jhunjhunwala was summoned by SEBI for alleged insider trading at Aptech Limited. As per reports, the regulatory body is investigating the period between February and September 2016. Apart from Jhunjhunwala, SEBI is also looking into his family member’s role in the matter.
- Balram Garg
Another high profile case of alleged insider trading came to light in December 2019, when SEBI sent a notice to PC Jeweller Managing Director, Balram Garg. At the same time, the government body ordered the impounding of around Rs. 8 Crore that two promoters and associated entities earned from suspected illegal trading.
There are countless more cases that are either pending or already complete that allege Indian insider trading. However, the conviction rate and the penalty that SEBI levies is generally quite limited. The government body has also come under severe criticism for improper enforcement of insider trading regulations.
The above-mentioned insider trading examples can give you an idea regarding a lack of conviction.
Many blame SEBI’s lax attitude toward the offence as the primary reason for growing cases of illegal trading of this sort. Still, as a responsible trader, you must understand the exact regulations that the authoritative body has laid down to reduce such instances of NSE insider trading.
SEBI Regulations against Insider Trading
Section 11(2) E of companies act, 1956 mainly prohibits insider trading for the following reasons –
- To provide equal opportunities to every participant in the market
- Ensure fairness and transparency in all transactions
- Offer free flow of information and prevent information symmetry
The following information is deemed sensitive. Possession of such information by a trader may expose him/her to insider trading litigations.
- Intended dividend declaration
- Periodic financial reports
- Buy-back or issuance of securities
- Major changes in policies or operative plans for the company
- Any upcoming takeovers and/or mergers
- Legal insider trading
In some cases, insider trading is legal. Such a trade is common since many employees of these public-traded firms also own stocks belonging to the company. The following example should help you understand legal insider trading.
Suppose there is an insider who plans to sell stocks of the company after their retirement for a specific period to earn returns. However, at a later date, he/she comes to possess UPSI. In this case, the trader may not be indulging in illegal insider trading, as they did not decide on selling their owned stocks based on the non-public information.
- PIT Regulation, 1992
According to the original legislation, companies needed to establish countermeasures to prevent the leakage of sensitive information. However, as per a 2019 update to the regulation, public firms need to have a plan in place to deal with such security lapses and information leakages.
With such stringent regulations against insider trading, attracting fine and/or imprisonment, investors need to ensure they do not partake in any such illicit activities, by knowing about the rules and regulations of the same.
- What is a trading plan?
The trading plan refers to predetermined trading initiatives that an insider or UPSI can formulate to trade legally. This is used so that even such people can take advantage of trading at a particular date.
- What is UPSI?
UPSI refers to Unpublished Price Sensitive Information. This is any sensitive, non-public information about a firm that can greatly impact the performance of its equities. Internal financial reports, impending mergers, a key change in company policies, etc. are classified as UPSI.
- Who can change the Code of Insider Trading for a company?
Only the Board of Directors of a firm can modify or change the code of insider trading if they deem fit to alter the current code.