What Is Insider Trading and Is it Legal in India?
The main motive behind investing in various securities listed on stock exchanges is to attain massive wealth resulting in financial freedom and stability. Some chose the traditional path of analysis, study and intuition to create wealth. However, there are some who indulge in illegal and unethical means to gain profit.
Insider trading is one such way of investing and earning gains which is illegal in the eyes of law of the land. It involves buying, selling and underwriting of shares by key management personnel of the company who have access to sensitive and confidential information.
In this article, we will be discussing various aspects of this concept!
What Is Insider Trading?
It refers to stock trading carried out by an insider of the company by using unpublished price-sensitive information for personal gains. These insiders use some sensitive material, which can alter the behaviour of shares in trading, to earn huge profits.
As per the definition provided by the Securities and Exchange Board of India, an insider is an individual who has unfettered access to unpublished price sensitive information. They are classified as insiders if they are associated with the company for 6 months preceding such trading.
How Does Insider Trading Work?
Unpublished price-sensitive information (UPSI) of a company means information such as quarterly results, mergers and acquisitions deals, or any other important information that has not been made accessible to the public.
Suppose Mr Agarwal is working at a senior management level in a company. He comes to know some important and confidential information about the company. This information will lead to a significant rise in the stock price in the near future. If he passes on this information to his close associates and they buy shares in large numbers anticipating a rise in price, it is quite evident that Mr Agarwal has taken part in insider trading.
Once the price rises as per the expectations, the associates can sell the same and book profits. This entire process of trading by using one’s position to extract an unfair advantage is insider trading. However, it is important to know that although insider trading is illegal, it is not completely banned in India.
Some management personnel holding ESOPs may be trading the same by using information available to them. This practice will not come under insider trading if they inform SEBI about their actions.
Who Is an Insider?
Here are some individuals in a company who tend to participate in insider trading:
- Officials like directors, board members or employees of a company who undertake trading of shares of the company after accessing some confidential information.
- Friends, relatives, peers and family members of such individuals who buy or sell securities after getting information from them.
- Employees of the press, banking firms and legal houses who receive some undisclosed information during the time of providing some services to the company.
- Government officers who use unpublished information learnt from their office.
Therefore, it is not necessary that insiders are always members of the respective company. They can be individuals who receive undisclosed information from others and use it to exchange or transfer securities.
What Are SEBI Regulations on Insider Trading?
The Securities and Exchange Board of India (SEBI) had come out with a regulation in 2015 which dealt with restriction and regulation of insider trading activities in India. Under this regulation, any transfer of confidential information about the company is not allowed by an individual unless he/she is authorised to do so.
If a company’s employees and non-employees use such information for their gains, it is considered to be a criminal offence. It is punishable with an imprisonment of 10 years or a fine of ₹25 crores or three times the profit, whichever is higher.
As per rules notified by SEBI, the arbitrator can penalise parties concerned for all offences except those committed under Section 24 of the Companies Act 2013.
Insider trading is an unethical and illegal practice. Under this trading strategy, the members of the company take advantage of their position and gain an unfair advantage. You should gain complete knowledge about this concept to make sure that you are not acting as an insider unknowingly and report violations if you come across any fraudulent practices.
Frequently Asked Questions
When is insider trading considered to be illegal?
Insiders themselves indulging in trading or abetting trading through someone else by using any information which is not yet publicly available is illegal. This is because it gives them an unfair advantage. However, if company insiders are trading after information that they know is accessible to all, it is not considered to be illegal.
What are the types of insider trading?
There are two insider trading strategies. The first one is buying securities just before the price of security witnesses exponential growth. Second is selling securities prior to the announcement of bad news. In both cases, the insider gets the information before other market participants.
What are the investigative powers of SEBI in insider trading?
SEBI can use its powers to investigate complaints from intermediaries, investors, current employees or ex-employees in matters relating to the use of this practice. Moreover, they can also take up investigations based on their findings or knowledge.
How does insider trading affect a normal investor?
Usage of unpublished information that can influence the price of shares gives insiders an unfair advantage and defeats the purpose of stock trading which is based on demand and supply.