Insider trading is the buying and/or selling of securities, such as bonds and equities, based on information not available to the public. This information is provided by ‘insiders,’ including employees, executives, and directors, who may have access to unpublished sensitive information or receive it from someone within the company.
Why is insider trading bad?
Unfair advantage: It gives individuals with non-public information an edge over other investors, disrupting the fair market principle of equal access to information.
Erodes trust: It reduces investor confidence in the market and institutions, as hidden information leads to hesitance and hinders market activity.
Discourages investment: If investors believe that the market is unjust due to insider trading, they may be less likely to invest. This impacts the economic growth and access to capital for businesses that do not engage in such behaviours.
Rules and regulations according to SEBI
The Securities and Exchange Board of India (SEBI) considers some information to be sensitive. Possession of such information by a trader may expose them to insider trading litigations. This information includes:
- Intended dividend declarations
- Periodic financial reports
- Buy-back or issuance of securities
- Any significant changes in company plans
- Any upcoming takeovers and/or mergers
Therefore, if you are in any of the following groups, it is advisable not to trade stocks in the same:
- Family members of insiders or people connected to them
- Companies directly linked to each other or are part of the same ownership
- High-ranking executives in a company connected to the main company
- Officials working at the stock exchange or any such institutions
- Board members of asset management companies or are trustees in mutual fund management companies
- Board members, Directors, Executives, or leaders of public financial organisations
SEBI also states that you cannot obtain secret price-related information unless required by law or legal proceedings.
Hypothetical examples of insider trading
Here are a few hypothetical examples of insider trading:
- Executive tip-off: A high-level executive of a publicly traded company learns about an upcoming merger deal that has not been made public yet. Knowing that the company's stock will likely soar once the merger is announced, the executive purchases a significant amount of company stock before the news becomes public. This action is illegal insider trading because the executive used non-public information for personal gain.
- Family connection: An employee working in the finance department of a pharmaceutical company learns that the company's latest drug has successfully passed clinical trials and is going to be approved by the FDA. The employee shares this information with their sibling/s, who then purchases a large amount of the company's stock before the news is made public. Both the employee and their sibling are guilty of insider trading since they used non-public information to profit from trading securities.
- Supplier insight: A supplier to a tech company overhears during a meeting that the company is about to secure a major contract with a large client. Aware that this information will likely cause the tech company's stock price to rise, the supplier buys stock in the company before the contract is officially announced. Even though the supplier is not an employee of the company, using confidential information obtained through business dealings for personal gain still constitutes insider trading.
- Legal counsel leak: A lawyer working on a high-profile corporate merger learns about the impending deal and its favourable terms. Instead of keeping this information confidential, the lawyer shares it with a friend who then buys stock in the merging companies before the news is made public. Both the lawyer and their friend are engaging in illegal insider trading by using privileged information for personal profit.
- Board member betrayal: A board member of a publicly traded company learns in a closed-door meeting that the company's quarterly earnings report will be significantly higher than analysts' expectations. The board member immediately sells off their own shares in the company before the earnings report is released to the public, avoiding losses. This action constitutes insider trading as the board member used confidential information to avoid financial losses.
These examples illustrate various scenarios where individuals with access to non-public information exploit that information for personal financial gain, thereby violating securities laws against insider trading.
Prominent examples of insider trading
Acclaim Industries - SEBI found that Mr. Abhishek Mehta was in charge of Acclaim Industries when the insider trading occurred. SEBI fined him Rs. 42 lakh for violating the rules. The investigation covered the period from January to December 2012, focusing on changes in Mehta's share ownership after the board approved a merger plan with Database Software Technology Pvt Ltd (DSTPL) in January 2012.
SEBI discovered that in February 2012, Acclaim Industries' board decided against the merger, a decision not disclosed to the Indian stock exchange. Mehta was accused of selling shares and decreasing his ownership in Acclaim Industries while possessing important, non-public information, leading to SEBI issuing the penalty in an order dated January 25.
General Insurance Company of India - A close watch was kept on Axis Bank's shares, and it was discovered that the government-owned GIC failed to disclose changes in its ownership of the bank, as required by rules against insider trading.
Before taking further action, SEBI gave GIC a chance to settle the matter. In October 2019, they issued a notice stating that the case could be resolved if GIC submitted a settlement application along with a payment of over Rs. 1.23 crore.
In response, the General Insurance Company decided to file a settlement application "without admitting or denying the findings of fact and conclusions of law, proposing to settle the defaults" and set aside the settlement amount.
As a result, SEBI, in an order dated December 12, stated that the potential actions for the violations have been settled concerning GIC. The General Insurance Corporation of India (GIC) resolved the case with SEBI by paying over Rs. 1.23 crore as settlement charges for the alleged breach of insider trading rules.
Conclusion
Insider trading poses a threat to the integrity and working of the Indian financial market. Ultimately, combating insider trading is essential for fostering a fair and trustworthy market environment. This benefits all participants, from individual investors to businesses seeking capital, ensuring an even playing field and promoting healthy economic growth.
