We all have heard the term ‘insider trading’ multiple times in the headlines. But, what is insider trading? Insider trading is malpractice where the traders carry out a transaction based on the non-public or unpublished information they got access to, which can be necessary for making investment decisions.

This unpublished information can be about the performance or other relevant matters of the company. The three essential elements of insider trading are:

● Material non-published or price-sensitive information

● The information obtained from an inside source

● A trader must have dealt with the securities based on the information obtained

Let’s understand insider trading with a few examples:

1. For instance, one top executive of the XYZ company shares acquisition information with his relative, Mr. A, who owns around 25% stakes. After receiving the material information, Mr. A sells all his shares before the information goes public.

2. An employee of ABC company overhears top-level executives talking about the merger. Understanding the impact of this information on the price of the shares, he buys stakes in his wife’s name, committing an insider trade.

SEBI’s regulations for insider trading

SEBI regulates insider trading in India with SEBI Regulations on Prohibition of Insider Trading Regulations Act, 1992. According to this act,

● No insider or a connected person has the right to disclose any secret information related to the company to the public if it can affect the price or securities of the company.

● All the listed companies, intermediaries, recognized stock exchanges, public financial institutions, corporate or professional firms need to form the internal procedure code to prevent illegal insider trading.

● Price-sensitive information must be disclosed on a ‘need to know’ basis to those who need the required details to carry out their duties.

● If any person related to the company discloses any secret insider trading information, they will be liable to punishment.

● If any person/employee/director/worker violates the insider trading rules, they will be held liable for actions such as wage freeze, suspension from future affairs, and more.

SEBI had amended the Prohibition of Insider Trading Regulation Act, 1992, a few times to upgrade with changing market conditions. The latest revision includes unlisted companies. There is an inclusion of ‘Informant Mechanism’ and reward policy for the informants to overcome challenges faced with insider trading.

Obligations of a company to prevent insider trading

Every listed company needs to follow the below-mentioned guidelines:

● Designate the role of Compliance Officer to a senior-level employee

● Follow the Code of Corporate Disclosure as specified in Schedule (ii) of the act

● Frame and implement code of conduct for internal procedures

● Identify the price-sensitive information

● Lay down the procedure for pre-clearance of trade and delegate the Compliance Officer with the duty of adhering to the same

● Ensure data security of important insider information

Conclusion

To conclude, insider trading is buying and selling of securities based on non-public information of a company. Any individual involved in insider trading will face considerable fines and may even have to face prison sentences. With the strict norms and guidelines laid down by SEBI, insider trading incidents have significantly reduced. It is believed SEBI will implement more stringent regulations in the future to curb insider trading altogether.

 

Related Terms

1. Insider

An insider is a connected person in possession of or has access to unpublished price-sensitive information.

2. Non-public or Unpublished Information

Information that is not widely available or is not disclosed to the public.

3. Material Information

Any information that can significantly influence an investor’s decision about buying or selling security is material information.

4. Informants

An informant is a person who discloses any secret information of the company or has a belief that insider trading is about to occur.

5. Compliance Officer

Compliance Officer is any senior officer designated to fulfill the following responsibilities:

● Make sure that all the prescribed policies and procedures are followed

● Maintains proper records

● Prevents price-sensitive information and monitors implementation of the codes specified in the regulations by SEBI

6. Intermediaries

Any person who has been connected with the company during the period of six months before the inside trade directly or indirectly is known as an intermediary.

7. Price-sensitive Information

Any information that is likely to affect the price of securities and is related to the following is known as price-sensitive information:

● Financial Results

● Dividends

● Change in capital structure

● Change in key managerial personnel

● Mergers, de-mergers, acquisitions, expansion, and other related transactions

● A material event following the listing agreement