INSIDER TRADING- know all about it.
What will you gain after reading this article?
1. Knowledge of what constitutes insider trading.
2. Knowledge of arguments for and against the practice of insider trading.
3. Knowledge of regulations (and its critique) regarding insider trading, in India.
What is insider trading?
• Insider trading is the practice of using information that has not been made public, to execute trading decisions.
• It gives traders an unfair advantage over others and most forms of insider trading are illegal.
• It is a malpractice wherein trade of a company’s securities is undertaken by people who by virtue of their work have access to the otherwise non-public information which can be crucial for making investment decisions.
What are the arguments against the practice of insider trading?
• If a select few people trade on material non-public information, the integrity of the markets will be damaged, and investors will be discouraged from partaking in them.
• Insiders with non-public information will be able to avoid losses and benefit from gains, effectively eliminating the inherent risk that investors without the undisclosed information take on by investing in the markets.
• If those investors, who do not have the access to the information in question, begin to withdraw from the markets, there would be no other investors for those partaking in insider trading to sell to or buy from, and insider trading would effectively eliminate itself.
• It robs the investors who do not have non-public information of receiving the full value for their securities.
• If non-public information became widely known before an insider trading situation took place, the markets would integrate that information and the securities in question would become more accurately priced as a result.
What are the arguments for the practice of insider trading?
• One argument in favour of insider trading is that it allows for all information to be reflected in a security’s price and not just public information. This makes the markets more efficient.
• As insiders and others with non-public information buy or sell the shares of a company, for example, the direction in price conveys information to other investors.
• Outlawing the practice only delays what will eventually happen: a security’s price will rise or fall based on material information. If an insider has good news about a company, but is barred from buying its stock, then those who sell in the time between when the insider knows the information and when it becomes public are prevented from seeing a price increase.
• Its costs do not outweigh its benefits. Enforcing laws related to insider trading and prosecuting insider-trading cases cost the government resources, time and people that could otherwise be used to pursue crimes considered more serious, such as organized crime and murder.
Regulation in India
The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015, replaced the SEBI (Prohibition of Insider Trading) Regulations, 1992.
1. India significantly toughened insider trading rules, expanding what constitutes “unpublished price-sensitive information” to include “any information” that is not “generally available” and that could have a market impact.
2. The law also expanded the scope of who constitutes an “insider” to include “anyone in possession of or having access to unpublished price-sensitive information” regardless of how they came “in possession of or had access to such information”.
3. The new regulations prohibit not only dealing in securities when in possession of insider information, but also communicating or procuring of insider information, except for legitimate purposes.
4. If found guilty of insider trading, a person could be sent to prison for up to 10 years or be required to pay a fine of up to Rs.25 crore or thrice the amount of profits made.
5. The new rules specifically define trading, prescribe a more structured disclosure regime, and permit due diligence exercises when someone wants to buy a listed company, subject to appropriate disclosures and compliance.
6. The new regulations apply to companies that are proposed to be listed.
7. The definition of “connected persons” now covers anyone who has a connection with a company that is expected to put the person in possession of insider information, including public servants such as judges and bureaucrats who may be aware of a judgment or policy which, when made public, may impact the price of shares of the company.
8. Also, the new regulations require the compliance officer of the company to monitor trading by employees and connected persons.
9. The new regulations allow for the formulation of trading plans. Under this, a person can formulate a trading plan, get it approved by the compliance officer and trade in accordance with it. However, such trading needs to comply with certain specific conditions to ensure any insider information in not misused.
10. The new regulations also require companies to come up with codes for regulating, monitoring and reporting trading by employees or connected persons, and fair disclosure of material information, such as financial information, key business decisions, etc., by the company.
Critiques of the 2015 rules
• In addition to listed companies, the new regulations apply to companies that are proposed to be listed. It is unclear what “proposed to be listed” means. (Refer to point no.6)
• Given the wide ambit of the definition of a “connected person”, it may be an uphill task for the compliance officer to monitor their trading activities. (Refer to point no.7)
• The phrase “legitimate purposes” has not be defined. Accordingly, it is unclear what purposes are legitimate enough to allow insider information to be communicated or procured. (Refer to point no.3)
• Compliance with these codes appears to be cumbersome, particularly for companies with large shareholder and employee bases. (Refer to point no.10)
There’s hope that the regulations are interpreted by courts and authorities in a progressive manner and timely clarifications are issued by the capital market regulator.
Read the following news items to know why insider trading is in news in India: