IRJMST Vol 5 Issue 7 [Year 2014] ISSN 2250 – 1959 (0nline) 2348 – 9367 (Print)

Problem of Insider Trading in Indian Capital Market- A Literature Review

*PRASHANT KUMAR

** DR. MOHAMMAD ANEES

_____________________________
* Research Scholar (S.R.F)
prashant_kumar015@yahoo.com
Contact no-09451419531
** Assistant Professor
drmohdanees@gmail.com
Department of Business Administration,
University of Lucknow, Lucknow - 226 007 (Uttar Pradesh), India

Abstract

What is ethics? Why it is essential for business to be ethical? Is company listed in Stock exchange is
doing its business ethically? These are some of the burning question in today scenario and we heard
about it more after the collapse of Satyam and Enron in the Market.

The purpose of the study is to study about insider trading and how it affects the companies and is
ethically challenge for companies going for IPOs. The paper is based on the literature review done on
ethics and insider trading and on the basis of that review the findings are made. In this paper we have
discussed about the insider trading, the regulations for insider trading. The main arguments
supporting insider trading are that it promotes economic efficiency and enterprise. The Insider
Trading Regulations have been amended 5 (five) times and the last amendment was in the year
2011.As on date, SEBI, the market watchdog regulates insider trading through the SEBI Act and the
Insider Trading Regulations. On the basis of literature review the primary argument against insider
trading found are that, it can be a breach of fiduciary duty, the other arguments of asymmetrical
information, in-principle unequal access to information and Misappropriation seems relatively
difficult to accept. Overall it is concluded that the insider trading is unethical. The paper is limited to
literature review only so might be different findings may come if it is done through primary data or
survey.

Keywords: Insider trading, Capital markets, Corporate Social Responsibility, SEBI.

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Introduction

Ethics and ethical behavior are issues which are increasingly being focused on the business
community around the world. After the collapse of giant like Satyam due to its unethical practices and
bad corporate governance people are becoming more concerned with what the companies are doing in
the name of growth and how they are playing with the sentiments of investors. There are many
examples like SATYAM at global level too which shows how companies behave unethically in the
name of competition, growth. High returns etc.

Insider Trading

Insider trading refers to “buying” or “selling” of securities of a listed entity by individuals with access
to unpublished price sensitive information about the particular entity insider trading is not only a tort,
that is a civil wrongs but also a crime.

“Insider trading is difficult to prove and the initial burden to bring home a charge could be heavy.
However, where the charge is indeed established, the delinquent should be dealt with severely and in
an exemplary manner in accordance with the rule of law,”

“Insider trading” is a term subject to many definitions and connotations and it encompasses both legal and prohibited
activity. Insider trading takes place legally every day, when corporate insiders – officers, directors or employees – buy or
sell stock in their own companies within the confines of company policy and the regulations governing this trading. - Mr.
Thomas C. Newkirk, Associate Director, Division of Enforcement, SEC.

SEBI has amended certain provisions of SEBI (Prohibition of Insider Trading) Regulations, 1992 vide
notification dated November 19, 2008 for the purpose of better disclosures and prevention of insider
trading.

A high-level committee set up to suggest ways to curb insider trading and reform norms relating to
such malpractices has proposed that public servants in possession of price-sensitive information, be
brought under Securities and Exchange Board of India‟s (SEBI) purview. The 15-member committee‟s
report, released by capital market regulator SEBI recommends that even “connected persons” or any
individual in possession of unpublished price-sensitive information (UPSI) be considered as an
“insider”. A “connected person” is one who is in possession of UPSI and is associated with the trade
concerned at the time of occurrence or during the six months prior to the trade concerned, in any
capacity. “Simply put, the proposed regulations entail a prohibition on trading by insiders in securities
when in possession of UPSI, thus obtaining an unfair advantage,” the report stated. The definition of
the term “connected person” has been changed to “explicitly include public servants who handle UPSI
relating to listed companies,” said SEBI in its 74 page report. The high-level committee also said that
every company listed or to be listed, should be required to frame a “code of fair disclosure”, requiring
disclosure of events and circumstances that would impact price discovery of its securities. The new
norms will require companies to appoint a compliance officer, and seek details of holdings of all
employees and related parties. At present, any trade of above a value of above Rs 5 lakh falls within

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IRJMST Vol 5 Issue 7 [Year 2014] ISSN 2250 – 1959 (0nline) 2348 – 9367 (Print)

public disclosure, while public disclosure is also mandatory regardless of value if the securities traded
are more than 2,500 in number, or if the shares represent more than 1% of the total share capital. ----
Financial Express

Objective of study

Objective of the study is to throw light on how insider trading is unethical and what are different SEBI
norms for this practice.

Research Methodology

The study is based on review of the paper of different researchers on ethics and insider trading. The
report of SEBI and its regulations for insider trading are also studied for the paper and on the basis of
all these secondary information study on the ethical issues and insider trading is done.

Literature Review

According to Dr. C. Anbalagan - Business ethics is a contested terrain not just because celebrated
persons in the field of economics and business questioned the relevance of ethics in business, observe
editors of respected business ethics textbook, but also because what is presented in the name of ethics
is either sentimental common sense, or a set of excuses for being unpleasant.

Berrone, P., etal in their study “Corporate Ethical Identity As Determinant Of Firm Performance: A
Test Of The Mediating Role Of Stakeholder Satisfaction”, argue that firms with a strong ethical
identity achieve greater degree of stakeholder satisfaction, which in turn, positively influence the
firms’ financial performance. They state that Ethics and business are not unrelated worlds, acting
well is ultimately in the company‟s best financial interest. In their study they investigated the
connection between corporate ethic identity (CEI) and Corporate Financial Performance (CFP)
and the role of Stakeholder Satisfaction (SS) in mediating this relationship and their study showed
that strong CEI was positively related to high levels of SS. In turn, stakeholder satisfaction had a
positive influence on the financial performance of the

Khomba, J.K., and Frans N. S. Vermaak in their paper “Business ethics and corporate governance:
An African Socio-cultural framework” revealed the extent to which companies in Africa deal with
issues regarding the business ethics and good corporate governance. It has been established that the
Africa‟s socio-cultural dimensions affect the inclusiveness of corporate governance framework. The
study reveals that operations of companies in Africa are revolved around the fulfillment of governance
issues based on different phenomena. Largely, companies in Africa are premised on an inclusive
stakeholder-centered approach of business ethics and corporate governance rather than on an exclusive
shareholder-centered approach in business ethics and corporate governance. The research findings
support the rationale that an inclusive stakeholder-centered approach accommodates all

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organizational stakeholders, including shareholders, government, customers, suppliers,

management and employees, the community and the natural environment.

Jalil, M.A Dr., etal in their paper “Implementation Mechanism of Ethics in Business Organizations”
has identified that ethical practices and the proper implementation of ethical practices are very
important for organizational goodwill. It is also noticeable that an ethical organization’s
employees are more satisfied and loyal to the company than those of an unethical one. There
should have adequate emphasis on the implementation of the code of business ethics in business
organizations. Proper implementation of business ethics can ensure satisfaction of all
stakeholders of the business organization. It is the ultimate desire of all stakeholders of a business
organization that it will implement its code of business ethics in the true sense

O’Hara, P.A in his paper “Insider trading in financial markets: legality, ethics, efficiency”, are fairly
clear: the current state of knowledge about insider trading does not provide a strong case against the
practice beyond reasonable doubt. The arguments in favor of insider trading are well developed,
he says that a considerable amount of further research is needed on these and other matters, however,
before the question of legality can be seriously considered. Many of the ethical arguments against
insider trading are problematical, as seen. The notion that traders should have equal information in
the market is easily dismissed on the basis of the standard ethical and institutional workings of
capitalism. The view that all traders should have ``in principle‟‟ access to relevant information used in
the market given sufficient hard work, contacts and research fails because information is relative rather
than absolute.

Insider trading in India

Insider Trading in India#

The first concrete attempt to regulate insider trading was the constitution of the Thomas Committee in
the year 1948, which committee evaluated the global practices in restricting insider trading inter alia,
the Securities Exchange Act, 1934. Pursuant to the recommendation of the Thomas Committee, 5
sections 307 and 308 were introduced in the Companies Act 1956.

This change paved way for certain mandatory disclosures by directors and managers, but was not very
effective in achieving the objective of preventing insider trading.

Subsequently, the Sachar Committee and the Patel Committee were constituted in the years 1978 and
1986, respectively, to recommend measures for controlling insider trading in India. The Patel
Committee had defined insider trading as “the trading in the shares of a company by the person who
are in the management

of the company or are close to them on the basis of undisclosed price sensitive information regarding
the working of the company, which they possess but which is not available to others”. Along with

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other recommendations, both the Sachar Committee and the Patel Committee had recommended the
enactment of a separate statute for curbing insider trading.

The Abid Hussain Committee constituted in 1989 had recommended that a person guilty of insider
trading should be penalized, both in the form of civil and criminal proceeding. A separate statute for
prevention of insider trading was one of the recommendations of the Abid Hussain Committee too.

On the basis of the recommendations made by these committees, a comprehensive legislation, „SEBI
(Insider Trading) Regulations, 1992‟ was promulgated and brought in to force. This regulation was
substantially amended in the year 2002 to plug certain loopholes revealed in the cases of Hindustan
Lever Ltd. v. SEBI 6 and Rakesh Agarwal v. SEBI7 and was renamed as the SEBI (Prohibition of
Insider Trading) Regulations, 1992. Ever since then, the Insider Trading Regulations have been
amended 5 (five) times and the last amendment was in the year 2011.As on date, SEBI, the market
watchdog regulates insider trading through the SEBI Act and the Insider Trading Regulations.

# Insider Trading Regulations - A Primer by Nishith Desai associates legal & tax counseling worldwide pg 4

Findings from Literature Reviewed

From the literature reviewed It shows that ethics is good in terms of social performance as it provides
greater degree of satisfaction to stakeholders. Thus, effective management of corporate ethical identity
can play a significant role for the overall firm performance.

The primary argument against insider trading is that:

 it can be a breach of fiduciary duty

 the other arguments of asymmetrical information
 in-principle unequal access to information
 Misappropriation seems relatively difficult to accept.

Insider trading in general

 Create potential conflict of interest between innovators and shareholders

 Create possible lack of confidence in the market
 Changes the behavior of agents
 Destroy the image of company in market.

According to Jalil, M.A Dr., etal “With strong ethical enforcement, companies can build long term
profitable relationships with their stakeholders. On the other hand, a good number of cases of unethical
practices are being reported each year all over the world. The reason might be the wrong
implementation and communication of ethical standards.”
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O’Hara, P.A states that becoming an insider or a professional trader is a skill like being a plumber,
and outlawing insider trading effectively would give more power to professional traders than the
average ``ill informed‟‟ everyday trader. Similarly, there is no real evidence that having insider trading
legalized has ever contributed to a significant degree of lack of confidence which has led to instability
in the markets.

It is not possible to completely remove unethical practices. But it can be minimized through
continuous reminders. In the present business atmosphere, there are some organizations that are ethical
and in some organizations ethics are not practiced as rationally expected. Despite this type of mixed
attitude towards business ethics, it can be said that ethical trend will change an organization‟s internal
and external reputation

Conclusion

Insider trading refers to “buying” or “selling” of securities of a listed entity by individuals with access
to unpublished price sensitive information about the particular entity insider trading is not only a tort,
that is a civil wrongs but also a crime. The primary argument against insider trading is that it can
breach of fiduciary duty, cause of asymmetrical information, in –principle unequal access to
information and in general Insider trading in general creates potential conflict of interest between
innovators and shareholders also create lack of confidence in the market, changes behavior of agents
and spoil the image and goodwill of company.

The company issuing IPO must take care that it is not indulge in activity like insider trading because it
not only affect the IPOs price in market but also spoil the image of company and the investor lost
confidence in the market. As the Business works with the aim of long term growth and wealth
maximization which is not possible if the company indulge in unethical activity. And is very important
for company to follow fair practices and rules for working and emphasize more on ethical practices
and good corporate governance and it is significant to have a code of business ethics for each and
every company and the corporate managers must adopt appropriate means to implement the contents
of that code of business ethics.

It is also true that if we want to change the world we should change ourselves first as we know that by
nature, human beings are greedy. So it is not possible to completely remove unethical practices but can
be minimized if we have strong will to remove it. Despite the mixed attitude of companies towards
business ethics, it can be said that ethical trend will change an organization‟s internal and external
reputation. In future, ethical considerations will move from individual awareness to organizational
practice for the purpose of better business strategy.

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References

i. Dr. C. Anbalagan; “Impact Of International Business Ethics, Economic Systems And

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ii. Pascual Berrone, P., et.al, “Corporate Ethical Identity As Determinant Of Firm
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iii. Khomba, J.K., and Frans N. S. Vermaak, “Business ethics and corporate governance: An
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