Insider Trading

What is Insider Trading?

Insider trading refers to the practice of purchasing or selling a publicly-traded

company’s securities while in possession of material information that is not yet public
information. Material information refers to any and all information that may result in a
substantial impact on the decision of an investor regarding whether to buy or sell the security.

By non-public information, we mean that the information is not legally out in the public
domain and that only a handful of people directly related to the information possessed. An
example of an insider may be a corporate executive or someone in government who has
access to an economic report before it is publicly released.

Hypothetical Examples of Insider Trading

 The CEO of a company divulges important information about the acquisition of his
company to a friend who owns a substantial shareholding in the company. The friend
acts upon the information and sells all his shares before the information is made
public.
 A government employee acts upon his knowledge about a new regulation to be passed
which will benefit a sugar-exporting firm and buys its shares before the regulation
becomes public knowledge.
 A high-level employee overhears some conversation about a merger and understands
its market impact and consequently buys the shares of the company in his father’s
account.
 A lawyer representing the CEO of a company came to know in a confidential meeting
that the CEO is going to be indicted for accounting fraud the next day
 An employee working in a government is aware that new law and regulation is going
to be passed that will significantly benefit the real estate companies.

Why is insider trading illegal?

In most of the countries, some kinds of trading based on insider information is made illegal
by making rules to prohibit or criminalize insider trading. The reason being:

1. Unfair for other investors

Insider trading is seen as unfair to other investors in the stock market, who do not have access
to the information.
The investor with the non-public information could potentially make far larger profits from
the stock market than a typical investor could not make.

2. Morally wrong and un-ethical terms

It is a morally wrong and unethical way of trading in the stock market. All investors should
get equal opportunities to trade with the same piece of information about the company.

3. Hampers people’s confidence

Insider trading in any market reduces people’s confidence in the trading process. If the people
investing in stocks did not think that the market was fair, they would be less likely to enter
into trading and this would seriously hurt the market conditions.

Who Regulates Insider Trading in India

Section 194 and 195 that dealt with insider trading under the Companies Act have been
omitted by the amendment of 2017 from the Companies Act, 2013 and presently insider
trading in India is completely regulated by SEBI.

In accordance with Section 12A of SEBI Act, 1992, a person is prohibited from engaging in
insider trading or dealing in securities while in possession of material or non-public
information (forward dealings) and using the same for his or her own advantage in
contravention of the provisions of the SEBI Act. Furthermore, the SEBI (Prevention of
Insider Trading) Regulations 2015 (“PIT 2015”) comprehensively provides the framework
for such preventions.

Penalty under Section 15G of SEBI Act, 1992 shall not be less than 10lakh and may go up to
25CR or three times the profit made whichever is higher.

These norms apply only to public listed companies. This has been the effect of omission of
Section 194 and 195 of Companies Act, 2013 that brought under its loop ‘any person’ from
indulging in such activities in ‘any company’. This in turn reduced the fund raising capacity
of such companies.
 The Restrictions/Prohibitions imposed by SEBI

The Insider Trading regulations impose the following restrictions:

The Regulations restrict/prohibit Insiders from communicating, providing, or providing
access to UPSI (unpublished price sensitive information) related to any publicly traded
company or security to any person, including other Insiders.
These regulations restrict/prohibit a person from purchasing a UPSI from an insider
related to a publicly traded company or securities to any person, including other insiders.
The Regulation restricts/prohibits an insider, when in possession of UPSI, from dealing
in securities listed or proposed for listing on a recognized stock exchange.
SEBI also has the authority to investigate NSE Insider Trading and related matters. SEBI
may exercise investigative powers for two main reasons:

 Investigate complaints from investors, intermediaries, or other persons regarding matters

relating to allegations of this practice; and,
 Investigations based on its knowledge or information in its possession to protect the interests
of securities investors against violations of these regulations.