What is Insider Trading? – All You Need to Know
The most prevalent practice in India is buying and selling shares before the information is made available to the general public. It is considered to be a serious offense and can lead to jail, fines, or both, considering the severity of the offense. According to data, SEBI has received 1150 insider trading complaints till 2022, which has resulted in SEBI issuing a fine of almost 1 billion. In this blog, we will learn about this type of trading and ways to prevent it. So, let’s begin.
Insider Trading Meaning
Insider trading refers to trading a public company’s securities, such as stocks and bonds, by people who are not officially associated with the company but possess insider information. It is illegal in most countries because it gives an unfair advantage to investors with access to non-public information.
Generally, it is only legal for two parties to have equal access to all relevant information about a security or investment. Moreover, both parties must agree on the terms of the trade before any transaction can take place. In some cases, specific trades between insiders may be permissible if they occur within specific guidelines set by governmental regulatory agencies, such as SEBI (Securities and Exchange Board of India).
SEBI Regulations
The Securities and Exchange Board of India (SEBI) has put in place several regulations to protect investors from the effects of such unfair trade practices. The primary regulation against insider trading is the Prohibition of Insider Trading Regulations, 1992. It prohibits insiders from purchasing or selling securities based on nonpublic information. Under this rule, an “insider” includes directors, key managerial personnel, and promoters as defined under section 2(e) of the SEBI Act.
These individuals are prohibited from buying or selling any security when they possess any non-public material information related to that company’s performance or prospects that may influence its share price.
The penalties for engaging in such activities can be severe depending on the circumstances. Individuals found guilty face significant fines and/or imprisonment. Some cases may even result in both penalties being imposed simultaneously. In addition, companies can also be held liable for losses incurred by their shareholders due to illegal activities involving insiders. These include tipping off other persons about inside information, which leads to them taking advantage and making profits through trades based upon this knowledge.
Such unfair trading activities are considered a serious offense because it undermines public confidence in markets. It also violates fundamental principles governing fair competition between market participants who do not have access to privileged information about a particular stock or investment opportunity.
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Past Instances of Insider Trading
Following are a few instances of such unfair trade practices in India:
Infosys Backdated Options Case
It is one of the most well-known instances. In 2006, Infosys Technologies was accused of backdating stock options to its employees without informing the public or shareholders. This gave those employees an unfair advantage over other investors as they had access to non-public information that allowed them to make profitable trades before anyone else knew about the backdating. The Securities and Exchange Board of India (SEBI) investigated this case and found that seven senior executives at Infosys were involved in backdating options. It resulted in a fine imposed on the company for violating SEBI regulations.
The Raj Rajaratnam Galleon Group Case
It is another example that occurred within India’s financial market between 2003 and 2009 when billionaire hedge fund manager Raj Rajaratnam illegally traded shares using confidential information obtained from sources inside various companies like Intel Corporation, Goldman Sachs, and McKinsey & Company among others. As a result, he made more than $63 million through illegal trades, while his co-conspirators also profited significantly by using their connections to obtain confidential corporate data ahead of time. After an extensive investigation by US and Indian authorities, Mr. Rajaratnam was convicted on multiple counts, including securities fraud and conspiracy charges. Some convictions carried jail terms of up to 11 years imprisonment and hefty fines totaling million dollars.
Rakesh Jhunjhunwala Case
In 2018, prominent Indian investor Rakesh Jhunjhunwala was also implicated in a case involving alleged unfair activities related to Titan Industries Ltd., where he served as Chairman until 2013 but still held significant stakes. Charges were filed against him by SEBI for allegedly manipulating price-sensitive information regarding Titan’s quarterly results before its release into the public domain. It resulted in profits for himself and certain other entities associated with him.
Impact of Insider Trading
The reputation of a company can take a severe hit if it is found to have been involved in illegal activities. Investors may lose trust in the integrity and fairness of the market and in the company’s ability to maintain an ethical approach toward its operations. This can lead to lower stock prices, reduced investor confidence, and decreased overall profitability for the firm.
The economy can also be greatly affected by such activities because such practices are illegal under most countries’ laws and regulations. They give certain individuals or groups an unfair advantage over other investors who do not possess access to non-public information. This creates an uneven playing field where those with inside information stand to benefit at everyone else’s expense.
Lastly, when businesses engage in unfair trade practices, it sends out a message that they are willing to break existing laws and regulations for their gain. This could lead potential customers or partners to perceive them as untrustworthy. Therefore, it reduces their chances of doing business with these customers, which could further hurt their brand image and adversely impact prospects.
Ways to Track Insider Trading
One of the most commonly used methods for detecting suspicious trades is surveilling stock price movements to determine any abnormal patterns or trends. Such activities include looking at large trades which could indicate possible manipulation. It also includes tracking network connections between traders and insiders who possess non-public material information about a particular security or investment opportunity.
Monitoring unfair practices requires dedicated resources such as personnel, software, databases, and analytics tools to effectively detect potential violations. This includes implementing processes within organizations that ensure responsible use of all available data by monitoring employee activities. These activities include stock purchases, communications with outside parties, sales made on behalf of customers, etc.
Punishment for such violations varies but typically includes substantial fines imposed on both individuals found guilty along with the companies. In some cases, jail terms may also be handed out alongside monetary penalties based on the nature and extent of each case.
Conclusion
Insider trading is illegal and can seriously impact the integrity of financial markets and the economy. It involves individuals or groups using privileged information to gain an unfair advantage over other investors by profiting from non-public material information before it has entered the public domain. SEBI continues to strengthen its regulations against such activities to protect market participants’ interests while ensuring fair competition within capital markets throughout India.
