You are at a party, and someone tells you that a major company is about to launch a groundbreaking product. You feel the excitement—this could change everything! You think about investing in that company’s stock before the news goes public. But then you wonder, is that okay? The world of insider trading is complicated, with legal and illegal aspects that can confuse even seasoned investors.
What is Insider Trading?
Insider trading involves buying or selling shares of a publicly listed company by individuals with access to confidential, important information not yet available to the public. Once disclosed, this data, called Unpublished Price Sensitive Information (UPSI), can influence the company’s stock value. In India, the Securities and Exchange Board of India (SEBI) handles insider trading through the SEBI (Prohibition of Insider Trading) Regulations, 2015.
An insider in the share market trading can be company directors, officers, employees, external advisors, consultants, or even the relatives of these people. For example, in 2019, SEBI investigated a case concerning the General Insurance Corporation (GIC), where certain employees were caught trading shares using confidential information about the company’s financial results.
Different Types of Insider Trading
Here are five different types of insider trading in the Indian share market:
- Classic Insider Trading: This occurs when corporate insiders, such as senior executives, board members, or other employees, buy or sell the company’s securities based on exclusive, non-public information. For example, a CEO purchasing shares before an upcoming product launch, which is expected to increase stock value, is considered a prime case of insider trading.
- Tipper-Tippee Trading: This type involves a company insider (the tipper) sharing non-public information with an outsider (the tippee) who trades based on that information. Both individuals may be held accountable for insider trading. For example, if an executive leaks confidential earnings data to a friend who trades in the company’s shares, both parties could face legal repercussions.
- Trading During Blackout Periods: Companies commonly enforce blackout periods, during which insiders are barred from trading company securities. These periods generally coincide with major announcements, like earnings reports. Even if unaware of the specific information, trading within these blackout windows may still be seen as insider trading.
- Misappropriation Theory: This theory applies when an individual misuses confidential information gained through a breach of duty to the information source. For instance, a lawyer involved in a merger who trades via a stock trading app based on the details without company approval would be liable for insider trading under the misappropriation theory.
Scenarios When Insider Trading is Legal in India
Five scenarios where insider trading in the share market is permissible are:
Block Deal Window Mechanism
Transactions classified as insider trading are allowed when executed through the block deal window mechanism. Here, a high-value share exchange (typically above ₹5 crore) is arranged between two parties on the stock exchange at a predefined rate and during a specific trading period.
Regulatory Requirements
Transactions executed to fulfil legal or regulatory requirements are not subject to insider trading restrictions. For example, if a court order requires the sale of shares, the insider is obligated to comply, regardless of their possession of unpublished price-sensitive information.
Exercise of Stock Options
ESOPs are incentive programs that allow employees to purchase shares of their company at a predetermined price through the share market trading app. This aligns employees’ interests with shareholders and encourages them to contribute to the company’s success. For example, if an employee is granted options to buy 100 shares at ₹50 each through the share market app, they can purchase them later if the market price rises. Exercising these options does not constitute insider trading, even if the insider has access to UPSI at the moment of exercise.
Trading Plan
According to SEBI regulations, insiders can design a trading plan requiring approval and public disclosure. Once the plan is implemented, the insider is free to trade in line with it without being charged with insider trading, provided they follow the plan’s guidelines closely.
Off-Market Transfers Between Insiders
Transfers of securities between insiders, including promoters and directors, are allowed when conducted as off-market transactions. Such transactions occur directly between the parties rather than on a stock exchange, which can help maintain confidentiality. However, these off-market transfers must be reported to the stock exchange to ensure transparency and compliance with SEBI regulations.
Mechanisms to Prevent Insider Trading
Some of the practices that companies can follow to restrict share market investment through insider trading are:
Corporate Governance
Corporate governance is essential for stopping insider trading by creating a set of rules and practices to guide a company. The board of directors and management play key roles in this structure. They set an ethical tone, ensure transparency, and nurture a positive culture.
Effective strategies to combat insider online share trading include enforcing strict rules on confidential information, providing regular employee training, and outlining clear steps for reporting any suspicious behaviour.
Compliance Programs
Compliance programs are vital for preventing someone from investing in the share market via insider trading because they ensure that a company follows all legal and regulatory standards. A strong compliance program has several important parts: a clear code of conduct, ongoing staff training and education, strong internal controls, and a whistleblower policy.
Regular audits and assessments can also spot potential risks and highlight areas needing improvement. By encouraging a proactive compliance approach, companies can stop insider trading and safeguard their reputation.
Monitoring and Surveillance
SEBI utilises advanced technology and data analysis to observe trading actions and detect unusual patterns that may suggest insider trading. Companies also apply surveillance systems to monitor employee trading behaviours and ensure compliance with internal policies. The role of technology in detecting insider trading cannot be overstated; it enables real-time monitoring and provides valuable insights that assist in the early detection and prevention of illicit activities.
Famous Cases of Insider Trading
In the history of stock exchange, some noted investments in the share market that turned out to be insider trading.
- Rakesh Agrawal vs. SEBI (1996)
Rakesh Agrawal, the managing director of ABS Industries, was engaged in a transaction with Bayer AG. He traded shares using unpublished price-sensitive information (UPSI) related to the acquisition, prompting a SEBI investigation. Though initially deemed guilty, the Securities Appellate Tribunal (SAT) later ruled in his favour, stating his actions were for the company’s benefit.
- Hindustan Lever Limited (HLL) vs. SEBI (1998)
HLL, which is now Hindustan Unilever, faced accusations of insider trading during its merger with Brooke Bond Lipton India. SEBI determined that HLL used unpublished price-sensitive information (UPSI) for trading shares, leading to a hefty fine.
- Reliance Industries Limited (RIL) vs. SEBI (2004)
Reliance Industries was accused of insider trading after discovering that the company manipulated stock prices using unpublished price-sensitive information (UPSI).
- WhatsApp Leak Case (2017)
This case revolved around the leakage of UPSI via WhatsApp groups. Employees from multiple brokerage firms were discovered sharing confidential details.
- Kishore Biyani and Future Retail (2020)
Kishore Biyani, the founder of Future Retail, faced accusations of insider trading in connection to the company’s deal with Amazon. As a result, SEBI prohibited Biyani and other key executives from accessing the securities market for one year.
- Infosys and Insider Trading (2017)
Infosys encountered insider trading allegations when employees were found trading shares based on unpublished price-sensitive information (UPSI) regarding the company’s financial outlook.
- NDTV Promoters (2008)
NDTV promoters Prannoy and Radhika Roy were accused of insider trading, allegedly using UPSI to make financial gains. SEBI subsequently banned them from the securities market for two years and imposed a substantial fine.
- SRSR Holdings Private Limited (2010)
The promoters of SRSR Holdings were involved in insider trading, reportedly trading shares based on UPSI related to the company’s financial troubles.
- Manappuram Finance Limited (2013)
Executives of Manappuram Finance were found guilty of insider trading after trading shares based on UPSI about the company’s financial performance.
- Chintalapati Srinivasa Raju (2014)
Chintalapati Srinivasa Raju, a promoter of Satyam Computer Services, faced insider trading accusations during the company’s financial scandal. Following SEBI’s investigation, Raju was penalised and banned from the market.
Conclusion
Understanding insider trading is essential for any investor. While acting on insider information can be tempting, knowing the legal boundaries is crucial. Legal insider trading can occur when information is disclosed properly and in compliance with regulations, but illegal insider trading can lead to severe consequences.
If you are yet to start your investment/trading journey, you must open Demat account first. You can choose HDFC SKY as your broker as the platform offered by them provides in-depth information about the listed companies and how their shares have traded over the years. So what are you waiting for? Proceed with the Trading App download today!
