Behind Closed Doors: The Fascinating World of Insider Trading

Introduction

We all have heard those epic dialogues “Ye Market Ka Masala Na Char Cheezo Se Banta Hai, Pehla Tip, khabar insider trading…” and “Bada Aadmi Banna Hai, Toh Line Cross Karni Hogi” from movies like Scam 1992 and Bazaar? This is so thrilling and still sends shivers down our spine! 

But here’s the thing, between the legal and illegal insider trading, where exactly is that line, and who decides where it’s drawn? 

With this article, we aim to explore the depth of the very hot topic in the stock market that has fascinated and surprised many: “Insider Trading.” You may have come across the ongoing buzz on the topic and wondered what this fuss is all about. Be ready to delve into the nitty-gritty of insider trading, its relevance, regulations, types, real-world examples,  and other insightful data. So, let’s get going!

What is Insider Trading?

Alright, let’s start with the basics. In the stock market realm, insider trading is when someone buys or sells shares of a company based on confidential information not yet available to the public. It’s like that secret recipe your grandma keeps hidden, shared only with a few people, and you know that it’s not for everyone. 

Fun Fact: Insider trading is illegal due to the Securities Exchange Act of 1934. The act was passed after the 1929 stock market crash, to regain public trust in the markets. So, always remember, fair trading is the way to go!

To get a better view of the concept, let’s say an insider knows the company is about to launch a super cool product. Hence, they quietly buy that company’s shares before the big announcement. Once the news is out, everyone rushes to buy the stock, and the price shoots up. And that’s when the insiders then sell their shares at a higher price and make a profit.

What is UPSI?

UPSI, acronym of Unpublished Price Sensitive Information, is the confidential data or information of the company (2(1)(n) rule), i.e.;

• Not yet released/known to public,
• Can potentially influence the security price (including, merger, expansion, dividends, etc) if it becomes public. 

For example, a company is going to announce bankruptcy. However, few C-level executives figure out the information before the announcement and sell their shares. Hence, UPSI information can significantly impact the company’s stock price if it becomes known to the public.

Who is an Insider?

An insider is like an inside/internal person, someone who knows the secrets of a company. This could be 10% stockholder, top executives, directors, or employees who have an unfair edge over regular investors and don’t have access to such information. But who else comes under this category? Let’s figure out:

• Company officers, stockholders, directors, and employees with access to internal info.
• Peers, friends, or relatives of these insiders who also trade after getting a tip.
• Employees of legal, banking, and press firms trading based on privileged access to information.
• Government employees exchanging confidential data they learned at work.
• Political intelligence consultants using non-public information from government sources.
• Others misusing confidential info from employers, family, or friends.

As per SEBI, any close relative (financially stable) of an insider who gets access to forbidden information ‘tip’, and trades in securities, also be considered as an “Insider” under ‘immediate relative’ (2(1)(f)) rule. For example, if the CEO of the company tells his wife about the upcoming merger and she buys stocks before the news goes public, both ‘CEO’ and his ‘wife’ would be considered as “Insider”.

How does Insider Trading work?

Imagine you’re playing a game of cards, and you know the cards your opponents are holding! You’d have a huge advantage, right? That’s how Insider Trading works. These insiders use their secret knowledge to make stock transactions, giving them an edge over regular investors like you and me. In simple terms, when an insider (individual) has access to some confidential information (acquisition, profit gain, execution of trade, etc.) and makes a profit from it.

Impact of Insider Trading

Insider Trading is like adding mirch (spice) to the market curry. It can stir up big trouble and create an unfair playing field. When insiders use confidential information to make trades, it can lead to price manipulation, losses for small investors, and a loss of trust in the stock market. Definitely not good for our investing mojo!

Types of Insider Trading

Insiders can be quite creative in their trading journeys with quite a few tricks up their sleeves. They can be insiders buying or selling shares, or even tipping off their friends with secret information. It’s like a thrilling game of hide-and-seek, but with money at stake! Let’s take a look at some common types:

Insider Buying

When insiders purchase shares of their own company, it’s like saying, “I believe in our company’s future!” This can attract other investors, but it’s essential to keep an eye out for any red flags.

Insider Selling

On the flip side, when insiders start selling shares, it could mean they’re cashing out before a bad financial report or some other negative news comes out.

Tipping

No, we’re definitely not talking about giving gratuity here. Tipping is when an insider spills the beans to someone outside the company. Like a friend telling you a secret recipe, but for stocks!

Front-Running

Front-runners are those who place significant orders on behalf of the corporations or customers.Well! This help may take you behind bars or who knows.

Misappropriation

As word speaks for itself, when someone trades on the basis of the misused/stolen confidential information. Everyone knows cheating and stealing is not good, right!

Detecting & Preventing Insider Trading

Detecting and preventing insider trading go hand in hand like ‘Kohli’ and ‘Ashwin’, or ‘Batman’ and ‘Robin’. While detecting catches the culprits in action, preventing builds a strong defense to stop them from even trying. Together, they create a market that thrives on fairness, trust, and equal opportunities for every investor.

Tracking insider trading can be a bit like finding a needle in a pile of hay. However, the authorities have some analytical and sophisticated tools to keep an eagle eye on suspicious activities. For instance, they use data analysis and insider trading trackers to catch those mischievous insiders red-handed. Market superheroes also know the needs of a fair and transparent market. Hence, they educate insiders about rules and regulations as well as dos and don’ts to maintain ethical behavior and culture of integrity.

Who Regulates Insider Trading in India?

SEBI to the rescue! The Securities and Exchange Board of India is like the referee of the stock market game. It’s like the market police, keeping a close eye on insiders’ actions. With the strict guidelines under the SEBI (prohibition of Insider trading) regulations, 1992, and Companies Act and SEBI regulations 1992,  SEBI sets rules and guidelines to prevent unfair practices and maintain market integrity. Any suspicious insider activities are thoroughly investigated, and strict penalties are imposed to deter wrongdoing.

Fun Fact: In 2021, SEBI banned 85 entities, including Sunrise Asian Ltd for manipulating share price. Similarly, for the violation of PFUTP (Prohibition of Fraudulent and Unfair Trade Practices) guidelines, they banned 178 entities in 2015, cracking down a tax fraud of 420 crore.

Insider Trading Examples – Cases of India

TBH (to be honest), it’s never fun to read something so long without real-life cases. So here, let’s add some tadka (flavour) to our understanding with some real-life examples from India:

The Raj Rajaratnam Case

This sounds like a Bollywood movie plot, but it’s a true story. Raj Rajaratnam, a SriLankan-American and former billionaire hedge fund manager, got caught in 2009 for insider trading. He made millions using confidential information from company insiders.

Fortis Healthcare

In 2018, Fortis Healthcare was involved in an insider trading case. The company’s promoters were alleged to have traded shares based on undisclosed information about the company’s financial troubles.

Rajat Gupta Case

Another twisted story where Rajat Gupta, a former director of Goldman Sachs and McKinsey, was charged with insider trading in the US. He leaked confidential information about Goldman Sachs to Raj Rajaratnam, a hedge fund manager, resulting in illegal stock trading.

Balram Garg Case

Surprising yet full of drama! This was a high-profile instance of alleged Insider Trading that made headlines in December 2019. SEBI, like a vigilant watchdog, issued a notice to Balram Garg, the Managing Director of PC Jeweller, suspecting his involvement in illegal trading. In a swift move, the government agency also ordered the confiscation of around INR 8 Crore from two promoters and associated units, who were believed to be linked to the illicit trade.

Global Insider Trading Cases

Who doesn’t like some more gossip based on facts, especially when it’s about some international companies. Let’s talk about some more juicy insider trading cases!

Martha Stewart:

You know her as the famous American businesswoman and TV personality. Surely, millennials remember her from the“Roast Revenge”episode. Back in 2001, Martha Stewart got insider information about a biopharmaceutical company about the drop in stock price of ImClone Systems. When Martha sold her all the shares before the news went public, authorities got suspicious. With further investigation, they found her guilty of insider trading and obstruction of justice. She had to pay the price and even spent some time behind bars. A real-life drama in the world of finance!

Amazon:

Now, let’s talk tech! In September 2017, a former financial analyst at Amazon, Brett Kennedy, got caught in an insider trading web. He spilled the beans to a friend, Maziar Rezakhani, about Amazon’s first-quarter 2015 financial results before the official announcement. Rezakhani paid Kennedy $10,000 for the tip, and he went on to make a cool $115,997 by trading Amazon shares with that secret information. But guess what? The SEC got wind of it and took them both to task for their naughty actions.

SEBI Regulations Against Insider Trading

SEBI has laid down some ground rules to keep those insiders in check. They are like the rulebook that insiders must follow to play fair in the market. Here are a few key regulations:

Insider Trading Code of Conduct

Companies have to frame their own code of conduct, prohibiting insiders from trading based on unpublished price-sensitive information.

Trading Window

SEBI sets specific periods called “trading windows” when insiders are allowed to buy or sell shares. Outside these windows, they have to keep their hands off the stock-pot!

Disclosure Requirements

Insiders must promptly report their trades to SEBI to ensure transparency.

Restrictions on Tipping

Insiders cannot share confidential info with others to benefit from it.

Penalties

SEBI imposes heavy fines and other punitive actions on those caught in insider trading.

The Restrictions/Prohibitions Imposed by SEBI in Insider Trading

SEBI means business when it comes to preventing insider trading. Its stringent restrictions and prohibitions act as a shield against unfair practices, making the Indian stock market a place of integrity and equal opportunities for all investors. Some restrictions include:

No ‘Tipping’ Allowed

Insiders can’t share confidential information with others unless it’s for legitimate purposes. No secret-sharing parties here!

Disclosure Obligations

Insiders must report their stock trades and holdings to the company and the stock exchange to maintain transparency.

Blackout Periods

Insiders cannot trade during specific periods, such as before financial results are announced, to prevent using confidential information.

Pre-clearance of Trades

Insiders must seek approval before trading in company securities to ensure compliance with regulations.

Legal Instances of Insider Trading

Not all insider trading cases are black and white. Some have shades of gray! In some instances, insiders might have valid reasons for their trades, like emergency financial needs or fulfilling regulatory requirements.

When Is Insider Trading Illegal?

Just like masala (spice) without proper seasoning, not all insider trading is legal. It becomes illegal when insiders use confidential information to gain an unfair advantage over other investors, like that secret card trick we talked about earlier.

When Is Insider Trading Legal?

Believe it or not, there are legal ways for insiders to trade! They can do so when the information they have is already available to the public, or after a specified period has passed since the information became public.

Penalties for Insider Trading

SEBI has some serious punishments when it comes to penalizing insider trading offenders. Under the section u/s 15G of the SEBI Act, 1992, the penalties may include hefty fines, bans from trading, and even criminal charges. 

Depending on the gravity of crime, the conviction of insider trading under SEBI Act 1992 (Section 15G) and Companies Act 2013 (Section 195) can result in;

• Penalty ranges from INR 10 lakhs to INR 25 crores or 3 times the profit made, whichever is higher.
• Imprisonment of up to 10 years depending on the severity of the case. 
• Cancellation of license or disgorgement orders.
  

What Measures Should Be Taken to Prevent Insider Trading?

Preventing insider trading is a collective responsibility. Conducting significant compliance programs for staff education about repercussions, legal obligations, policies and guidelines, executing routine audits, and fostering honest as well as ethical company culture.  Here are some measures that can help:

Education: Educating insiders and market participants about the dos and don’ts of insider trading can go a long way.

Strict Monitoring: Constant vigilance and sophisticated tracking systems can help nab potential culprits.

In Essence

Insider Trading – a tantalizing tale of secret information and market maneuvers. We hope we’ve simplified this complex topic and spiced it up with some relatable examples. The stock market curry tastes best when it’s seasoned with fairness and transparency. Let’s invest wisely and ethically, making the Indian stock market a level playing field for everyone. Remember, knowledge is power, and learning about insider trading can make you a ‘dabangg’.

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