Insider Trading - Definition, Examples, SEBI Regulations

Insider trading involves trading in the stock market using undisclosed or unpublished price-sensitive information that is otherwise not ordinarily available to the general public. 

It is primarily those with a direct connection to the company, such as directors, promoters, employees, and auditors, who typically know the inside information.

If a market participant decides to act on the inside information to profit from a price change in the stock market before the information is publicly available, that action would be an example of illegal insider trading.

The regulations of SEBI stipulate that all important company-related information must be announced to the exchange publicly in a timely fashion without any delay, prior to company insiders acting on the information before it becomes public.

Quick Summary

Insider trading occurs when an individual uses non-public information about a company to trade its shares before the public announcement of the information. 

The Securities and Exchange Board of India (SEBI) is very strict in preventing insider trading in India. They do this for many reasons, including that insider trading gives certain individuals an unfair advantage over other retail investors.

Put simply, markets are efficient and fair when everyone possesses the same information at the same time.

Our Focus in the Article

• What is Insider Trading and how their work 

• Types of Insider Trading and when it is considered legal

• SEBI’s rules and regulations against inside trading

• Effects of Insider Trading on market Investors in trading

What is Insider Trading?

Insider trading happens when someone purchases or sells a company's stocks, bonds, or other securities based on key, material, non-public information about the security that could impact its price. 

This involves people who have privileged access to confidential information about the company, such as company executives, directors, employees, or anyone with close ties to them, using that information to initiate buy or sell orders before the rest of the market has common access to it.

How Does Insider Trading Work?

Insider trading is the trading of the securities of a company using material, non-public information that is not available to the general public. 

The information may be on future mergers, financial performance, product release, regulatory clearances, or any other major events that may have an effect on the stock value. 

When these insiders buy or sell stocks based on this hidden information, it becomes NSE insider trading, which is illegal because it gives an unfair advantage over normal investors who do not know the upcoming news.

Insider trading usually operates in the following manner: Insiders gain access to sensitive and non-public information due to their position/ relations. 

They then either sell or purchase the securities of the company, depending on this data. Lastly, they conduct trades in order to gain profits after the information has been made public on the anticipated changes in the stock prices.

Whereas certain insider trading, like legal trades by executives which have been disclosed to regulatory agencies, is legal, the trade on material nonpublic information for personal gain is unlawful. 

Insider trading is illegal and not only destroys investor confidence and fairness in the market but is also subject to heavy fines and jail terms.

These rules make sure no one gets an unfair advantage by using secret information. When laws are strong and strictly followed, cases like BSE insider trading can be controlled, and this helps the financial market stay trustworthy, transparent, and respected by society.

Types of Insider Trading: Legal vs. Illegal

There are a number of different types of insider trading, all of which involve the utilization or misutilization of confidential, non-public information to undertake trade activity in the securities of a publicly traded company. 

The insights on these kinds can help to explain why insider trading may be legal when it comes to one case and illegal when it comes to another.

1. Legal Insider Trading

• Insider trading is the buying and selling of the stocks of the same company by the executives of the company, the company directors, or employees who buy and sell the shares of the company under regulation.

• Involves trading within specified trading periods and within the required mandatory disclosure requirements.

• Trading of based on information as to what is publicly known or information that has been disclosed in the past or as per pre-approved trading plans.

2. Illegal Insider Trading

• The trading activities should be based on material non-public information (MNPI), which is not accessible to ordinary people.

• Involves the personal gain of using unpublished price-sensitive information (UPSI).

• Tipping or being tipped with confidential information and dealing with the information.

• Trades are conducted in blackout or without disclosure by the regulators.

When is Insider Trading Considered Legal?

Insider trading is permissible if the individual trades based on information that has been made public and disseminated through an official announcement. 

This means the information must be shared with everyone at the same time, so no one gets a special benefit. 

Only when data is publicly available and equal for all investors, then and only then can we judge is insider trading is legal in India or not.

Examples of public information:

Company earnings are disclosed on the relevant stock exchange website. 

The Company provides official shareholders and potential investors with a press release, and the SEBI filing is available to every investor. News anchors/companies have reported the public announcement. 

In this circumstance, even if the company’s director, employee, or c-suite executive buys or sells shares, it is legal, not considered insider trading, because it is no longer a "secret." 

Insider trading is also legal where:

The insider receives authorized approval from the compliance officer of the company before the trade 

The trade is reported to the exchange within the SEBI requirements. 

The trade is made during the "open trading window" of the company-not while restricted.

SEBI’s Role and Regulations Against Insider Trading

The Securities and Exchange Board of India (SEBI) plays its role regarding insider trading and provides a fair degree of fairness to the Indian stock markets. SEBI insider trading regulations are made to stop people from buying or selling company shares using secret information that the general public does not know. 

What SEBI Does

SEBI rules concerning insider trading are extremely strict. The rules prohibit insiders (directors, employees, consultants, close relatives, etc.) of the company from buying or selling the company's shares if they have access to unpublished price-sensitive information (UPSI) related to the company's financial performance, dividend announcement, or acquisitions, etc. 

SEBI also requires companies to maintain a list of insiders and closely monitor the trading activity undertaken by insiders. SEBI investigates suspicious trading activity. SEBI can impose substantial fines and even imprisonment if people are found guilty. For example, the maximum fines are 25 crores and 10 years of imprisonment related to insider trading violations.

Just like reporting the legitimacy of insider trades above a threshold value requires timely reporting and a whistleblowing system should be in place to help employees report wrongdoings.

Insider trading is not only negligent, but it can also harm the common investors. The main purpose of SEBI's rules is to:

• Equalize the playing field for all traders.

• Ensure the integrity of the market.

• Provide safeguards against cheating by investors.

Past Instances and Examples of Insider Trading in India

Here are some past instances and examples of insider trading in India, explained in simple and meaningful words:

• Hindustan Lever Limited Case: This is one of India's first famous insider trading cases. Insiders of the company purchased shares of another company before a public announcement about a merger. They had unpublished secret information regarding this merger, enabling them to reap insolent profits when the news was made public. 

• WhatsApp Leak Case: In this case, an employee distributed secret information on companies such as Wipro, Ambuja Cement, Bajaj Auto, etc. via WhatsApp groups before the information became public. SEBI conducted an investigation and penalized the individuals who were responsible for sharing and trading on unpublished information. 

• GIC Case: SEBI conducted an investigation into GIC for insider trading. Once evidence of insider trading with unpublished information was discovered, a penalty was imposed. The company later settled a case of insider trading by paying the penalty.

• Big-Name Investigations: Billionaire investor Rakesh Jhunjhunwala came under the scrutiny of the SEBI due to insider trading to do with Aptech Limited shares. Other well-known individuals and companies were also given notices by SEBI on account of insider trading.​

• Zee Entertainment Enterprises Ltd (ZEEL) Case: SEBI imposed a year's trading ban and a fine on some people on the basis of trading on unpublished financial performances and sensitive information concerning ZEEL.​

• Rajat Gupta Case (International): This case is not located in India, but the top business executive of Indian nationality was the one who pioneered providing a hedge fund with secret information regarding the company, resulting in insider trading. The case has made it clear to us the level of risks and implications of insider trading, including its top executives.

Effects of Insider Trading on Markets and Investors

Insider trading is the event when an entity with insider, discrete, and significant knowledge about the company buys or sells the corporation’s stock prior to this information becoming available.

Many insider trading cases in India also prove that such actions can shake trust and confidence in the stock market. Below, we list the major effects in simple and easy words.

1. Breaks Trust in the Market

• What transpires: When the people get to know that insiders are making their money using their insider knowledge, the people lose their trust in the fairness of the stock market.

• Impact on the investors: Ordinary individuals are reluctant investors. They worry about losing their cash to the insiders. In the long run, the number of individuals would reduce and the market would become smaller.

• Real-life experience: Visualizing: When playing a game, some of the members can view all the cards of the players except their own. You’d quit playing.

2. Hurts Fair Pricing of Stocks

• What occurs: The price of stocks ought to reflect all the public information. Secrecy-based insider trades invert the actual value - the stock soars or bombs due to a false cause.

• Investor result: This sets up the situation of you purchasing a stock because it seems to be on sale, it takes off on you at the time that the secret news finally leaks out.

• Mundane illustration: When an insider sells a lot in advance of the receipt of bad earnings, the price goes down without much warning, leaving high-fidelity purchases in shatters.

3. Reduces Market Efficiency

• What will occur: The real information is rapidly taken up in the healthy market, which means that prices remain true. This is postponed by insider trading.

• Investor outcome: Loans are being directed to the wrong businesses. Good firms are left alone, and weak ones are seen as being strong in the short term. No, no one loses chances.

• In conclusion, the market is turned into a casino rather than an intelligent investment device.

4. Enhances Volatility (Unstable Price Movements)

• What occurs: Huge insider trades contain misleading signals. The other traders respond, leading to severe ups and downs.

• Investor outcome: Your portfolio is playing like a yo-yo. The long-term planning results in increased difficulty and risk.

• Every day, Retirement savings or college funds are less secure.

5. Rewards Unethical Conduct.

• What occurs: When insiders get off the hook, more imitate them - further leaking, more cheating.

• Investor outcome: The entire system is corrupt. True company managers are concerned with short-term tricks rather than creating genuine value.

• Costs in the long term: Business enterprises lose, employment becomes less stable, and development is slowed down.

6. Legal and Financial Costs

• Look what has happened: Insider trading is fined and jailed by regulators such as the SEC.

• Investor outcome: Organizations in the big pay their attorneys a fortune, distracting management and burning shareholder cash.

• Short pronouncement: One lawsuit can be tens of millions of dollars, and the money could have been used to divide or develop.

7. Minuscule Deliberate Fallacy (But Still Damaging in the Long Run).

• Others claim that the government can be insider traded and information is leaked quickly to assist the price adjustment.

• Business calculator: The damage done to the aspect of fairness and trust is far greater than the slight speed advantage. Laws ban it for good reason.

Pros and Cons of Insider Trading

Insider trading is when people inside a company, like directors, employees, or close associates, buy or sell its shares using secret information not yet shared with the public. 

So insider buying stocks in India without public disclosure is a serious offence because it gives an unfair advantage over normal investors.

Pros of Insider Trading

Though banned, some argue it has a few benefits:

• Rewards Knowledge: Insiders work hard and know the company best. Trading on this info is like getting paid for smart insights.

• Faster Price Correction: When insiders trade, share prices quickly reflect the real value, helping the market stay accurate.

• Extra Incentive for Employees: It acts like a hidden bonus for those who take risks with sensitive information.

Cons of Insider Trading

The downsides are serious, and that’s why it’s illegal:

• Unfair to Regular Investors: You and I don’t get secret tips. Insiders win, we lose, it’s like racing with one team knowing the finish line.

• Damages Market Trust: If people think the stock market is rigged, they stop investing. Confidence drops, and the market suffers.

• Hurts the Company: Secret trades can spark rumors, panic selling, or bad press, hurting the company’s reputation and share price.

• Legal Trouble: SEBI monitors unusual trades. If caught, insiders face heavy fines, jail time, or both.

Conclusion

Fundamentally, insider trading is the trading of stocks based on material information that is not yet disclosed to the public. 

While it may provide quick financial benefit to a few people, it would undermine the integrity of the market as a whole. 

This guide has presented both sides- arguments in favor of the theory and real-world arguments against it- in order to provide a balanced yet clearer perspective for the beginner.

FAQs