Gist of Insider Trading Regulation

Insider trading denotes dealing in a company’s securities on the basis of confidential information relating to the company which is not published or not known to the public and used to make a profit or loss. It is fairly a breach of fiduciary duties of officers of a company or connected persons toward the shareholders. This article briefly explains the Gist of Insider Trading Regulation, SEBI Regulations & Insider Trading Regulations.

What is insider trading?

Insider Trading is the practice of using confidential information (unpublished price-sensitive information) of a company to trade in the company’s securities. The unpublished price-sensitive information is not known to the general public as it is not published and is related to the decisions taken by the Board of Directors of the company. The use of such information to cause wrongful gain or loss is termed insider trading. The information is referred to as ‘price-sensitive as it is capable of influencing a company’s securities’ price in the market.

Insider trading is an act of buying, selling, subscribing, or agreeing to subscribe to the securities of a company, directly or indirectly, by the key management personnel or the director of the company who is anticipated to have access to Unpublished Price Sensitive Information with reference to securities of the company and it is deemed to be insider trading.

Who is an insider?

Insiders can be referred to as persons who are in a position to access confidential price-sensitive information, connected with the company. They use such information against uninformed investors in making huge profits before it comes to the knowledge of the public. The term “insider” has wide interpretation and includes partners, directors, officers and employees of a company and related companies, persons holding some kind of official relationship with a company, professional or business (e.g., auditors, consultants, bankers, and brokers), stockholders, government officials, and stock exchange employees, etc. It can be noted that the board of directors and employees have direct access to price-sensitive information and therefore are in a position to use such information in the manner they want. There can be instances where the insider can supply the information to an outsider and hence, deal with the outsider without letting the blame fall on him. The insider can engage in many other such malpractices and remain unnoticed. Hence, it becomes important to point out such deficiencies in the system. 

The basis of insider trading is the exchange of securities willingly on receipt of some piece of confidential information that is not publicly available and which has the potential to affect the price of these securities drastically. For instance, a director of a company is aware that the company is in a bad financial state and sells his shares in the company knowing that there will be an announcement made to the public about the cut in a dividend. Similarly, the director would be engaged in insider trading if he buys more stocks in a company upon receiving information about the discovery of diamond or gold on the company’s land, before a public announcement expecting the price of stocks to rise on such announcement. Thus, an insider who knows that the company is in a financial mess may sell his shares in the company knowing that shortly there will be a public announcement of the news. 

Any person having any kind of professional or business relationship may become a connected person and thereby an insider, if he may reasonably be expected to have access to unpublished price-sensitive information. The relationship and accessibility to unpublished price-sensitive information facilitated by such a relationship are necessary.

What are the effects of insider trading?

The effect of insider trading is borne by those who are not aware of the confidential information. Due to this, they do not deal in securities. Insider trading is unethical and amounts to a breach of fiduciary position as it involves a breach of trust and confidence. The misuse of insider information is discouraged for numerous reasons:

• Insider takes unfair advantage of the information-deprived person;
• It results in a conflict of interest as it is beneficial for the insider’s self-interest and not in the company’s best interest;
• It lowers the market reputation and acts as a disincentive to investment.

The Insider Trading Regulations

The Insider Trading Regulations require the board of directors of every listed company and market intermediary to formulate a code of conduct to regulate and report trading by its employees and other connected persons to comply with these regulations. Such a board of directors shall adopt the minimum standards as stated in the Insider Trading Regulations.

The Regulation requires every other person who is required to handle UPSI to formulate a code of conduct to regulate and report trading by employees and other connected persons towards achieving compliance with these regulations. Such a person shall also adopt the above-mentioned principles. The Regulation requires every listed company, market intermediary, and another person to formulate a code of conduct to identify and designate a compliance officer. It is essential for a fair trade that insider information must not be utilized by the directors or employees to further their own interests. Doing such an act would amount to a breach of their obligation towards the company. People will lose interest in such companies.  There should be a continuous check on such practices to ensure the integrity of the market is not degraded by the loss of confidence of investors. These practices are immoral, and unethical and can cause damage to a large number of innocent investors. 

SEBI Regulations

Insider trading in India is prohibited by the Companies Act, of 2013 and the SEBI Act, of 1992. SEBI has formed the SEBI (Prohibition of Insider Trading) Regulations, 2015 which prescribe the rules of prohibition and restriction of Insider Trading in India. The Regulations passed by the Securities Exchange Board of India i.e., SEBI (Prohibition of Insider Trading) (Amendments) Regulations, 2018, are applicable mainly to “dealing in securities” which involves “buying, selling or agreeing to buy, sell or deal in any securities by any person either as principal or agent, by insiders on the basis of any private confidential information.” The Regulations are only applicable to the exchange of listed securities.

Conclusion

There has been an evolution of the laws prohibiting the practice of insider trading to a great extent since 1992. The authorities have considered the practice of insider trading an alarming offense and have amended the statutes with new and stringent provisions from time to time. SEBI has succeeded in punishing the offenders of insider trading to some extent.