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Insider trading is an illegal practice as far as the stock market goes. Considered an unfair means of having an advantage in trading, insider trading involves traders gaining insider information about a company, and therefore, its stock. What does this mean? It means that an individual with inside knowledge could profit from investing in certain stocks while others who lack information or knowledge cannot have the same advantage.
The main governing body of the stock market in India, SEBI or the Securities and Exchange Board of India, highly discourages insider trading in an effort to boost fair and ethical trading practices. This ensures benefits to the common retail investor.
In simple terms, insider trading is a malpractice whereby certain individuals (insiders) may trade in listed securities like stocks and bonds. Such individuals gain an unfair advantage in their trading as, due to their work or some other influence, have access to information about a company (and its stock). This information is private and confidential information that is not made public by the company in question. As you may gather, such information may be crucial in the decision-making process of investment in the company’s stock.
Plainly put, a person buys or sells company stock on the basis of information that is not available to the general public. The person who has access to inside information and partakes in insider trading may be an individual on the board of directors of the company, a corporate officer, a company employee, or anyone who has gained access to non-public information about the company.
Established in the SEBI act on insider trading in 1992, the Prohibition of Insider Trading Regulations, SEBI has mandated that insider trading has to be curbed and misconduct prevented at all costs and with stringent consequences. In 2019, SEBI took the decision to hold company promoters responsible for insider trading violations if they possessed price-sensitive and unpublished company information without having any legitimate reasons.
In a press release by the Securities and Exchange Board of India, it has specified that legitimate reasons include the sharing of unpublished information about the company with lenders, collaborators, partners, customers, legal personnel, auditors, merchant bankers, or any other professionals or persons, with the provision that such sharing is not undertaken to circumvent the SEBI regulations.
Including India, most countries have laws and regulations in place to prevent insider trading and it is illegal to trade using such practices. Here are the reasons for which insider trading is an illegal practice in India:
The most obvious reason for insider trading being deemed illegal is that it is an unfair and unethical practice relative to other investors who trade without the benefit of insider information. Investors or traders with sensitive and insider information could potentially stand to make greater profits from their trading activity than investors who lack such information. Furthermore, the stock market and exchanges aim to enforce fair and ethical practices to all who are involved in trading and investing.
It is essential that trading, on the part of traders and investors, takes place with a certain level of confidence. Insider trading brings down levels of confidence in traders, investors, and the market as a whole.
Insider trading promotes an environment of unfairness among traders and investors who may believe the market is rigged or unfair. This would, in turn, impact market conditions in a negative manner. It is important to note that insider trading may be permitted if it involves employees who do not rely on company information that is not made public. However, in such cases as employees trading in their own company stock, instances have to be reported and transactions must be monitored.
According to SEBI, the punishment for insider trading is a penalty by way of a fine of “not less than ₹10 lakh which can be extended up to ₹25 crore or 3 times the profit made from the insider trading transaction, whichever is higher.
There have been real-world cases of insider trading. The most famous case in the news was associated with a member of the board of Goldman Sachs. The charges against the insider included leaking information from board meetings to a hedge fund investor who traded based on the information. Of course, the perpetrators were convicted of insider trading charges.
Under Indian law, people engaged in insider trading could face monetary penalties and, in some cases, imprisonment, if convicted, depending on the kind of insider information and extent of the crime. Insider trading is not encouraged in any markets, both in India and globally, as the financial markets aim for fair and ethical standards and best practices for all parties involved. Trading and investing are done in good faith and for this to be upheld, insider trading is highly illegal.
Sources:
(PDF) Insider trading in India – regulatory enforcement (researchgate.net)
SEBI | Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015 [Last amended on August 05, 2021]
Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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