It has been published by Rachit Garg.
Table of Contents
Insider trading is a serious issue that can greatly impact the goodwill and sustainability of a company. As a company secretary, it is essential to have a comprehensive knowledge of insider trading laws, regulations, and best practises to protect a company from this malpractice. This article aims to provide an overview of insider trading, its implications, the legal framework, and the role of a company secretary in preventing and detecting insider trading activities.
What is insider trading
Insider trading refers to the buying or selling of publicly traded companies’ securities based on the possession of some material information that is not yet available to the public. This material information denotes information or data that has a substantial impact on investors while making decisions. Generally, it is possessed by corporate insiders, such as directors, officers, employees, or major shareholders of the company, as these corporations have easy access to confidential information that could significantly impact the company’s stock price. Many big insider trading scams happened all over the world, which resulted in loss of goodwill, financial damage and further heavy penalties and imprisonment imposed by the regulators.
Intended declaration of rights issues in the near future, opening another branch or plant at a different location, the chairman of the company resigning to the boards under any internal disputes and the company negotiating with a foreign company to sell a 20% stake are a few examples of material information that could be misused by any director or key management personnel (KMP). When these handfuls of corporations misuse this material information to manipulate the stock prices at the Stock Exchange for their own benefit, this is termed insider information.
Implications of insider trading
In this section, we will understand various serious implications of insider trading:
- Legal impact: Insider trading is declared illegal in India, which can result in civil and criminal penalties, including fines and imprisonment. These legal consequences also badly impact the company’s operations and business.
- Investor confidence: Insider trading adversely affects investor trust and confidence in the fairness and accuracy of financial market transactions. It creates an unfair advantage for those with access to non-public and material information. Ultimately, it depletes the capital and savings of investors due to the manipulation of stock prices.
- Reputational damage: Whenever insider trading scams are disclosed in public, it significantly damages the company’s reputation. Negative publicity and loss of investor confidence can harm the company’s brand image and long-term prospects.
Regulations to control insider trading
Insider trading is regulated by SEBI (Securities and Exchange Board of India) through the Prohibition on Insider Trading Regulations, 1992. In this regulation, various laws are enacted to safeguard the interests of various parties related to the company, directly or indirectly. A few laws are outlined below:
- Disclosures by certain persons- This includes initial and continual disclosures related to holdings of securities required by the director or key management personnel (KMP) who resumed office in the company under new appointment. It also covers disclosures of holdings of securities by other connected persons.
- Chinese Wall Policy- A ‘Chinese Wall’ is a type of practise in which information known to one person for one part of the business of a company is not available to another person who belongs to another part of the business, directly or indirectly. It prevents the misuse of material and confidential information within a company. By adopting this policy, a company can have control over sensitive information from being misused in some way by the employees for their personal benefit.
- Unpublished price-sensitive information- This information is generally related to major company decisions or its securities, which, directly or indirectly, are not available or published in the public domain. It constitutes:
- Dividend policy.
- Financial results before the board meeting for approval.
- Merger, de-merger, expansion, and disposal-related decisions.
- Change in capital structure.
- Changes in key management personnel (KMP) or board of directors (BOD).
- Penalty provisions- Insider trading is punishable under Section 15G of the SEBI Act, 1992. It prescribes penalties for insiders not less than Rs. 10 lakhs, which can extend to Rs. 25 crore or three times the profit earned through insider trading, whichever is higher.
- Code of conduct- The code of conduct should be prepared to regulate, monitor and report on various aspects by compliance officers pertaining to the prohibition on forward dealings in securities by the director or KMP, trading in securities by insider restriction, trading window, pre-clearance of trades, trading plans, and many more.
Role of a Company Secretary in preventing and detecting insider trading
The company secretary role is very crucial in ensuring compliance and preventing insider trading within the organisation. He is responsible for complying with all rules and regulations prescribed by law, keeping watch over malpractices, and maintaining legal papers and other documentation related to law related matters. The company secretary shall act as a compliance officer and ensure that all laws have been complied with to control insider practises. To perform the duties of a compliance officer, it is required that the company secretary have specific knowledge of all applicable laws, regulations and related amendments. He/She will prepare a report and submit it to the board and chairman of the audit committee in relation to the insider trading requirements of a company. He shall perform the following duties:
- To establish strong and robust code of conduct, internal controls and procedures as specified in the regulation and get these approved by the Board of Directors.
- To implement comprehensive insider trading policies and procedures that outline guidelines for employees, directors, and officers. These policies should cover trading restrictions, pre-clearance procedures, reporting obligations, and consequences for violations.
- To frame rules and policies to protect price-sensitive information. Various aspects are required to be taken into consideration while framing policies, such as the flow of information in the company, how it will be protected from unauthorised use, person/department holding it, and effective controls to be put in place to secure it. Implementing the Chinese Wall Policy in the company is one of the most effective methods to develop a better culture among employees.
- To ensure strong data protection policy and related information technology. It is very difficult to secure online data nowadays, as it is accessible to the entire world in seconds. Hence, cyber To maintain a record of trading window rules such as close period at time of financial declaration, at time of dividend declaration, public or right issue, expansion, merger, disposal of part of any subsidiary and so on.
- To secure and record price sensitive and material information. This list is very crucial as company sustainability depends on these events and leakage of this information results in serious reputational and financial damage to the company.
- To prepare a list of key management personnel, directors and other connected persons and their disclosure information related to the holding of securities.
- To review, modify and suggest improvements in internal control and code of conduct policies at regular intervals. Every change in business and method impacts the internal controls and their degree of effectiveness. Therefore, it is suggested to review these controls on a regular basis to detect fraud and errors on time and take remedial measures accordingly.
- To furnish accurate information as requested by Board and SEBI from time to time pertaining to records maintenance, details of issue reported, trading window compliance, an enquiry of any other document, etc.
- Conduct regular training and development sessions to inform employees about insider trading laws, regulations, and the importance of maintaining confidentiality, which will definitely help in creating awareness and foster a culture of compliance within the company.
- To implement effective internal controls and monitoring systems to control trading activities, identify suspicious transactions, and promptly investigate potential violations.
- To ensure timely and accurate disclosure of material information to the public in compliance with applicable securities laws and facilitate the reporting of suspicious activities internally, encourage employees to report potential violations anonymously and without fear of retaliation.
- To collaborate with the legal and compliance department as an ongoing activity and work closely with these teams to ensure alignment of policies, reporting mechanisms and investigations related to insider trading. Regular communication and coordination are essential to maintaining a robust compliance framework.
Insider trading is a severe offence that can have serious consequences for both companies and investors. It is the vital responsibility of a company secretary to maintain strict controls in the company to curb such practises, advocate ethical standards, ensure compliance with laws and regulations, and protect the interests of the company, its shareholders, its investors and the broader financial markets and economy. The company secretary acted as a safe wall between the company’s interests and insider trading activities. It is a real challenge to remain vigilant constantly about the activities of the companies, changes happening inside the company and outside the world impacting the business of the company and be compliant with every part of the prescribed regulations and laws.
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