This article has been written by Chitrakshi Mohnot, a student of the Institute of Company Secretaries of India, currently doing a Diploma in Law Firm Practice: Research, Drafting, Briefing, and Client Management by Lawsikho. This article has been edited by Yashprada (Associate, Lawsikho), Ruchika Mohapatra (Associate, Lawsikho), and Indrasish Majumder (Intern at LawSikho).
This article has been published by Shoronya Banerjee.
Table of Contents
Recently in the USA, a man was held for profiting from insider trading in his brother-in-law’s company. The USA Board of insider trading – SEC based its decision solely on inferences. There was no substantial evidence that demonstrated that the man was involved in insider trading. Just because one knows an insider, it can not be concluded that the person has taken part in some form of insider trading, and besides, not all insider trading is illegal. The illegality of insider trading happens when a securities transaction (i.e., purchase or sale of stocks) is influenced by only a small group of people inside the company whose stocks are being traded in volume at the stock exchange.
The term “insider trading” is mainly perceived with a negative connotation. Various cases relating to insider trading have approbated a negative connotation to the term but Insider trading is not always illegal. The problem of insider trading emerged with the introduction of the concept of trading securities in the global market. In India, SEBI regulates the functioning of the capital market. It was established in 1992 under the SEBI Act 1992.
Meaning of ‘insider trading’
Insider trading is a practice of trading in shares based on unpublished price-sensitive information (UPSI). It involves buying or selling shares of a listed company not only by an insider but also involves directly or indirectly, key management personnel or the director of the company, or someone who has received the unpublished information. Using unpublished price-sensitive information, sometimes, can materially impact the stock price of the company in the stock exchange.
Meaning of ‘insider’
According to Regulation 2(1) (c) of SEBI (Prohibition of Insider Trading) Regulations, 2015, Insider means any person who is:
i) A connected person;
ii) In possession of or having access to unpublished price-sensitive information (UPSI);
An ‘insider’ is someone who is a connected person or has access to UPSI. A connected person can be anyone who during the six months preceding the insider trade has been associated with the company in some way. This could be a company director or employee or their close relatives, or a legal counsel or banker to the company, or even an official of the stock exchanges or trustees or employees of an asset management company who has interacted with the company.
Meaning of UPSI
“Unpublished price sensitive information” means any information, relating to a company or its securities, directly or indirectly, that is not generally available which upon becoming generally available, is likely to materially affect the price of the securities and shall, ordinarily be including but not restricted to, information relating to the following:
(i) Financial results;
(iii) Change in capital structure;
(iv) Mergers, demergers, acquisitions, delisting, disposals, and expansion of business
And such other transactions;
(v) Changes in key managerial personnel.
UPSI alone is not restricted to information relating to a company’s significant capacity expansion, quarterly/annual financial results, mergers, amalgamation and acquisition deals, major shutdown plans, or any such significant activities that have not been openly made to the public at large. When insiders use the UPSI to conduct trades; if they are caught, they can be taken to task by the regulator.
For instance, a company’s insider informs his connected persons/acquaintances about upcoming business activities, and the latter passes on this information to his known persons who then buy the company’s shares, making substantial gains. Then, the insider and his connected persons/acquaintances can be booked for violation of insider trading norms.
Meaning of ‘connected person’
According to Regulation 2 (1) (d) of SEBI (Prohibition of Insider Trading) Regulations, 2015 “Connected Person” includes any person who is or has during the six months prior to the concerned act, been associated with the company, directly or indirectly, in any capacity including by reason of frequent communication with its officers or by being in any contractual, fiduciary or employment relationship or by being a director, officer or an employee of the company or holds any position including a professional or business relationship between himself and the company whether temporary or permanent, that allows such person, directly or indirectly, access to unpublished price sensitive information or is reasonably expected to allow such access.
The persons enumerated below shall also be deemed to be connected persons if such persons have access to UPSI or is reasonably expected to have access to UPSI.
1). An immediate relative or connected person.
2). A holding company or associate company or subsidiary company.
3). An intermediary as specified in Section 12 of SEBI Act or an employee or director thereof.
4). An investment company, trustee company, assets management company, or an employee or director thereof.
5). An official of a stock exchange or a clearinghouse or corporation.
6). A member of the board of trustees of a mutual fund or a member of the board thereof.
7). A member of the board of directors or an employee of a public financial institution as defined in Section 2(72) of the Companies Act, 2013.
8). An official or an employee of a self-regulatory organization recognised or authorised by the SEBI.
9). A concern, firm, Hindu undivided family, company, or an association of persons wherein a director of the company or his immediate relative or banker of the company, has more than ten percent of the holding of interest.
Legal insider trading and illegal insider trading
Legal insider trading
Insider trading sometimes is not always illegal. While trading with UPSI is illegal; all insider trading is not barred. Corporate insiders, officers, directors, employees, and large shareholders, buy and sell stock in their own companies. For instance by selling their ESOPs, etc., for personal needs. If such trades are disclosed to the stock exchanges as per SEBI Rules, it isn’t illegal. However, a company must notify the exchanges within a few days about the trading details of such insiders.
Many investors and traders use the information of insiders to identify potential companies for investment. In other words, if the insiders are buying the stock, they must know more about their company than everyone else, so they prefer to buy the stock. But when the insiders sell stock the investors or traders cannot be driven by their sentiments because they might be selling stocks due to varied personal reasons. Natural influence through an insider does not amount to insider trading. Additionally, even purchasing shares and then disclosing them to SEBI does not amount to legal insider trading.
Illegal insider trading
No insider who is in possession of unpublished price-sensitive information shall trade in securities that are listed or proposed to be listed on a stock exchange. When insider trading is done on the basis of UPSI and as the insider earns profit, it results in illegal insider trading. Directors and senior management are not the only people that can be convicted of insider trading; anyone with access to unpublished price-sensitive information can be convicted if they used the information to make illegal profits. Large companies can have hundreds of insiders, which can make analysing their buying and selling more difficult. Anybody who has material and unpublished price-sensitive information can commit the illegal act of insider trading. This means that nearly anybody, including brokers, family, friends, and employees, can be considered an insider.
According to Regulation 4 of SEBI (Prohibition of Insider Trading) Regulations, 2015, Insider is prohibited directly or indirectly to:-
- Trade in securities that are listed or proposed to be listed when in possession of UPSI;
- Trade in securities of the company except when the trading window is open and the insider is not in possession of UPSI.
Provided the restriction in 2 (i) above shall not apply to:
- A transaction that is an off-market inter-se transfer between promoters who were in possession of the same UPSI without being in breach of these rules and both parties had made a conscious and informed trade decision; and
· B) Trades, pursuant to a trading plan set up in accordance with these rules.
An insider who has ceased to be associated with the Company shall not, for a period of six months from the date of such cessation, directly or indirectly trade in the Company’s Securities while in possession of UPSI.
Further, According to relevant provisions of SEBI (Prohibition of Insider Trading) Regulations, 2015, it has been stated that “All directors, officers, designated employees who buy or sell any number of shares of the company shall not enter into an opposite transaction, i.e. sell or buy any number of shares during the next six months following the prior transaction. All directors, officers, designated employees shall also not take positions in derivative transactions in the shares of the company at any time. In the case of subscription in the primary market (initial public offers), the above-mentioned entities shall hold their investments for a minimum period of 30 days.”
Nowadays, insider trading goes unnoticed for good reasons. Even after the implementation of the insider trading regulatory system, it is sometimes difficult to differentiate between guilty insiders and victims. Not all insider trading is unethical, especially insider trading done through the natural influence which does not amount to insider trading, and sometimes the investment community is also benefited by them at large. Thinkers in various fields have two-dimensional views, one is positive while the other is negative in nature.
Insider trading affects the integrity and transparency of capital markets. We always cannot rely on the laws or the mechanisms by the regulatory body for insider trading prevention. It totally depends on the insider as to how he preserves the price-sensitive information as trading on UPSI gives insiders an unfair advantage over regular investors and, it becomes the responsibility of the directors, officers, and other members of the company to keep a check on the insiders so that information is not leaked which will affect the goodwill of the company.
In order to curb the practice of insider trading activities, SEBI has made mechanisms and regulations that from time to time have failed, in many instances. Therefore, SEBI should try to inculcate such a habit of sharing the unethical practices of insiders and rewarding the person for his effort to curb the malpractices. Another measure is to make punishments more stringent and separate special fast track courts for speedy trials of such cases should be made. Although complete elimination of insider trading is not possible, overregulation is also not the clear solution, but trying to limit it is one factor that can be worked upon.
- Shoronya Banerjee, Insider trading in India : regulations and controlling authority’ (ipleaders)
- Shradha Rajgiri, ‘AN ANALYSIS OF INSIDER TRADING IN INDIA’ (2019) 9 PRAMCI 137.
- Himanshu Chahar, Sumeer Sodhi, ‘Insider Trading in India’ (Legal Service India).
- J Sarkar & Subrata Sarkar, ‘Large Shareholder Activism in Corporate Governance in Developing Countries: Evidence from India, International Review of Finance’ (2000) 161-194.
Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skills.
LawSikho has created a telegram group for exchanging legal knowledge, referrals, and various opportunities. You can click on this link and join: