What Is Insider Trading: Meaning, Types, Examples
Insider trading is a practice that involves the buying or selling of shares in a publicly-traded company based on non-public or material information. This information can significantly impact investment decisions. Also, insiders can be anyone working in the company such as corporate executives, directors, or government officials. Insiders use this privileged information to make money or avoid losses.
However, SEBI regulates insider trading. By monitoring share market activity, the government tries to stop and detect rigged markets. Moreover, there are penalties for insider dealing in India under SEBI laws. In this article, we'll explore what insider trading is, who is an insider, and some real-life examples of insider dealing in India.
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What is Insider Trading?
The practice of insider trading refers to purchasing or selling shares of a publicly-traded company before the material information is publicly available. In investing, material information refers to information that may have a substantial effect on whether or not a decision is made to buy or sell a security.
Generally, non-public information is not in the public domain and is only known to those directly involved in it. For instance, a corporate executive or a government official who has access to an economic report before it is made public might be considered an insider.
This malpractice involves trading in the company's securities using unpublished sensitive information. This information is used to make an improper profit or loss. Because the information can affect a company's share price in the market, it is also called “price sensitive.”
Who is an insider?
An insider is someone who owns shares in the company he trades. He may be a company's director, president, or senior executive who owns more than 10% of the company's stock. Also, it's possible the insider isn't an employee of the company but has plenty of information about stock performance. Here are some examples of insiders:
- Employees, officers, and directors of a company who trade in the company's stock after learning of confidential business development.
- The officers, directors, and employees' friends, peers, or relatives who exchanged securities after learning of the information.
- Companies which provide legal, banking, and press services to companies whose securities they trade.
- Confidential information shared by employees.
- Government employees with material nonpublic information who can make suggestions or act on it.
Types of Insider Trading
There are legal and illegal types of insider dealing, depending on what type of material information the insider has access to. Generally, insiders aren't allowed to trade their stock for that company if they have non-public information. However, if the information is already public, these people can trade legally without getting in trouble.
What is the consequence of insider trading?
The following are the consequences of inside information:
- Whenever insiders gain access to a person's information, they take unfair advantage of them.
- Since it is in the insider's interest and not in the best interest of the company, it creates a conflict of interest.
- In addition, it damages the prestige of the market and discourages investors from investing in it.
Real-life Examples of Insider Trading in India
Pia and Mehul Johnson Case: Indiabulls Venture, former non-executive director Pia Johnson, and her husband Mehul Johnson were fined by SEBI for exchanging the company's shares using USPI (Unpublished Price Sensitive Information).
Rakesh Jhunjhunwala Case: Rakesh Jhunjhunwala, a billionaire investor, was summoned by SEBI for insider dealings at Aptech. In addition, SEBI investigated the role played by a member of Jhunjhunwala's family.
Balram Garg Case: In December 2019, SEBI issued a notice to PC Jeweler's Managing Director, Balram Garg, regarding alleged Insider dealing. The government agency also confiscated about INR 8 Crore.
Reliance Industries: RIL was banned from the derivatives sector and fined by the Securities and Exchange Board of India. The exchange regulator accused the company of skirting its legally permissible trading limits and lowering its stock price in cash to make profits.
Regulations/Prohibitions imposed by SEBI
The following restrictions apply to Insider Trading:
Insiders are prohibited from communicating, supplying, or providing UPSI regarding publicly traded companies or securities to anyone.
In accordance with these regulations, one cannot purchase a UPSI from an insider of a publicly traded company or sell securities to another insider.
An insider is restricted/prohibited from dealing in securities listed on a recognized exchange when he is in possession of UPSI.
Penalties for Insider Trading
In India, the SEBI Regulations address the prohibition and restrictions on rigged markets. It is prohibited for an insider to transmit confidential information about a company unless authorized by the company.
An individual or another person misusing information is treated as committing a criminal offence under the law. Depending on the severity of the offence, it can be punished by up to 10 years in prison or a fine of up to 25 crores.
In the financial markets, insider trading is a serious offence that compromises fairness and integrity. The act involves buying or selling shares based on non-public material information. Furthermore, this non-public material information has a significant impact on investment decisions. The insider can also be a corporate executive, director, or government official using privileged information to make money or avoid losing money.
There have been several real-life examples of insider dealing in India. A number of individuals have faced fines, investigations, and legal action for engaging in insider dealing. These individuals include Pia and Mehul Johnson, Rakesh Jhunjhunwala, Balram Garg and Reliance Industries. However, regulations and penalties have been implemented by regulatory bodies like SEBI to combat this illegal practice.
Insider Trading FAQs
Yes, legal and illegal are two types of insider trading.
By monitoring market activity, the government tries to prevent and detect insider dealing.
SEBI regulates insider trading in India.
Yes, CEOs can engage in insider dealing by purchasing shares of the company and influencing the price movement of the stock
Depending on the severity of the violation, insider trading can be punished with up to ten years in prison or a fine of up to 25 crores.