What Is Insider Trading?

Insider trading basically refers to buying or selling securities using unpublished price-sensitive information that is not available to the public. In simple terms, it happens when someone trades shares based on confidential company details that can influence stock prices. Nowadays, as more people rely on online platforms for investing, maintaining fairness and transparency has become very important. Insider trading rules exist to create a strong and reliable market environment. These regulations help ensure that all investors get access to the same information at the same time.This article explains what is insider trading meaning, its types, regulations, and its impact on investors and financial markets, so you can get the most from your investment decisions. 

Types of Insider Trading

When we define insider trading, the term "insider trading" refers to a variety of unethical and frequently criminal actions involving the trading of securities using material, non-public information. These activities fall into a number of categories, each with, special traits and consequences of its own. The following are a few basic types of insider trading: 

1. Classic Insider Trading

The purchase or sale of a firm's stocks by insiders (such as officers, directors, or employees), based on significant non-public knowledge about the company is known as classic insider trading.  

For instance, the business executive develops inside information about its planned merger before the release of the same and then uses such information to decide when to buy or sell his shares. 

2. Trading During Blackout Periods

Companies may have blackout periods when selected people are not allowed to trade in the security of the company. Insider trading occurs when transactions take place during these prohibited times. 

Example: When a publicly traded company has announced a blackout because of upcoming financial results, an employee of the company sells shares at that time. 

3. Front-Running

When an insider, such as a broker or financial advisor, trades ahead of major orders on behalf of clients or the company, they are engaging in front-running, which is the practice of profiting from anticipated price movement. 

Example: Before fulfilling the client's order, a broker purchases the same stock for their account after learning that a sizable institutional client intends to acquire a significant quantity of the stock. 

4. Tipper-Tippee Trading

This kind of insider trading happens when someone (the tipper), gives others (the tippees) access to private information, which they, subsequently exploit to trade stocks. It is possible to hold tippers and tippees accountable. 

Example: An accessible earnings report is leaked to a friend by a company official, and the friend uses the inside information to buy or sell stock. 

Who is an Insider?

• An insider is a person who has unique access to material, confidential knowledge about the business. It is because of their position or affiliation with the company. Insiders are typically top-level executives, directors, officials, and employees.  
• They have access to insider information which may critically affect the stock price of the company. Insiders are those who can enter into a financial decision based on their insider knowledge.  
• It is important to keep in mind that trading based on inside information is strictly prohibited by law.   
• Insiders are legally required to act in the best interests of the company and its shareholders. 

How Does SEBI Regulate Insider Trading?

The following restrictions apply to insider trading.  

1. Insiders are prohibited from communicating, supplying, or providing unpublished price-sensitive information (UPSI) regarding publicly traded companies or securities to anyone.  
2. By these regulations, one cannot purchase a UPSI from an insider of a publicly traded company or sell securities to another insider.  
3. An insider is restricted/prohibited from dealing in securities listed on a recognised exchange when he has UPSI.  

What is the Consequence of Insider Trading?

The following are the consequences of insider trading.  

1. Whenever insiders gain access to a person's information, they take unfair advantage of them.  
2. This creates a conflict of interest, as the insider's actions prioritise their own interests over those of the company.  
3. Moreover, insider trading undermines the integrity of the market and may deter potential investors from participating.  

Legal vs Illegal Insider Trading Transactions

At a glance, the difference between legal and illegal insider trading is explained below: 

How Investors Can Protect Themselves from Insider Trading Risks

Retail investors can reduce exposure to insider trading risks by relying on verified and publicly available information instead of rumours or tips. In most cases, using reliable stock research, company disclosures, and regulated platforms helps investors make strong and reliable decisions. The practice of disciplined data-based investment leads to better and more effective results during extended periods of time. 

Real-life Examples of Insider Trading in India

Here are a few examples of real-world 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: Mr. 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 Jeweller's Managing Director, Mr. Balram Garg, regarding alleged Insider dealing. The government agency also confiscated about ₹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. 

Conclusion

Understanding what is Insider trading definition is crucial as it is a severe offence that compromises honesty and fairness in financial markets. Buying or selling shares based on substantial non-public information is illegal. Furthermore, investing decisions are greatly impacted by this significant non-public information. An insider can be a director, government official, or business executive who uses proprietary information to increase profits. Real-world examples of insider trading are also available in India. Insider dealing results in penalties, investigations, and legal action for numerous individuals. Laws and penalties have been implemented, by regulatory bodies like SEBI to curb this illicit behaviour and protect market integrity, even on platforms like a stock market app.