Insider Trading in India: Is It Legal or Illegal?

Insider trading is a term that often pops up in the news, especially when scandals break out in the stock market. It involves buying or selling stocks based on non-public information. This can give unfair advantages to those with access to this information, leaving regular investors at a disadvantage. This blog will help you understand what insider trading is, recent changes in SEBI’s rules, examples from India, and why it’s illegal.

Understanding What is Insider Trading? 

Insider trading happens when someone uses non-public information to buy or sell stocks in a company. This information can provide the person with an unfair advantage over regular investors. Insider trading is illegal in India because it affects market integrity and raises questions about rights and equality in the marketplace. It gives insiders, such as company administrators, employees, or individuals, privileged access to confidential information. 

For example, if a company’s employee knows about an upcoming merger and buys the company’s stock before the news goes public, that is insider trading. Since the employee has access to information that isn’t available to others, they can make profits or avoid losses unfairly.

SEBI’s Latest Change in Insider Trading Rules 

Recently, SEBI introduced new updates to make insider trading rules stricter. These changes aim to increase transparency and make sure everyone follows fair practices in the stock market. 

SEBI now defines insiders more clearly. This means that not only employees but also others connected to the company, like consultants or family members, can be considered insiders if they have access to secret information.

Another major change is that companies need to keep better records of all insiders and their trading activities. SEBI requires companies to monitor insiders closely and report any suspicious activities right away. This helps catch insider trading before it becomes a bigger issue.

In addition, SEBI has increased penalties for those found guilty of insider trading. The new rules also focus on closing loopholes so no one can misuse the system or gain unfair advantages. 

Examples of Insider Trading in India 

1. A CFO’s Accountant Acts on Confidential Information

An accountant working closely with the CFO of a large tech company learns that the company’s quarterly earnings report will reveal massive losses due to a failed product launch. 

Before the report is made public, the accountant sells 2,000 shares of the company, knowing the stock price will fall significantly once investors learn about the losses. This act is illegal insider trading because the accountant used confidential information to avoid a loss.

2. A Family Member Uses Insider Information to Profit

Imagine my cousin is working as a project manager for a pharmaceutical company. During a family gathering, she mentions that their company is about to get approval for a groundbreaking new drug. Knowing this information isn’t available to the public, I quickly buy 1,500 shares of the company at Rs 200 each. 

A week later, the drug gets approved, and the stock price shoots up to Rs 300 per share. I sell my shares for Rs 4,50,000, earning a profit of Rs 1,50,000. While this sounds like smart investing, it’s actually illegal insider trading.

3. A Government Advisor Uses Policy Knowledge

An advisor working in a government ministry knows about a major infrastructure project that will benefit certain construction companies. Before the news goes public, the advisor buys shares of these companies, expecting their stock prices to rise once the project is announced. 

This is insider trading because the advisor used non-public government information to make a profit from the stock market.

Ill Effects of Insider Trading

An efficient and effective stock market should have excellent information processing ability. However, even the most active stock markets in the world sometimes lack these attributes.

The effects of insider trading are as follows :

• The few privileged ones benefit, and the ordinary investors suffer.
• Rampant insider trading discourages foreign investors from the capital markets.
• Insider trading sabotages investor confidence in the rights and integrity of the capital market.
• Insider trading is often coupled with rigging share prices to attract genuine investors into mergers and acquisitions. The ultimate gain accrues to a corrupt investor, and the ultimate loss accrues to a genuine investor.

Consequences of Insider Trading

The consequences of insider trading can be severe for both individuals and companies, impacting their financial stability, reputation, and legal standing. 

Important Insider Trading Case in India – Hindustan Lever Limited vs. SEBI

A core team consisting of common directors from Hindustan Lever Limited (HLL) and Brook Bond India Ltd. (BBIL) was formed to consider the modalities of a merger between HLL and BBIL. Unilever Inc. of the U.K. is the parent company of HLL & BBD. On January 17, 1996, the Regional Directors of Unilever granted in principle for the merger.

HLL purchased 19.74 lakhs of Brook Bond Lipton India Ltd. shares in phases. The first lot of 7 lakh shares was purchased before January 1996, and the second lot of 8 lakh shares was purchased in March 1996 through public financial institutions, UTI, for Rs. 350.35 per share, by paying a premium of 10% over the market price of Rs. 318. The purchase deal was finalised on March 25, 1996. The public announcement of the merger was made on April 19, 1996. The third lot of 4.7 lakhs shares was purchased in December 1996. 

Under many complaints, SEBI investigated the matter and concluded that HLL, as an ‘insider,’ purchased 8 lakh shares of BBD based on unpublished price-sensitive information and had, therefore, violated SEBI (Insider Trading ) Regulations, 1992. So, HLL has been charged with being involved in insider trading practices. SEBI thus passed an order directing HLL to compensate UTI to Rs. 3.04 crores and directed prosecution against HLL and its five directors.

Why Is Insider Trading Illegal?

Insider trading is illegal because it creates an unfair playing field in the stock market, damaging trust and harming regular investors. Here’s why it is prohibited:

1. Unfair Advantage

When insiders use confidential information to trade stocks, they gain an unfair advantage over regular investors. This harms people who don’t have access to this inside knowledge, making the market unbalanced and unjust.

2. Loss of Market Trust

The stock market relies on trust. If investors believe that insiders are taking advantage of secret information, they will lose confidence in the market. This distrust can lead to fewer people investing, which negatively impacts the economy.

3. Hurts Regular Investors

Insider trading harms small investors who are unaware of the company’s secret information. They may lose money because they cannot react in time to events that insiders already know about. This creates an unequal opportunity for success.

4. Legal and Economic Risks

When insider trading happens, it damages the reputation of companies and individuals involved. Legal actions, heavy fines, and prison time are some of the consequences. On a larger scale, it can also hurt the company’s value, causing financial instability for shareholders.

How Insider Trading Works in Options Markets

Insider trading in the options market is at a different level when people with confidential details about a company use options trading to capitalise on that information. Options bring power, meaning that even a tiny shift in stock price can translate to a much more significant profit or loss. 

What is Options Trading?

Options trading is investing where you buy or sell the right to trade a stock or other asset at a set price within a specific period. Unlike buying shares directly, options allow you to buy or sell without obligation. 

For those who continuously put up this question, “Is options trading profitable?” The answer is both yes and no. It largely depends on how you handle options trading as a business or as a form of gambling.

Another frequently asked question is, “How profitable is options trading​?” The answer is that options trading can be risky but also profitable, provided it is done correctly. There is no assurance that any specific trading strategy will always be successful, but a few techniques have often proven effective.

How to Prevent Insider Trading

Preventing insider trading is crucial for maintaining market integrity. Here are some ways to ensure it doesn’t happen:

1. Training: Employees and insiders should be trained on the dos and don’ts of stock trading. They should know what qualifies as insider information.

2. Monitoring: Companies need to monitor the trading activities of their employees, especially those in senior positions, to catch any suspicious behaviour early on.

3. Whistleblower Policies: Encouraging whistleblowers to come forward with information can help in identifying cases of insider trading before they escalate.

4. Strict Penalties: SEBI must continue enforcing strong penalties to deter individuals from engaging in insider trading.

Conclusion 

Insider trading is a serious offence that affects the fairness of the stock market. SEBI’s rules and penalties are designed to protect investors and maintain market transparency. By understanding what insider trading is and how to prevent it, investors can avoid falling into illegal activities. It’s important for everyone, from company insiders to retail investors, to play their part in ensuring a fair trading environment. Stay informed, follow the rules, and always make your investments based on publicly available information.