Legality of Insider Trading

This article is authored by Sujata Porwal, third year BA LLB (Hons.) student at Symbiosis Law School, Pune. The article focuses on the concept of insider trading and its applicability in India and abroad.

Understanding Insider Trading

The term ‘insider trading’ resembles the structure of multifarious definitions in the business world. Insider trading refers to a practice of trading (i.e., buying or selling) of a company’s stock by officers, directors or employees of a company who gain from the knowledge of nonpublic information of a company by the virtue of their work and thereby use this crucial information to act in accordance with the future possibilities or to trade these secrets to draw maximum benefits. In simple words, insider trading includes buying and selling of stocks of a company while obtaining undue advantage of being an ‘insider’.

Insider trading can therefore be labelled as the ‘trading of material information of a company’ that is not available to the general public. Promotion of insider trading leads to the establishment of unfair trade practices in a society. The Securities and Exchange Board of India (SEBI) therefore, strictly prohibits such malpractices and promotes fair techniques of business in the stock market.

Examples

Some prominent examples of such insider trading can be:

A family member working in ABC Ltd. informs Z about the upcoming launch of a new product that is going to be a huge success in the Indian market. As a result, Z purchases the highly undervalued shares of the company at Rs. 100 per share. Within a short time frame of 15 days, the prices of the share boost to Rs. 550 per share. Z would thus be able to gain huge profit from this situation while Q, a colleague of Z, who had sold his shares at Rs. 100 two days before the launch of the product due to his apprehensions wouldn’t be able acquire similar benefit from the situation. The trade by Z would be considered illegal for the mere reason that he took advantage of an information that wasn’t open to the general public.
Similarly, a lawyer of a company acquires knowledge of confidential information that indicates fall in the prices of shares and hence sells all the shares of the company possessed by him. The same shall also fall under the ambit of insider trading.

Insider Trading in India

In India, SEBI has laid down guidelines to confer liability upon the organizers of a company with regard to insider trading norms. If any associate of a company holds ‘non-published price-sensitive’ information (also known as UPSI) about a company without the proof of a legitimate reason, then he/she shall be liable for the violation of insider trading norms regardless of their shareholding status. SEBI has also clarified that the term legitimate purpose is inclusive of sharing information with partners, lenders, merchant bankers, legal advisors, auditors, etc, until such disclosure doesn’t circumvent the purpose of these regulations. It implies that in the ordinary course of business, non-published price-sensitive information can be shared for professional reasons if it doesn’t defeat the purpose of the control put forth by the Board.

The amendment was introduced in 2019 under the title of prohibition of Insider Trading. The Indian law implicates fines along with federal punishment on the perpetrators of Insider Trading.

The key reasons behind attaching an illegal aspect to Insider Trading are:

The question of fairness

Insider Trading is a direct violation of the notion of fairness in the stock market since it raises the platform for a few individuals who happen to have access to material information of a company. This assists the emergence of a biased market for the investors who have contacts in multinational companies. This creates a huge gap between a traditional investor who is unaware of the upcoming ups and downs of the share market merely due to lack of resources.

Is it morally correct?

While we often tend to separate morality from legality, the present situation calls for a unanimous analysis. Insider trading is often viewed as a morally and ethically wrong way of dealing in the stock market. Taking undue advantage from a situation has, time and again, been criticized due to moral and ethical reasons. An equal opportunity to trade and invest is the sign of a healthy growth of a market and hence is the utopian aspiration of every nation.

Preserving interests of the common public

Insider Trading is poisonous to the stock market. If an individual is not confident about his/her position in the stock market, it is likely that he/she would refrain from indulging in any such trading. This would discourage the masses from investing in the stocks of a company which would further cripple the economy of the whole country. It is therefore conclusive that the interest of the economy rests with the interest of the masses and not a privileged few. The integrity of the market and its smooth and healthy functioning is the vital for development.

Case Laws

Samir C. Arora v. SEBI

The ratio of the decision declared insider trading to be unquestionably detrimental to the interests of ordinary investors. It was held that insider trading resembles the behavior of professional misconduct and is therefore condemned by the SEBI Act, 1992.

Reliance Industries Ltd. (RIL) vs. SEBI (2001)

The present case plays an important role in assessing the validity of the concept of insider trading in India. Reliance Industries Ltd. was found to have purchased around 2.5 crore shares in a short time frame of 7 days. The same shares were sold to Grasim Industries Ltd. after a few days at almost 50% higher price. However, SEBI found out that the price-sensitive information was available not by virtue of the inside position in L&T but rather due to the virtue of their position as directors of RIL. Therefore, they cannot be held liable for insider trading.

Insider Trading in U.S.

Similar to SEBI, US has a regulating body called Securities and Exchange Commission (SEC). The SEC has also deliberated upon the status of insider trading in the US. Illegal insider trading has been defined as:

‘The buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, nonpublic information about the security.’

SEC, in its attempt to maintain a fair marketplace in the country, has also illegalized insider trading. The access to an unfair edge over other investors, resulting from the knowledge of material-insider-information is condemned by SEC. The leak of insider information has no direct link with the employment of the person at the company whose information is being shared. The Commission has also set certain rules and guidelines to govern the same. The commission has also defined legal insider trading as a situation where the transaction with regard to the trading is disclosed legally. An important case law of insider trading in the US resonates with the case of Brett Kennedy (former financial analyst at Amazon.com Inc.) who was accused of trading the shares of Amazon. The SEC held him liable for the same.

Latest Posts

Archives