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INSIDER TRADING

INTRODUCTION
Insider trading is the trading of a public company's stock or other securities (such as bonds or stock
options) by individuals with access to nonpublic information about the company. Insider trading is
basically the buying or selling of the securities of a listed public company by a person who has
unpublished price sensitive information relating to that company. Insider trading refers to a situation
where in a person by virtue of his position to access unpublished price sensitive information of the
company, gains such access and subsequently uses the information obtained for his or her personal
benefits.

Insider information is information (about company strategy and plans) that someone within a
company has but that is not available to those outside the company.
The moral problems connected with insider information concern the use that individuals may
make of such information while they are still members of the firm.
Two aspect of the problem:
1. One is that of some one within the firm using information for his or her private gain, at
the expense of the firm. This is called conflict of interest
2. The other is the use of insider information by someone within a firm advantage over those
not in the firm.
Those who attempt to justify insider trading in terms of market efficiency are mistaken. They
believe in the market as an impersonal mechanism which does not care who gains or loses in
its transaction. Winner and losers are beside the point, because the market is simply an
efficient means of matching buyers and sellers.
The second case of illegitimate use of insider information also concerns personal gain, not at
the companys expense but at the expense of those not connected with the company. This
typically occurs in trading the stock of the company for which one works

Definition
Insider Trading generally means trading in the shares of a company by the persons who are
in the management of the company or are close to them on the basis of undisclosed price
sensitive information regarding the working of the company, which they possess but is not
available to others.

Insider Trading means trading by an insider 5 of a company in breach of trust or confidence in


the stock of the company on the basis of non-public price sensitive information to the
exclusion of others.
SEBI considers an insider anyone who has pertinent information that is not publicly available, and
that gives the trader an advantage over public. Thus the secretaries, lawyers, consultants, financial
printers, and others who have access to inside information become insider because of their
knowledge.

Insider trading gives a negative impact for both, the investors and the country. It curbs the fair
quantum of demand and supply for the stocks and leads to an artificial increase in the price of stocks,
thereby inducing the innocent purchasers to purchase the stock at a very high price than that of its
original value.
Insider Trading means trading by an insider of a company in breach of trust or confidence in the stock
of the company on the basis of non-public price sensitive information to the exclusion of others.

How does insider trading works?

In an illegal insider trading, an insider in a company buys the stock, shares price-sensitive information
with a small group of people who buy the stocks and spread the word. Soon a huge artificial demand
is created for the particular stock resulting in higher prices.

At a certain point when the prices hits the 'satisfactory' level the insider exits along with his small
group of people or in other words sells the stocks and make profits. Soon the stocks plummet resulting
in huge losses for the public investors, which in turn leads to a massive dip in the SENSEX value
finally weakening the economy as a whole.

How it affects the market?

The impact of illegal insider trading is considered negative for both the small investors and for the
markets. Illegal insider trading ensures that there is no fair play involved and there is no fair demand
and supply of stocks, all detrimental to the functioning of a healthy capital market.
Illegal insider trading weakens the faith of investors in the investing system and an unchecked
insider trading could keep off people from investing capital and this could potentially harm
the economy as a whole. There is no efficiency and fairness. Efficiency is not the only
important factor in market or in ethical thinking. Fairness is central to both.
Insider Trading leads to loose of confidence of investors in securities market as they feel that
the market is rigged and only the few, who have inside information get benefit and make
profits from their investments. Thus the process of insider trading corrupts the level playing
field as public confidence in directors and others are closely associated with companies,
require that such people do not use inside information to further their own interests.

Popular insider trading scams

Perhaps, the most recent and biggest hedge fund insider trading scam in the US is the $20 million
Galleon hedge fund scam by billionaire financier Raj Rajaratnam who has been accused of carrying
on a conspiracy for over three years since January 2006 along with two Indians at the Intel Capital
treasury department.

For the first time in the history of Wall Street insider trading case, Raj was accused of using telephone
wire taps to share trading tips and make profits.

One of the most sensational inside trading scams till today is of TV tycoon Martha Stewart who was
accused of receiving insider information and selling shares of ImClone drug just a day before the US
Food and Drug Administration (FDA) denied approval for the drug.
Take the insider trading case of Enron, the energy company, which imploded in 2001. It took four
years for the Justice Department to find out the fraud that wiped out its employees' retirement
accounts and stunned the investors. The company's former CEO Jeff Skilling made a killing with a
$89 million profit allegedly from the sale of artificially inflated Enron stocks and options.

Insider trading is difficult to prove. In 2008, Samir Arora, the former fund manager at Alliance Capital
Mutual Fund was arrested on charges of insider trading and fraudulent trade practices. He was let off
the hook by the Securities Appellate Tribunal (SAT) for want of evidence.

Legal or Illegal insider trading

Legal insider trading in a company means trading on a company's stock or other securities by
employees of the company and done based only on public information related to the company.

In other words, insider trading is legal only up to the point when trading is done without taking
advantage of the non-public information some high profile employees have access to. It will be
considered illegal the moment trading is manipulated to make profits or avoid loss based on the non-
public information and thus potentially harming the other investors.

Even if an insider gives 'tips' to an outsider say his friends to buy or sell stocks of his company and
help them make profits or to avoid loss it is still considered as illegal insider trading.

Legal Insider Trading Examples

The Securities and Exchange Commission explains that while most people hear the words "insider
trading" and think of the illegal act, "insider trading" can also be legal under some circumstances.
Examples of insider trading that are legal include:
A CEO of a corporation buys 1,000 shares of stock in the corporation. The trade is reported
to the Securities and Exchange Commission.

An employee of a corporation exercises his stock options and buys 500 shares of stock in the
company that he works for.

A board member of a corporation buys 5,000 shares of stock in the corporation. The trade is
reported to the Securities and Exchange Commission.

Illegal Insider Trading Examples


Illegal insider trading is very different than legal insider trading. A person who engages in illegal
insider trading may work for the company that he buys the stock for, but does not necessarily have to.
The key is that the person who buys or sells the stock acts on insider information (not public
information) in violation of the law.
Examples include:
A lawyer representing the CEO of a company learns in a confidential meeting that the CEO is
going to be indicted for accounting fraud the next day. The lawyer shorts 1,000 shares of the
company because he knows that the stock price is going to go way down on news of the
indictment.
A board member of a company knows that a merger is going to be announced within the next
day or so and that the company stock is likely to go way up. He buys 1,000 shares of the
company stock in his mother's name so he can make a profit using his insider knowledge
without reporting the trade to the Securities and Exchange Commission and without news of
the purchase going public.
A high-level employee of a company overhears a meeting where the CFO is talking about
how the company is going to be driven into bankruptcy as a result of severe financial
problems. The employee knows that his friend owns shares of the company. The employee
warns his friend that he needs to sell his shares right away.
A government employee is aware that a new regulation is going to be passed that will
significantly benefit an electricity company. The government employee secretly buys shares
of the electricity company and then pushes for the regulation to go through as quickly as
possible.
A corporate officer learns of a confidential merger between his company and another lucrative
business. Knowing that the merger will require the purchase of shares at a high price, the
corporate officer buys the stock the day before the merger is going to go through.

Exceptions to Insider Trading


The distinction between legally permitted share trading by insiders and what is illegal needs to be
carefully understood. The presumption that an insider who is involved in the management or affairs of
a public company would have access to privileged information is but natural. However they cannot
absolutely preclude insiders from acquiring or alienating any securities. Such a blanket provision
would not be reasonable, and would be in violation of the legal rights of the insiders and would defy
the logic of freely tradeable securities. More importantly such a provision may not even be practically
viable as it would be irrational to stop promoters of a company from dealing in their securities. This is
exactly where a distinction is required to be drawn between what is permitted and what is not
permitted.

The restriction is on corporate insiders directly or indirectly using the price sensitive information that
they hold to the exclusion of the other shareholders in arriving at trading decisions. There is
absolutely no restriction on insiders in trading in securities of the company if they do not hold any
price sensitive information that the public is not already aware of. Upon the price sensitive
information being disclosed to the market, the share prices would surge if the price sensitive
information is perceived to be positive and the same would plummet if perceived to be negative.
During that short while, insiders receiving the price sensitive information and the public disclosure of
that information, insiders attempt to deal in securities such that they can take advantage of the market
reaction, that is about to follow.
REGULATIONS

Safety measures to detect insider trading

In India, the first set of regulations for insider trading was introduced in 1992 by the Securities and
Exchange Board of India (SEBI). The regulations restricted insiders and companies in trading
securities during times of possession of undisclosed price-sensitive information and barred them from
sharing it with any other person outside the company.

Sebi has also prescribed disclosure norms for any directors/officers holding shares in the company
besides amending the Model Code of Conduct in 2008 that restricts the directors/officers who have
bought or sold shares from getting into an opposite transaction within the next six months to sell and
buy shares.

The penalty is high for insider trading which is at three times the amount of profits made out of
insider trading subject to a minimum of Rs 25 crore (Rs 250 million) and punishable with
imprisonment upto 10 years.

Insider Trading Regulations, 2015 An Overview


India has put her efforts and has made a move towards the enactment of the new Insider Trading
Regulations with a view to align its laws on Insider Trading with that of the developed countries. This
would effectively help in combating Insider Trading to a very large extent. SEBI in order to modify
the law on Insider Trading and ensure that it is in consonance with the global best practices,
constituted a high level committee under the Chairmanship of Justice N.K.Sodhi which drafted the
Prohibition of Insider Trading Regulations, 2015.

The new Insider Trading Regulations has brought about sweeping changes by amending the
definitions of various concepts. This Regulation comprises of Five Chapters, Two Schedules and 12
Sections. Chapter I deals with the definitions. Chapter II deals with the Restriction on
Communications and Trading by Insiders. Chapter III talks about the disclosures to be made by the
companies while trading its securities by Insiders. Chapter IV prescribes a Code of Fair Disclosure
and Conduct. Chapter V contains provisions dealing with the Powers and Sanctions.

The salient features of the Regulations are;

a) Under the new regulation the definition of Insider has been strengthened by expanding the
definition of Connected Person. According to the new regulations every connected person is an
Insider. It is a term of wide connotation and includes even public servants who are reasonably
expected to have access to UPSI are also considered to be Connected Persons. Further it includes
Immediate Relatives also.

b) The new regulation has modified the definition of UPSI. It has been defined to mean any
information that is not generally available, which upon becoming generally available, is likely to
materially affect the price of the securities to which it relates and will ordinarily include information
relating to the following :

i) Financial results

ii) Dividends
iii) Change in Capital Structure.

iv) Mergers, Demergers, Acquisitions, Delistings, Disposals and expansion of business and such other
transactions.

v) Changes in key management personnel.

c) Trading Plans are novel concepts introduced under the New Regulations, wherein Insiders who are
liable to posses UPSI all round the year are permitted to formulate trading plans with appropriate
safeguards. It was introduced to facilitate compliant trading by Insiders who are constantly in
possession of UPSI. It has been introduced in line with Rule 10b5-1 of the Securities Exchange Act,
1934.

d) The new regulations contain a code of fair disclosure and conduct. According to this Code the
Board of every listed company is required to formulate and publish a code of practices and procedures
to be followed for fair disclosure of UPSI in accordance with the principles set out in Schedule A to
the Regulations.

It sets out certain minimum standards such as equality of access to informations, publication of
policies such as those on dividends, inorganic growth pursuits, calls and meetings with analysts,
publication of transcripts of such calls and meetings etc.

e) Another important development is in relation to notional trading windows which are used as an
instrument to monitor compliant trading by designated persons within the company. The concept of
notional trading windows has also been made applicable to external agencies having contractual or
fiduciary relationships with the company such as law firms, accountancy firms etc. The time frame for
such re-opening of trading windows has been set to 48 hours after the UPSI becomes generally
available.

f) The key feature of this regulation is that it contains a specific carve out for communicating and
procurement of information, for instance for the purpose of conducting due diligence in connection
with potential transactions including mergers and acquisitions. It states that as long as the Board is of
the opinion that the transaction is in the best interest of the company due diligence may be conducted.

CONCLUSION

The act of insider trading is a serious crime. The prohibition of Insider Trading Regulations, 2015
by the market regulator SEBI is a welcome development appreciated by the general public as it
provides a stringent set of regulations with a view to curb Insider Trading and is in consonance with
the International practices. This new regulation ensures a fair level playing field in the securities
market and to safeguard the interest of the investors, and this move by SEBI will facilitate further
economic buoyancy in the Indian Capital Market.

Further it introduces a plethora of new concepts that aim at plugging the loopholes which were
prevalent in the previous regulations. In my opinion I would like to state that this regulation is a
comprehensive regulation as it addresses the present day needs and trends in the Capital Markets, and
would hold good atleast for the next five years (half a decade). The present regulation has got its heart
in the right place and it has started on the right path in attaining its objective.
PREPARED BY
CA XYZ