You must have often heard of the term “insider trading”, mainly in connection with some wrongdoing. Various cases relating to insider trading, including the recent sentencing of Raj Rajaratnam of Galleon Group in the US, have established a negative connotation with the term. Insider trading is, however, not always illegal.
What is it?
When a person privy to the company buys or sell shares of that company based on some private information that is not yet in the public domain, it is called illegal insider trading. Not only does the person know some company secret, but also knows that if this fact were to become public, the company’s share price may go up or down substantially. However, if such transaction is informed to the stock exchanges and put up as announcements, it is not illegal. Information on legal insider trading can be found on the websites of both BSE Ltd and the National Stock Exchange. These transactions are not illegal till they are done within the ambit of laws laid down by the Securities and Exchange Board of India (Sebi).
Counting notes. Photo: AFP
What laws govern it?
Insider trading is overseen by Sebi (Prohibition of Insider Trading) Regulations, 1992. Under its provisions, this law sets the rule that should not be violated. It says: “All directors /officers/designated employees who buy or sell any number of shares of the company shall not enter into an opposite transaction, i.e. sell or buy any number of shares during the next six months following the prior transaction. All directors/officers/designated employees shall also not take positions in derivative transactions in the shares of the company at any time. In the case of subscription in the primary market (initial public offers), the above mentioned entities shall hold their investments for a minimum period of 30 days.”
To read the entire text of the regulations governing insider trading, go to www.sebi.gov.in/acts/InsiderTrading.html
What can you infer?
Insider trading when done legally has little impact on your investment. These transactions are reported to the stock exchanges. More importantly, this information sends out some signals. For instance, company management increasing stake in the company may mean that the firm is bullish on its prospects. But you should not rely solely on this information while buying shares of that company; you must continue to monitor the company’s fundamentals. Also remember that stock prices of companies which have low percentage of share issued to the public gets more affected by insider trading compared with companies with high percentage of shares issued to the public due to lower liquidity.