It is not easy to identify people having inside information, safely hiding amid our bulls, bears and penny investors. Insiders look pretty much like you and me. While common investors put their money honestly believing in the fair play of the stock market, some insiders are unable to resist the temptation of taking unfair advantage of their position.
A little bit of information could be worth tons of money. But insiders beware! Sooner or later, the searching eyes of law are bound to catch you.
Johnny: We often hear about regulators coming down heavily on people involved in insider trading. What’s so bad about insider trading that makes regulators so concerned about it?
Jinny: Well, our market regulators believe that all investors have the right to equal opportunity of information. Every investor must have a fair access to all material information concerning any stock. Only then can he make any judgement about its true worth. Concentration of information in a few hands always leads to unfair advantage for some at the cost of others. Prohibition of insider trading has been one of the key measures for ensuring that there is a free flow of “price-sensitive” information in the market.
Almost all developed markets have such a law in place, which makes it compulsory for insiders to either disclose all price-sensitive information pertaining to any stock or abstain from the trading of such stock. In short, this is known as the “disclose or abstain” rule. However, the rigour of law varies from country to country, with laws of some countries, such as the US, considered most rigorous while that of many other countries are considered lenient. Indian laws prohibiting insider trading appear to be moderate by world standards.
Johnny: Tell me, what exactly constitutes insider trading?
Jayachandran / Mint
Jinny: Before you can be held responsible for insider trading, you need to, first of all, fall in the category of an insider. Now, who is an insider? The Securities and Exchange Board of India, or Sebi, put out a rule—the Sebi (Prohibition of Insider Trading) Regulations 1992—that provides an exhaustive definition. If you are one who occupies the position of a director, officer or employee of the company or hold a position involving a professional or business relationship with the company, then you fall under the category of an insider.
Even relatives of people connected with the company are deemed to be insiders. But falling in the category of an insider itself is not enough. You must also be reasonably expected to have access to unpublished price-sensitive information. Now, that leaves some scope for argument. Who can be reasonably expected to have access to price-sensitive information and who does not? A CEO of the company definitely can be expected to have access to all information about the company, but what about his secretary? Most insider trading allegations are challenged on the ground that the insider was not privy to unpublished price-sensitive information.
You should keep in mind that our laws do not completely bar insiders from trading their shares of the company. It is perfectly legal for the director to buy or sell the shares of his company. The problem arises only when trading is done while you have access to any unpublished price-sensitive information.
Johnny: What kind of information is considered unpublished price-sensitive information?
Jinny: Any information that has not yet been announced by the company but which, if announced, is likely to materially affect the price of the securities of the company is considered unpublished price-sensitive information. Sebi regulations require that all price-sensitive information be disseminated through public announcements.
You may have observed that the websites of the Bombay Stock Exchange and the National Stock Exchange prominently display all public announcements made by firms. But what kind of information is considered price-sensitive? Some types of information, such as periodical financial results of the company, declaration of dividends, amalgamation, mergers or takeovers, among others, are deemed to be price-sensitive information under Sebi rules.
However, the list given in the Sebi regulations is merely illustrative. You can have many more types of information that may affect the price of securities in one way or the other. For instance, refusal of licence for carrying out any business activity may affect the price of securities.
Johnny: How do regulators deal with people indulging in insider trading?
Jinny: In many countries, insider trading is treated as both a civil and criminal offence. In India, too, Sebi can launch criminal prosecution apart from imposing monetary penalty or debarring the violator from the stock market.
In many countries, insider trading laws impose liability on “outsiders” also for trading on the basis of material non-public information provided by an insider. However, there are many countries that do not impose any liability on outsiders.
In India, Sebi regulations hold the insider responsible for communicating any price-sensitive information to any outsider. However, no liability can be imposed on the outsider for trading on inside information.
Johnny: Really? Let me then search for an insider who is fool enough to part with some valuable information.
What: The trading of securities by an “insider” on the basis of unpublished price-sensitive information is called insider trading.
Who: The definition of an insider varies in different jurisdictions but it generally includes people enjoying close proximity to the company.
Why: Insider trading is prohibited to prevent the abuse of unpublished price-sensitive information by insiders.
Shailaja and Manoj K. Singh have important day jobs with an important bank. But Jinny and Johnny have plenty of time for your suggestions and ideas for their weekly chat. You can write to both of them at email@example.com