What about rampant insider trading in India?

What about rampant insider trading in India?
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First Published: Mon, Oct 19 2009. 09 07 PM IST

Updated: Mon, Oct 19 2009. 09 07 PM IST
The alleged insider trading criminal case against Galleon Group hedge fund’s Raj Rajaratnam and executives of companies, including International Business Machines Corp., is likely to be the first in many such cases that will be unearthed in the US, a news report by Bloomberg suggests. The US Securities and Exchange Commission (SEC) and law enforcement agencies are aggressively going after insider trading networks, according to the report.
What about the integrity of the Indian markets? Hardly any prosecutions come to mind, although the practice of insider trading is rather rampant.
Back in 2003, Julan Du, professor at the Chinese University of Hong Kong, and Shang-Jin Wei, an adviser in the International Monetary Fund’s (IMF) research department, had done a study on insider trading in 50 countries for IMF. One of the conclusions they reached was that insider trading is relatively high in India, China, Russia, Venezuela and Mexico.
The situation hasn’t changed much in the country since then. Very often, one would observe share prices of firms already having moved in anticipation of a major corporate announcement. Based on market gossip, many of these pre-announcement trades are at the behest of the promoters.
While the Securities and Exchange Board of India (Sebi) has investigated a lot of these trails, it hasn’t been as successful in prosecution as much as SEC. To be fair to Sebi, regulators worldwide have had little success with convictions in insider trading cases. The trades are normally done through front entities and generally difficult to prove since the evidence can be circumstantial. (In this context, since SEC is armed with recorded conversations of the alleged conspirators in the Galleon case, the likelihood of prosecution seems relatively high.)
Besides, SEC’s powers far outweigh those of Sebi’s. SEC is also staffed much better and has more resources at its disposal, including government support in prosecution.
So should Sebi make more investments and act tougher against insider traders?
Some experts have suggested that it doesn’t make much sense to expend the limited resources of a regulator on insider trading cases. The argument is that since it is difficult to prove such cases, it would amount to a waste of regulatory resources. And even though the US regulator has made relatively high investments in tackling the problem of insider trading for many years now, such cases still crop up.
The opposite view, of course, is that it is the regulator’s role to maintain market integrity and ensure that there’s no information asymmetry in the markets. When the market’s integrity is maintained, its efficiency is enhanced and this eventually leads to a lowering of the cost of capital for companies.
The central finding of the IMF study was that countries with more prevalent insider trading have more volatile stock markets. Keeping this in mind, deterring insider trading should lead to desirable results from a regulatory perspective.
According to a paper by Utpal Bhattacharya and Hazem Daouk of the Kelley School of Business of Indiana University in the US, the cost of equity in a country does not change after the introduction of insider trading laws, but decreases significantly after the first prosecution.
India seems to be in the category where insider trading laws exist, but prosecutions are too few to be noteworthy. The disincentive for offenders, therefore, isn’t high enough. While there are signs of progress on the market surveillance and investigation front since Sebi’s current chairman C.B. Bhave took over, there need to be some significant prosecutions before incidences of insider trading come down.
Hopefully, the Galleon case will prompt Indian policymakers to add some teeth to its tackling of insider trading cases.
In The Money runs every other Tuesday. Comments are welcome at inthemoney@livemint.com
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First Published: Mon, Oct 19 2009. 09 07 PM IST