INSIDER TRADING AND ITS LEGAL IMPLICATIONS

Suryansh Katoch, Army Law College

Introduction

In the complex world of financial markets, where transparency and trust are critical, insider trading stands out as one of the most controversial and closely scrutinized activities. Insider trading refers to the practice of buying or selling securities based on non-public, material information about a company. While it may seem tempting to gain an edge in the market through privileged knowledge, insider trading raises significant ethical and legal concerns. Insider trading is a controversial practice that has long captivated investors, authorities, and the general public. This illegal activity includes purchasing or selling shares based on important secret information that gives some people a disproportionate advantage in the world of finance. These people, often known as insiders, have special access to information that could include impending corporate statements, financial outcomes, or significant events that could significantly impact the price of a company’s shares.

What is Insider trading?

Insider trading refers to the buying or selling of a company’s securities, such as stocks or bonds, by individuals who possess material, non-public information about the company. Material information is any information that could significantly affect an investor’s decision to trade, such as details about upcoming mergers, financial results, regulatory actions, or changes in leadership. Insider trading becomes illegal when this confidential information is used to gain an unfair advantage in the market, either directly by the insider or indirectly through tipping others. Such activities undermine the integrity and fairness of financial markets, erode investor confidence, and are subject to strict legal penalties in most jurisdictions, including fines, imprisonment, and reputational damage.

Insider trading refers to the buying or selling of securities by individuals who have access to non-public information about a company or its securities. This information can be about financial performance, strategic planning, or other material events that can significantly impact the price of the company’s securities. Such practice is illegal and considered a form of securities fraud. It weakens the integrity of financial markets and harms other investors who do not have access to the same information. Understanding insider trading is crucial for investors, traders, legal professionals, business executives, students, and the general public. Insider trading can have a significant impact on the financial markets, leading to a distortion of market prices, discouraging other investors from trading, and reducing liquidity.

Effects of insider trading?

Insider trading, especially when conducted illegally, has wide-ranging effects on financial markets, businesses, and the broader economy. These effects are often negative like-

Insiders receive an unfair edge, which causes unjust market circumstances.
Insiders receive an unfair edge, which causes unjust market circumstances.
Investor’s loss of faith in the integrity and fairness of the financial markets.
Stock price manipulation and potential harm to investors without access to confidential information.
Reducing the market’s efficiency and openness.
Material Non-public Information: Trading is conducted based on information that is not generally known, which could significantly impact the stock price.
Fiduciary Duty Breach: Insiders, including company executives or workers, violate their obligation to behave in the best interests of shareholders by misusing or disclosing secret information for their benefit.
Misappropriation: Trading is based on confidential information that has been improperly obtained from others or stolen.

Landmark cases on insider trading

1) Reliance Industries

The SEBI fined Reliance Industries Limited and banned it from the derivatives market for a year. The exchange regulator accused the company of trying to make money by evading restrictions on its legally permitted trading limits and lowering the stock’s cash market price.

2) Rakesh Agrawal

Rakesh Agrawal, Managing Director of ABS Industries Ltd., was accused of using material, non-public information about an impending merger with Bayer A.G. to purchase ABS shares through a third party, intending to sell them for a profit post-announcement.

3) Hindustan Unilever Limited

LL, now Hindustan Unilever Limited (HUL), was accused of insider trading when it purchased shares of Brooke Bond Lipton India Ltd. (BBLIL) ahead of their merger announcement. As HLL had representatives on BBLIL’s board, SEBI argued that HLL possessed material, non-public information about the impending merger, giving it an unfair advantage over other investors. SEBI alleged that the transaction violated insider trading regulations by exploiting confidential information for HLL’s benefit.

4) Kishore Biyani case

The Kishore Biyani case involves allegations of insider trading against the founder of Future Group, Kishore Biyani, and other related parties. In February 2021, the Securities and Exchange Board of India (SEBI) found Biyani guilty of trading in shares of Future Retail Ltd. (FRL) while in possession of unpublished, price-sensitive information (UPSI) regarding a significant deal with Amazon in 2017. SEBI alleged that Biyani and other entities used this non-public information to execute trades ahead of the announcement, gaining an unfair advantage.

Legal Implications

Insider trading regulation in India falls under the purview of the Securities and Exchange Board of India (SEBI), the apex regulatory body responsible for overseeing the securities market. SEBI’s mandate encompasses the formulation and enforcement of regulations aimed at maintaining market integrity, protecting investor interests, and ensuring fair and transparent market conduct.4 Within this regulatory framework, SEBI plays a central role in preventing and deterring insider trading activities through the enactment and enforcement of stringent regulatory measures.

The SEBI (Prohibition of Insider Trading) Regulation, 2015, represents a cornerstone of SEBI’s regulatory framework, providing a comprehensive and robust framework for regulating insider trading activities in India. The regulation encompasses a wide range of provisions aimed at preventing insider trading, promoting transparency, and enhancing market integrity.

Key provisions of the SEBI (Prohibition of Insider Trading) Regulation, 2015, include:

Prohibition on Insider Trading: The regulation prohibits insiders from trading in securities based on unpublished price-sensitive information, thereby preventing unfair advantages and ensuring a level playing field for all market participants.
Disclosure Requirements: Insiders are required to disclose their trading activity and shareholding positions to the designated authorities within specified timelines, ensuring transparency and accountability in their dealings.
Trading Window and Blackout Periods: The regulation mandates the establishment of trading windows, during which insiders are permitted to trade in securities, subject to certain restrictions. Outside these trading windows, insiders are prohibited from trading to prevent unauthorized transactions based on undisclosed information.
Insider Trading Code of Conduct: The regulation imposes an insider trading code of conduct on listed companies and market intermediaries, outlining ethical standards and best practices to prevent insider trading and ensure compliance with regulatory norms.

The regulatory framework established by the Securities and Exchange Board of India (SEBI) for insider trading, as outlined in the SEBI (Prohibition of Insider Trading) Regulation, 2015, marks a significant step towards ensuring market integrity and investor protection. However, a critical evaluation reveals both strengths and limitations in the effectiveness of SEBI’s regulatory measures.

What Measures Should Be Taken to Prevent Insider Trading?

Implementing vital compliance programmes, educating staff about legal obligations and repercussions, establishing specific policies and guidelines, keeping an eye on trading activity, enforcing stringent information barriers, carrying out routine audits, and fostering an ethical and honest culture within the company are all ways to prevent insider trading.

Conclusion

In India, insider trading is a serious offense with far-reaching legal, financial, and reputational consequences. Governed by stringent regulations under SEBI, the framework ensures that offenders face heavy penalties, imprisonment, and market bans, aiming to protect market integrity and investor confidence. By employing advanced surveillance mechanisms and enforcing strict compliance, SEBI underscores its commitment to creating a fair and transparent financial ecosystem. The implications of insider trading serve as a strong deterrent, highlighting the importance of ethical conduct and adherence to regulatory norms in India’s evolving capital markets.